Why Startups Fail: Run Out Of Cash, Run Out Of Commitment

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Why Startups Fail: Run Out Of Cash, Run Out Of Commitment

 

One thing I've been pondering this weekend is figuring out why startups fail.  But, in order to figure that out, I had to first decide what constitutes failure.  The more I thought about it, the more I realized that a definitive failure is when the startup simply stops trying.  And, the only reasons to stop trying are that you run out of cash, or you run out of commitment -- or both.

Let me elaborate a bit.  Lets say your startup had an unlimited amount of cash (hypothetically).  Whenever you needed money, you'd go to the money tree, pick some more cash, and go back to your business.  If this were the case, it's likely the number of startup "failures" would be vanishingly small.  Why?  Because you haven't failed yet, you simply haven't figured out the model that works.  As long as you still had commitment, you could keep going indefinitely.  Of course, there's no such thing as unlimited cash. 

Similarly, lets say you had a day job, and your startup didn't really require any cash.  And, you were fanatically committed to your vision or idea.    In theory, you could run your startup for decades and still never really "fail".  You'd just keep going and rather than being a failure, you'd be a startup that hadn't succeeded yet.  As long as you were committed, you could just keep going.

So, with that set of abstract concepts in place, let's dig in a little deeper.

Constraints On Cash and The Paradox of Venture Funding

Given that you have a finite amount of cash, how long your startup can survive is a function of how much cash you put in (revenues + funding) and how much you take out (expenses).  You'd think that a venture-funded startup would be more likely to succeed, because it has longer to "figure it out" (i.e. more time to get to success).  But, I'm not sure that's true.  What ends up happening is that VC-funded startups tend to increase their expense-base such that their time horizon is actually pretty short (about 1.5-2 years on a Series A funding).  On the flip-side, a bootstrapped startup might not have a large influx of cash, but might actually have more time to figure things out.

As an example, my first startup was bootstrapped.  No VC funding.  We did things the old-fashioned way.  We charged people money, and spent less than we made.  We were profitable from our first year of existence (and remained that way for 9+ straight years).  We were profitable, because we had no choice.  How much we spent was always a function of how much we made.  In the long run, we didn't grow as fast as we might have otherwise, but overall we succeeded

Contrast this to a couple of venture-backed competitors of this bootstrapped startup.  They had each raised $25MM+ in venture funding.  Of course, this was in the midst of the bubble, but the lesson is still similar (it's an issue of magnitude).  These companies ran through their cash, and couldn't get funding to keep going.  They failed.

This is just one data point, and it would be silly to try and generate any conclusions from it.  But, it does generate an interesting idea:  Perhaps startups should simply be trying to give themselves enough time to figure out what will work.  And, the time available is not a function of the amount of cash raised, but the amount of cash being consumed.  Profitable startups don't consume cash -- they generate it.  Hence, they've got more time.

For the record, my current startup, HubSpot, is venture-funded.  This means I have some work to do to figure out how to get to the point of having an infinite amount of time to figure things out (otherwise known as becoming profitable).  The good news is that profitability is something we actually talk about (which you would think would be a common conversation in startups, but it's not).

In a follow-up article, I'll discuss the tradeoffs between bootstrapping and venture funding a startup.  Having seen it from both sides, I'm beginning to form an opinion (always a dangerous thing). 

Posted by Dharmesh Shah on Thu, Feb 28, 2008

COMMENTS

If the question is "why" then I think it's the founders don't start with a simple plan that they can modify in response to events, they don't change methods and experiment when their initial concepts don't work (no business plan survives contact with the market doesn't mean you shouldn't plan, without a plan it's hard to be explicit about what you are changing), or they don't change when the market changes.
We have a good interview up with Dave Stubbenvol at
http://www.skmurphy.com/blog/2008/01/25/founder-story-dave-stubenvoll-of-wowza-media-systems/
His model of how to grow a startup is controlled experimentation:
"We continue to evolve both our marketing and the product. Our focus is on three things; market development, product development, and organizational development. We are finding that if you take an evolutionary approach to organizing yourself to ensure survival, performing enough trials so that no one mistake can kill you, you get stronger."

posted on Thursday, February 28, 2008 at 11:23 AM by Sean Murphy


With VC-money often comes a sense of greater responsibility and pressure. So in this regard it isn't difficult to see cash as a constraint.

posted on Thursday, February 28, 2008 at 12:37 PM by Vladimir Dzhuvinov


Well-said, Dharmesh, and applicable to other endeavors in life. I'm looking forward to the follow-on!

