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This is why so many startups end up in financial trouble

October 29, 2015, 5:51 PM UTC
David Smith, founder of Vexti
Courtesy of Vexti

The Entrepreneur Insider network is an online community where the most thoughtful and influential people in America’s startup scene contribute answers to timely questions about entrepreneurship and careers. Today’s answer to the question “What are some common mistakes young entrepreneurs make?” is written by David Smith, founder of Vexti.

When starting a new business, it can be tempting to discount your own time and lower prices in order to juice sales. I suspect there are a variety of reasons for this — cash flow pressure, fear of rejection, and wanting to show progress and build a portfolio.

Young entrepreneurs, especially — often without a mortgage, car payments, kids or health expenses — have an easier time rationalizing below-market rates. They also have less pressure to earn more — the younger the entrepreneur, the less his or her peer group is making — than older entrepreneurs, who often feel pressure from existing financial obligations, as well as pressure to be in a similar income bracket as their friends.

But lowering pricing is a seductive solution and can cause serious issues:

Future cash-flow problems
If booked revenue is paid before a service is delivered, a young company may end up spending more cash delivering the service than it received.

A false sense of hope
Lowered pricing can give entrepreneurs the hope that the business will succeed because sales seem thriving. But only when they try to expand the business, earn a reasonable income or take a vacation do they realize the low sales prices gave them a business model that doesn’t work.

Stressful projects
If projects are underpriced, they can drag on, as entrepreneurs likely become focused on other projects to increase revenue. Or they’ll end up using the low price to justify doing low-quality work. These are all recipes for disaster.

Instead of lowering prices when sales seem shaky, I recommend young founders find out what others are charging for similar services and price competitively.

See also: This is where most startups go wrong

Company websites will often list price points, especially bigger companies. If not, ask friends who have had the service done before what they paid for it. Look on LinkedIn for a competitor in a different market and ask them what they charge. I’ve even used that technique to ask for help bidding a project. But keep in mind your business type and specific project. As a small business owner, what I buy and what I spend with a company like Microsoft (MSFT) or AT&T (T) is completely different from what a company like Nike (NKE) buys and spends with those same vendors.

Successfully selling a product incurs expenses (labor, product, etc.) and liabilities (delivering what is promised), so don’t feel bad about losing a bid on price. In my experience, selling an offering that is priced too low is worse than not selling anything, and finding out early on that a business model doesn’t work is better than executing a broken one.

Charge market rates for your service, and you’ll be starting with a business plan that works — meaning less stress for you and more opportunity for your company.

David Smith is the founder of Vexti, where he helps business owners solve their website headaches by teaching them how to use platforms designed to meet their needs. David is the director of Startup Grind Lansing.


Read all responses to the Entrepreneur Insider question: What are some common mistakes young entrepreneurs make?

Doing these 3 things will destroy your startup by Michael Gasiorek, editor-in-chief of Startup Grind.

The avoidable mistake every entrepreneur makes by Andrew Filev, founder and CEO of Wrike.