Surviving the Startup Gauntlet: Lessons in Failure and Success

ntrepreneurship has become incredibly popular in the US economy over the last few decades. Part of it is the immense growth in opportunity presented by new technologies. Once upon a time, dropping out of Harvard to pursue an ephemeral entrepreneurship opportunity in an as yet unrealized industry would have been madness but that is exactly what Bill Gates did and the rest is history. 

More recently, Americans have been forced to become entrepreneurs by the painful and dysfunctional realities of our job market. In an employment arena characterized by rampant downsizing and the vagaries of at will employment, is anyone’s job really safe? The days of stable employment characterized by the stereotype of the man in the gray flannel suit are long gone. 

Change is almost the only constant in this economy. But there is one constant: the persistent need for capital amongst those who elect to pursue an entrepreneurial path. This is where venture capitalists enter the picture. And in the world of venture capital, there are few questions more important than the overarching one: Why do startups fail? It is the answers to these question that dictate how venture capitalists invest and the strategies and tactics that they utilize when making an investment. Let us explore this foundational issue.

What Exactly is a Startup?

To be concise, a startup is a company in its first stages of operations. It will have been founded by one or more entrepreneurs who are seeking to develop a product or service for which they believe but do not definitely know that there will be demand. This uncertainty along with the high costs and limited revenue at their inception, makes startups very risky business propositions. 

It also requires innovation—both technological and in terms of the business model—because to challenge and “disrupt” entrenched competitors, a new entrant to the market must be offering something so much better to customers that it will induce them to switch their purchasing habits. That is no easy task which adds to the risk of startups. In the United States but increasingly in other countries as well, the risks inherent to startup investing have been addressed by a new breed of financiers known as venture capitalists who are willing to embrace great risk for outsized returns. 

Over the years, certain areas within the United States such as Silicon Valley and Boston have emerged as epicenters for startups due to their entrepreneurial culture and connections to research universities where the latest technologies are incubated. 

However, the geography of innovation and entrepreneurship is rapidly broadening both within the United States and abroad as public policy initiatives to support the development of a startup ecosystem begin to bear fruit and as entrepreneurs, engineers and technologists who were trained in America return to their home country to build a version of the US-based technology firms that they were once satisfied to simply work for in America. This process has in turn sparked the development of local venture capital firms to support these entrepreneurs in building their new businesses.

In the United States, there are some very important and at times surprising statistics regarding startups:

• 90% of startups fail
• 10% of startups fail within the first year
• According to the Small Business Administration, across all industries, startup failure rates seem to be close to the same.
• Failure is most common for startups during years two through five, with 70% falling into this category.
• Experience matters. Founders of a previously successful business have a 30% chance of success with their next venture. Founders who have previously failed have a 20% chance of success. First time founders have an 18% chance of success.
• In 2022, male founders brought in $156.2 billion in venture capital while female founders only brought in $28.1 billion in venture capital.
• About 1% of startups evolve into a unicorn (market capitalization of $1 billion or more).
• 33% of startups begin with less than $5,000.
• Business loans, credit cards, and lines of credit account for about 75% of financing for new firms according to the SBA.
• The average age of tech startup founders is 45.
• Tech-driven startups offer better pay opportunities as they pay an average of $102K which is more than double the US average of $48K.

What is evident is that startups are hard. There is no other conclusion from an industry with a 90% failure rate. Few are successful and fewer still evolve into the mega successes that venture capitalists yearn for so as to compensate for the failures in their portfolio. These are general statistics. The important question is what are the reasons that so many startups fail.

The Dynamics of Startup Failure

Due to the uncertainties of whether or not there will even be a market for what a startup eventually produces, many venture capitalists will openly state that they invest in founders not companies. 

According to Softbank’s Masayoshi Son who has the distinction of having invested in the largest venture capital win—Alibaba—and the worst loss—WeWork: “I don’t look for companies. I look for founders.” That emphasis on the quality of the personnel in the startup is taken one step further by venture capitalist Ron Conway: “When you’re talking to me in the first minute, I’m thinking—is this person a leader?” 

