The avoidable pitfalls hidden in plain sight
In short
Beyond a bad idea, team or timing we have to date had limited insights into why startups fail. Our research, which informs our approach as early stage investors in enterprise technology startups, shows that a surprisingly large number of ventures fail for avoidable operational shortcomings.
In this article we talk through this research and its implications. Strap in; this is a (slightly less than) ten minute read but well worth your time to understand how operational resilience can be nurtured in your venture or your portfolio.
In future articles, we will consider practical steps founders can take to avoid mistakes across six key operational domains.
So, why do they fail?
The fact that 9 out of 10 startups fail is pretty much received wisdom. And unlike some forms of received wisdom, there is plenty of research supporting this general proposition. However, there is surprisingly little publicly available data to understand why so many early stage ventures don’t succeed. There is some interesting work like this from CB Insights, which indicates (as matches intuition) that product market fit and team are two of the most important factors.
But what of the rest? Most interestingly, what was the cause of failure not accounted for by product market fit or team issues? In other words, what should one have an eye to in order to protect those ventures with good products and good teams? This is the question we set out to understand further, focused particularly on the enterprise technology start-up sector.
What we found will surprise some but ring true for others: 1 in 4 startups failed because of an avoidable shortcoming that had nothing to do with their idea or their team — it was the result of mis-steps in business building.
The research
Working with a team from Oxford University, we analysed over 100 enterprise technology start-ups that failed since 2000. Some of these firms had raised significant amounts of money. Between them, a total of over $3.6 billion was raised from external investors. But eventually they all failed.
It is important to pause here and consider what we mean by failure. Of course, common-sense plays an important role with these things, but for the purposes of our research we wanted to be slightly more precise. By failure, we mean the inability of the venture to reach a successful point for the founders. So an IPO is an obvious win, and an insolvent liquidation clearly a failure; a trade sale is likely a win, whilst an acquihire or fire sale a likely failure. For those grey areas, we defined a ‘success’ as achieving an exit (outside of an IPO) where the price was on average greater than 2X the valuation at which external investors invested. By this metric, in most cases the founders would receive some form of equity upside (although unlikely to be life-changing at a 2X returns level).
As an initial level of analysis, we first divided the failures into three broad categories: product market fit issues; business model issues; and operational issues. Product market fit is a topic of itself, but in this case it means: was there a problem that effected lots of potential customers and did the founders have a solution that those customers wanted? Included in this is timing — if the product was ahead of its time then one could expect the venture to struggle to find customers. By business model we are referring to those ventures that found customers and demand but were unable to scale the economics or leverage that demand to either capture value or secure value longer term in the broader ecosystem in which they operated. Finally, operations refers to the fundamental building blocks required of any venture as it scales. This aspect is discussed further below.
Primary reason for failure in enterprise technology startups
As you can see in the above figure, of the failed ventures we examined over half failed for product market fit issues. This is not unexpected; a great deal of time is spent with startups to help them explore the needs of customers and iterate their offering to match it. Indeed, many venture capital firms focus almost entirely on this issue as their value-add proposition for founders. Interestingly, 29% of them failed for operational reasons whilst for 20% the primary cause of failure was related to their business model.
The prevalence of operations as a cause for failure is significant, not least because of the fact that it is an area that, in general, is traditionally deprioritised by those supporting startups (including incubators, accelerators and early-stage investors). Focus on operations has long been considered the domain of later-stage private equity investment (where ‘operations’ is often used as shorthand for seeking efficiencies and overhead management). Our research suggests that attention must be brought to these matters sooner in the startup lifecycle; traditional later-stage techniques should be introduced to early-stage ventures.
Understanding the operational challenge of a startup
Each failed startup presented a telling case study, where missteps is business building can present an existential threat completely separate from the strength of the idea and customer demand for it. The internet is littered with the stories of founders. What has been missing is an aggregation of these lessons into common themes and patterns.
One of the challenges with operations as a term is that it is so broad. A common short-hand is this: anything in a venture that isn’t customer facing. That is, its the ‘back office stuff’. This kind of works, but underplays the importance and, again, the breadth of operations. To explore this, a second layer of our research focussed on the particular discipline(s) of operations that led to the startup failure. We categorised operations across six core areas: corporate governance; legal & regulatory; cyber & privacy; management information (MI) & operational processes; assets; and people (in the HR / operations sense of building and managing teams). It is often more than one element of operations at play, as founders struggle with learning which elements to prioritise and which can be postponed.
We will go into some detail across these six core areas in future articles.
Sense-checking the research
When speaking with participants in the startup ecosystem about our findings, we are most commonly met with nodding heads and agreement: often a great idea and a great team (on paper) don’t quite make it because a fundamental building block of a solid business was missing. This is a repeating challenge, and it makes sense; of the hundreds of ‘boring and basic’ things a founder must do to build a business from scratch, it can be hard to know what to do first. This is perhaps one reason that serial entrepreneurs have an advantage; they have learnt these lessons the hard way.
This repeating theme also speaks to some basic truisms of many entrepreneurs: by definition founders need to have a vision and a passion for the problem they are trying to solve. Oftentimes, the qualities that make them successful at creating that vision and drive are the direct opposite of the qualities needed to plan out and execute an efficient and scalable operation.
For a long time that has been fine. Build it now, fix it later is a mantra many in the startup community have been proud of. But that culture needs to change, particularly where (as is the case with enterprise technology) your customers insist on compliant, resilient and mature suppliers. No longer can operations be something to sort if you’re successful; resilient operations are needed to be successful.
What this means for your startup
What this data shows is that operations is important to a startup’s success, but also that operations is hard! Building a business that can efficiently scale to 1,000 customers when you only have one today can be a complex planning task. But there are steps that can be taken that aren’t resource intensive and that promote the right habits and hygiene that will be needed as a venture grows.
Importantly, this research shouldn’t have you demanding operational perfection from day one. The challenge is figuring out which of the hundreds of operations decision and actions that need to be taken in due course should be taken first.
One approach is to hire a COO or broader operations team early in your venture’s journey. However, this can be costly (in salary and / or equity). Another approach is to work with consultants to help you navigate the complexity … but this is costly and your investors won’t favour their capital being unnecessarily deployed on external consultants.
A third approach is to work with an investor, like Osney capital, who can support you in building operational resilience and has the tools, know-how, team and extensive networks to help you achieve it.
Osney Capital
Alongside our investment and the conventional support that you’d expect from a VC investor, we support our founders to develop early operational excellence in a way that doesn’t slow them down. We do this using our unique and data-driven operating model; supporting the companies that we invest in with the tools, support and access to networks to build robust foundations from which to scale at pace.
For more information on our approach and how to apply for funding, please visit www.osneycapital.com or contact apply@osneycapital.com.
Why startups fail was originally published in Osney Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.
