Hi, my name is Vincent, a now-familiar face in Tech IT Easy’s blogging family, and today I’d like to write about my thoughts about startups’ reasons to fail (and as a consequence: reasons to succeed). This is my 3rd non-tech topic in a row, and if you hadn’t guessed it, I have little inspiration to write about tech these days.

So, “why do startups fail?” seems to be a relevant question these days and I guess to everyone running or thinking about running or working in a startup. Depending on who you talk to, no actually pretty much everyone, over 90% of startups fail within 2 years of their launch. The stats vary according to whom the startup works with, it is much lower with venture-funded companies, as well as within certain incubators.

The Credit Crunch

One of the most popular reasons I heard while writing my thesis (which involved me interviewing over 200 tech-startups), is of course lack of money. That seems really relevant today, and is certainly a factor.

To give a personal example of how the credit crunch is affecting our lives negatively, back when I started a bachelor in Manchester, UK, about 10 years ago, I was able to get a student-loan quite easily at a British bank. You walk in with your details, get a 1000 pounds overdraft and a credit-card to boot. This was still the case until a few months ago. My brother, who just left for Lancaster, UK, was counting on a similar deal. But banks had withdrawn that service to non-UK citizen, rather abruptly, forcing my brother to find alternative solutions. Banks don’t care about who needs or deserves a loan, when they cut it off, we’re all screwed.

Fred Wilson pointed out that seed-funding will likely suffer most, and true, banks are, both directly and indirectly, an incredibly important source in that arena, as well as at later stages. The graph below showed my own results, for two measures carried out during 2005 and 2006 on the investment climate for high-tech startups in the Netherlands (a Dutch version of that report can be downloaded here).

What this graph also shows is that even pre-credit crunch, most startups didn’t use or weren’t able to use much beyond their own savings (the turquoise part) at the seed and sometimes the later stage (of course that still includes credit cards and similar bank-related funding sources). No way that this is something that should be generalised across all countries of course, I imagine that the distribution of investors will vary quite substantially from country to country.

Forget funding

I happen to think that funding is not the factor to focus on when talking about startup failure. In a perfect financial market, which, many financial people try to convince me, exists, you get funding if other conditions are in place. Receiving an investment is a validation of your idea, and if you can’t get investors to talk to you it’s either because:

1. Your idea is bad.
2. Your presentation is bad.
3. There are too many similar startups applying for funding.

The key here is then for 1. to improve your idea, for 2. to improve your presentation, and for 3. to stop being a sheep and reinventing the mousetrap. While this makes me sound like an asshole, the point is that none of these reasons have to do with funding, they have to do with the quality of your venture.

Non-financial reasons for failing

A startup is a machine that needs to be built, needs to operated and maintained, and needs to produce sufficient output/income to cover the costs that building, operating, and maintaining require.

Therefore, startup-failure is related to:

• Too expensive a building-process (both in money, people, and time), which comes out of bad planning and insufficient skillsets to get results.
• Improper operation and maintenance, which is really to do with bad HR-practices.
• Insufficient output/income, which can be related to the quantity produced (bad planning, skills), bad pricing, and of course a bad market.

The “bad market” factor is an interesting one, because it seems very related to the credit crunch problem. My brother, who is forced to look elsewhere for funding, will be less likely to buy a laptop from the start now. Everything ties back into funding somehow.

Bad market or bad business-model?

The top business models, in my mind, are built to withstand recession. Some could argue that they are built during a recession. An example of this is discounters like Aldi, which was built in a poor Germany, many years ago, and has caused a revolution in European retailing. Im not 100% sure, but I think that the strength of European discounters here has even prevented monsters like Wal Mart from taking over the place.

Other streams of thought about this take you into “blue ocean” or “long tail” territory, both somewhat hip ways of saying that you should think outside the box.

A bad market can be a lack of desire on consumers part to pay for your product. And it can be that the market is simply to small, suggesting that it may be a good idea to think globally from the start. Certainly, investors like the idea of entrepreneurs thinking (realistically) big. Also when you see some of the industry-growth-stats in emerging economies, it makes sense to target those markets, instead of the many 0-2% growth economies in the Western world.

I guess what I’m saying is that a bad market is just an excuse for failure. If your business is advertising dependent, you should be aware that most advertisers cut their spending during recessions, a recession that has been predicted for years now. The same applies to certain luxury goods, etc. So, perhaps the market isn’t bad, perhaps the business-model is bad too.

