Why Startups Fail Scaling

Why Startups Fail Scaling (Startup Failure)

Why Startups Fail Scaling

During our startup program PreXLR, we will set out to find you a sustainable and scalable revenue model, without developing a product or service. But, why do we do it this way? Why is it so important to first create a queue of customers? In this article, we will discuss why the PreXLR was created, the startup failure rates, and the main reasons for the failure of startups.

The numbers of Startup Failure

Research institute Statistic Brain regularly releases new figures out about the ‘Startup Business Failure Rate’. The rate shows which percentage of enterprises fails in the first 3 years, and then which percentage of companies within certain sectors is still active after 4 years. The conclusion: between 40 and 60% of starting enterprises don’t make it past the first 5 years.

Keep in mind, that many startups are financed (by investors, banks, friends, relatives or personal capital), usually without having done a commercial feasibility test that proves that the startup will be able to make it and can develop a sustainable and scalable revenue model. It is not uncommon that over €1,000,000 is invested in such a startup.

Percentage still operating after 4 years

Source: http://www.statisticbrain.com/startup-failure-by-industry

In the chart presented above, we can see that 25% of enterprises fails within the first year, 36% in the second year, 44% in the third year, and up to 63% in the fourth year. In the image from Census Bureau below, we can even see an upward trend in the number of enterprises that fail in the first year.

 

Startup Failure rate over the years

Source: http://fivethirtyeight.com/features/corporate-america-hasnt-been-disrupted

The number of enterprises younger than 10 years has been dropping for nearly 20 years. The number of enterprises older than 10 years has been increasing for nearly 20 years. This means that there are ever less startups that persist for more than 10 years. The number of companies that are older than 10 years, does increase. The companies that are older than 10 years then also survive longer.

US Companies by age

Source: http://fivethirtyeight.com/features/corporate-america-hasnt-been-disrupted

 

But, what are the most important reasons for startup failure?

Main Causes of Startup Failure

In 2011, a large-scale research was done into the factors for success and failure of Silicon Valley startups. This research, by the name of the Startup Genome Project, has examined over 3200 startups. Not only did they discover during the investigation that 11 out of 12 startups fail within the first 5 years, they also found the 14 leading causes of failure.

The 14 main reasons startups fail:

  1. Founders that learn are more successful: startups that have helpful mentors, track metrics effectively, and learn from startup thought leaders raise 7x more money and have 3.5x better user growth.
  2. Startups that pivot once or twice times raise 2.5x more money, have 3.6x better user growth, and are 52% less likely to scale prematurely than startups that pivot more than 2 times or not at all.
  3. Many investors invest 2-3x more capital than necessary in startups that haven’t reached problem solution fit yet. They also over-invest in solo founders and founding teams without technical cofounders, despite indicators that show that these teams have a much lower probability of success.
  4. Investors who provide hands-on help have little or no effect on the company’s operational performance. But the right mentors significantly influence a company’s performance and ability to raise money. (However, this does not mean that investors don’t have a significant effect on valuations and M&A.)
  5. Solo founders take 3.6x longer to reach scale stage compared to a founding team of 2 and they are 2.3x less likely to pivot.
  6. Business-heavy founding teams are 6.2x more likely to successfully scale with sales-driven startups than with product-centric startups.
  7. Technical-heavy founding teams are 3.3x more likely to successfully scale with product-centric startups with no network effects, than with product-centric startups that have network effects.
  8. Balanced teams with one technical founder and one business founder raise 30% more money, have 2.9x more user growth and are 19% less likely to scale prematurely than technical or business-heavy founding teams.
  9. Most successful founders are driven by impact rather than experience or money.
  10. Founders overestimate the value of IP before product market fit by 255%.
  11. Startups need 2-3 times longer to validate their market than most founders expect. This underestimation creates the pressure to scale prematurely.
  12. Startups that haven’t raised money over-estimate their market size by 100x and often misinterpret their market as new.
  13. Premature scaling is the most common reason for startups to perform worse. They tend to lose the battle early on by getting ahead of themselves.
  14. B2C vs. B2B is not a meaningful segmentation of Internet startups anymore because the Internet has changed the rules of business. We found 4 different major groups of startups that all have very different behaviour regarding customer acquisition, time, product, market and team.

