👋 Hi, I’m Andre and welcome to my weekly newsletter, Data-driven VC. Every Tuesday, I publish “Insights” to digest the most relevant startup research & reports, and every Thursday, I publish “Essays” that cover hands-on insights about data-driven innovation & AI in VC. Follow along to understand how startup investing becomes more data-driven, why it matters, and what it means for you.
If you haven’t seen it yet, we just announced the first-ever virtual Data-driven VC Summit on 5-8th May 2024!
We’ll present the new “Data-driven VC Landscape 2024” and bring together 20+ speakers from leading institutions such as Lightspeed, ICONIQ, EQT, and Moonfire sharing their hands-on learnings from innovating at the forefront of venture capital.
Moreover, we’ll have renowned researchers from Stanford, UCL, and more presenting their insights from the data about startups and their unique paths to success.
The Flipside: Why Do Startups Fail?
Wrapping up our trilogy on why founders soar to success (#1 Impact of Founder Education, #2 Impact of Previous Work Experience, #3 First-Time vs Serial Founders), today's edition takes a different turn to explore crucial insights from the flip side.
Scientific studies have spotlighted the key factors that can, unfortunately, ground even the most promising ventures. While we've celebrated the ingredients of success, understanding the most common pitfalls—like shaky business models, stalled business development, or the ever-dreaded cash crunch—is equally vital.
Most studies point towards a blend of these elements, highlighting the importance of foresight and strategic planning. So, let’s dive into what to watch out for, completing our comprehensive view on navigating the entrepreneurial journey. Knowing these hurdles can be just as empowering as understanding the factors that propel us forward.
It is important to note that there is an overarching factor that has the most direct impact on all the decisions that lead to failure and success, which is the founding team, their personalities, and skillsets. We were able to confirm this not only through scientific studies but through our own post-mortems as well. Team is make or break in early-stage venture.
Since this factor permeates the company and all important decisions, we will dedicate an entire future episode to analysing founding teams, their skills, adaptability, personality traits, network, hiring practices and similar moderating variables.
Top 3 Reasons for Startup Failure
#1 No/Bad Business Model
A critical point for startups, as revealed by a comprehensive study on startup failures, is a flawed or non-existent business model. A 2018 paper by Cantamessa et al. investigated 214 startup post-mortem reports and finds that overlooking a structured business development strategy often spelled doom for these ventures.
Surprisingly, the root causes of startup demise extend beyond the mere absence of a viable business model. They typically include a combination of factors such as poor market positioning, lack of product/market fit, and deficient customer development efforts.
The most common blunders stem from a failure to adapt the business model based on market feedback, a misunderstanding of the product-market fit, and inadequate efforts in customer segmentation.
This lack of agility and market understanding underscores why many startups fail to translate innovative ideas into sustainable business venture, even with a product, charismatic founders, and a large addressable market.
✈️KEY INSIGHTS
Most founders underestimate how difficult it is to identify the right customers, understand their problems, incorporate their feedback, and adapt quickly. More than a third of failed startups suffered from this.
#2 Lack of Business Development
Combining insights from two incisive studies [1, 2], it's evident that a lack of robust business development is a significant contributor to startup failure. The absence of a well-thought-out business development strategy often leads to a startup's demise, rooted in a failure to secure market position, inadequate customer development, and insufficient adaptation to market feedback.
Common missteps include an over-reliance on untested assumptions about market needs without adequate validation, overlooking the importance of customer engagement and feedback loops, and neglecting competitive analysis. Many startups falter by not iterating their offerings based on real-world interactions, leading to a misalignment with market demands. Furthermore, a failure to adequately plan for and execute on strategic partnerships and sales channels can leave otherwise promising ventures struggling to find their footing in a competitive landscape.
Addressing these issues requires startups to prioritize market validation and customer-centric development from the outset. Engaging with potential users early and often, leveraging data to guide pivots, and building flexibility into the business model are crucial steps in crafting a business development strategy that not only avoids common traps but also positions new ventures for sustained growth and success.
✈️KEY INSIGHTS
Reliance on untested assumptions (which can be hard to untangle from your thinking, check this awesome test and framework on implicit assumption by the open university) and not iterating quickly enough on feedback and data played a substantial role in 28% of startup failures.
#3 Just Running Out of Cash
Running out of cash is one of the most direct paths to startup failure, striking at the heart of a business's ability to sustain operations, pay debts, and grow. It’s less about inability to fundraise, but more about the fundamental challenge of misalignment between cash inflows and outflows, particularly during the early stages of a startup's life when revenue streams are still uncertain or developing. Many startups find themselves grappling with this issue due to several key missteps:
Underestimating Initial Capital Requirements: Entrepreneurs often fall short in accurately projecting the initial capital needed to cover the acquisition of assets, operational expenses, and buffer for unforeseen costs. This miscalculation can lead to a shortfall before the business even gains momentum.
Ineffective Cash Flow Management: The inability to manage cash flow efficiently, including the failure to anticipate and plan for the cyclical nature of cash inflows and outflows, can leave a startup financially vulnerable. For instance, not accounting for the time lag between making payments for raw materials and receiving payments from customers can create significant cash flow gaps.
Growth Mismanagement: Startups may also falter by pursuing growth too aggressively without ensuring the financial sustainability of their operations. Rapid expansion often requires substantial upfront investment and may not immediately generate the additional revenue needed to cover these costs, leading to cash shortages.
