The reality is that a very high number of small businesses and startups fail. What you are working on now will statistically, most likely fail. Well done for getting this far. From those who have studied business failure in detail, the quantum of that failure is estimated anywhere between 75% and 90%+ of all businesses starting. The timing of when they fail depends on the circumstances of the business although there are some important trends.
The reasons for failure are complex and varied. In this article I will bring together all considered thinking into one place to present a holistic view.There is no one single answer as to why businesses fail. Also, different people have different viewpoints based on their own experiences. Experts working in the space, whether investors or entrepreneurs may even contradict each other on reasons for business failure. That’s not to say someone is wrong and someone else is right, just that why businesses fail is a very complex topic and there can be any permutation of reasons for ultimate failure.
I present the over-arching themes that you need to watch out for to give your business the best chance of success. This is evidenced by extensive research as well as guidance by authorities on the subject. You will look at some of the reasons for failure and think that it’s obvious that it’s a reason for business failure. But what this article will do is give you the context of why a particular reason causes failure. Often some of the bigger reasons of failure don’t just happen. Lots of small problems start to occur in the business first that lead to a large cataclysmic failure.
But even more than understanding potential causes of failure in your business are the things you can do right now in your business to have a better chance of success. If you are already running a business read on to see what sounds familiar and what you should do. If you are just starting out, identify what you need to get right from the outset.
This article will form the resource for you to understand how you can help your business succeed when all others are collapsing around you. Let’s begin.
1. What The Data Shows
Fortunately, a lot of research has been done all trying to understand more about why businesses fail. Given all businesses are different, it is important to review the results to identify what the research shows and to understand how we can use it.
1.1 Top 20 Reasons Why Businesses Fail
CB Insights published the most comprehensive recent research on 101 startup failure post-mortems to get beneath the surface of business failure. The chart below shows key findings.
Note: many businesses offered multiple reasons for their failure, hence why the percentages for each reason total more than 100%
Clearly there are three key reasons that resonated with founders of failed businesses more than most. Having no market demand, running out of cash, and having the wrong team are perhaps the most obvious reasons one would expect for a business to fail. Due to the complexity of business failure, unless you are unlucky, no one thing will result in the failure of your business. More likely, it will be a number of things that ultimately cause failure although it may start with one catalyst. Having said that, the three reasons at the top of this list above; lack of market demand, no cash, and poor team are likely to be the reasons that ultimately kill your business. That ultimate failure manifests itself in no market demand, no cash and poor team. Obviously understanding if you have a poor product doesn’t immediately alert you to the fact you have a problem. But if any of these areas are materially wrong, or if enough of them in tandem are not working, then you should be concerned.
Similarly, running out of money would kill any business. But if your business is burning up lots of cash or has pricing issues with customers then you can believe your business is at risk. Having a business model from day one is not essential for your business. In the early days you should be focusing on your product and market. But if no business model has been identified for a long enough period of time, then cash flow will increasingly be a problem for you to the extent that it is fatal. Inability to raise funding from investors will limit the cash runway you have and is a problem many businesses face. This in turn, limits anything else you can do with your business. That’s not to say you are dead and buried. It just means you need to change your criteria to have any chance of surviving in your current circumstances. I’ve previously written about when you look to raise funding from investors is an important decision to help increase chances of success. That advice should be revisited if you are still struggling with your financing.
The third most popular reason businesses fail according to CB Insights research is because they don’t have the right team. Many of the factors for wrong team are personal characteristics that can derail a business such as lack of passion and focus, and burning out through poor management. However, not fully utilising your resources such as your network and poor decision-making can also materially harm your business. Of course, disharmony in the camp will cause untold damage to your business.
Of course there will be some businesses for whom, based on their circumstances, having a legal challenge, for example, is the straw that breaks the camel’s back. But this is an operational risk feature in any business.
1.2 Fundraising And Why Businesses Fail
Running out of cash has already been cited as one of the primary reasons for failure. But what impact has funding raised had on business failure according to the research? The chart below shows that most dead tech companies raised less than $1m before they died. The median amount of funds raised is a better indicator of the funding failed businesses secured as it eliminates outliers. This research showed that dead tech companies raised $1.3m before failure. This makes sense in that startups are most vulnerable in the earlier stages when the proposition is still being formed and you are still trying to understand your customers. That initial level of funding of c.$1.3m for most startups is not enough to get to some meaningful milestone to encourage the investor to support you further.Stewart Butterfield, CEO of Slack which has itself raised $340m in funding, is amongst a large contingent of people who believe raising money for startups has never been easier. And so given that its not the case businesses aren’t getting funded, the problem seems to at the ‘continued proof’ stage for early stage businesses. Companies fail to achieve on set milestones which prevents investors from following up on their initial money. This is evidenced from the chart below.
