Building a startup is complex.
Success means conquering every major challenge. Failure is getting caught by any showstopper. I’ll use data to identify what makes startups’ fail and succeed.
I graduated University in 2003. My course mates Duane Bong and John Clayes asked me if I could code. “Poorly” I answered. Luckily they were both great coders.
Duane believed growing camera sales, DSLR specifically, meant amateur photographers would soon take professional quality pictures. At the time photos were expensive. Duane wanted to make them easy and cheap. Vizero placed second in Imperial’s first Entrepreneurship competition and won £5000. Our VC pitches failed but the excitement of working closely with 2 friends where a 3am email would get a response 15 minutes later and seeing daily progress was thrilling. It was the best post-Uni learning experience I could wish for. We didn’t conquer the photography market place, iStockphoto beat us, but the business is still running.
In February 2005, 3 PayPal employees, Chad Hurley, Steve Chen, and Jawed Karim, launched an online dating service with an optional video upload and the slogan “Tune In, Hook Up”. The concept failed but the video uploading and sharing function worked great. In November 2006 Google bought YouTube for $1.65BN.
Two great ideas with passionate founders and the skills to execute. What made YouTube a runaway success and Vizero a come up short? Or more generally: What factors cause venture failure and drive success?
Different types of ventures
Not all ventures are created equal. To understand the risk of failure and chance of success we distinguish between different types of ventures.
Startup definition:
A new business launched by an entrepreneur.
Some ventures take on external funding. These receive a lot of attention but are far from all ventures. Some are self-funded and some driven by a solopreneur with the intention of staying a one person show.
This graph is my categorization of 8 venture types with their ability to scale and innovate along with those attractive for external, e.g. venture capital (VC), funding.
Venture types, characteristics and famous entrepreneurs, ranked by scalability.
Type | Characteristics | Entrepreneurs |
Innovative | Cutting edge product or service | |
Imitative | Copies of existing businesses | |
Research | Regulated markets with strong IP focus like pharma and biotech | |
Intrapreneurs | Innovate within corporations | |
Social | Solve social problems | |
Solopreneurs | Writers, consultants, coaches | |
Small businesses | Locally operated restaurants or shops | The owner of your favorite store |
Lifestyle | Travel bloggers, fitness coaches |
The Role of Venture Capital in Startup Success
This categorization shows not all startups should seek venture capital. Furthermore, venture capital is no guarantee, nor requirement, for success. Some entrepreneurs, like Oliver Eidel, are highly critical of external investment. Some solopreneurs like famed Tim Ferris talk about how to make $1MM+ from a one-man operation. OpenAI Sam Altman said we will see 10-man companies with $1BN valuation with the help of AI. An idea that Evan Armstrong drills into.
Even companies with ideas and business models that qualify for venture capital might be poor candidates. I've both bootstrapped and run VC funded ventures. I'd see 5 reasons to caution against seeking VC investment:
Raising capital takes time and effort
Owners give up control and ownership
Investors seek extraordinary returns increasing risk
Goal is IPO or sale which often means selling the venture
Capital generate a sense of validation which may delay push for customers
“The best money is your customer’s money”
INSEAD MBA professor
According to a study on IPO offerings with VC backing there were 9181 IPOs in the US between 1980 and 2023 with a price > $5 per share. Only 40% were VC backed. Among the 36% classified as tech ventures the share was higher. 60%. I was very surprised by these figures. VC funding is far from a must.
If VC funding is so rare, how come we hear about it so much? The most successful ventures often received investment. VC firms have a strong self-interest to promote. The ventures themselves may also see benefits from strategic investors in the form of:
Valuable advice
Industry connections
Entrepreneur publicity
Market stamp of approval
To make good candidates for VC funding firms have the following characteristics:
Potential for exit: To provide a return for the investment. Think IPO.
Highly scalable: Significant opportunity for growth. Enter new markets.
Low marginal costs: Serving more customers is cheap. Software.
High network effects: The more users the more value for each user. Phones.
Winner-takes-all market: Market leader makes disproportional gains. LinkedIn.
What went Wrong? Analyzing the Most Frequent Causes of Startup Failures
VC funded ventures tend to be larger, have more traction, and critically generate more documentation. I analyzed the failures of 422 VC funded firms up until 2023 from CBInsights post-mortems, excluding the original list of 50 published Jan 2014.
First, words of caution.
The most common cause is 'running out of cash' which is likely a symptom of other underlying problems.
Causes are reported by different sources including a) venture leadership, b) employees, and c) external parties, such as journalists all of which likely introduce bias.
Failure is associated with complex emotions including stress, shame, and embarrassment. I am grateful for the many stories shared by entrepreneurs and insiders enabling others to learn from their experiences.
