What is failure? According to a venture capitalist
Across the venture capital space, it is common to hear various statistics regarding how many startups fail. For Shikhar Ghosh, Harvard Business School’s Senior Lecturer, 75% of venture-backed startups fail, while the National Venture Capital Association estimates that 25–30% of venture-backed businesses fail completely. The reason these two well-known statistics vary greatly is due to various definitions of failure startups and successful startups across the venture capital landscape.
When searching for statistics and hard facts regarding the number of startups that make it and those that don’t, Shikhar Ghosh’s study is certain to appear. In 2012, Ghosh conducted a research study on 2,000 venture-backed companies that received funding of at least $1 million between 2004 and 2010. Of these companies, 75% never returned cash to their investors, receiving Ghosh’s stamp of failure. To Ghosh, complete failure occurs when a potential start-up must liquidate all of its assets, which he found happened to 30–40% of all the high-potential startups in his study.
The NVCA’s estimation of 25–30% failures aligns closely to the traditional rule of thumb in venture. The rule in question: Out of 10 startups, 3–4 fail completely, 3–4 return the original investment, and 1–2 produce significant returns.
So what does it actually mean to be a “failed startup” from a venture capitalist’s point of view? Well, it’s subjective. No venture capitalist sees the exact same way and each holds different values and priorities when considering investing in a company. Bread and Butter Ventures MP Brett Brohl separates his definition of a failed venture-backed startup into two categories — a financial failure and a total failure:
“Financially, a failure is if we have to write off the investment and return little to no capital — 2X or less. A total failure is if the investment provides 0 financial returns AND I wouldn’t invest in the founders again”.
When considering an investment, Brett focuses primarily on the team to indicate whether the company will be successful or not. While the team is the most important aspect for Brett, he also emphasizes the importance of the product, market and traction.
Bread and Butter Ventures MP Mary Grove shares that the B&B team enjoys working with founders who have succeeded and with those whose companies have failed. She makes it clear that oftentimes you will learn more from the latter than the former. Mary sees “failure” in a positive light and encourages founders to embrace any mistakes or roadblocks they may come across and take the opportunity to learn from them:
“In general, within the startup ecosystem, I’m a huge believer in embracing “failure” and building without a fear of failure mentality. That means proving, changing course as needed, abandoning V1 of a product, changing business models, making sometimes difficult changes to team, etc and moving quickly as needed to adjust. So don’t shy away from it!”
From a financial standpoint, Mary emphasizes that the entire portfolio has the means to accomplish B&B’s financial goals:
“As venture investors, we’re targeting a minimum of a 3X cash on cash returns on our portfolio of investments. But, we have a portfolio approach to accomplish this. So we’re super comfortable investing in moonshot ideas that have the opportunity to return 10–100X (and also ok that some might completely fail and go to zero). Each investment we make we have to believe is a moonshot opportunity to return 10–100X”.
There may not be one percentage or definition of successful or failed startups that the entirety of the venture capital space can agree on, but there is a clear emphasis on the team and the passion driving the business when VCs are deciding whether or not to invest. This is something that all entrepreneurs should keep in mind when building their business and pitching it to and working with investors.
At the end of the day, the only person or people who can declare success or failure are the founders. This is a tough reality for builders in the startup world because failure to them often differs greatly from those who invest in them. Achieving success could be a multitude of things, such as getting into the business, having a first sale, or getting to profitability. Exiting and providing returns for investors takes a lot longer to achieve and sometimes doesn’t happen. It is up to a founder or a founding team to set their own personal goals for success and take it day by day to get there.
A key takeaway here is that a founder and an investor may not have the same definition of success (and thus failure), and it’s paramount to build strong relationships with those who are aligned with your goals, timelines, and ultimate vision of success. We encourage founders and VCs to have transparent conversations out the gate and believe that with the right combination, founders have an outsized ability to change the world for the better.
Sources:
1: Report: 75% of Venture-backed Start-ups Fail | Inc.com
2: The Venture Capital Secret — 75% of Startups Fail — Scale Finance
3: Harvard’s Shikhar Ghosh: 75 percent of startups fail — Silicon Valley Business Journal
4: Why Most Venture-Backed Companies Fail — News — Harvard Business School
