Startup Failure Rate Is Not OK!
Article 2 in the series. This one: when do startups fail (some facts)
1. Introduction
This and original article can be found at our site: http://Mashauri.org
This is the second article in the series: Its not OK, where we try and bust the myth that 80% of new ventures must fail and that this ratio is fine. Our claim is that this level of failure is far too high and we can learn from the mistakes of others as well as our own failures. This may be a little controversial, so hopefully it will spark debate!
NOTE: infographic at end of article.
The 3 main conclusions we will cover, with data-driven support, are:
- About two thirds of all businesses fail within the first five years
- Almost one third of new businesses never gain traction (ie receive income from customers or receive funding)
- We are not getting better at helping new businesses become successful — in fact we are getting worse
Naturally, we do accept that there will be some failures and we also accept that fear of failure should not be a barrier to trying to develop a business. Please read our first article where we introduce the theme.
We believe the topic of “when do new businesses typically fail” will make for interesting reading for both entrepreneurs and those involved in the entrepreneurial world (such as investors, accelerators, incubators, universities, governments and corporate innovators). The article that will follow as to the “why” of failure will likely be of higher value, but it is necessary to build some sort of fact-based platform as to “when” to develop this. Our article is based on the UK data but we feel it is of value across the globe, although the conclusions will need to be adjusted for local factors.
It is worth mentioning that “success is in the eye of the beholder”. A Venture Capitalist (VC) idea of “success” would be their investment in a very high growth company that exits; while an investment in a company that ends up surviving and providing a good lifestyle for the owners may be a failure to the VC, but the founders may be happy with their success. For the purpose of this article, a failure is a company that legally gets dissolved as the owners/authorities do not believe it is a going concern.
In this article we take a fact-based approach to getting to grips with startup failure rate and when failure happens. We have used multiple sets of statistics published by the UK government (Companies House and Office of National Statistics). The sources and detailed calculations are available in the appendix. Admittedly the data is messy: different sources, different start/finish dates, limited cohort information and rounding errors. However, on the positive side, we are dealing with big numbers (more than 600,00 companies were incorporated in the UK last year) and a year-to-year comparison reveals reasonable consistency. Furthermore we do not have to get to decimal place accuracy and so the data and conclusions can be considered reliable.
This is UK data (including Scotland, Wales and Ireland) and when considering other geographies, you may need to adjust for local factors. For now we consider, this to be fairly representative of the entrepreneurship failure rate in most developed economies — but the failure rates are probably somewhat higher in developing economies. In a subsequent article, we will use Global Entrepreneurship Monitor (GEM) data to see how we can assess for those differences
2. The evidence
2.1 Conclusion: almost two thirds of new businesses fail in the first five years
The two charts below show the data in different formats (source: UK Companies House).
The “Number of companies remaining” shows a cohort view — that is if 100 companies are launched at the same time, the number remaining at the end of each year is shown by the column (eg in year 3 only 56 would remain).
The “Average failure rate” shows the number of companies that fail each year. For instance in the 3rd year, 16% of companies who started year 3 will have failed by the end of the year.
The number failing in the first year does appear low to those who have helped prepare this article. Our logic is that there is a sort-of “honeymoon period” where founders cannot conceive they will fail (and so continue in the face of warning signs), and more importantly there is a delay in actually getting started and facing reality.
In the next article, we will spend more time on the “how” of failure.
2.2 Conclusion 2: more than 30% of new businesses never reach “traction”
A separate set of data from the UK Office of National Statistics (ONS) captures the number of companies that have registered to pay VAT or to pay tax on behalf of employees. Both these payments offer a reasonable proxy for “traction”, which we define as having paying customers or having received funding (which would normally mean a strong indication of paying customers or paying customers in the near future).
The number of tax paying companies as a proportion of all companies incorporated, is shown in the chart below. Over the last 5 years the proportion of companies gaining traction is steadily decreasing. Although we are launching more new businesses (which is partly due to the ease in which this is possible), we are not doing a great job of helping them learn how to reach the point of having paying customers — 3 out of 10 never achieve that goal!
2.3 Conclusion 3: we are not getting any better at improving new business success rate
Despite the increasing number of new business starts, we are not getting any better at improving business success rate. The previous point above demonstrates this. However, there are two more sets of data that also give this statement credence. Below is a chart showing new incorporations and dissolutions by year. It is clear we are starting more businesses and we know that there is greater encouragement to do so; and it is far easier to do so. Despite this, the ratio of dissolutions to incorporations is deteriorating which would indicate that the survival rate is dropping — albeit net new numbers is increasing. If you throw enough infantry at the enemy, although many of the cannon-fodder will die, but some will get through!