This highlights an enduring reality of startups. A leading cause of failure is people issues that begin at the top. This has been quantified in academic studies. According to research by the Harvard Business School, a survey of leading venture capitalists found that 65% indicated that bad management at the senior level was the major contributing factor for failure in high-potential startups. Surveyed venture capitalists consistently indicated in research dating back to 1989 that senior management is the critical ingredient that makes or breaks venture-backed businesses. 

People problems are the prime reason for startup failures and this includes tension between founders, management and employees as well as venture capitalists: “The reality is that founders are inextricable from their business and their attitude and motivations become the company culture. VCs place the highest importance on the founders when selecting investments. Founders were listed as “an important factor” by 95% of VCs, and as “the most important factor” by 47%.”

One of the reasons that poor leadership is so intrinsic to startup failure is that vision and passion are so essential to startup success. According to venture capitalist Eva de Mol:  “Startup teams that reported high levels of previous experience but average to low levels of passion and collective vision were overall weaker…Experience alone does not make a team successful—soft skills such as “entrepreneurial passion” and “shared strategic vision” are required as well.” 

Due to the uncertainty intrinsic to startups, the leaders of the organization must have the vision, communication skills and stature required to obtain “buy in” from the other members of the firm so as to navigate the difficulties that are sure to come. In the startup phase, one’s employees are not just paid staff, they are allies in a struggle that one may not win so it is essential that they believe not only in what the organization is building but also in who is in charge of the project. 

Startups are not just a job but a very personal activity for the founders and for the employees as well. Failure to understand this reality can be catastrophic. Indeed, 23% of startups surveyed indicated team issues as a leading cause of failure. In the world of startups, the absence of a vision or the inability to effectively communicate it in such a way as to motivate one’s employees to give their all is a major cause of failure. These are not just 9 to 5 jobs.

Bad management is always associated with failure in business but the impact is magnified in startups because they are inherently risky: one is trying to acquire customers from other well-entrenched actors in a competitive marketplace; and one is also trying to win the loyalty of employees who—if they are of high quality—usually have a number of options in the job market. 

As the saying goes: “People don’t quit their job; they quit bad managers.” In larger organizations, bad managers can be hidden by moving them, transferring them or paying them to leave. In resource strapped startups, this is typically not the case. What is a bad manager? Aside from the critical issue of making poor strategic decisions that undermine the viability of the organization—all businesses including startups should be results-based activities—bad managers have a number of characteristics that contribute to startup failure. 

Firstly, since passion and vision are so important, a bad manager is someone who lowers morale and reduces interest in the goals of the firm. Evidence of bad management may be demonstrated by the inability to retain good employees. In a startup, keeping track of retention rates for employees is as important as keeping track of retention rates for customers. 

Another characteristic of bad managers who contribute to startup failure is the inability to listen. The ability and more importantly the willingness to absorb information from disparate sources but especially other employees by listening to their feedback is intrinsic to being a good manager. Others may know what should be done as they are on the frontlines but only the manager is authorized to act so it is essential that the latter be willing to get the best information to do so instead of making poorly informed decisions. 

This is especially important in fast-moving technology markets such as those in which startups typically operate. An unwillingness to embrace the lessons to be learned from technical people about technology trends, sales people about what customers want, and financial staff about what the numbers are saying has been the downfall of many a startup—and it is all due to bad management. 

Likewise, managers who make decisions that are not logical or fair nor in the best interests of the organization but rather motivated by favoritism or personal animus are setting a startup up for failure. When people know that they will not be treated fairly, they will not be motivated to do their best for the startup. But surprisingly, this is part of the political reality of many business settings. 

Finally, the unwillingness or inability to trust other employees enough to relinquish control to them is a characteristic of bad managers and a prescription for startup failure. A good startup team from the managerial level on down is a collection of people who trust each other. When that trust is lacking, dysfunction will eventually set in and the startup will fail.

Bad hiring decisions are also a major factor in the failure of startups. 25% of startups fail because they did not hire the right team. Good founders are insufficient. A startup needs a robust group of talented individuals with diverse skill sets, perspectives and experiences. Those people should bring complementary skills to the table but they should also be united by their commitment to the vision of the company. 