Analysis of 422 VC funded ventures
Failure reasons were identified in 405 cases. In the remaining 17 cases no public analysis of failure was found. I identified 10 discreet failure categories.
>99% of cases had ≤3 documented failure reasons. 51% had 1 and 37% had 2.
The average duration from launch to failure was 5.4 years. The mode was 3 years.
The most common reason for failure was running out of cash. Across the 405 startups there were 658 failure reasons in total.
355 startups had 1 to 2 reasons for failure. 340 of the interrelationships are illustrated in the Sankey diagram above. The remaining 15 failure reasons were combinations of the factors on the right.
From this we learn:
Running out of cash and poor product market fit are correlated
Legal problems and team are correlated
A majority of scaling problems link to poor productmarket fit
A majority of market problems link to running out of cash
A significant share of competition problems link to poor product market fit
Understanding Startup Failures: Lessons from Ventures that Failed
Just like each success is different the failures also failed in their own unique ways but below I draw some general insights from each failure mode.
1. Cash
All businesses need cash to survive. Running out of cash is articulated as failure to raise (additional) capital, pay off loans, financial difficulties, or excessive burn rate. In case of bad actors it may also be linked to financial mismanagement and fraud.
Costs associated with hiring a team, building a product, and promoting it to prospects are fraught with challenges. You may hire the wrong people, fail to execute on the product vision, or target the wrong prospects. With enough capital a venture may pivot into a profitable business and many entrepreneurs believe capital provides the lifeline to pivot enough times to find a value proposition that fits.
Jawbone raised $950MM in funding from PE and VC investors such as Sequoia, Andreessen Horowitz, Khosla Ventures and Kleiner Perkins Caufield & Byers, BlackRock, J.P. Morgan, and Silver Lake Waterman before it went bust in the second-largest VC backed bust of all time behind solar panel maker Solyndra. It went bust due to an excessive burn rate.
2022 autonomous startup Argo AI backed by Volkswagen and Ford shut down amid mounting losses. The decision is tie to growing losses for its backers, amounting to billions, and uncertainty about the timeline for commercially available Level 4 technology applying to all autonomous vehicle developers.
2. Product/market fit
Product/market fit means serving a market with a profitable product. Poor fit is expressed as failing to commercialize products, product development issues, no strong market fit, poor unit economics, failure to find an audience, lack of demand.
Low margins due to high costs or high customer aquisition costs are fundamental product/market fit problems. With unlimited funds most needs can be served but only businesses that do so profitably have found product/market fit.
Google's X lab "moonshot" project Loon aiming to deliver global internet access with a fleet of balloons floating on the edge of space closed down after 9 years. It failed to control the balloons to stay over areas it wanted to provide internet service.
“despite the team’s groundbreaking technical achievements over the last nine years, the road to commercial viability has proven much longer and riskier than hoped”
Head of X Astro Teller
Juicero raised $120MM for its luxury juice machine business serving the health diet consumer market. Challenges were the high price, $400, of the juice press. It also required a montly subsription of ready-made packets of dice fruits. The nail in the proverbial coffin was the discovery by customers that the pre-packaged juice bags could be squeezed nearly as quickly and effectively by hands as by the machine.
3. Team
Similar to cash a venture needs a team with the necessary and complimentary skills for success. The responsibility for attracting it falls on its founders. A poor team is expressed as slow progress, underperformance on critical tasks, failure to implement ideas, and poor decision making like focusing on a single client or supplier. In worse cases it resuts in mismanagement, misuse of funds, scandals, and fraud.
Theranos premise, to make blood testing more convenient by using a smaller sample of blood at lower cost, made for excited investors. Its failure could be considered a product/market fit issue had the product been feasable but not only did it fail to do so, its failure was hidden by deceptive and fraudulent practices at the hands of its leadership headed by CEO Elizabeth Holmes along with its top management. While deceving investors, partners, and customers it actively focus on quieting internal dissenters and external journalists of its fradulent activities. Hence the 11-year sentence in federal prison for the superstar CEO.
Katerra was a technology construction startup aiming to be come the Salesforce of construction. A vertically integrated construction project management company aiming to reduce construction project cost. It raised $835MM from Softbank. Part of its failure was due to an inefficient workfoce of talented architects and engineers from traditional firms who had never worked in a high growth environment. It also went through a roster of CEOs excuberating its team challenges.
4. Market
Success depends on predictability of market conditions or changes which do not disproportionally harm the ventures business model. Sudden or negative changes are expressed as difficult market conditions, changing consumer preferences, or sudden market shifts, such as the impact of Covid-19.
Stockwell. raised $45MM to offered vending machines for apartment blocks and office buildings. Revenue for the market dropped 90% during the pandemic. The main reasons were consumers prefered large bulk purchases over small casual purchases as people spent more time at home and fear of infection from unattended vending machines.
