Startups fail. The startup road is littered with the carca.....and...swirling above there are vult...well - I'll spare your gory analogy. Let's just say if you're walking that road, wear your Wellingtons because it's inevitable you'll step in some startup. While we know some startups will fail, that does not make us any less determined to make sure the ones we're invested in don't become the bad statistic. That means understanding why it happens. In this episode Dave brings studies and lists and is his best comprehensive self in examining why startups fail - and how Seedfunders uses that knowledge to support its portfolio companies.
How are you doing Joe?
Not so good, because we’re going to talk about failure today. Why do startups fail?
There’s a lot of reasons.
You previously mentioned that, even if an angel investment group does significant due diligence. And has industry experience. And helps the entrepreneurs after investing, that still 42% of the portfolio companies fail, why?
Joe, I could write a book on the topic. Actually, it’s already been done. So, I won’t. One of the most common misconceptions is, that lack of funding is the main cause of startups to fail. Another misconception I think, and I actually mentioned this myself is lack of sales, lack of revenue. Both financial issues; lack of getting funds or lack of being able to get revenue to fund the company. But it’s actually a lot more complicated than that. A lot more complicated than money, whether it’s funding or revenue. Those are just symptoms of a much deeper issue in the failure of these companies. That’s been stated in various areas. But I think one line I really like, they simply fail to offer a product or service that the market wants.
Okay, makes sense, but kind of broad. Any more color?
Sure. I mentioned, there are books written on this. In fact, there’s one written by Harvard Business Professor Tom Eisenmann. It’s actually entitled, Why Startups Fail. Doctor Eisenmann looked for what he called recurring patterns, rather than single issues, but recurring patterns. Rather than a list of factors, as some other publications have offered. He looked at it more as concepts, what concepts that led to failures. For example, you remember we recently talked about investors betting on the horse or jockey. And how we analyze both when we’re doing due diligence. Is it the horse, really the company that we’re betting on or is it the rider – the jockey that is running the company? I told you, we look at both of those in depth when we’re looking at due diligence. The Harvard Business Review recently published an excerpt from Doctor Eisenmann’s book. Basically, the subtitle is, It’s not always the Horse or Jockey.
So it’s not the horse or jockey. Then, does that mean it’s something completely out of control of the founder?
Not exactly. As I said, Doctor Eisenmann looked at recurring patterns. He identified six that can cause a startup to fail. The first, he calls bad bed fellows. This deals with problems with the team members, the founders, employees, manufacturing partners, investors, anybody that’s involved in the company. It’s basically having all interested parties get along and act like a team on the startup. The startup can be doomed to fail if that doesn’t happen. The second thing he identified as a pattern is false starts. He called that a recurring pattern and identified it as a potential cause of failure. Because he believes in lean startup philosophy. We’ll do a whole podcast on lean startup philosophy. But just to explain in a minute or so.
Lean startup philosophy basically says, “Get your MVP – Minimum Viable Product – out to the customer as soon as possible, as fast as possible. And get customer feedback.” Get the customer feedback and then use that feedback to iterate and make your product better. It doesn’t just mean do it on the cheap. It means, it’s a process. Doctor Eisenmann says, the entrepreneur often skips the first step in a rush to market. In a rush to get their product out. To get that MVP out to market. They actually skip the first step of lean startup philosophy. That is customer discovery. Otherwise, they have a fall start. They have feedback from the customer, they pivot. They use all their capital and then they fail. Again, failure to really follow lean startup philosophy by skipping the customer discovery session or initial customer discovery, can lead to a huge false start and failures of a startup.
That makes a lot of sense. I’ve seen that. All right, so you said Doctor Eisenmann had six, that’s two. What are the other four?
They would include, growing too fast, hurrying and funding decisions which he lumps together as one pattern; hiring and funding. Basically, missing the market demand. Just misinterpreting what really is out there as far as the demand is or not understanding it, and cascading decisions. Those are the other four. The first three are relatively straightforward. We’re talking about growth issues, talking about people and capital and market demand. Those are relatively straight forward patterns that can be looked at in the company and why the company has failed.
The last pattern however, cascading decisions. It gets a little complicated. It actually deals with a number of issues simultaneously. These are all the decisions that go with establishing a successful startup that all have to be dealt with at the same time. He lists five of those decision areas all under cascading decisions as: gaining customers, new technology, partnering with established companies, regulations and raising capital.
That’s a big list. How about any other startup failure reasons outside of Doctor Eisenmann’s six?
