Aiming for a Black Swan

by Daniele Diab

If failure means shareholders losing most or all the money they invested, then the failure rate for startups is 35%. If failure refers to failing to achieve the forecasted ROI, then the failure rate is 75%. Finally, if failure is defined as not hitting a projection, then the failure rate is greater than 90%. “Failure is the norm”, concludes Shikhar Ghosh, senior lecturer at Harvard Business School.i

It is therefore important to understand the reasons for failure.

Reason #1 – Market issues such as the entrepreneur builds a vitamin and not an aspirin.

One of the major reasons for failure is that there is no market or little market for the product that is built. This can be translated into the fact that the total market size is actually not large enough or that the value proposition is not attractive enough for the target buyer to convert to purchasing. It could also be explained by bad market timing: the market might not be mature enough to accept a particular solution. As an entrepreneur, you therefore have to always ask yourself: “Why this product? Why now?”

Reason #2 – The entrepreneur fails to effectively test the underlying business assumptions.

Startups frequently fail because of the lack flexibility of the entrepreneur to change direction when needed due to psychological biases such as optimism bias or confirmation bias such that people have a tendency to interpret information in ways that validate their hypotheses rather than assess them in an objective manner. Additionally, they can be fooled by sunk cost fallacy considering expenses that have been incurred and cannot be recovered. These factors kick in and blind entrepreneurs in ways that prevent them from realizing that some base assumptions of their business are false or from factoring in objectively the market feedback they receive. This in turn leads to a late or no pivoting resulting in an eventual failure.

Reason #3 – Too much funding! Yes, not too little, but too much funding!

Too much funding is one of the main problems that lead to startup failure. Running fat covers up all the problems and critical issues that a company faces, giving room for errors and mistakes. Too much funding also makes it more difficult to create a sense of urgency at the company level allowing management to focus on things that are not necessarily important catering to a market that they think they could predict rather than focus on the current state of the world. Furthermore, too much funding often results in inefficient hiring where the benefits of having a small team are lost and communication and iteration become more complicated tasks. In the article “Being fat is not healthy,” Fred Wilson explains that “…the success rate of fat companies versus lean companies is stark. [He has] never, not once, been successful with an investment in a company that raised a boatload of money before it found traction and product market fit with its primary product”.

But let’s not be discouraged by these numbers… Let’s keep shooting for the stars, aiming big and high, though leaving some room in the back of our mind to remember the top reasons for failure, keeping them on our watchlist and trying to avoid them to best set ourselves up for a Black Swan event.

i Why Companies Fail—and How Their Founders Can Bounce Back, Carmen Nobel, March 7th, 2011