They should have buy in with regards to the vision of what the startup is seeking to build. Cultural fit is key as it is imperative that the organization be cohesive. According to Peter Drucker: “Culture eats strategy for breakfast.” Likewise, very people have the skills to be leaders in every aspect of the company. The phrase: “Jack of all trades, master of none” is very much true. 

Thus, it is essential that the company have the humility to identify and recruit people with the technical and professional skills to flesh out the team as well as the perspective to challenge established assumptions while remaining committed to the firm’s vision. Finding these people, recruiting them and earning their support is very difficult which is why so many startups fail.

The team members that are essential to the success of the firm are not just those who are directly employed by the startup. Having poor stakeholders—affiliated actors such as strategic partners, investors and even suppliers can play a critical role in the failure of a startup. HBS Professor Thomas Eisenmann presents the example of Quincy Apparel, a startup whose mission was to provide young professional women with affordable and stylish work apparel that fit well. A factor that contributed to the failure of the startup was the shortcomings of its stakeholders, particularly its venture capitalists:

Quincy had some traction after two seasons but not enough to lure new backers, and the venture capital firms that had provided most of its money were too small to commit more funds. Furthermore, the founders were disappointed with the guidance they got from those VCs, who pressured them to grow at full tilt—like the technology start-ups the investors were more familiar with. Doing so forced Quincy to build inventory, burning through cash before it had resolved its production problems. In summary, Quincy had a good idea but bad bedfellows: Besides the founders, a range of resource providers were culpable in the venture’s collapse, including team members, manufacturing partners, and investors.

This is why the most important aspect of what the very best venture capital firms bring to startups is not capital but experience, connections and strategic guidance. Many startups fail because they have bad partners. A startup’s chances of success are enhanced by being connected to a great ecosystem that will support its development and maximize its ability to overcome challenges. 

The real value of the best venture capitalists is evident in their work with startups. The best venture capitalists and angel investors provide not just financing but sound strategic advice and a network of connections to support and steward the startup during the periods of vulnerability that it will experience. Even the choice of suppliers can be important as they can help an inexperienced entrepreneur to understand how best to navigate an industry and the best ones will think long term about how they can also benefit from the success of a startup. But it is imperative that the interests of all stakeholders be aligned and mutually beneficial. 

Startups & Finding Product-Market Fit

In the world of startups, poor product-market fit is a leading cause of failure. According to CBInsights, the lack of a market need (35%) or a product whose entry into the market has been mistimed (10%) or simply having a poor product (8%) are among the major reasons that startups fail. An example of a mistimed product is the Apple Newton which was a precursor to the iPhone, the first successful smartphone. Launched in 1992, the Newton was billed as a Personal Digital Assistant. It could take notes, store contacts, and manage calendars as many smartphones easily do now. The problem is that the handwriting software worked poorly and the 9 x 12 model was too overpriced--$5,000—to gain mass market traction especially with the technology problems. 

The technology wasn’t ready and the market was not ready or willing to pay that price. In 2007, that would change with the introduction of the iPhone. This is a dramatic example of a challenge that startups face. Sometimes the market is not ready to pay for the technology at a particular price point for it to be produced profitably and more manufacturing innovation is needed. 

A related issue with regard to product-market fit is not having a good business model to monetize the innovation. 17% of startups fail due to a lack of a clear, well-defined business model to enable the company to consistently generate revenues. 

For example, an underappreciated aspect of the success of Google is not just the power of the search engine that they developed but their ability to monetize its use with an innovative advertising model that has enabled the firm to generate billions of dollars in annual revenue by taking the data from each search and transforming it into highly targeted ads. This innovative business model is as much the key to the secret of Google as a business entity as their innovative technology.

Failure to Adapt

One of the reasons that startups are such a risky investment is that those that have the highest returns are often in fast-moving technology markets characterized by rapid innovation. In such markets, the inability to adapt to change is a leading cause of failure. According to a Harvard Business School study, 75% of venture-backed startups undergo at least one major pivot during their journey. 

The capacity and willingness to adapt instead of remaining stubbornly committed to a predetermined course of action is an essential survival trait for startups. The business plan must be consistently reassessed in response to new information just as agile product managers change product features in response to feedback from customers. 