After having secured funding, on average, companies survive around 20 months before dying. The above charts demonstrate in the 20-month period following a fundraising, businesses are unable to progress further in their development, so much so, that they are written off. This is a good example of how running out of cash would have caused the business to fail but the underlying reasons may be something else. For instance, not achieving a key milestone of securing x million users. If we iterated further using the Five Whys technique, we would get down to what is the root cause for the business failing.
1.3 Premature Scaling
In their analysis of 3,200 companies, Compass (formally know as Startup Genome) discovered that the principal reason businesses performed worse was because they scaled prematurely, that is, grew too quickly. These businesses lose the battle early by getting ahead of themselves in scaling their team, their customer acquisition strategies, or their product build. Key findings from their report highlighted the following reasons for success and failure of businesses as shown below:
- the right mentors significantly increase a business’ performance and ability to raise money
- businesses with solo founders take nearly four times longer to scale their business, and are less likely to see if their business needs to pivot, i.e. change direction, because something is not working
- businesses typically take two to three times longer to validate their market than entrepreneurs expect
Compass identified that 70% of businesses scaled prematurely from their sample of 3,200 and that premature scaling goes a long way towards explaining the 90% + failure of startups cited earlier. This prematurity is usually along one of five dimensions according to Compass: customer; product; team; business model; and financials.
I’ve highlighted examples below of what you need to look out for in your business as potential signs of premature scaling (data source Startup Genome).
- Customer premature scaling
- spending too much time on customer acquisition before product market fit
- overcompensating for missing product market fit with marketing
- Product premature scaling
- building a product without problem / solution fit
- investing into scalability before product market fit
- adding “nice to have” features or services to your offering
- Team premature scaling
- hiring too many people too early
- hiring managers instead of doer’s
- having more than one level of hierarchy
- hiring specialists before they are critical
- not hiring all-rounders
- Financials premature scaling
- raising too little money
- raising too much money
- Business model premature scaling
- focusing on profit maximisation too early
- failing to focus on business model and finding out you can’t get costs lower than revenue at scale
- over-planning, executing without a regular feedback loop
- not adapting your business model to a changing market
A big part of the development of the business model, which ties up a number of the other points outlined above, is around customer acquisition. Getting initial customers who help you develop a product that solves a pain point is one thing. But acquiring real customers is quite another. The point in the diagram above that reads “finding out you can’t get costs lower than revenue at scale” is an example that your customer acquisition cost is too high.
The customer acquisition cost is something that entrepreneurs grossly underestimate in their business. This is the cost for the business to acquire a new customer. Acquiring customer is not easy. Acquiring customers at a rate where the economics work is even harder. What do I mean by this? “Build and they will come” is a foolish strategy to grow your business and will very quickly be proven wrong. Customers won’t be banging down your door because you have a great product or service. Especially when you are trying to grow at scale. Given that the customer acquisition cost can be very expensive, having a customer acquisition strategy in place is sensible to help with this.
A customer acquisition strategy works on the basic principle that you need to acquire customers at a cost that is less than the lifetime value of that customer. The lifetime value is the projected revenue that a customer will generate during their lifetime. Firstly you need to calculate the lifetime value of your customers. This will then inform you about the right approach to attract new customers. That approach will be one where the customer acquisition cost is less than the lifetime value you have calculated. This is an important cornerstone for your business that will give you confidence that you are building your business in the right way. It will also ensure that you don’t get into problems with running out of cash due to excessive customer acquisition spend. Having a customer acquisition strategy in place is extremely important.
2.What The Experts Say
Data is great when we want to see what is happening statistically across a large pool of companies. However, expert opinion can be more insightful to bring some context and practicality to the issue.
Specialists on growing businesses such as Paul Graham, Guy Kawasaki, Marc Andreesen and Bill Gross know what they are talking about. They have worked in and supported some of the most well known businesses in the world. They are now advising businesses or funding them to success. Though some of their advice may seem contradictory, its important to note that it’s a reflection of their experiences and you need to put it in that context.
2.1 Paul Graham
Be willing to let your ideas change
As co-founder of Y Combinator, Graham has seen many businesses succeed and fail. And he has written extensively about the things that kill startups and small businesses. Graham focuses on a number of key points.
Principally Graham urges entrepreneurs to make something people want. This is at the core of business thinking and many have focused on the importance for a team to demonstrate that what they are developing is a need for the market they are targeting. The more compelling and urgent that need, the greater the chance of success. Graham underlines the importance of this test by sharing that one of the questions on application to Y Combinator is “what are people forced to do now because what you plan to do doesn’t exist yet?”
