The #1 Reason Startups Fail — One Angel’s Perspective
#1 Reason Why Companies Fail
It is a commonly accepted rule of thumb among angel investors that 50% of all investments in early-stage companies will fail — the issue is knowing “what 50%?” After a career in Enterprise IT and 12 years as an angel investor I am no closer to knowing what the outcome of an investment will be at the point of writing a check. However, thanks to the multiple failures I have witnessed first-hand, I do believe that I am in a better position to spot potential problems, than I was when I made my first investment. During that time, I have seen one issue wreck companies more than any other.
TL;DR: It’s the people.
When advising companies, I often tell founders to think of their venture as a line of dominos that need to fall over in a predefined pattern when the first is tipped. With too much space between the dominoes the pattern stops. With insufficient space the dominoes do not fall correctly and pile-up. A slip when setting the dominoes out and a section of the pattern will get destroyed. However, when each domino is correctly aligned and the first tipped, a successful company is possible. I then tell the founder to think of each domino as a person. Do they have the correct person in every position? If they are hiring, what qualities do they need for the person to be an effective part of the overall team? A bad or missing team member, or the wrong new hire can stop the company from reaching its potential — just like the pattern of dominoes.
Clearly this analogy is an oversimplification. A recent report by CB Insights (download here) indicates that “running out of money” is the #1 reasons why companies fail, but to me this is a symptom as opposed to the root cause. There are many reasons why companies fail, but nearly all involve running out of funds. For example, one of the most unfortunate examples I have seen is a friend of mine who founded a very exciting FinTech company. They had two major financial institution as their pilot customers. The customers loved their product, the company was growing and, well, everything was wonderful. That was until the day when their two poster child clients (which accounted for almost 80% of their revenue) merged, and put all non-essential IT spend on hold. In an instant the company went from fast-growth to fighting for survival — there are some things you simply can’t legislate for. However, in my experience situations like this are very much in the minority, and I have seen many more companies fail because of people problems, leading me to believe that every business is a “people business”, and urge founders to put people at the center of their plans.
I know this from personal experience. I was a founder of a start-up ten years ago. Our MVP was successfully created with a tight group of experts. We had big plans, we were well funded, so we went on a hiring spree. And that is where we went wrong — badly wrong. We confused quantity with quality and nobody took responsibility for rigor in the hiring process, induction or training. We were too busy charging forward. With the wrong people in the wrong jobs, cliques of developers formed, pulling in different directions. Our productivity hit a wall, quality fell apart, we became inwardly focused, and the company ultimately failed. At the time a friend of mine made me laugh by saying, “you guys were working on your Oscar acceptance speech before the first scene had even been shot”. But in retrospect it was people issues, not technical, sales or market-related problems that caused our downfall, and, as the management team, those people issues were our responsibility. As Jack Welch (former CEO of General Electric) once said:
“When you were made a leader you weren’t given a crown, you were given the responsibility to bring out the best in others.”
We didn’t pay sufficient attention to the people. We hired the wrong individuals and we didn’t put them in a position where they could succeed, and as a result we failed.
This taught me that recruitment is such an important part of growing a business. Consequently, when hearing a start-up pitch, I am always interested who will be their first hire post-funding, as a mis-step at this point can kill the company. I saw this with a founder who went to make his first big hire — his VP of Sales. The successful candidate came well recommended, had an impressive resume, deep rolodex, but proved not to be a cultural fit. This one hire caused a near-death experience and forced the company into a pivot. Today the company is once again growing but they have lost 6–12 months in a competitive market. If they had made the correct hire, they would be in a much better position today.
A previous boss of mine had a theory that you need to put people in a position where they could fail — otherwise you do not know their true potential. I very much agree with this, but it is essential that all possible safety nets are put in place to ensure that people do not fail. And this can be the problematic part, partly because people can do irrational things that no safety net can prevent. I am currently invested in a zombie company, whose revenue has not grown in the past five years. The founder of that company refused the opportunity to raise badly needed funds, because any further raise would have diluted him below 50%, and his growth came to a screeching halt. None of his investors envisioned such a situation, so consequently no mitigation or “safety-net” was deployed.
Similarly, a colleague of mine at New York Angels was drafted in as interim CEO because the senior management were not on speaking terms. After the experience he declared that his young niece showed more maturity than the exchanges between the managers. Again, it is very hard to plan for a non-functioning management team. People can be highly unpredictable.
From an investor’s perspective the problem is much greater if the leader is part of the people problem. I once invested in a software company that raised millions of dollars of funding over several rounds. The CEO was very credible on her feet, passionate about her vision and all of the investors sincerely believed that she would succeed. Consequently, when it came to status reporting we all very much wanted to believe that things were under control, giving her the benefit of the doubt. Alas, this was not the case and the company failed. Now, would the company have succeeded with a CEO with more focus on financial reporting and internal rigor? It is impossible to say, but it certainly would have made much better use of the two rounds of funding it took to realize that we had the wrong person running the company — shame on us, but the lesson is that people matter, and the top person matters the most.
Tom Siebel (latterly of Siebel systems and now of C3), speaking at Princeton University several years ago, gave, what I consider to be the best explanation of why people are critical to a business. He pointed out that the business problem that any start-up is addressing will change over time. Also, the technology that is being used will evolve. Consequently, if the people that are hired must not only be able to cope with a changing business environment but also a different technology landscape. If they can not, then the company is relying upon the wrong people, and is doomed to failure.
Fortunately, the flip-side is also true — high-quality, flexible founders can make all the difference between success and failure. This was demonstrated to me by a nascent mobile technology company. When the initial idea failed to take off, the founders instantly pivoted. Unfortunately, that pivot was also unsuccessful. So, recognizing their predicament, and taking control of the situation, the founders were able to sell the assets and deliver a 2x return to their investors. I am convinced that I only received a return on my investment because of the timely actions of the two founders.
This brings me to my ultimate conclusion that, in my experience, the primary reason why companies fail is down to its people. By assembling a team of passionate, skilled, like-minded individuals, and putting them in a position where they can all succeed, wonderful things are possible. Success for the founders and a positive return for the investors. Unfortunately, too often this is not the case, and the row of dominoes refuses to fall.
