Business analysis: Reasons why start-ups fail

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Most start-ups don’t succeed.

More than two-thirds of start-ups never deliver a positive return to investors.

Why? If you have talked with any venture capitalists, you may be familiar with the “Horses and jockeys” metaphor. The “horses” refer to the opportunities start-ups are targeting, and the “jockeys” are the founders. Both are important, but if forced to choose, most VCs would favor an able founder over an attractive opportunity. Consequently, when asked to explain why a promising new venture eventually stumbled, most are inclined to cite the inadequacies of its founders – in particular, their lack of grit, industry acumen, or leadership ability. 

Putting the blame on the founders oversimplifies a complex situation. It’s also an example of what psychologists call the fundamental attribution error – the tendency for observers, when explaining outcomes, to emphasize the main actors’ disposition and for the main actors to cite situational factors not under their control – for example, in the case of a failed start-up, a rival’s irrational moves.

Putting scapegoating aside, there are usually 2 patterns of failure.

Good idea, bad bedfellows

VCs look for founders with the right stull: resilience, passion, experience leading start-up teams, and so forth. But even when such rare talent captains a new venture, there are other parties whose contributions are crucial to it. A broad set of stakeholders, including employees, strategic partners, and investors, all can play a role in a venture’s downfall.

Indeed, a great jockey isn’t even necessary for start-up success. Other members of the senior management team can compensate for a founder’s shortcoming, and seasoned investors and advisers can likewise provide guidance and useful connections. A new venture pursuing an amazing opportunity will typically attract such contributors – even if its founder doesn’t walk on water. But if its idea is merely good, a start-up may not become a talent magnet.

Some start-ups begin with a good idea. The venture’s value proposition can be very appealing to target customers, and the business may have a sound formula for earning a profit – at least over the long term, after shaking out the bugs in production. But they still fail. Is this because their founders are poor jockeys? Not necessarily. 

A start-up founder team may only have 1 or 2 individuals. The employee and investor teams may consist of many people. And those people can create, sometimes even bigger than the founders can, a big impact. For example, most founders tend to have no expertise in the industry their start-ups reside. And they hire veterans in the industry, assuming that they’d fill multiple functions – as jack-of-all-trades team members do in most early-stage start-ups. However, the fact is that most employees are not flexible about tackling tasks outside their areas of expertise.

Investors, too, can play a role in a start-up’s demise. Investors may sometimes force the founders into directions that do not align with founders’ strategies. This is very likely to happen when the investors are investing in an industry that they are not familiar with.

In summary, start-ups with a good idea but bad bedfellows are doomed to failure. Beside founders, a range of resource providers are culpable in the venture’s collapse, including team members, business partners and investors.

False starts

The lean start-up approach, a methodology for developing businesses and products that aims to shorten product development cycles and rapidly discover if a proposed business model is viable, is well loved by most start-up founders and VCs. However, many entrepreneurs who claim to embrace the lean start-up canon actually adopt only part of it. Specifically, they launch MVPs and iterate on them after getting feedback. By putting an MVP out there and testing how customers respond, founders are supposed to avoid squandering time and money building and marketing a product that no one wants.

Yet by neglecting to research customer needs before commencing their engineering efforts, entrepreneurs end up wasting valuable time and capital on MVPs that are likely to miss their mark. These are false starts. The entrepreneurs are like sprinters who jump the gun: they’re too eager to get a product out there, the rhetoric of the lean start-up movement – for example, “launch early and often” and “fail fast” – actually encourages this “ready, fire, aim” behavior.

But there’s more to the lean start-up approach than those practices. Before entrepreneurs begin to build a product, they must complete a phase called “customer discovery” – a round of interviews with prospective customers. Those interviews probe for strong, unmet customer needs – problems worth pursuing. Failing to conduct up-front research to validate the demand is an incomplete lean start-up approach.

Why do some founders skip up-front customer research? Entrepreneurs have a bias for action; they’re eager to get started. And engineers love to build things. So entrepreneurs who are engineers often jump into creating the first version of their product as fast as they can.

This problem is not specific to engineers. Founders without technical training also fall victim to false starts. They hear repeatedly that having a great product is crucial, so they bring engineers on board as soon as they can. Then, feeling pressure to keep those expensive engineers busy, they rush their product into development.

Maintaining balance

Of course, there is no way for founders to know which deadly trap they may face as they launch. Familiarizing oneself with these 2 dominant failure patterns can help. But so too can understanding why they afflict start-ups so frequently.

Part of the answer is that the behaviors that conventional wisdom holds make a great entrepreneur can paradoxically increase the risk of encountering these failure patterns. It’s important for an entrepreneur to maintain balance. Guidance based on conventional wisdom is good – most of the time – but it shouldn’t be followed blindly. Consider the following advice given to many first-time founders and how it can backfire: 

  • Just do it! Great entrepreneurs make things happen and move fast to capture opportunity. But a bias for action can tempt an entrepreneur to truncate exploration and leap too soon into building and selling a product. When that happens, founders may find themselves locked prematurely into a flawed solution.
  • Be persistent! Entrepreneurs encounter setbacks over and over. True entrepreneurs dust themselves off and go back at it; they must be determined and resilient. However, if persistence turns into stubbornness, founders may have difficulty recognizing a false start for what it is. They likewise may be reluctant to pivot when it should be clear and their solution isn’t working. Delaying a pivot eats up scarce capital, shortening a venture’s runway.
  • Bring passion! A burning desire to have a world-changing impact can power entrepreneurs through the most daunting challenges. It can also attract employees, investors, and partners who’ll help make their dreams a reality. But in the extreme, passion can translate into overconfidence – and a penchant to skip critical up-front research. Likewise, passion can blind entrepreneurs to the fact that their product isn’t meeting customer needs.
  • Bootstrap! Because resources are limited, entrepreneurs must conserve them by being frugal and figuring out clever ways to make do with less. True enough, but if a start-up cannot consistently deliver on its value proposition because its team lacks crucial skills, its founders must decide whether to hire employees with those skills. If those candidates demand high compensation, a scrappy, frugal founder might say, “We’ll just have to do without them” – and risk being stuck with bad bedfellows.
  • Grow! Raid growth attracts investors and talent and gives a team a great morale boost. This may tempt founders to curtail customer research and prematurely launch their product. Also, fast growth can put heavy demand on team members and partners. If a team has bad bedfellows, growth may exacerbate quality problems and depress profit margins.


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