Another area where entrepreneurs suffer is in being stubborn. Graham says entrepreneurs need to “be willing to let their ideas change”. An example he gives is of Reddit who initially wanted to help people order fast food on their cell phones. A lack of enthusiasm led to the team launching the successful company as we all now know.
In his post on The 18 Mistakes That Kill Startups, Graham goes into some detail around a whole raft of things entrepreneurs need to be aware of to prevent business suicide. This post in itself contains numerous important nuggets you can refer to and immediately act upon and I encourage you all to read it.
Some of his more pertinent ideas are summarised below.
- slowness in launching – only by bounding ideas off your users will you fully understand it
- spending too much – don’t do it if you can avoid it
- half-hearted effort – the biggest mistake you can make is not to try hard enough
2.2 Guy Kawasaki
Always be cheap
Guy Kawasaki has seen and done it all so can bring a wealth of experience and insight to the topic of why businesses fail. Guy was kind enough to offer his views when I asked him and offered the following advice:
“Let’s assume that you and your team are smart and hardworking and addressing a reasonable market. This is a good assumption most of the time. Then the principle reason a business fails is because it runs out of money. Sounds like a “duhism,” but it’s not. As long as you have money, you’re still in the game. When you’re out, you’re out. So the thing to do is ABC: always be cheap. Unlike life, money buys time when it comes to business.”
As Kawasaki says, having money may sound obvious, but it’s more what having that money represents. The luxury of time for a business is immense – especially if things aren’t going right. Additional time leads to additional opportunities. Time gives you a further chance to improve the product, to convince customers, to pivot. Netscape and Open Market are two companies that went through several business models before finding one that worked. They could only do that because they had the cash to give them the runway to experiment.
Interestingly there is a good debate happening right now around burn rates at early stage businesses. Many have waded in to point out that startups need to keep their burn rates in check.
In a recent post on his own blog, Kawasaki talked about an approach entrepreneurs can use to improve chances of success. Conducting a pre-mortem by pretending your business has failed can prevent a post-mortem later. This is a process businesses can employ whatever stage your company is in. It ensures that teething problems don’t build into chasms later. This is one of many highly actionable strategies that Kawasaki talks about in his book, The Art of the Start 2.0.
Kawasaki offers more insight and guidance in a presentation he gave at UC Berkeley discussing the top 10 mistakes of entrepreneurs. The video is extremely informative and quite humorous too. I highly recommend you watch it.
2.3 Marc Andreesen
Do whatever is required to get to product market fit
Marc Andreesen is very vocal about what he sees as the rights and wrongs of the small businesses and startups. And he is strikingly clear on the reason he thinks businesses fail.
He has consistently written (and spoken) about the only thing that matters for a new startup is product / market fit (PMF). He summarises very well the trichotomy of team, product, or market as principal reasons for business failure. But he concludes that the best strategy for success is aiming for product / market fit. How? Put simply, he quotes Andrew Rachleff and says this is “being in a good market with a product that can satisfy that market.” Andreesen says that many startups fail before PMF ever happens – he believes they fail because they never get PMF.
Andreesen underlines the importance of getting to PMF by urging entrepreneurs:
“Do whatever is required to get to product/market fit. Including changing out people, rewriting your product, moving into a different market, telling customers no when you don’t want to, telling customers yes when you don’t want to, raising that fourth round of highly dilutive venture capital — whatever is required.”
That puts across quite strongly from someone who is an authority on starting, funding and growing companies, the level of focus that should be given to PMF if you want your business to succeed.
The point around high burn rates is something Andreesen picks up on again. Despite large fundraisings for many businesses, especially in the tech space, many companies are struggling to keep their heads above water due to grossly insufficient cash control. Andreesen offers the following advice to companies:
“Stay lean. It’s not going to be fun, but keep your business as small as possible. Keep the team as small as possible, lower the business’s budgets and maybe even consider cutting your own wage as the founder. This is definitely not the time to “look” like success — your work must speak for itself. Efficiency and turning a profit is the only way to look safe to investors.”
Cash control is a big theme coming through from all corners if you want your company to succeed.
2.4 Bill Gross
Timing is everything
At Idealab, Bill Gross has started more than 100 hundred companies with over 300 rounds of financing. And it is this experience that makes his insights so valuable. In a recent TED Talk, Gross shares the single biggest reason why startups succeed.
