CHAPTER 1
COUNTING THE COST
More than 100 million startups are founded every year (that's about three every second), but 92 per cent of them will fail within three years - and the crazy thing is that this is largely preventable.
Just think about that for a second. In any other area of your business or personal life, if 92 times out of 100 a course of action didn't work, you'd think of doing something quite different. Yet in the startup world these high failure rates are accepted with a shrug, because 'that's how it is'. Why?
This book aims to challenge that acceptance. Failure shouldn't be the natural way of things.
We need to study startup failure more closely to understand why it happens. That's what struck me when I started investing in startups. If we can better understand why and how startups fail, then we can increase the chances of their success. By learning from others' mistakes, we can ensure we don't repeat them. If we can move the needle to decrease the failure rate by just a small amount, it will have a huge impact - both to the founders who put their heart and soul into their startups and to the investors who back them.
Paul Graham, the respected venture capitalist and co-founder of Y Combinator, distinguishes between startups that are default dead (if they maintain their current trajectory on sales, growth rates, expenses, they will run out of cash) and those that are default alive. The reality is that most startups, especially in the early stages, are default dead. Many founders don't even ask this question, or they ask it way too late. Graham goes on to describe the 'fatal pinch', where a startup is default dead, unable to raise the cash to survive, essentially the 'walking dead'. The founders are deluded into thinking they can raise more cash, but they are essentially in a death spiral. Raising capital is by no means easy or certain, and even for those who do manage it, fundraising success does not equate to future success. Especially if the company is default dead.
Default alive, on the other hand, means a startup is at or heading to break-even and can survive and thrive on its available cash. These businesses have a viable future, and can move on from thinking about fundraising to thinking about growth and new prospects. I want to help founders think about the default state of their startup, and to consider why and how it could fail.
THE CULT OF FAILURE
Failure is a word you hear a lot in the startup community. The term fail fast is associated with the lean startup movement, which is very well articulated by Eric Ries in his book The Lean Startup. However, I believe the term is much overused in the startup community and indeed misunderstood by many founders and their teams.
Behind the lean startup is the concept of iteration. The idea is that if a new product proves to be unsuccessful, the business should let it fail fast, after which the product can be iterated based on customer testing and feedback. You develop a minimum viable product (in which you invest the least expense needed to make it workable), and you test it with customers. You iterate and improve it, then repeat the cycle.
It is a sensible approach, but it is often misunderstood by founders. What Ries is talking about in The Lean Startup is a robust approach to product development and a way of validating product/market fit. Let's get some customer feedback, then we'll test, iterate, test, iterate, and we'll go through that product cycle. The challenge is that founders often misconstrue the fail fast idea by applying it at the company level.
Ries doesn't mean that your startup should fail. He is talking about iteration and customer feedback loops at a product level. The startup community gravitates towards these catchphrases and sound bites that don't mean much outside their proper context. Your startup still needs a plan.
I'm all for developing a learning culture inside a startup and truly practising the ideas behind the lean startup, but I want to define the difference between good failure and bad failure.
SELF-HARM: GOOD FAILURE VS BAD FAILURE
Most founders think about failure as an 'external' event - something that happens to you, causing you to fail. More often failure is an 'internal' event. It's about self-harm: you are doing something or not doing something that causes you to fail. Sadly, most startups fail from the inside.
The insight here is recognising that it's not about karma or fate. Most startups are disruptive to some extent: it is they who are delivering external competitive pressure to traditional businesses, not the other way around. Most startups are not disrupted by someone else - they implode. And guess what? That's great news, because it means you can develop a plan and take action yourself to avoid failure.
Later I will discuss the 10 main reasons why startups fail. Every single one of those reasons can be prevented. There is a belief that startups defy gravity. We have this twisted idea that startups are somehow special, but the truth is this: a startup is no more special than any small business. If I intended to start a small business such as a bakery or a café it would be reasonable to be asked, 'Do you have a sales plan? Do you have a marketing plan? Have you thought about where you're going to locate it and the demographics of your customers?' Many startup founders, however, think they don't need a plan. They are just going to 'fail fast'. No shit. The startup myth perpetuates the view that gravity does not apply to them. In fact, they need all the planning and execution that any small business needs.
PLACE YOUR BETS: THE VENTURE CAPITALIST APPROACH TO FAILURE
Venture capitalists (VCs) understand very well the risks associated with investing in technology startups and have developed a simple but effective approach to managing that risk. The conventional VC approach to risk mitigation is to invest in a broad portfolio of startups. VCs traditionally came from finance backgrounds. Before and during the internet bubble, they funded startups with little understanding of the companies or business models they were investing in. They knew there were high failure rates, and their approach was 'let's just lay a lot of bets'.
The premise was if 92 out of 100 startups fail, then put down 100 bets and the eight successes need to pay off big enough to make up for the failures (and they did). In a world of unicorns, the eight paid off at rates that were so high that it made the 92 failures insignificant - except to their founders.
It was a reasonable strategy from the VC point of view. Let's just lay out a whole lot of bets, assume that 92 of them are going to fail, and make sure the eight are unicorns.
Today VCs are far more sophisticated. They are more involved with the companies they invest in (many of them are former entrepreneurs and startup founders), and far more interested in examining the reasons for failure and mitigating them. If you look at the problem from a venture capital perspective, there's an absolute economic reason to improve the success rate of startups - investor return. More success equals more money for everyone.
That said, a lot of investing behaviour, particularly at the early stage, is still very much influenced by what I call the slot-machine effect.
THE SLOT-MACHINE EFFECT
Human behaviour is a funny thing, especially when it comes to payoffs. Everyone knows that you can't win at the slot machines, that they are wired and programmed for you to lose - casinos were not built by the winners. Everyone knows the statistics, but people play them anyway. Imagine 100 people playing slot machines; 92 of them pull the handle, and 92 lose their money. Then eight people sitting near them pull the handle and make a billion dollars. Human behaviour doesn't look at that in a rational, statistical way.
It's the same reason people play the lottery. Even though people know the chances of winning are minuscule, the jackpots are so enormous that they create a reality distortion field. People don't think rationally about the losses.
When people see an Uber, a Facebook, an Instagram or an Atlassian - all high-profile startups - they put them on a pedestal. There's a lot of cultural storytelling about those businesses, which has created a powerful mythology. In fact these companies are rare exceptions to the rule, yet humans have this inbuilt emotional belief that says, 'If I want it badly enough, I'm going to be one of the exceptions.'
I listen to three or four startup pitches almost every week. Most people who pitch to me haven't addressed the core, foundational issues around avoiding startup failure. They don't have a business model. They don't have a value proposition for a product or service that customers will pay for. It's astounding.
I meet prospective founders all the time who say (and believe), 'I've got an excellent idea - it's going to be the next Facebook.' That's easier said than done. There's a big journey between a brilliant idea and Facebook. Too many founders don't recognise that or they minimise in their minds how...
