Close to 90 percent of startups fail or shut down, which is only a bit higher than the failure rate for venture-backed startups. A recent study by Shikhar Ghosh, a senior lecturer at Harvard Business School, revealed that 75 percent of venture funded startups failed to return invested capital. If the failure parameter is return on investment, almost 95 percent funded companies in the study sample didn’t make the cut.
Shattered dreams, hopes, and aspirations — entrepreneurs have always had it tough. The current hyper-judgmental, adrenalin-rushed entrepreneurial era of venture and angel fund backed startups has not made it easier for business innovators. The demands of unrealistically high-growth rates and quick returns have caused lots of sound businesses to boom-burst-and-sink quickly and unfashionably.
But why is the startup world so ridden with failure? Does it come down to fundamentally flawed business ideas or do these businesses fail along the way? Many and diverse reasons are behind startups that don’t take off: Some start with a flawed market assumption while others fizzle because of a lack of funds, poor execution, or bad timing, or they choke on high growth. In other words, they tasted success, and this success doomed them. In many cases, the obsessive push for high growth is fueled by venture funds aiming for a quick kill.
The acceptance of such high failure rate by the venture fund industry is in itself problematic. Only one out of four startups get anywhere near delivering reasonable returns. This by its very nature lends instability to the startup ecosystem. I understand that the blockbuster investment philosophy has worked a couple of times, if not on a sustainable basis, for some funds and investors – for instance, those who invested in Facebook, Instagram, and Groupon (assuming they got out in time). But many funds’ returns often just mirror regular money markets.
What I don’t understand is why venture investors work with more or less the same philosophy, accepting such a high startup failure rate. Surely, someone can decide to go against the herd and invest in companies that seek sustainable, possibly slower growth, with solid bottom lines. Three out of four successes, even if not blockbusters, can offer robust returns.
In one of the reverse pitch events I attended, a seed fund partner boldly announced that he sought only billion-dollar ideas. The fund’s team would exercise extensive control and offer no more than $100,000 per venture, much to everyone’s amusement. It’s an extreme example, but such rhetoric doesn’t lay a solid foundation for a healthy startup ecosystem. Consider this: How many billion dollar companies have been built in the last decade, compared to the number of successful multi-million dollar profitable businesses?
This maddening race to growing faster has destroyed several promising companies. One of these, Ecomom.com, led to a tragic end for its founder. A study by Startup Genome in 2011 identified premature scaling as the most common reason why startups performed poorly.
Ninety percent of the companies on the Inc 5,000-fastest growing list have grown at two times or less per year, and we are talking about some of the fastest growing companies in the country. The multiples of five-times to 10-times growth, often sought by venture investors, are not the norm, but an exception. Pushing for growth more than what is manageable creates unstable businesses, which topple easily the moment one of the many variables of company sustainability go out of favor. The funds’ availability for instance has killed many ventures — with no profitability, running out of funds puts fundamentally sound businesses in a tight spot. Then they have hardly any negotiation leverage and sometimes no future funding options. The death knell sounds and that’s the end of a dream run.
Instead, consider companies like Steals.com, which despite operating in a high-growth industry took it slower than competitors and built a solid, sustainable, and profitable business. There are millions of small- to mid-sized businesses like Steals.com that were built with patience and years of labor and have yielded multi-fold returns to their founders. Sometimes they grow into mammoth businesses. Walmart, for one, wasn’t built in only three or four years. Sam Walton invested and experimented for 24 years before the company reached $12.6 million in sales in 1962.
[Illustration by Hallie Bateman for PandoDaily]