Through research that spans 100 Idealab companies and 100 non-Idealab companies Gross identifies the factors that affect the success or failure of a company the most. He looked at the following five factors:
- Business model
Timing accounted the most for the difference between success and failure of the sampled group.
Gross gives the example of Airbnb and Uber as companies that launched and offered many an opportunity for extra income during a recession. He gives good insight into the importance that timing played in making Z.com a failure because broadband penetration was too low in 1999 and a codec problem hindered progress. But a few years later these technology issues were overcome which led to YouTube being a massive success.
2.5 Shikhar Ghosh
Don’t go too niche (too soon)
Shikhar Ghosh is a senior lecturer at Harvard Business School. He has also held top executive positions at a number of businesses. Ghosh believes one of the principal reasons why startups fail is because founders (and investors) fail to look before they leap. He argues:
“Entrepreneurs tend to be single-minded with their strategies—wanting the venture to be all about the technology or all about the sales, without taking time to form a balanced plan.”
He reinforces a point made by Graham earlier that companies go too niche too soon. This causes issues down the line in not giving them room to manoeuvre and pivot if the initial idea does not hit the mark. He gives the example of Webvan to illustrate who bought warehouses all over the US before realising there was not enough customer demand for its grocery delivery service.
You’re probably starting to see that ensuring a business succeeds is a fine balance and requires a level of self-assurance to make the right decisions at the right time.
3. In The Word’s Of The Founders
Time and again one thing we continue to hear is that failure is good and something to learn from. Investors back entrepreneurs who have failed. They know that they are backing guys who bring with them the benefit of experience of knowing what it means to fail in a business. The lessons they learn are invaluable. This mitigates risk for an investor.
If you want to give your company a chance of surviving, benefiting from others’ mistakes is something you must do. I have compiled thoughts of entrepreneurs who give their thoughts on why their companies failed. Read on for a brief insight into the raw points that stick in their mind when they think back on their failed businesses.
3.1 Treehouse Logic
Treehouse Logic developed a product customisation platform that enabled easy creation of fast, guided, visual shopping applications. It was founded in 2009 and closed down in 2013.
We were not solving a market problem
“Companies fail when they are not solving a market problem. We were not solving a large enough problem that we could universally serve with a scalable solution. We had great technology, great data on shopping behaviour, great reputation as a thought leader, great expertise, great advisors, etc. but what we didn’t have was technology or business model that solved a pain point in a scalable way”.
3.2 Standout Jobs
Standout Jobs was a recruiting portal aimed at facilitating relationship building between mid-sized companies and job candidates. It was founded in 2007 and acqui-hired in 2010. The company raised $1.6m from a number of investors.
We didn’t have the validation needed
“I raised too much money, too early. We didn’t have the validation needed to justify raising the money we did. Part of the reason for this is that the founding team couldn’t build a minimum viable product on its own. That was a mistake. If the founding team can’t put out product on its own (or with a small amount of external help from freelancers) they shouldn’t be founding a business”.
Founded in 2006 and closed in 2009, Imercive was a social media marketing company that provided an instant messaging marketing solution to help brands create new channels for consumer engagement.
We stuck with the wrong strategy for too long
“I think this was partly because it was hard to admit the idea wasn’t as good as I originally thought or that we couldn’t make it work. If we had been honest with ourselves earlier on we may have been able to pivot sooner and have enough capital left to properly execute the new strategy. I believe the biggest mistake I made as CEO of Imercive was failing to pivot sooner”.
Submate was a social network for daily commuters headquartered in Paris. The company launched in 2010.
Quit your job, you need to be dedicated to your project
“My philosophy was to get as far as possible with a small seed round. To do this, I thought keeping my day job would allow me to spend the money wisely on product or marketing actions. Wrong. Quit your job (if you can), and get down to business. Period. You need to be dedicated to your project, meet people, talk about it, code and hack this sh*t out of it. At the end of the day, I was doing both things wrong: my day job, and my company”.
RewardMe was a real-time CRM solution for local commerce providing merchants with customer insights. It was founded in 2010 and closed in June 2015. The business had raised $1.1m.
Don’t scale until you’re ready for it. Extend your cash runway as long as possible
“We were funded, had a working product, clients, and revenue. On the surface, it seemed like we were growing fast and moving toward the right trajectory. Within 2 years, we had grown tremendously, but that growth ultimately killed us. Don’t scale until you’re ready for it. Cash is king, and you need to extend your runway as long as possible until you’ve found product market fit”.
4. The Psychology Of Business Failure
This graph quite nicely shows what working in a early stage business is like. Many companies do not get past the trough of sorrow and die. However others do make it past this phase. The important thing this curve shows is that the fall off that occurs (“wearing off of novelty”) is quite a common occurrence in early, small businesses. The trough of sorrow that follows this can be quite a long phase. But the success that follows for those who persist is what we all work towards.