In summary…

Yes, the credit crunch is scary, as are all recessions. Yes, we would all like our ideas to simply be output – input = profit. But the core of entrepreneurship is to think in opportunities, to not get stuck in ideas, and be market-focussed. It is about breaking rules and making new ones. And, while it is a harsh world where failure is accompanied by a high price, at the core of entrepreneurship is also optimism—the belief that everything can be solved with the right perspective.

So why do startups fail? By setting themselves up to fail.

Vincent out

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Just briefly… I did a practice defence for my thesis yesterday, was certainly interesting, and got to listen to a whole lot of other entrepreneurship-students (and potential entrepreneurs) on their own thesis-topics. Why I love universities is, of course, because of all the smart people I meet, but also because there usually isn’t a confidentiality agreement attached to our conversations, which means I can brainstorm about it openly with you.

The one thing I came away with was that networking is in… “Hah!” you say, and I wouldn’t blame you. With the rise of social networks and its media attention, of course it’s “IN.” No, but what I mean is that about 70% of the thesis-topics I heard being presented yesterday, were in some form or fashion centred on networking. And I can’t remember it being so dominating a topic before.

As was mine, incidentally, being in part about incubation and innovation systems, and how to improve the connection between tech-startups and investors, but there was one thing I didn’t look at, which was: Weak ties, strong ties, and their implications. I won’t explain it in great detail now, if interested, you should definitely read this pdf, I just uncovered, by Mark Granovetter, the originator of that theory and how to measure (!) it.

The idea is that we are surrounded by possible ties, some of them non-existant and potential, some of them strong, meaning that we meet frequently and that psychic distance is low, some of them weak, meaning that we see them rarely and that they are perhaps based on less emotional factors. If you’re in a university environment, it’s of course easy to imagine that you have a lot of strong ties. As everyone enters their careers, your ties to to each other become weaker and weaker. The same, to some extent is happening on this blog: some I have stronger ties with than others, simply because of the frequency of interaction. Of course, I’m hopefully a not-to-weak tie to all of you on this blog

Regarding the power of weak ties, Granovetter also writes:

The macroscopic side of this communications argument is that social systems lacking in weak ties will be fragmented and incoherent. New ideas will spread slowly, scientific endeavors will be handicapped, and subgroups separated by race, ethnicity, geography, or other characteristics will have difficulty reaching a modus vivendi.

In other words, strong ties aren’t everything either—they, rather, lock you into a clique and prevent ideas from spreading and changing the world!

The strength of ties & funding

Some things I learned yesterday, was that networking and its strength has certain implications in areas pertaining to funding and sales. One student did his thesis on the Greek semi-conductor industry and how it was funded. He found that (my phrasing):

strong ties are important for finding early-stage funding, like friends & family. But that weak ties are actually the predominant factor in finding funding from VCs and similar. His opinion is that those investors make their decisions not on emotions, but on business-reasons. A connection certainly helps, but is not the primary decision-maker.

The strength of ties and sales

If you ever worked in sales, you know that it’s often not really a job focussed on relationship-building. Rather it is about maximising turnover, which can best be achieved by selling to as many people as possible in a short period of time.

Another student did his thesis on how the social environment of startups affects their sales strategies. He interviewed three independent ICT startups and three, which were located in incubators, and found that the first group was much more focussed on developing their sales-force, while the latter group depended much more on the ties it had with their respective incubator, often finding their first customers within, one even supplying the incubator with software. Kind of scary, I think, this co-dependency in the latter case.

Strong ties were an important factor in business development, which were more intense relationships between businesses, trying to get a larger project off the ground. Sales, in general however, relied mostly on NO ties, aka cold approaches to customers. So if you want a job in sales, that’s kind of what to expect.

Thoughts and questions

While I dig theses a lot for their practical research alone—it sometimes reads like a section of a business-plan, and I have used it before to research an industry—we are obviously dealing with theories that are generalised across whole populations. But it seems like strong ties are actually not a very important factor in either getting funded or making a sale.

So some questions to you…

• How do you feel about networking after hearing this?
• Can you provide counter-argument, where a strong tie to a person actually improved your career? Ok, wives, girlfriends, boyfriends, and husbands should definitely be left out of this
• Are there other areas, apart from funding and sales, where either strong or weak ties are better?
• How often do you use contacts-of-contacts on LinkedIN or otherwise for professional reasons?
• Can you provide some Best Practices in regards to “Weak-tie management”?

I look forward to your answers!

Vincent

P.S. I asked a friend to send me the names of these students. I’ll try to fill them in later.

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