posted on Thursday, February 28, 2008 at 12:55 PM by Sam Tanner


<p>I like the phrase from Dave Stubbenvol quoted by Sean Murphy in an earlier post: "Controlled experimentation". </p>
<p>In fact, I think scientific experiments could be a good analogy for assessing the success or failure of a startup. Scientific research involves many of the same tradeoffs and value assessments as a startup. There is no single determinant of "success", but we still have a gut feel for whether we have achieved that success. And sometimes the assessment changes over time, as the value of a discovery gradually becomes more apparent.</p>
<p>If we were to think about "success" in similar terms to scientific research, some of the dimensions might be:</p>
<ul>
<li>How does the scale of the effort compare to the value of the result? I might be willing to spend my life in pursuit of nuclear fusion, but might not spend more than a couple of months on a Facebook plug-in.</li>
<li>How (intellectually) significant is the work? Even if I make money, I may not feel that a brute-force process is a success.</li>
<What is the time frame in which it produces real value? Is that time frame reasonable in light of the effort required and the resulting value produced?</li>
<li>Can the value be translated to commercial terms? Does the value exceed what we have invested in time and capital?</li>
</ul>
<p>It seems to me that "success" is a multi-dimensional measure. Each of us will weight those dimensions differently. But it seems clear that the key personnel involved in a given startup (VCs also, if they are involved) should have definitions of success that are at least compatible, if not identical!</p>
<p>--Carl</p>

posted on Friday, February 29, 2008 at 10:49 AM by Carl Strathmeyer


Oops... as you can see, I tried to format my post with some simple HTML and it didn't work! (That in response to Raza's post about formatting.)
--Carl

posted on Friday, February 29, 2008 at 10:51 AM by Carl Strathmeyer


Carl: Thanks for the great comment.
Apologies for the formatting problem. Looking into the problem now (the good news is that the comments were saved with the right formatting -- it's the rendering that seems to be the problem).

posted on Friday, February 29, 2008 at 10:53 AM by


Dharmesh and everyone here,
I struggle with this exact question everyday. We bootstrapped Passageways, our first startup and have been now profitable for all 5 years. The growth is a healthy 50% as we sell corporate portals to financial institutions and have 150 clients. This is all good but the opportunity is much greater..we could/should be selling this product to all verticals and sell it the worldover...now that calls for some VC funding..or some cash infusion......I get calls from PE and VC guys every now and then but we keep delaying this...the decision is whether to keep at our current pace and grow at this growth rate or to involve some professional money and try to call from our most aggressive pages of our growth playbook .
Anyone willing to discuss this on the phone....please email me back..........Dharmesh can you talk?

posted on Friday, February 29, 2008 at 12:28 PM by Paroon


Hello Paroon,
This is a good problem to have - a successful enterprise that feels that it could be orders of magnitude more successful.
Don't assume that the solution is to throw cash at it. It looks like you have a marketing problem; you need to make your offering known to a much wider audience. But maybe it's not a "shouting louder" problem; maybe it's a "saying it clearly" problem. Don't assume that prospects can recognize that your offering can address their need. You need to speak clearly and directly , showing them that they NEED your offering.
Plus, of course, you have to figure out WHO to speak to and exactly what their needs are. That's an iterative process, as I''m sure Dharmesh would agree.
So don't immediately think "VC funding" or "cash infusion". Instead, think "How can my communication be more effective?"
--Carl

posted on Friday, February 29, 2008 at 6:49 PM by Carl Strathmeyer


Question 1 was "Why startups fail?". Startups don't fail because cash runs out, they fail because of the issues that lead to cash running out. Running out of cash is a consequence of failure, not a cause. It is the point at which failure is crystalised.
Question 2 was "What is failure?". I think that there are two types of failure. The first is business failure, where the startup itself fails. The second is entrepreneur failure. In the second scenario the startup does not fail, but the entrepreneur does not achieve his or her goals.
Questions 3 was "Bootstrap vs. VC?". There isn't an off-the-cuff answer to that question. Every startup has different requirements and every entrepreneur has different motivations. However, I think that you can broadly correlate the chances of "Entrepreneur-success" by the timing and amount of VC raised. In other words, if you raise more money early on your startup has more time to figure out the path to success, but you are less likely to do well personally from your efforts.
I have started companies and both bootstrapped and raised VC. Personally, I found that the bootstrapping approach forced better discipline in all areas of the business that when I was mainlining VC cash.

