Startups
10 min

Why only 1% of startups "take off" - and that's normal 

November 26, 2021
Why only 1% of startups "take off" - and that's normal 

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MVP's
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  • Onectus is a startup and mobile e-commerce technology provider.
  • We will help you to build and scale your awesome ideas following Agile values.
  • Our scope is to build products of perspective businesses as well as guarantee the best start and scaling strategy based on our knowledge achieved in years of activity.
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The only thing that can increase the chances of success is the real experience of the entrepreneurs, the effectiveness of the business, the established connections, the spirit, the willingness to do business to the end and not to give up.

For the vast majority of people, the venture capital market is unpredictable. And rightly so. Professional venture capitalists believe that investing in new businesses is a craft that can be learned to generate targeted returns. Try playing golf or tennis for the first time: if you get one good shot in the beginning, hundreds or thousands of "curves" will follow. And only after them will come the skills, and a confident game still requires self-control, mental stability and the ability to bring things to an end.

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Instead of long and painful training in real business and projects, many people find it much easier to believe in the lucky hand and the coffee grounds, to rely on the advice of friends and predictions of experts and analysts. Some may get lucky, but the percentage of "lucky" people is negligible.


All of us - investors, startup managers and project managers at the same time - invest our time, health, money and our own internal resources in other people (be they family, employees or partners), projects and charities. There is a small percentage of people who do this as consciously as possible: they value the resources they have acquired and strive, by developing themselves, to build up this "capital" and manage it effectively. As a rule, exactly such people become entrepreneurs, professional managers and investors. They often combine several roles - this is yet another way to "get rich".  That is why so often we see successful entrepreneurs move into the ranks of professional investors and vice versa. They are constantly making investment decisions within their companies, planning budgets, accepting and rejecting proposals for M&A deals, working with a large number of counterparties, assessing the quality of internal or external teams, looking for ways to improve the efficiency of business processes. They make mistakes, but at some point they realize that there are fewer of them every year. Overcoming difficulties and often relying on luck, sooner or later they realize: success has become repetitive.  It may take five, ten, fifteen years, or it may never happen. The ups and downs of young entrepreneurs in a few years are only exceptions that prove the general law.  Almost all successful investors, including members of the Forbes ranking, have gone this way. All of them first developed their own businesses or managed someone else's, and then, having accumulated resources and capital, they became professional investors - now they return to management only when they cannot find decent management. The range of interests and activities of these people is really wide. As they accumulate capital and resources, they tend to move on from early stage investments to later ones.

But only a small percentage of entrepreneurs and investors who believe in their ideas succeed in building their businesses. According to Startup Genome Report calculations, 92% of launched startups die, and 74% of Internet startups close due to premature scaling, overestimating their strength and bloating the company's staff several times over.  Half of startups close within the first five years, and this is typical of all sectors.  This means that at the beginning of the journey, the risks for any entrepreneur and investor who becomes a partner are maximized. It may seem crazy to find people willing to support projects in the early stages, despite the fact that the probability of succeeding in the moment will be several times lower than in a casino, and you have to wait several years for a return on investment.

The success of a fund is influenced by the composition of partners, geography of investments and their history: a successful fund gets more cool projects, such a fund has accumulated expertise and network, which can help both in development and with the "exit". For example, the Sequoia fund, operating since 1972, has made investments, many of which have already been "monetized" in companies whose combined value is now approaching $1.5 trillion. The probability of an "exit" for investors in such a fund increases several times over. How does a startup get such a shareholder? It is not that easy. As a rule, such funds give a relatively low valuation of the company at the moment of entering the project, because they know what enormous value they can provide to a startup business.   The key for a startup is not to confuse a fund with a large set of portfolio companies, which nevertheless has the resources to work closely with each of them, with a fund that just has a lot of portfolio companies, and its team is busy arranging the chips on the table.