Livestreaming concert platform Mandolin launched 2020, during Covid-19, to provide an alternative to physical touring not possible during this time. Once the pandemic passed live performances returned to norm the platform was unable to compete.
5. Legal
Some high profile disruptive tech firms have been successful at changing legislation by lobbying or hiding its impact by settling cases to minimze business disruption.
A case in point is the 124,000 documents about Uber's violations leaked by chief lobbyist for Europe Mark MacGann in 2022. The confidential files showed how Uber had flouted laws, duped police, and exploited violence against drivers while secretly lobbying governments over a 5-year period.
Another firm is AirBnB which has spent millions lobbying the US government and faces increased regulations restricting the short-term rentals in cities with high tourism and rental prices.
While Uber and AirBnB has been successful for other ventures legal or regulatory problems can seal their fate. These are expressed as failure to overcome regulatory obstacles, regulatory violations, to legal disputes involving fraud, data breach, revelations of selling private data, and court orders to shutdown operations.
Binance CEO Changpeng Zhao, operating the worlds largest cryptocurrency exchange, pleaded gulty to charges of failing to maintain an effective anti-money laundering (AML) program, to register as a money transmitter and violating US sanctions as it prioritized growth and profits over US law compliance. While the company still operates it was forced to close its Singapore portal.
Fintech LendUp, with investments from Google Ventures, Andreessen Horwitz, Kleiner Perkins, was convicted of deceptive marketing barring in 2021. It told consumers that by repaying loans on time and taking free courses they would qualify for lower interest rates and larger loan amounts. This was false. It was barred from offering loans, collecting outstanding loans to harmed customers, selling consumer information, and misrepresentation when providing loans or collecting debt.
6. Competition
Competition exists in all markets. To succeed ventures must find ways to win customers, either through better prices, higher quality, superior service, innovative solutions, or another factor valued by its customers.
This is expressed as increased or intense competition or a crowded market.
InVision enabled designers to make quick prototypes and designs. However many users relied predominantly on Figma and Sketch using InVision Studio as a secondary tool. As integrated workflows and advanced features became more important competitors left InVision behind. Figma's full browser functionality was another strong selling point. In an example of a winner-takes-all market with low marginal costs and network effects the competition spelled the doom for InVision.
Periscope was a social network launched in 2014, bought by Twitter in 2015, that allowed broadcast and consumtion of live-streamed video content. Users could choose streamers from an interactive map. It faced tough competition from the start from Meerkat, another livestreaming app using Twitter's social graph to distribute live video streams reaching 1MM users in its first weeks before Twitter cut off access. Periscope was closed down in 2021 faced with competition from Facebook, Instragram, YouTube solutions and even Twitters own livestreaming feature.
7. Scale
As we've seen scalability is a must for VC funded ventures. Once product market fit is found the business will allocate capital to drive growth. Its absence is expressed as difficulty to scale, gain traction, gain user adoptation, or low growth rates.
Poppy care company helped families with young children book caregivers for thousands of families needing support. It closed down because it was unable to scale profitably with the prices parents were willing to pay after paying caregivers adequately while providing the hands on vetting service that differentiated it from more hands-off open marketplace competitors.
Cyan Ta'eed launched Hey Tiger, an ethical chocolate bar company that aimed to highlight social issues in the cocoa industry. It generated more than $3MM annually but the leadership decided the business model was not scalable.
“In creating a chocolate experience like no other, we designed a business that customers absolutely love, but that was hard to scale into the profitability it needed to be a sustainable social enterprise”
Cyan Ta'eed Hey Tiger CEO
8. Conflict
Conflicts between founders, with investors, strategic partners, suppliers, or parent companies can break a venture and is expressed as disagreements or misalignment of interest or long-term vision.
Israeli security-technology startup Fifth Dimension was forced to close after its controlling shareholder failed to transfer the capital he had committed. In addition the investors' involvement caused the collapse of a deal with another Israeli-security tech company, NSO.
“Not only could he not deliver the money he promised, but his presence on the list of company shareholders at a time when his foreign assets were being blocked by the U.S. treasury prevented any other venture fund from coming in as an investor”
Fifth Dimension executive
Vatler was an on-demand valet service in San Francisco which aimed to solve the parking problem in congested cities. It started by offering late night parking for restaurant visitors charging them $15-20 per time. It applied for, and was granted, 5 permits. In the course of expansion it applied for an additional 5 permits. It was contacted by the police informing it that the permits had not been granted and it was operating illegaly in most locations. This stunted growth and caused the loss of 30% of existing accounts. The business was shut down shortly afterwards.