This imperative to be adaptable must be balanced against the need to avoid a lack of focus: 13% of startups fail because they try to do too much at once. To minimize the chances of failure, an intelligent startup should focus on the effective delivery of one product or service, perfect it and only then consider expanding to other offerings. The key is to avoid spreading the startup too thin and consolidate support from new customers before exploring new opportunities.

Striking a balance between being adaptable to change but also remaining focused is very hard to achieve. It highlights a critical issue about startups. Sometimes they fail because they have too many founders. There are times when having too many founders can undermine the ability to adapt to change and remain focused because they inhibit the ability of the firm to be fast and nimble in decision making in rapidly changing markets. 

Speed of execution is critical in startups and the inability to make good decisions in a timely manner when one has less than ideal information can undermine the viability of a startup. Quincy Apparel provides additional lessons: “…the founder team wobbled in…[an] important way. First, unwilling to strain their close friendship, Wallace and Nelson shared decision-making authority equally with respect to strategy, product design, and other key choices. This slowed their responses [my emphasis] when action was required.” The key issue is the speed of response. Sometimes that speed can be slowed by conflict. According to Prof. Noam Wasserman, 65% of startups fail because of conflict among co-founders. 

Indeed, according to a study, solo founders are 2.6 times more likely to have success with a for-profit venture than three or more co-founders. In addition, solo founders are less likely to dissolve or suspend their business, with a 54% and 41% lower likelihood versus that of a three-person and two-person team respectively. While it is easier to share the burden of activities in a startup with multiple co-founders, unless mechanisms are in place to facilitate rapid decision making, the capacity of the firm to rapidly execute under duress will be compromised and it will fail.

Financial Challenges

Not surprisingly, money or the lack of it is a major factor in why startups fail. According to CBInsights, 38% of those surveyed indicated that they failed because they ran out of money. Indeed, there is a growing body of data that can predict the likelihood of startup success based upon the amount of funding raised in early rounds. 

For example, a seed investment of a minimum of $1.5 million seems to be an early predictor of company success. Those with less than that amount tend to not raise the additional funding needed to be successful in the long run. In addition, cash flow problems in general are a major factor in the failure of startups. 

In their earliest phases, startups need to have stringent control over the very scarce resources at their disposal. They cannot be profligate in any way. Cash flow problems are often the result not just of spending too much but of a failure to have strong financial systems in place to track spending and also identify areas where it is possible to get more revenue. Remember in business, profits are revenue minus costs so a profitable business will be able to maximize the former while minimizing the latter. 

This requires investments in financial control system so in effect, one has to spend money to make money. Finally, with regards to finances, the mismanagement of growth can contribute to the failure of a startup. 70% of startups fail due to premature scaling. When a firm begins to grow, additional financial pressures are placed on it and it must often spend more money to accommodate increased demand for its products and services. 

If it is unable to meet the financial requirements of increased growth, it will overheat and blow up from the stresses. It is important for the firm to steward enough resources to responsibly support its growth so that it does not overpromise and underdeliver to its customers and other stakeholders in its commercial and entrepreneurial ecosystem.

Poor Sales and Marketing

Sales and marketing are essential to all businesses, especially startups and neglecting this critical business function is a major reason that many startups fail. 14% of startups fail due to poor marketing. For technology-based startups this is actually quite natural because their proficiency with engineering and technology will typically undermine their ability to understand the human art of how to sell products and services. 

Yet, without customers, one cannot build a business. This is why it is so important to hire and properly incentivize a strong team of marketing and sales people. The challenges of sales and marketing can become even more profound at the enterprise level where there are long sales cycles and very demanding customers. This is where a good venture capitalist can be especially useful to startups as they often have the industry contacts and know how required to understand and facilitate the sale of the products in their portfolio.

Starting a new business is the most arduous, challenging but potentially rewarding activity in the commercial world. Businesses fail for so many reasons. This is why startups are risky and also why a highly specialized financier—the venture capitalist—had to be invented to aid in the building of these business. 

All of the factors that have been identified as contributing to the failure of startups can be mitigated in some way through a strong partnership between visionary entrepreneurial leaders—not managers but leaders—and venture capitalists who have the willingness and capacity to contribute far more than just money. The universe of such individuals is tiny which is why the success rate of startups will likely remain tiny for years to come.

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