Lessons from epic fails of hot-shot start-ups

Taxi drivers demonstrate outside the chamber of deputies in the neighborhood of Se, Sao Paulo, Brazil.
Miguel Schincariol | AFP | Getty Images

Silicon Valley's love of billion-dollar start-ups doesn't extend to the rest of America.

For every Uber fan, there's an uber Uber hater. If you've heard of blood-testing company Theranos, you know there's been a turn in press coverage and public perception when it comes to "rock star" start-up culture.

Many start-ups have transitioned from praise and awe to media and regulatory firestorms — some into financial trouble at the same time. A good deal of the damage has been self-inflicted.

That provides the opportunity for some lessons for anyone who thinks they've got a brilliant idea with "boom" written all over it — and wants that boom to become a lasting business.

The more money there is, the more need there is to stay grounded.

Source: Skully

Recently news broke that one of the more successful consumer products companies to raise funds on crowdfunding platform Indiegogo, smart motorcycle helmet maker Skully, was preparing to declare bankruptcy. A lawsuit filed by a former employee of the company also alleges that Skully's founders spent lavishly instead of spending to execute on a long-term business plan. Skully issued an apology on Indiegogo to its backers. Skully had recently installed a new CEO and just a few months ago was still sending out positive press releases about its product.

Patrick Hillmann, a senior vice president at crisis-management firm Levick, said start-ups are prone to big spending mistakes like any person put in the position of sudden wealth. "It's the Hollywood syndrome," Hillmann said. "They are stars and rich beyond their wildest dreams, and everyone is saying how brilliant they are. ... You need to stay grounded."

Hillmann, who was not commenting on Skully specifically, said sudden riches in the business world specifically raise the stakes: "You're running a business, growing a business, responsible for what's right and what's wrong and keeping a company under control."

"You have people in these companies who are certified geniuses but have no business experience and haven't lived through company crises," said Michael Sitrick, chairman and CEO of strategic communications firm Sitrick and Co., who has represented companies including ExxonMobil, Disney and Hewlett-Packard during various crises.

Hillmann said if the boss "goes out and buys a new Lamborghini," raise the red flag.

"Innovate or die" is not a business plan; it's not a very good risk-management plan, either.

Parker Conrad, CEO, Zenefits
Source: Zenefits

Human resources software company Zenefits was one of the fastest-growing start-ups in Silicon Valley, but it was growing too fast for its own good. Earlier this year it disclosed that co-founder and then-CEO Regulators in California and Washington launched investigations into Zenefits' business practices. Conrad resigned.

Intensity of competition and speed of change, especially in tech, is no excuse for excessive risk-taking.

"Lots of these start-ups are being thrust into the limelight in highly competitive markets and don't have the ability or time to mature like traditional companies, where leaders are groomed, like an IBM or GE," Levick's Hillmann said.

He said the fact that many start-up business models can easily be replicated does mean they rarely have the opportunity to be comfortable and enjoy their place as a market leader, and they have to "protect market share at every second."

But Hillmann said the perception that they need to "innovate or die" doesn't help. "It leads to riskier and riskier decision-making," he said. "It cultivates bad behavior."

Is the hype surrounding your company the envy of rivals? Good for you! Now, how about that business model?

Ben Kaufman, CEO, Quirky
Scott Mlyn | CNBC

Bankrupt crowdsourced invention platform Quirky had deals with companies including General Electric and Mattel, but it also burned through cash before figuring out a business model that could make a profit. One thing Quirky seemed to have going for it was its visionary leader: CEO and founder Ben Kaufman. He had become a regular in the press as an affable pitchman for his lineup of quirky inventions.

"Investors and the press have leaned toward the vision, not the leadership experience with a product or service," Levick's Hillmann said. "There are far too many companies not looking beyond their nose, and that's what gets them in trouble."

Any start-up that wants to stay ahead of problems needs to be able to provide a sound two-year business plan and model its business over five and 10 years as well. In some cases, founders make good CEOs throughout the growth cycle, but at many companies, growing the smart way means bringing someone on board to put in checks and balances.

Matthew Bird of 1-800-PublicRelations, who has done PR for Skully, asked, "How does a company that raises millions and is a top crowdfunded product on a platform not deliver?" Bird helped out by providing some answers to his question:

1. "Stubborn entrepreneurs so wrapped up in their idea, they thought that it was the most important thing, not shareholders."

2. "Young entrepreneurs acting like idealists who didn't care what anyone else thought."

Surround yourself with a team that will cut you down to size; sycophants and celebs need not apply.

Elizabeth Holmes, founder and CEO of Theranos
Mike Blake | Reuters

In the aftermath of the Theranos debacle — which resulted in regulators banning company founder and CEO Elizabeth Holmes from running the blood-testing business for at least two years — a few important points were made by outside observers. A look at the investors backing the company revealed something telling: It lacked investors from Silicon Valley's A-list of VC firms. What's more, the blood-testing company's board of directors was a who's who of political power but lacked members with a background in medicine.

Putting together a team that can serve as a check on a CEO or founder is critical for start-ups that rise quickly.

"You need someone to tell the emperor they have no clothes on," said Sitrick, who was not commenting on Theranos specifically but the broader issue. "You can't have sycophants who tell you that you're the best-looking CEO in Silicon Valley."