posted on Saturday, March 01, 2008 at 4:22 AM by Mat


Well said, Mat.
However, let me pick at one of your assertions. Cash can be both a consequence and a cause. I agree with you that it is most often a consequence (or indicator) of some other root cause. I suspect Paroon (earlier post) is in that situation, and I don't think simply adding more cash will solve his problem. Re-reading "Crossing the Chasm" might be more helpful!
Startups (and more established companies too) often assume that more cash can fix anything. But if you have a leaky ship, all the fuel in the world isn't going to get you to port. You have to fix the leak or you'll sink. And that means you have to recognize (and acknowledge) the leak. That 'acknowledge' step is often the hardest.
Now the other side of the coin. Cash can sometimes be a cause in itself. A startup involves an investment of money (yours or someone else's) and you'd better have enough sources of cash to cover that investment. To continue my analogy, you'd better leave port with enough fuel to get back safely (and with some to spare for unforeseen situations). Even if the ship has no leaks, running out of fuel is a problem!

posted on Saturday, March 01, 2008 at 3:43 PM by Carl Strathmeyer


Carl.
I like your reference to crossing the chasm. One VC funded startup I was involved with was "encouraged" by the VCs to bring in McKinsey (this was 2000!). Several hundred thousand dollars later we had a report that gave us nothing more that a good read of Crossing The Chasm would have. Several of the VCs were ex-Mckinsey. Funny that.
I also like the analogy of leaving port with enough fuel to get back. "Even if the ship has no leaks, running out of fuel is a problem!" Agreed, but I still content that a startup running out of fuel, but still executing well, can top up the tanks relatively easily.

posted on Sunday, March 02, 2008 at 5:43 AM by Mat


To Mat's prior post:
"A startup running out of fuel, but still executing well, can top up the tanks relatively easily."
Yes, absolutely! To continue the analogy, if you know there's a refueling depot partway along your route, you can include that in your plans. A refueling stop can help you cover more territory than would be possible with your onboard fuel tanks alone!
--Carl

posted on Monday, March 03, 2008 at 2:04 PM by Carl Strathmeyer


Dharmesh:
Inspired piece and inspiring comments! I like your simple recipe for startup success: bring in more money than you spend. Could this be the secret to financial success that millions of debt-ridden Americans are seeking? Thanks for your, and the commenters', thoughts.
Anthony Kuhn

posted on Monday, March 03, 2008 at 3:35 PM by Anthony Kuhn


Great post and even better comments! I myself have started a start-up (sorry for the redundancy!) and am facing the dificult task of choosing between the two options, litghting a candle that will last or go after wood to make a great bonfire that will last a few months...
I am eager for your next post.

posted on Wednesday, March 05, 2008 at 2:22 PM by Nathan Schorr


Interesting post and revealing comments - I tend to think about VC funding as afterburners for your startup, they are great to get that highly needed speed but are inefficient long term (conflicts of priorities present any time "tank is refilled" among inefficiencies). Of cause if company is without plan and direction but amount of additional power would help...
If anyone in the group reads Russian , there is a song "Koster" (Bonfire") by Mashina Vremeni ("Time Machine" with lyrics describing the choice between lighting a candle or going after wood.

posted on Wednesday, March 05, 2008 at 9:41 PM by Simeon Schwarz


I think another reason startups fail in-general is because they don't take advantage of the resources that are directly targeted to them. There are a lot of programs out there but Sun Microsystem's startup essentials program is offering x64 server discounts, free tech support and access to other startup 'missing pieces' through their free conferences. For those interested, check outwww.sun.com/startup

posted on Thursday, March 06, 2008 at 7:30 PM by Brody


I have a simple theory in regard to the above. With or without funding I make sure I never lose the feeling of my back to the wall. Having your back to the wall while a startup is a good thing. It keeps you edgy, responsive and aggressive. Rare is the moment when something comes to a startup. You need to go out there, shake trees and make it happen in all areas of your business. Success demands it.

posted on Friday, March 07, 2008 at 12:43 AM by Kate


@Sean
I agree that a start up is about controlled experimentation. In that way you never fail. You read your results. If your experiment says change, drop it. The change and drop it.
Equally if your startup is a hobby and you drift off to do something else, who cares?
A failure is when you had grand ideas and are bitterly disappointed they don't work out. You are in a bit of a psychological hole and have to dig your way out. And even that is only a failure, if you trap yourself there by refusing to get out all the while complaining about how unlucky you have been.
Package up your experience to show what you have to show and move along to the next experience.
Of course you might fail in other people's eyes. They really should stop living vicariously!! Buy them a drink. Set them a task. Get them going on their own journey and you be the 'second' for a while.

posted on Sunday, March 09, 2008 at 10:34 AM by Jo


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