Premature Scaling

The most important reason for failure according to the research, is the so-called “premature scaling”. According to Blackbox (the research institute that carried out the Startup Genome Project), premature scaling happens when the growth/development of product, client, team, finances, and revue model doesn’t happen synchronously.

For instance, consider a situation where you expand your startup team with sales staff, while it isn’t exactly clear what the specific revenue model of the startup is, and the product isn’t ready for large-scale introduction to the market yet. The cost for the sales staff needs to be covered, yet it is not exactly clear what these new additions to the team will be selling. As a result, activities are no longer synchronised and “premature scaling” is created.

It is important to take the phasing of your startup into consideration with this. An “early stage startup” is looking for a product/market fit in extremely insecure circumstances, which involves different activities than are necessary for a “late stage startup”.

We at BW Ventures see that startups go through the phases as seen in the image below. After forming a vision, the startup sets out to find a relevant need or a painful problem, in a specific client group (the problem/solution fit). We see that many startups are under the assumption that they have passed this stage or have already finished it. Yet, when we dig a little deeper and ask them what the specific problem is that the client experiences, at which moment of the day, on which location, and how they wish to solve this, most entrepreneurs will fumble for an answer. We find that this is one of the most important reasons for premature scaling. If you want to grow rapidly as a startup, it is crucial to thoroughly understand what latent need you provide in.

 

Startup Growth Stages

Startup Growth Stages

When the problem/solution fit has been found, the startup will go on to find the perfect value proposition. The value proposition is based on the problem/solution fit. We have the startup create a queue of clients, as it where, before development of a product or service is started. That way, the startup will understand exactly what the client wants, at which time, which shape the solution will take, and what the revenue model will be.

“Late stage startups” are looking for a repeatable and scalable revenue model (execution and scaling of a working revenue model). Many startups start with this immediately, by working with a business model canvas. After all, we are used to “think big” and create immediate solutions, with all its consequences. Premature scaling…

Solution to Premature Scaling

Before scaling your startup, it is important to understand what value you are going to be providing to your potential customers. This doesn’t have anything to do with technical value, but rather with the result the client achieves when they use your product or service: “The promised paradise”. Or, as we see it: a commercial feasibility test. Does your startup idea have a chance of succeeding commercially?

Traditional commercial feasibility tests are often performed through desk research (usually market research). The results are presented in a report, and are meant to prove whether the introduction of the product or service has a chance of succeeding. As we see it, this is virtually impossible; the entrepreneurs or development/innovation teams are then assembled based on the results of the report; premature scaling…

The commercial feasibility of a startup can only be tested through the end user. Are end users willing to use your product or service? Are there clients that are willing to agree to a commitment (i.e. payment, data, time) regarding your product or service? Hence, you should be talking to your Earlyvangelists, and be testing all your assumptions in a process-oriented way.

Once you’ve found a value proposition that you can submit to multiple clients (without modifications), and receive the same commitments, you can start thinking about scaling. Because only then do you understand exactly what needs scaling. After all, then it is clear to you which value you will be providing your clients, how they will receive this value (what the product looks like, and how it is to be distributed), through which channels your value proposition is best represented, and why your client finds your value so important.

During the startup program PreXLR, all (commercial) assumptions of your startup idea will be tested, and we will prepare you for continued funding. We do this by using a highly structured process, in which you will be testing your assumptions and adapting your idea, in cycles of 2 days. You will be in immediate contact with your potential clients and will examine your entire business model. After three months, you will understand what needs scaling, and it will be clear whether your startup idea has a chance of succeeding commercially.

 

 

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