4.1 Mental Preparation
Consequently, in addition to everything discussed up until now, one thing this curve demonstrates is that being mentally prepared for this rollercoaster is also what separates the successes from the failures. In trying to understand why companies fail and prevent it, we need to address psychological challenges that may surface. The novelty wearing off may be too much for many entrepreneurs and in their short-sightedness, they may pack their bags.
Those who persist past this phase may get depressed with the trough of sorrow where you do not seem to be moving forward at all for long periods of time leading you to call it a day. The fact this phase is followed by the “crash of ineptitude” is even more disheartening. But the purpose of me showing you this curve is that persistence is an important characteristic, which is also a contributor to the success or failure of a company.
Now, that’s not to say that you should continue with your business on a prescribed strategy regardless. You need to try new things and give them some time. Exactly how much time you give any new changes may be determined by the runway you have. But understanding the personal characteristic and psychological influences on business success or failure is extremely important.
Tom Eisenmann, Professor of Business at Harvard also argues that entrepreneurial success depends a lot on the founder’s mastery of psychology. Suggesting that the entrepreneurs flawed ego is the root cause, the arena of doubt that plagues many entrepreneurs works to magnify an already precarious situation.
The consideration this needs to be given by you is underlined by an article that was published in the 80’s but still referred to today called The Dark Side of Entrepreneurship. This article chronicles important challenges faced by all entrepreneurs that they need to grapple with in order to succeed. In particular, the article warns against traits such as distrust and overt control.
4.2 Grit And The Growth Mindset
Getting demoralised is a key reason for business failure. Three psychological traps are typically spoken about that keep startups in the trough of sorrow; giving in to despair; obsessing blindly; and becoming fearful.
Psychology professor Angela Duckworth says
“If you’re myopic and only look at the next moment in time and you base your decisions on ‘what am I going to get out of this in the next nanosecond?’ . . . then when you hit a plateau, your natural conclusion is to quit and move on to the next thing.”
This is known as the plateau effect and grates against progress. It is similar to the concept of diminishing returns in that results are marginally decreasing for marginal increases in your effort.
In a TED talk she gave, Duckworth talked about grit as being the key to success. Calling it a “significant predictor of success” Duckworth defines grit as the “passion and perseverance for very long term goals”.
The trough of sorrow in particular, is an area in your company’s lifecycle where you will undoubtedly have to demonstrate grit to give your business the best chance of success. However, in empirical terms, grit is a relatively new concept. However, work done by Professor Carol Dwek of Stanford University suggests that having the “growth mindset” can help to achieve greater success.
The growth mindset is predicated on the fact that the ability to learn is not fixed but can change with your effort. It puts out there that failure is not a permanent position, (proven through experiments with kids). As an entrepreneur, having this mindset will assist greatly to get through the trough of sorrow.
4.3 Self Awareness
Jerry Colonna is an independent life and business coach who works with businesses and has worked as an investor previously as well. As such, no one understands the strains of starting a business more than him. Colonna has previously spoken about the six biggest mistakes founders make.
He mentions key areas of concern such as, for example, deluding yourself and your team, not understanding the role of the CEO and being ambiguous. His views on the mistakes of founders are a good example to understand pitfalls and how to manage yourself for the success of your business.
Ultimately, there will be a lot that determines why businesses fail separate from the product, or the customer or the amount of money in the bank. As you will have seen from everything I’ve discussed, important decisions need to be made everyday for your business. These decisions determine the fate of the company.
I hope this article has gone some way to help you identify the things you need to think about to make your company a success. Having a successful business is typically the result of doing lots of small things right rather than getting one big thing wrong. Follow the advice in this article and make sure you get the basics right (listening to your customers, managing cash burn, and hiring wisely) and you will automatically increases the life expectancy of your business.
Being self-aware and showing resilience (i.e. grit), especially as a leader of the business, will also be a determining factor. It is through your self-awareness that you can hire the right people to complement your weaknesses. That same self-awareness can help you make decisions on the data when needed vs. making gut based decisions because that is in the longer term interests of the company. Part of showing resilience is having the awareness to really know that a business is a rollercoaster. Stick with it but don’t be afraid to change things if its not working.
If you are aware of the warning signs and implement the steps I have outlined above, you can vastly increase the odds of success for your company.
To assist you further, I have created a free guide on how to ensure your company survives in the early stages of its life, which you can download below.
Email to let me know what you think and also share this on social media if you think anyone can benefit from it.