Putting together a strong team means having a trusted network of advisors who are helping to find the right team members before any crisis hits, but Hillmann said a start-up's investors are not always going to be the best advisors. When start-ups get into trouble, he said, the buck tends to stop at the start-up's CEO, and a fair amount of blame has to fall on them, but investors tend to get away scot-free.

"There needs to be more oversight from VCs and institutions looking to pump money into these start-ups. A culture where VCs and institutions are not really ever getting blamed can lead to bad decisions," Hillman said.

The workforce that gets you to scale won't be the workforce that keeps you there.

Andrew Harrer | Bloomberg | Getty Images

DraftKings and FanDuel seemed to have it all: high valuations in a brand-new market, daily fantasy sports games and powerful advertising partners, like ESPN. But then a single internal mistake — which partly can be attributed to a basic lack of corporate risk management — kicked off one of the most serious regulatory crises any start-up has faced: A DraftKings employee admitted to inadvertently releasing data before the start of the third week of NFL games, while winning $350,000 making fantasy bets on rival site FanDuel that same week.

That set off a flurry of state-level investigations and outright bans, though the companies have rebounded — New York State just legalized the business.

At DraftKings and FanDuel, many of the most knowledgeable employees were also some of the companies earliest and most sophisticated players. The start-ups wouldn't have reached their level of success without these players also being internal experts. But there was also a conflict of interest that the companies were glossing over. The companies would end up agreeing to ban their employees from playing, though they grumbled about it.

The grumbling made a decent argument — being able to use the product was essential to constantly making it better — but it also missed the larger point: "As soon as you reach scale, the pressures are totally different," Hillmann said. "You need to bring in experienced executives without totally having to sacrifice the free-spirit corporate culture. Start-ups that become juggernauts are the ones that find balance," Hillmann said. "That was what Google did and Microsoft did."

Don't let the internet fool you into thinking that bringing a product to market is easy.

The Coolest Cooler can do it all.
Source: Kickstarter

"When we look at all the crowdfunding models, we think there is a fundamental flaw," Hillmann said. "Most large corporations have decades to learn what products people want and respond to; these companies don't have those lessons learned." Hillman added, "Quirky didn't have the time to scale responsibly."

It's not just crash-and-burn examples from the world of crowdfunding, like Skully and Quirky.

Take the Coolest Cooler, one of the biggest Kickstarter successes of all time. It has proceeded with the type of product manufacturing delays that riled backers and annoyed them even further when it started selling through retail platforms to try and generate enough revenue to make more coolers for earlier Kickstarter backers. Product delays have become common in the world of crowdfunding — based on a Wharton professor's study that was done in conjunction with Kickstarter. Outright failures were few, but hiccups were many when it comes to crowdfunding projects becoming physical reality.

"It's far beyond having a great idea; it's marketing and production and sourcing of materials, and most are set up to fail," Hillman said.

If you look at the latest update from the Coolest Cooler on its Kickstarter page and recent comments from project backers, it's clear the situation is still far from cooling down.

If your idea has the potential to shake up a highly regulated industry, you better act as if you are on a collision course.

Renaud Laplanche, CEO and founder of Lending Club.
Adam Jeffery | CNBC

Theranos: Health care. DraftKings and FanDuel: gambling. Lending Club, the peer-to-peer online lending company: the loan market.

The first tech boom was mostly software and such, but now start-ups are getting into the traditional blue-chip sectors and highly regulated sectors.

"We have a group of businesses that have now been put on radar of regulatory agencies in a very large way, and it's only natural that gets more attention and juicier stories for the press to cover," Hillmann said.

Lending Club founder Renaud Laplanche resigned as chairman and CEO in May after a board investigation found that loans sold to an investor were known by company officials to not meet the investor's requirements, and Laplanche separately failed to disclose an investment in a third-party fund while the company was considering an investment in the fund.

Hillmann said even the best have trouble getting this right. Uber's success — and troubles along the way — show the difficulty start-ups have in assessing and staying ahead of regulatory scrutiny. "They were growing in the European market, and it was an amazing opportunity, but I don't think they understand the different powers they would have to deal with," Hillmann said. "They faced a near-infinite amount of reputation risk, and I don't think they were prepared to respond — and they are one of the better actors."

Hiding from the press is not a PR strategy.

Paul Bradbury | Getty Images

This final one applies to all start-ups, especially for the more successful ones. "Many times, no comment is PR malpractice," Sitrick said. "I'm not saying there are not times to say, 'No comment,' but I believe you have to engage. Never commenting is the wrong decision."

"These start-ups don't have the cushion of goodwill they used to," Hillmann said. "People will hold them to a high level of accountability."

Sitrick has a few PR pointers for entrepreneurs who find rapid success:

1. You need to anticipate attack. "I don't think the media wants to take down a company because it's getting good press, but I think you have to assume a reporter will be skeptical," Sitrick said.

2. Prepare for the media the way lawyers prepare for testimony.

3. Never think your secrets are safe. Any client who believes there are things that a reporter couldn't possibly know is making a big mistake.

"I always say it's not a matter of if you will have a crisis; it's a matter of when. It can be as simple as a disgruntled employee," Sitrick said.