Three main reasons for startup failure

Peter Drucker, also known as the founder of modern management, said that “if an organisation is not able to innovate, it faces decline and extinction.” Nowadays, in this era of fast-paced change, new technologies and disruption, this remains true. Innovation is one of the key drivers for business creation. Only those who are able to innovate can survive and thrive in the business world.

Due to the high risks, innovations are usually commercialised via startups. The increasing number of startups being launched every day all over the world that are successful and impactful attests such statement. Nevertheless, even though stories of success, fame and wealth are highly publicised, many startups fail.

This should not come as a surprise. The risk/reward ratio is extensively used to compare the expected returns of an investment with the amount of risk undertaken to capture these returns. Simply put, in order to reap higher rewards, one must undertake more risk. Thus, not surprisingly, for every startup success story, there are several others of failure.

However, in the business world, there is a risk threshold any capable person is willing to take. Sure, there will always be unknown variables over which we have no control or knowledge, but, similarly, by preparing, analysing and assessing in advance several uncertainties can be mitigated or, at least, minimised.

For this reason, among others, not only entrepreneurs, but also corporates, investors, economic development folks, academics and journalists want insights on what the reasons startups fail are and, more importantly, how to avoid them.

Wrong team

One of the success factors most commonly mentioned as being critical to the success of a startup is having a good and diverse team. In fact, 23% of failed startups referred wrongly choosing the team members to run the business as the main reason for startup death. The team is the driving force making the founder’s vision a reality.

In these cases, founders and the team initially recruited to develop the venture do not have the skills, experience, culture fit or vision/purpose required. Wishing one of the founders had a specific skill-set they do not currently possess, identifying that the founding team was not able to, independently, or with a small amount of external help, build an MVP (Minimum Viable Product), and recognising that another founding partner should have been engaged in order to balance people out are only a couple of the factors leading to failed entrepreneurial teams.

Some effective tactics in avoiding this mistake are to thoroughly identify the requirements and expectations for each position within the startup, use a good recruitment agency, recruit people matching the requirements listed, provide appropriate training, develop an effective compensation and a benefits scheme, and build an inspiring company culture, among others.

A curious and somewhat worrisome trend, even though still not very significant, are cases where it is uncovered that the team is responsible for financial discrepancies or other activities or operations on the fringes of the law.

Running out of money

Roughly 29% of startup deaths are due to running out of money. To be clear, this does not necessarily mean a lack of capital invested in the project. A startup can run out of cash due to several reasons, such as lack of planning or underestimated assumptions about the projected cash flow, both the short and the long term.

Steady and healthy cash flow is key for the proper functioning of a business. In order to avoid this, founders should develop a pessimistic financial statement and assume it to be true, calculate the initial capital required carefully, seek support from appropriate professional (accountants, consultants, angel investors, etc), and plan exit scenarios and thresholds, among others.

Building stuff no one wants

Entrepreneurs tend to focus on interesting problems to solve or on their own interests. Even though this is an interesting technique to boost passion and dedication to the new venture, 42% of startup deaths are due to focusing on these issues rather than serving a market need. Entrepreneurship is all about finding a way to solve a pain point in a scalable way.

Offering products or services that the market is not interested in buying at scale and/or repeatedly leads several startups to death. Additionally, often the market is not convinced about the value of the offering or is already buying it from a competitor with a better offer.

To avoid this common drawback, entrepreneurs must prepare a thorough business plan from day one, identify the weakest assumptions and prepare prevention and contingency plans accordingly. Similarly to what I previously argued, hiring appropriate professionals (consultants, accountants, etc) is also an effective tactic in avoiding this pitfall.

What else?!

These three factors are, undoubtedly, those contributing the most to startup failure. Nevertheless, these are not independent and are often tied to other reasons for failure.

Curiously several other start-up failure drivers are directly related to those mentioned above. For example, having a user un-friendly product and ignoring customers — factors leading to startup failure in 17% and 14% of cases — are directly related to offering products the market is not interested in.

In fact, most entrepreneurs fail on their own fault. From the top 20 factors leading to startup failure, less than 3 are due to external factors. In order to help entrepreneurs be more successful, it is important to focus on the development of their own skills, especially concerning the factors that, historically, have led most of them to failure.

Next time an aspiring entrepreneur tells you that there is no money available for entrepreneurs out there, come back to this data. It is really important to clear up some misconception and focus on the most essential.

Entrepreneurship is a well-recognised driver of economies and, for that reason, experts, business and political leaders, as well as scholars, argue it is a priority to foster an entrepreneurial culture. Concurrently, entrepreneurship education, which is a life long process, is key to prepare youth and adults for an entrepreneurial economy. Therefore, a significant investment in entrepreneurship education must be made and the proactive participation of the whole community, education system, government and businesses is required.

From my end, I have taken this seriously and invested a big amount of my time in giving visibility to entrepreneurship education, mentoring first-time entrepreneurs and producing content (hopefully engaging) about it. Through my consulting practice and mentoring activities, my collaboration with universities in providing entrepreneurship education together with more traditional curricula and my blog, I intend to help build this culture in Europe. What about you?