Why your start-up will probably fail

Last Christmas, like every other, had its ‘hottest gift’, and 2015 was ever so briefly the year of the hoverboard. Small boards with two wheels that can be controlled by leaning, their popularity was swiftly dampened when most failed safety checks and a small number began to explode. Like many other products rushed to market, the hype failed to live up to expectations and the product, quite literally, crashed and burned. It’s the trajectory of the typical technology start-up.

While companies boasting seemingly unstoppable levels of growth dominate the headlines, most quietly fade into obscurity. For every Uber, Snapchat and SpaceX, there are dozens of failed operations, including some that generated similar levels of initial interest. There are plenty of traps for entrepreneurs to fall into.

In memoriam
Last year saw a number of high-profile technology start-ups – some once considered darlings of the industry – shut down. Quirky was launched in 2009 as a platform for everyday people to pitch their ideas for new gadgets. Concepts were workshopped by the community, with Quirky developing and selling the most popular and paying out a percentage of profits to anyone who had helped. It struck gold with gadgets such as Pivot Power, a shape-changing power strip, but they weren’t enough to outweigh some disastrous flops: Egg Minder, an expensive egg tray that alerted your smartphone when you were running out of eggs, was a complete mess. The company also spent over $800,000 developing a set of wheels that could turn anything into a remote control car and a bathroom mirror that didn’t fog up, neither of which ever made it onto shelves, according to The Verge. Quirky raised $185m from investors but ran out of cash in August and was sold to a holding company.

By year 10, 71 percent of all start-ups, regardless of industry, had failed. Building something to last is tough, especially without help

Homejoy was an app for on-demand house cleaners, founded in 2012. It raised $40m from investors, but was never profitable, mainly due to poor customer and worker retention. People signed up for a heavily discounted first use and never bothered to use it twice. It was also under immense legal pressure from four pending lawsuits on the classification of its employees.

Secret was a social network where people could post anonymously; it raised $35m in 16 months but struggled to contain cyberbullying and was quietly shut down. Grooveshark and Rdio lost out to bigger music streaming companies despite raising $6m and $125.7m respectively. Leap Transit, a boutique commuter bus service in San Francisco, once described as a “crock of shit” by a city supervisor, generated more money in the sell-off of its fleet of luxury buses than it ever did from users.

The odds are a tech start-up will fail in its first few years. Research conducted by Statistic Brain Research Institute found only 37 percent of information start-ups were still operating after four years. By year 10, 71 percent of all start-ups, regardless of industry, had failed. Building something to last is tough, especially without help.

Andy Shannon is head of Startupbootcamp Global, an international start-up accelerator. Startupbootcamp invests in and mentors technology start-ups, guiding them through the difficult early stages. Each of its programmes focuses on a sector (e.g. fintech) to give start-ups targeted advice and access. Shannon said start-ups at the seed stage have a successful exit roughly 10 percent of the time, but those with mentoring have a far better chance.

“Talking from our own experience, the 300-plus companies we have invested in, in the last five years, have [had] an 80 percent survival rate”, he said. “We believe being part of Startupbootcamp will increase their exit rate much higher than 10 percent, in addition to the start-ups being strong from the start. We are already seeing over 70 percent of the teams raise funding, which is much higher than average. With exits taking place between eight and 15 years after seed stage, and Startupbootcamp existing five years, we have some time before expected exits will occur.”

So what goes wrong?
For young start-ups, there is no shortage of potential business-killing hurdles. Shannon said the first test should be seeing if there is a market for your product. “For instance, at the very early stages, some may struggle with finding the right product/market fit by not testing their hypothesis on the value, use and need for their product. Similarly, acquiring their initial customer or users is another challenge start-ups may face at the very early stages. On the other hand, once they’ve passed the early validation period, other challenges arise, such as not having a recurring revenue, metrics that show the business is not growing, or not being able to raise the investment needed to support product development or market expansion.”

When a start-up goes under, it’s now common to see a final blog post from its founder lamenting, celebrating or venting about what exactly went wrong. CB Insights has been maintaining and analysing a collection of these posts since 2014, identifying the most common reasons cited: 42 percent listed a lack of a market for their product – which shouldn’t be surprising – but only 17 percent mentioned a poor product, and the same amount mentioned the need for, or lack of, a business model.

Still, once a business has proved a viable market exists, finding the right growth rate is the next challenge. Often start-ups begin life as a loss-making operation, perhaps having a larger scale in mind for when their company can turn a profit. This is where funding comes in, providing the cash injection needed for quick growth.