A second number of interest is the number of acquisitions of more than £1 million that are occurring (source: ONS). Although the data is very “noisy” with many factors coming into play, we would hope for an increasing number of acquisitions that might indicate successful startup exits. However, if we compare the latest 5 years history with the prior 5 years we see a substantial decrease in this number. Although this data is inconclusive, it certainly does not show an increase in exits unless they are small — and that probably equates to acqui-hiring rather than a true acquisition. (Note: we recognise the imperfection of M&A data and the large amount of factors that play a role, but the trend is not positive over this period).
3. Conclusions
After considering all the 3 points above and merging them with what we know about the development of the entrepreneurial ecosystem and the life cycle of startups in general, we have arrived at some insights:
- Most new businesses survive the first year simply though a delay between registering a company and real work beginning, together with the passion, excitement and initial perseverance that goes with the initial stages of a new venture.
- Probably about 25% will steadily give up through years 2 and 3, as they conclude that they are never going to reach traction or not at a rate that will develop into a going and growing concern.
- A further 30% to 40% will fail over years 4 to 6, struggling with some level of revenue that perhaps exceeds breakeven but is not sustainable and certainly will never scale into a large company.
To avoid painting too gloomy a picture, there will be 20%+ who do make it — they will develop into flourishing enterprises, perhaps grow extremely large (the occasional fabled unicorn) or may be bought out for good value multiples by other corporates. In addition, many (or some) of those founders who do fail will learn from their errors. A few will start again and with that experience, increase their chance of success the second time around.
Our view is that this failure rate need not be so high. Although there are multiple and often combined reasons for failure, surely with the volume of dissolutions in the UK alone we should be doing a much better job of increasing new business success? There has been exceptional work done by people like Steve Blank, Eric Ries and Noam Wasserman to name a few. Organisations like the Global Entrepreneurship Monitor also do amazing research into understanding what are the factors required for new business success. Clearly however, this is not trickling down to the founders themselves who lemming-like seem to be starting and failing at increasingly higher rates.
Mashauri believes that it is possible to learn from experience and use technology to codify processes and activities into a flexible system that can guide founders along the path to success and avoid at least the major pitfalls and unnecessary risks. We do not naively believe that every new business will be successful, but we are convinced that through the right focus, efficient use of resources, shared experiences and the occasional re-direction, a significant portion of potential “failures” could be turned into successes. And lets call out the elephant in the room: failure really sucks — especially when you bring down others with you. When your families suffer, those friends who invested in you lose their money, those few employees who trusted you are without employment ….. getting slapped on the shoulder by some wealthy VC and being told not to worry and that it is a useful learning experience just somehow does not compensate.
I am not always a fan of the utterances of Peter Thiel (billionaire entrepreneur and philanthropist who founded payPal and was an early investor in Facebook), but in the case of startup failure we are in agreement. As he says:
“Every time a company fails it is not a beautiful working out of the Darwinian free market and it is not a fantastic educational experience for all involved. Every death is a tragedy and that is even true of deaths of companies.
“I don’t think that we should be setting people up for failure in all sorts of ways and that is something that should be avoided.”
By the way: Peter liked our article! Thanks PT.
The purpose of Mashauri is to make a difference to the success rate of new businesses across the globe. Our initial work has been to research entrepreneur failure (and success) and early stage founder requirements. We have run a beta site (Mashauri.com) for a number of years and helped various founders both online and offline. We are beginning to figure out how we can make a difference. It is likely that those startups selected by VC’s and the top accelerators have a higher than average chance of success (by nature of the competitive process if nothing more), but the vast majority of new businesses (probably in excess of 90%) do not fall into this elite category — and it is here that we believe we can make a difference. Learning from each other, understanding patterns of success (and failure), providing the right focus, encouragement and pace, using the tools that are available, providing critical training …. none of these will guarantee non-failure, but they will certainly increase the chances of success.
We are just launching this new site Mashauri.org, with a few acceleration programmes and soon-to-be training programmes. We admit that as it stands, the site is going to be creaky for a while and the programmes may not be overly sexy — but this is just the beginning and an extension of our earlier learning process. Future moves include using Mashauri information linked to other sources, to use big data to gain better understanding patterns of success and failure. Then supporting the process with AI-enabled mentors to help scale the system at a truly global level.
If you care about this as we do, it would be great if you could spread this article wider and help us to engage with other people who are also concerned about startup success — and can join us in our quest to make an impact in the world of new business.
Watch out for our next article where we will build on this one and start to discuss why and how failure happens. This is even a more complex subject with even less reliable data. However, we will tap into the excellent work of organisations like the Kauffman Foundation, the Global Entrepreneurship Monitor and we will rope in some real gurus on the topic to work with us on these hypotheses . Peter Thiel: are you available?
Thanks to contributors to this article, especially Apoorv Bamba, Guy Harris, Peter Quinlan and Peter Bryant.
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