9. Business Model
A business model is how a company creates, delivers and captures value. Examples of different models include subscription like Netflix, marketplace like Amazon, franchise like McDonalds, advertising like Google, freemium like Spotify, and aggregator like Skyscanner. Symptoms of poor business models are muliple pivot which fail to generate margins and traction.
Buildzar started as a B2C marketplace for construction materials. Within 9 months of launch it pivoted to a subscription model to sell leads. Neither model worked and it was forced to closed down. The CEO of its main competitor, Buildkar, suggests venture funding too early causes distractions and a focus on growth when you need to figure out how to build a profitable business.
Doorman aimed to sovle the problem of package theft from lobbies and doorsteps before the recipient had a chance to collect them in large cities like New York and Chicago. It offered an evening delivery service with a narrow time window for a flat fee. Unfortunately customers are used to free shipping making Doormans steep charges hard to sell reducing sales volumes. In contrast to other delivery firms like Instacart or Doordash where it also makes a margin on the products Doorman only charged for delivery reducing margins. By offering a tight delivery window it was unable to generate high stops per hour increasing costs.
10. Science
This occurs in cutting-edge biotech, pharmaceutical, and high-tech industries. It's expressed as ineffective therapies, safety issues during clinical trials, or drugs falling short of discovery goals.
The Hyperloop is an idea from 1799 by George Medhurst that was re-popularized by Elon Musk in 2013 as a way to travel at near-supersonic speeds in vaccum tube capsules. It was estimated to allow speeds of up to 1,200 km/h but no trial so far has come close. The practical challenges in implementation are so great, the money raised were spent on irrelevant, unrelated things like nice spacepod designs.
Vedere Bio II, a gene therapy start-up as decided to shut down after preclinical studies failed to meet their targets based on preclinical efficacy studies.
Other non documented causes
Failed acquisitions are never the sole reason and often combined with running out of cash. In some cases debts and legal bills from acquisition proceedings may have contributed to the company's predicament.
Founders tend to be an optimistic lot. But beyond the sense of accomplishment and control of ones destiny opportunity cost is an important consideration. So when chance of success is slim and alternatives attractive founders will just move on.
You've heard 99.9% of all startups fail
Hearing this makes me cringe. Without context does it mean?
This information lacks value without knowing some of :
Type of venture
Founder experience
Market
Time period
End-state
US Bureau of Labor Statistics keeps record of how many new businesses started each year and the remaining businesses from each cohort.
From this we learn:
20% of all new businesses close within 1-year
30% of all new businesses close within 2-years
40% of all new businesses close within 3-years
50% of all new businesses close within 5-years
After 10-years 66% of all businesses have closed
Survival are similar across cohorts
Survival rates increase over time
But we must be careful equating closure with failure. Citydeal, the European clone of Groupon, funded by the Samwer brothers was sold to Groupon after 5 months of operations for between $100MM - $300MM. Once the integration was complete CityDeal was no more. But this can hardly be considered a failure.
Some founders may sell their ventures and others move onto new and better things. Opportunities likely the result of the experiences and lessons gained through their ventures. Far from the homerun of CityDeal but not the same as forced bancrupcy.
Reasons for startup successes
We can't learn everything just by studying the failures.
Bill Gross founded Idealab, the world's first startup incubator. It’s so old the L in Lab is not even hyphenated! Idealab was started in 1996 and has invested in 150+ companies of which 50+ which have done IPOs or been acquired.
Actually, the practice of bicapitalization started much earlier. CinemaScope (1953), AstroTurf (1967) are some examples but it became more popular with high-tech company’s iMac, iPhone, eBay, FedEx, PlayStation and of course YouTube.
In an inspiring TED talk Bill ranks the most important factors for startup success from a study of 100 Idealab companies and 100 non-Idealab companies. He rated the companies across 5 factors and found that timing is the no. 1 factor for startup success.
Check out the video for his complete 6 min 40 second talk.
A few details from his talk discussing methodology, shortcomings, exampels of firms, justifications for the factors.
In a certain sense to be successful you also need a team of winners. So what personal characteristics correlate with success.
In another great 6 minute TED Angela Lee Duckworth declares grit to be the defining characteristics between succeess and failure for tough challenges.
Conclusion
Building a startup is hard. By analyzing common reasons for failure and success we can stack the deck in our favor. Deciding source of finance, specifically should you take on external investment, is a critical decision. Running out of cash is the number 1 reason for startup failure. Together with failing to find product/market fit and poor team they make up > 50% of failures.
Finally, esteemed TED presenters’ Bill Gross advocate for paying attention to timing for the venture and Angela Lee Duckworth for cultivating grit for the entrepreneurs as key drivers for success. Reflecting on my football career, only those who work harder when they are behind will get to relish the joy of a great comeback.
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