As in many sectors of the economy, there is a "mafia" in the venture capital market. The term has more of a positive connotation - it refers to a group of people who see the whole market, allocate resources efficiently and can reach out to any top decision-maker.  There are business angels and funds in Silicon Valley that specialize exclusively in early-stage investments - and they are successful because of their focus. For example, the Tech Coast Angels business angel network claims an IRR of 26%, while according to some data the average annual return on a U.S. business angel's portfolio is just over 20%. However, you should understand that companies are often born not for the sake of huge earnings, but for the sake of the idea of the entrepreneur, who is almost always interested in developing a project for self-fulfillment. The entrepreneur has a burning idea and is ready to take risks (now we do not take atypical situations when a person starts a business out of hopelessness or inability to find a good job). Business angels and venture capitalists, investing in early-stage companies, diversify risks - they form a portfolio of a large number of companies.  But as global average statistics show, they receive lower returns over a number of time horizons and greater investment volatility than later-stage venture capital funds and private equity funds.

As can be seen from the performance of 1,653 venture capital funds (1,051 early-stage, 190 late-stage and expansion-stage, 406 project-focused, and 6 providing venture debt financing) established between 1981 and 2016, the investment horizon should be quite long. Yields are volatile and highly dependent on the cycle and time of entry, with liquidity far from the highest.

For large companies and industrial giants, investments are increasingly becoming an opportunity to adapt to changing conditions or tipping points in their markets. A recent example is the active investment of automakers in cab aggregator services.  This trend is confirmed by global statistics, which in fact suggest that the conventional "offline" and the no less conventional "online" are increasingly intertwined and becoming inseparable.   

Of course, investors have many alternatives to investing in venture capital funds.   Among them are funds, bonds and shares of liquid companies in any sector. The returns on investments in these segments are often higher than venture capital investments if we're talking about fairly short-term investments.  In investments in liquid assets, you get more flexibility in both the size of the investment and risk management, while in private investments, you tend to have much less flexibility and often face crises of a different nature.

For serial successful investments in the venture capital market, you need to have a set of extraordinary abilities and accumulate a lot of baggage of mistakes and knowledge.  This also applies to startup founders and investors if they want their investments to "shoot out" more than 10-50% of the time (depending on the stage) and overlap failed investments by a margin.  Entrepreneurs and investors are trying to discount the emotional background and often irrational workings of consciousness, evaluation and perception and increasingly rely on data in their decisions. Systematic success is achieved by those with an effective "hybrid" combining data, experience, and intuition in their heads. True, "training" in the venture market is expensive: instead of an MBA in a top business school for a year or two with a guaranteed "crust" and graduation photo - years of trial and error, unclear prospects, and no one promises a diploma. All in all, for the average educated person who does not grab the stars from the sky, the venture capital market is a disgusting and for most unacceptable scenario.


Let's take the 100% (in theory!) probability of success of the born company and subtract the chances of success with spoilage of each "ingredient" (let's take only the basic ones: idea, business model, market, founders, team, investors) and see what probability of success we come up with:


  • Idea and business model. It often happens that the idea sounds promising, but the business model does not allow the startup to scale or it requires tectonic changes in the market.  For example, a startup focused solely on R&D development of a product without a clear and confirmed demand from the customer is likely to have close to zero chances of success.  But let's be optimistic: the company has a really strong idea, its implementation was also good, the startup did not have stronger and more intelligent competitors before it was launched, but they may appear in the future - then we "cut off" a conditional 50% of the probability of success.
  • Market.  Let's assume that entrepreneurs overestimate the size of their target market, do not understand the balance of forces and mechanisms of entering it, do not take into account the need for legislative changes to spread the innovation invented by the startup. Again, all these frequent mistakes reduce the probability of the company's success to zero. But again we will believe in the quality of our startup's market evaluation: there is a market, the entrepreneurs know it. At the same time, market demand indicators and the emergence and development of competitors is still difficult to predict at the start, so we will have to halve the startup's chances to "take off".   
  • Founders.   They may have no experience in results-oriented work (it happens all the time when a person leaves a job for a new company), no serious personal and team accomplishments. Often there is a lack of leadership skills and an understanding of people's psychology. Finally, the investor may not have checked the founder's merits too deeply and not find out that he embellishes them. Chances again tend to zero.  The situation when a startup is led by a single founder is an additional risk (almost 60% of successful startups are founded by at least two partners, Sage statistics show).  If a business has two or three equal co-founders, it's more likely that they've worked together before, stepped on the same rake - and didn't split up by arguing.  But back to our imaginary project with the remaining 25% chance of rapid growth. Let's say we have two partners, they didn't work together before the business they recently launched, but they were friends. Both are smart, decent, and agreeable guys. But that's at first glance. The risks of conflict or one of the co-founders leaving the project, as well as the risks of a lack of business competence among young entrepreneurs, remain. It is very possible that our entrepreneurs will not learn how to build processes inside the company, develop the team, motivate people, make complicated and sometimes very painful decisions. Again we subtract a conditional 50% of the remaining chances.   
  • The team. There are many pitfalls here - often young managers do not like anyone in the team to have their own opinion, do not allow good professionals to grow, or hire weak professionals to stand out from them. At the startup investor knows nothing about such low skills of forming a team of entrepreneurs who came to him, so after the deal closes, problems begin to appear - the replacement of people in key positions, dismissals and resignations, internal conflicts. All this does not allow the startup to focus on business development. Okay, in our invented case the team of two old friends looks adequate, but so far it is small and lacks competence. When will they work out? This is a big question and the risks - so out of the remaining 12% there is only 6% chance of success.  
  • Investors. Here it is necessary to understand that on one hand startups that decided not to attract external financing cut off a whole group of risks, on the other hand - for some startups rejecting investor money may be equal to failure (when it is too important to scale quickly, and for this you need substantial funding).  An entrepreneur can purposefully and persistently search for an investor, or an investor can find an entrepreneur. The investor may be passive or active, he may aim to help the project comprehensively and move the business to new heights, or may pursue the goal of maximizing share, to achieve his goals through deadlocks or strategies to dehydrate the company being a non-alternative source of capital at some point. The terms of the deal may turn out to be disaster and they do not make a smart entrepreneur happy and demotivate him, even though everyone is congratulating him on his "success".  All these are new and new risks. How and with whom the founders of the project agree will determine whether the remaining 6% will turn into zero or not. Either way: reading the news headlines about startups that have closed rounds of millions and hundreds of millions of dollars, you need to think about the terms of raising that money. Success in the startup world, which mistakenly people still try to equate to the amount of venture capital investment raised, very often turns out to be ephemeral.  In some cases, investors do help find the best people in the startup team, set up processes, make full use of their network of contacts, and even become "psychologists" for entrepreneurs. But such investors value their time very much and will not even take a share from you for free if they do not believe in the success of the event and joint work. For them it is important that the company is really strong (often just as important is personal sympathy of investors for entrepreneurs and business idea). Is this the kind of help that investors will offer you for negotiations with whom you are meeting tomorrow in a coffee shop in the center of Miami? In the motley world of financial investors, the risks of getting burned are very high, so we have to cut off another half.

What's the bottom line? We got a 3% chance of success in the baseline scenario for a typical startup.  That being said, you have to remember: the odds can be "zero" because of every component of the new business we're considering, and it can happen at the startup as well as along the way. And the probabilities overlap, so the real chances of success can hardly be estimated at more than 1%. Let's add to this all sorts of force majeure, country risks, changes in the investment climate, the likelihood of personal problems for key people in the company. Remember that the market may not be ready for a product or service, so one cannot ignore the time factor and the fact that many technological trends and global trends in changing consumption habits should converge at one point.  Only the real experience of entrepreneurs, the effectiveness of the business, the established connections, the willingness to do business to the end and not to give up can increase the chances of success. But such cases are still rare-"debutantes" in the startup market far outnumber the few truly successful serial entrepreneurs.  

Conclusion

Next time you read about the 1% of startups that made it to big sales and brought investors a high ROI, don't be surprised - the number is legitimate.  But without entrepreneurs and venture capitalists, there would be no world as we know it today, and the influence of these people in an increasingly innovation and efficiency-driven economy is only growing. It's a crazy world of crazy people. Not everyone can take it, but it never gets boring.

Let's build something great together!

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