The dilemma then becomes how to spend the money to grow the company, but not grow so fast you can never make back the cash you have already spent. Once a couple of million dollars is sitting in the bank, the pressure is on to spend it. But if the business grows to a size at which it can’t sustain itself, or can’t generate more investment, it’ll eventually fail. It’s a trend identified by Compass’ 2011 report The Startup Genome, which suggested premature scaling is the cause of 70 percent of failures.

Shannon said premature scaling and too much funding go hand in hand. “So often, young start-ups raise a few million dollars prior to true product/market fit, and they feel like they need to ramp up spending regardless if they have proven their scaling metrics”, he said.

Scaling should be an avoidable problem, but overconfident entrepreneurs are often the source of their own demise. The Startup Genome found entrepreneurs serially overestimate themselves and showed start-ups needed two to three times longer than founders expected to validate their market. Founders also overestimate the value of IP before product/market fit by 255 percent. Start-ups that haven’t raised money also overestimate their market size by a multiple of 100. It’s hard to blame them when it often looks so easy.

The lucky ones
Spectacular successes dominate the headlines generated by the technology start-up sector. Unicorns, named for their rarity, are companies that command a valuation in excess of $1bn, a feat once unheard of in the technology sector. From the outside, it looks like anyone with a good enough idea can join the start-up elite.

But there is such a thing as ‘survivorship bias’: it denotes a tendency to focus on examples of success over examples of failure. David McRaney, author of You Are Not So Smart, detailed the concept, which dates back to the Second World War. Returned bombers were filled with bullet holes along their wings and tails, so commanders wanted to put extra armour in those areas to increase survivability.

Researchers argued this wouldn’t improve the odds of surviving at all, as a plane could already be shot in those areas and make it home. What would actually be useful would be finding the places they were shot and didn’t come back, then make those areas stronger.

The same concept can be applied to the start-up sector. Success stories abound both in headlines and speaking circuits. The small team of entrepreneurs pulling all-nighters in a basement to get their first prototype up and running, the small launch, the first round of investors and then unstoppable growth is the industry’s equivalent of the Arthurian legend; anyone can be king if they can pull the sword from the stone. Shannon said survivorship bias is a very real part of such dreams.

“A start-up with $15m-plus in funding is often suddenly displayed as a case in what all other start-ups should try to emulate. What most forget is those founders and that company were successful at one specific point in time because of many variables. Is what they did applicable to other start-ups? Possibly, yes. But will the exact same thing happen to the next start-up? Unlikely.”

It’s pretty easy to dismiss failures because they are, well, failures, even though they might be the best equipped to hand out advice. Research conducted by Francine Lafontaine and Kathryn Shaw looked at the success and failure rates of businesses that opened in Texas between 1990 and 2011. On average, half closed after two years and 71 percent of entrepreneurs gave up: the 29 percent who persevered were far more likely to succeed the second time around. The more a person fails with a business, the better they will probably do in the future.

Turn on a dime
Even if a start-up is on the ropes, it has one last risky measure it can use to save itself. Coined by technology writer Eric Ries in his book The Lean Startup, ‘a pivot’ is when a company takes a completely different business direction. If its product or service isn’t working, a start-up small and nimble enough could try using that information to develop a new product.

A prime example of a successful pivot is Groupon, which started as activism website The Point in 2007. A person could register their interest in attending something (for example a protest), but would only commit to going if a certain number of other people also registered their interest. It failed to generate much interest, largely due to how unfocused it was; people could use it for virtually anything, so they used it for nothing.

The most popular campaigns on The Point were the ones that gave people buying power in numbers, such as a 20 percent discount if enough people committed to buying something. The Point’s founders saw the value in this and spun the site off into Groupon, the bulk deals website it is today. It became, at the time, the fastest growing company in web history. However, more recently, Groupon’s stock has suffered a major slide due to concerns it can’t expand beyond its current state.

But Shannon said he thinks the term ‘pivot’ is thrown around a little too often among start-ups. “To me, the key is having a vision for solving a core customer problem, and searching for a business model while solving that need. The best start-ups stay nimble during the early years by developing a minimum viable product and adopting the lean start-up methodology, where they build, measure and learn. This creates a feedback loop that provides data-driven insights.”

Shannon said, if these tests show a business is failing, it might be time for a pivot. “Of course, in an ideal scenario, if the start-up has a solution that solves a real-world problem and has validated their assumptions through their minimum viable product, then there won’t be a need for a pivot, and they can just go on taking over the world!” For start-ups to last in the long term, a cooling of expectations needs to happen. While it’s certainly possible to develop the next Snapchat, attaining a similar level of success is not easy or likely. Careful decisions, steady but restrained growth, and a refusal to emulate the unrealistic expectations of unicorns are what is needed if a company is to last longer than your average hoverboard.