How to Spot Trouble on the Horizon

Making nimble changes now could avert disaster and save your company

By Kevin Woo  Entrepreneur | March 4, 2010

There was a time when starting a business required foresight, a business plan and some capital. Today, an entrepreneur can sketch an idea on the back of a napkin in the morning and have the business up and running by the afternoon. However, the ability to quickly seize upon new market opportunities can be a double-edged sword, as more than 80 percent of all new business ventures fail.

While the statistics may seem grim, there are strategies savvy entrepreneurs can use to stop a business from going under. Startup veterans say that when there’s trouble on the horizon, entrepreneurs should consider making changes in product direction, cash burn rate, business model, potential new markets and the management team.

Changing product direction was the path chosen by Watercooler, a social network software firm. Two years ago, the company raised $500,000 in seed money from Canaan Partners, a venture capital firm, to fund the development of a Facebook-like social network that could be used internally by companies to link employees and improve communication. Watercooler was able to sell its product to 10 well-known companies, including PepsiCo and Gap Inc. But shortly after Watercooler closed its first deals, four customers unexpectedly banned the use of social networks within the workplace because some employees were using the applications to distribute trade secrets to outsiders and badmouth their employers. The actions of those four companies were an early warning sign of trouble for Watercooler.

After the four contracts were terminated, Kevin Chou, Watercooler’s CEO, and Maha Ibrahim, a general partner at Canaan, met to discuss Watercooler’s options. After reviewing the market data, they jointly decided to reuse much of the already written software code and the $250,000 that remained from the initial investment to build a new social networking application.

Within six weeks, Chou and his team were able to roll out a new fantasy football application that was widely used by those in the Facebook community who enjoy playing fantasy sports. Since then, Watercooler has expanded its product offerings to include more fantasy sports games, TV communities and trivia games. The company has also expanded beyond Facebook and now offers social products to users of MySpace, Bebo, TVLoop, hi5, Friendster, Google and Yahoo! Changing direction and market niche is not uncommon. “I think every company we invest in goes through major course corrections before they hit on that formula and really have success,” Ibrahim says. She adds that she expects there to be changes along the way. When the sky is falling, CEOs should always be prepared with suggestions and solutions to fix whatever isn’t working, she says.

In the summer of 2008, the sky fell in on the U.S. automotive industry. A combination of high gas prices, tight credit markets and the global recession crippled the Big Three automakers. National Payment Network, an online bill pay service system used by consumers to pay off auto loans quickly, was severely impacted by the unexpected downturn in the auto industry.

Based on total 2007 and first-quarter 2008 revenue, NPN built a large internal sales and customer support department to meet growing demand. By mid-2008, the company’s cash burn rate had ballooned to more than $600,000 a month. As auto sales slowed to a crawl, NPN found itself in a declining market with a bloated cost infrastructure. National Payment Network CEO Steve Baus knew that for the company to survive he would have to do two things: slash the cash burn rate and find new markets for NPN’s services.

Within 90 days of identifying the changing market conditions, Baus was able to cut the company’s monthly burn rate to $25,000 by dismantling NPN’s sales organization, outsourcing customer support and cutting all employee salaries–including senior management’s–by 30 percent. The leaner, more efficient NPN was able to diversify into new vertical markets such as home mortgages, student loans, personal loans and credit repair services. Baus’ quick action saved NPN from going bankrupt, and the company was able to raise another round of investments shortly after the reorganization.

But not all new businesses live happily ever after. Because the majority of startups fail, it’s important to be able to pull off a crash landing while minimizing the collateral damage, says Carolynn Duncan, CEO of Portland 10, a startup consultancy. “If a company is going to shut down, there are a lot of people who are going to be affected,” Duncan says. “The investors are going to lose their money, the founders are going to go through reputation damage, the employees will lose their jobs, and customers will lose their connection to the company. Founders and investors need to find a way to shut the company down and minimize the negative repercussions.”

The key to managing a crash landing is the ability to provide important stakeholders with timely information to keep the overall sense of desperation in check. Developing exit plans, providing outplacement resources, and quickly distributing information about severance pay, stock options and health insurance are crucial for employee relations. Investors, vendors and creditors need to know how debts will be paid.

Duncan advises entrepreneurs to never operate based on desperation, panic or anxiety and says the best results come when conducting business the same way you would if things were going well. Most professional investors and serial entrepreneurs have lost money before and understand that most investments do not pan out. But for the first-time entrepreneur who has devoted years to a single project–sometimes under less-than-ideal working conditions–the humiliation associated with failure can skew decision making.

So how does an entrepreneur know when it’s time to turn out the lights and call it a day? “When the sum total of liabilities–including complexity of problems, personnel issues and burnout–is greater than potential opportunities or energy level of the team,” Duncan says, it’s time to throw in the towel.

Duncan’s most important piece of advice for entrepreneurs? “Manage your brand as a professional because you’re likely to see these people again.”

Kevin Woo is a San Francisco-based freelance writer.