Five warning signs a tech startup is in trouble

By Melissa Chang, The Industry Standard |  Business, startup

The sound of a tech start-up crashing to Earth is loudest when it's unexpected. However, there are several warning signs that investors and customers can look for that almost always spell trouble:

1) Key people start to leave. In every business, employees will come and go, and most people have heard the HR mantra that "everyone is replaceable." But if founders or early hires that are in executive management begin to leave without a good reason, there's probably trouble in start-up land. In January 2008, Thoof, a start-up competitor to Digg in the news voting space, went on the block and subsequently went under. An early warning sign? Alan Ren, co-founder, COO and CTO, left the company.

2) The company loses focus. Having multiple revenue streams is a good thing for a start-up. It's also good when a company is flexible and agile. But when a company loses its focus to chase a quick buck, it's a sign that the company is in trouble. Akimbo launched in 2002 as a hardware-based video-on-demand company. In 2005, it morphed into a non-hardware solution. In February 2008, the company changed again, becoming a white-label video service provider. This final transformation was a far cry from the original business model. The company went under about three months after.

3) The technology is great, but no one is using it. No matter how terrific a start-up's technology is, if no one uses it, the technology is irrelevant. The key to any company's success is customers, and without enough of them, the company won't make it. Helio, a company that provided mobile services, was known for its excellent hardware and features on high-end cell phones. The service had a slow adoption rate, however, with only about 170,000 subscribers before it died and was scooped up by Virgin Mobile earlier this year 2008.

4) There are public disagreements between the founders and the VCs. It is fairly common for founders and VCs to disagree on some things -- after all, founders rarely like to give up control, and VCs often expect to take it as a condition of providing capital. However, when the disagreements go to the next level and someone takes their grievances public, it is often a sign of a company's imminent demise. Perhaps the most well-known example is ArsDigita, the software consulting poster-child of the late-90's that went under after founder Philip Greenspun had a very public spat with his VCs.

5) There are competitors that have more buzz (and an audience). Starting a business in a market where there is competition isn't a bad thing -- having competitors can help legitimize your business model and can help drive innovation. Sometimes a start-up idea hits multiple companies at the same time, and new services are being developed simultaneously. The warning bell sounds, however, when there is a crowded market and one start-up is just not catching on, while buzz and activity surround another service. Social.FM, the social music service that was competing with Pandora and iLike, fell victim to this problem -- it featured a similar service, but not as big an audience.

While it's hard to make generalizations about tech start-ups, the scenarios described above should serve as red flags that a start-up is in trouble.

Melissa Chang is the founder of Pure Incubation, an Internet incubator based in the Boston area. She blogs about start-ups at 16thletter.com.

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