There is a study done by CB Insights based on 101 failures that they looked at, CB Insights. They title it, The Top 20 Reasons that Startups Fail. So, right in line with what we’re talking about today. We won’t discuss all these, but I am going to list all the 20 reasons. Because other people have taken these. And they’ve actually done some analysis on the 20 reasons. But the 20 reasons that CB Insights for Top 20 Reasons Startup Fail: no market need, funding, the wrong team, competition, pricing, not user-friendly product, no business model, marketing, ignoring customers, timing, losing focus, team and investor disharmony, a pivot gone bad, no passion, failed geographical expansion, no investor interest, legal challenges, didn’t use their network, got burned out or a failure to pivot.
Those are the 20 items. A lot of them seem like they overlap, if you look at things like no investor interest and funding as being two things. Other groups have actually analyzed this data for us. So, we don’t have to try to figure it all out. Some other groups have analyzed and put it into categories.
And what do they have to say?
I’ll talk about two analyses I’ve seen on the CB Insights list. First, Denise Lee Yohn published an article in Forbes. And concluded that first of all, nine of those 20 items I just mentioned are related to customers. She also concluded that seven of those 20 are related to people and culture. Basically, you have 16 of the 20 reasons for failure are people related. She concluded basically, business is a human endeavor. According to the human side of the things, are much more important than anything else. Again, if you look at that, nine out of 20 are related to customers, seven to 20 people in culture, 16 out of 20 are human related. She also noted that only two of those 20 reasons that startups fail is related to money, just two.
Now, I was pretty surprised at this, because I’ve always thought that money was the most important thing. A lot of people think that. Again, startups say, “If I had more money I could have been successful.” But as an investor again I said, we look at the jockey. We look at the horse, and think the money will help get to the finish line first. But as it does, it’s only people related issues are dealt with. Otherwise, the funding is completely wasted.
I think you said they were two. Do you have another?
Yes, a company called BBVA published their own summary of the CB Insights data. They combined a list of 20 into 10 related issues. As I said, some seem to overlap. In the CB Insights’ study, startups could cite more than one reason for failure. These percentages are going to be obviously over 100, because one startup will say, “I have lack of funding and lack of market.” The numbers will be over 100%.” But when you look at the CB Insights’ data as recast by BBVA, their number one reason which was cited by 42% of the failed startups was, their product was not needed. Forty-two percent admitted their product was not needed. This goes back to the statement by Doctor Eisenmann that too often entrepreneurs skip the first step in lean startup process, customer discovery. Everything seems to be in line here. It’s all about the customer and people.
With a little fear of getting a Dave’s top 10 list habit going here, I need to know the other nine.
Thanks Joe. The second one, cited by 29% of the failed companies was liquidity. That one does relate to funding. But again, only 29% of all the failed companies said it was related to funding. A lot of that could have come from the original issue, failure to meet the market demand. That results in low revenue or lack of investment. Really, it’s all related. The initial one, failure to meet the customer demand results in low revenue or lack of investment from investors. The other eight are team, competition, pricing, bad user experience – again a customer related thing, poor business model, poor marketing, failure to respond to users – again another customer issue and timing. Again, you can see the pattern as it relates to customer’s satisfaction and meeting demand as being the prime reason that startups fail.
You always seem to have one more study report, anymore?
Actually, I do have one more. A company called Fractl looked at 193 failed startups. Again, there are multiple reasons that one company could have failed. So, their numbers will add up to more than 100%. But their top 10 reasons; number one, business model was not viable – 26%. Number two – again related to capital now, ran out of cash – 24%. Third thing was traction at 18%. Then you have the other issues: product issues, funding, no market need, competition, customer development, lack of focus and disharmony of the team and the investors, which comes in at 7%. If you look at those again, and you classify them into areas, customer related issues are 56% of the problem. Funding is only 37%. Again, this confirms the other analysis by CB Insights and the fact that it’s really the customer.
That’s wonderful, closing thoughts.
I would say, “It’s the customer, stupid!” as much founders say, “If I only had more funding, it would have worked,” but really, lack of capital is a symptom. The lack of getting investment and revenue is a symptom of having a failed concept or a failed business model. It’s the customer. If you want to meet customer demand, you need to solve a problem with an easy to use solution, and provide good customer service. Then the capital will come, investment and revenue. Failure to offer a product or service in the way the customer wants it, is the biggest reason that startups fail.