✈️KEY INSIGHTS
Startups often falter not just from a lack of market demand but from financial missteps, including underestimating the initial capital needed, premature scaling, and mismanaging cash flows. 21% of failed startup failures were (at least partially) caused by these preventable issues.
By the Skin of Your Teeth: How Pivoting Can Save Your Company
Pulling the ripcord early enough can often make the difference between closing up shop and living to fight another day.
From Instagram's simplification to the visual platform we know today from a cluttered prototype to Slack's evolution from a gaming project's communication tool, the journey of startups often involves significant pivots. Twitter transformed from a podcast platform, and Shopify shifted from a snowboard gear storefront to an e-commerce platform.
Each of these pivots, driven by the need to adapt to market demands or technological opportunities, underscores the importance of flexibility and vision in the startup world.
How and Why Do Startups Pivot Successfully?
A study by Sohaib et al. categorizes pivot types and identifies the triggers for these strategic shifts, providing a valuable compass for navigating the uncertain startup landscape. The essence of a successful pivot hinges on two core principles: validated learning from failure and (once again) astute observation of customer behaviors.
Among the ten pivot types identified, the “customer-need” pivot emerges as the most prevalent, underscoring startups' keen focus on refining their value proposition to meet unmet or evolving customer needs.
For instance, startups like Jammber and Docker shifted gears upon realizing their original offerings didn't resonate as anticipated, instead honing in on more pressing problems discovered through customer interactions.
✈️KEY INSIGHTS
External triggers have a much stronger “pivot-inducing” effect than internal challenges. Once again, quick reaction to new data and feedback marks the best examples of successful pivots.
Perseverance vs. Pivoting: Giving Up on the Right Things, at the Right Time
How do you know when the time for a pivot has come? Are you just giving up on your core thesis or are you making an important strategic move?
These questions can be extremely hard to answer when you’re in the midsts of your daily founder challenges. It might be worth to take a look at the classic Lean Startup Framework. A study by Shepard & Gruber (2021) tests how the framework lends itself to identifying the right triggers for a pivot.
The decision to pivot or persevere is underpinned by the concept of "validated learning" — a core component of the lean startup approach. This involves continuous testing of the startup's hypotheses about its business model against the realities of the market, enabling the startup to learn from successes and failures alike. This iterative learning process helps to clarify when a pivot might be necessary and when perseverance on the current path is more advisable.
Finding the right time to pivot or persevere is nuanced, relying on a combination of market signals, internal metrics, and sometimes, the entrepreneurial instinct. The choice is often influenced by factors such as the startup's runway, the feedback loop from MVPs, and the startup's ability to iterate and adapt based on what is learned from the market.
✈️KEY INSIGHTS
Building MVPs and iterating quickly, especially in the early stages, is your best continuous test for picking up on a pivot signal. Later in the maturity cycle, more structured processing of feedback is necessary.
So How Do You Pivot Successfully?
A back-tested academic framework by Chaparro & Gomes (2021) proposes a framework detailing four stages of the pivot process: recognition, generating options, seizing and testing, and reconfiguration. Each stage offers a strategic point of communication and engagement with stakeholders:
Recognition: Acknowledging the need for a pivot and openly discussing the factors leading to this point with stakeholders.
Generating Options: Involving stakeholders in brainstorming and evaluating possible directions, enhancing their buy-in for the chosen path.
Seizing and Testing: Sharing the decision-making process and the criteria for selecting the pivot direction can help stakeholders understand the strategic intent and the expected outcomes.
Reconfiguration: Keeping stakeholders informed about the changes being made and the impact on the business model can facilitate smoother transitions and maintain trust.
One way to judge the right timing for a pivot is by watching your product’s retention curve. Churn is inevitable but does it flatten out over time? You might not have PMF if it doesn’t.
✈️KEY INSIGHTS
There is no one-size-fits-all approach to pivots but there are validated frameworks such as the proposed study or the Lean Startup Framework that help structure the process.
Conclusion: Learning From Failure
As we wrap up our series on the dynamics of startup success and failure, we've dissected the common pitfalls that often lead startups to stumble: underdeveloped business models, inadequate business development, and the critical issue of running out of cash. However, there are strategies for overcoming them:
Market Validation: Entrepreneurs need to rigorously validate their business model and market assumptions. The failure to adapt the business model based on market feedback, misunderstanding of product-market fit, and inadequate customer segmentation efforts are common pitfalls that can be avoided with thorough market validation.
Customer-Centric Development: The lack of robust business development strategies often leads startups to fail. Successful startups engage with potential users early and frequently, leveraging data to guide pivots and build flexibility into their business model, ensuring that their development strategy is customer-centric and responsive to market demands.
Financial Management and Timing of Pivots: Running out of cash due to misaligned cash inflows and outflows, and the challenge of managing growth sustainably are critical issues startups face. Effective cash flow management and the strategic timing of pivots, based on validated learning from the market, are essential for maintaining a startup's viability and growth trajectory. Timing and narrative presented to stakeholders during a pivot are key to maintaining trust and support.
Thanks to Jérôme Jaggi for his help with this post.
Stay driven,
Andre
PS: Don’t forget to check out our upcoming Data-Driven VC Summit 2024
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If you have any suggestions, want me to feature an article, research, your tech stack or list a job, hit me up! I would love to include it in my next edition😎
Interesting to see that product market fit isn't at the top of the list.
I guess it depends on the stage of the startups.
Great insights.
Don’t. Ever. Delete. This. Post.
This is a good post for me to read. Building a business right now.