The Real Reason Why 80%+ of Funded Startups Fail

A friend confessed to me the other night that his funded startup had failed.

“It was growing,” he said. “We were getting customers. We just weren’t getting them fast enough to continue getting funding.”

This is a familiar refrain with startup founders, and I personally know several founders whose businesses fit this bill (including my last funded company.) They have a business that works, with customers. It just doesn’t fit the ridiculous growth profile that most VC’s (venture capitalists) expect.

That’s the untold story of the estimated 80%+ of funded startups that fail. Most of them don’t fail because of a complete lack of acquiring customers. They fail because they stepped on the funding treadmill and hired ahead of revenue for anticipated growth–and that growth either didn’t happen, or didn’t happen fast enough.

Fab.com — From Billion Dollar Valuation to Bust

Perhaps nowhere is this more obvious than in the painful story of Fab.com, the e-commerce startup that raised over $330 million and then sold for a comparatively paltry sum ($15-50 million, is the estimate.) In the story of Fab.com’s death, these quotes stand out:

“By October 2011, Fab was generating $100,000 a day. It hired 80 people and grew to 750,000 users. Etsy veteran Beth Ferriera joined Fab as COO and David Lapter joined as CFO. Fab was called the ‘fastest-growing startup in the world.’

The company finished the year with 1.3 million users and an annual run rate of $80 million. It closed a $40 million round of financing at a $200 million valuation from top Silicon Valley investment firm Andreessen Horowitz. Jeff Jordan, who also invested in Pinterest, joined Fab’s board.

…’There was a real business there,’ a former Fab employee lamented. “It could have worked.’

Another agreed: ‘People used to rattle off things they bought on Fab to me. We had that [magic] that got people to open emails and engage with content … There’s no question the core business worked. That’s the frustrating part about all of it.'”

Then disaster struck: “Fab’s 2013 kicked off with a five-hour board meeting. The board — which consisted of First Round Capital’s Howard Morgan, Fab CEO Jason Goldberg, Andreessen Horowitz’s Jeff Jordan, Atomico’s Geoffrey Prentice, Tencent’s James Mitchell, and Allen Morgan — decided Fab needed to move faster. It approved a plan to increase Fab’s burn rate to generate $200 million by the end of the year. The plan would drain Fab of its remaining capital by August, but as long as [CEO] Goldberg was able to raise $300 million more by then, the company would be fine.”

What’s Realistic for Businesses?

What I see here is a big example of a pattern that continually unfolds with venture-funded startups: The startup is growing, but in order to continue to attract financing, it needs to grow faster. That’s not realistic for 80%+ of companies. Most of them collapse when they fail to raise another round of funding. Some raise that round, like Fab, and then collapse when a board full of investors decides the company needs to “move faster” and “increase its burn.” Of course, everything will be fine if that plan works…but if it doesn’t, a successful business can go bankrupt literally overnight when cash runs out and investors refuse to throw it a lifeline.

Investors at the seed stage (the $10,000-$50,000 checks that most venture-funded startups accumulate at the beginning of their lifecycle) are conditioned to write 100 checks or more, and then only fund the “winners”–the ones that, in a year, are growing at 20% or more month over month. The other ones–the majority of the entire pool–won’t hit that target and won’t receive additional funding. That’s exactly what happened to my company last year–having received $640,000 in funding, we couldn’t hit revenue targets quickly enough, and thus couldn’t raise more capital, and failed.

The investors aren’t too bothered, because they (assuming they are professional investors, which all of mine were) have also been conditioned to know that 80-90% of the checks they write will return nothing. For the entrepreneur, however, this can be a tough situation. It certainly was for me. I went from running and selling two successful bootstrapped tech companies to falling hard with my first funded company.

I write this article not to denigrate VC funding, but to make entrepreneurs aware of what investors expect from your company. I now own or co-own two bootstrapped companies, Opportunity Space and 1Up Repairs, and it probably won’t surprise you to learn that both of them are profitable, growing, and generally doing well. However, neither of them have the growth rate that VC’s or “tech investors” expect. That’s fine with me; I’m content to make money running these businesses and serve happy customers.

That’s not to say I wouldn’t attempt to run a funded company again. But if I do, I’ll understand that we need to have a concrete plan to hit 20-30% month-over-month growth targets. This is exceptionally difficult. 80% or more of the businesses entrepreneurs start don’t fit this profile. 80% of the ones that do get funded (i.e. you’ve convinced investors that this is possible with your company) won’t make those targets and will fail. As an entrepreneur seeking funding, you need to understand this going in.

Bootstrapping is Awesome — But It Has Pitfalls, Too…

Bootstrapping is hard in a different way. You never have quite enough money to do what you want. If you don’t get enough customers one month, you may be eating cheap food or pulling from your savings. You generally finance their growth with loans (which is what I did with my hosting company in the mid-2000s.) Those loans usually require a personal guarantee (i.e. you are on the line even if the business fails.)

But with bootstrapping, you are in complete control. You can grow as fast, or slowly, as you want. You can close for a week if you need to. There is a lot more personal freedom available to you–and there’s something huge to be said for that!

Tech companies, especially funded ones, tend to get a lot of press these days, but to me, the media isn’t telling the whole story. Sure, it’s great to write about the 0.1% of businesses that will have off-the-charts growth. But there are also plenty of interesting stories to be told about all the companies that employ people, serve happy customers, and make great money for their founders! From my perspective, it’s a lower-stress business to run, as well, which suits me just fine.

Last year, I had the idea of doing a podcast covering some of these entrepreneurs, and I came up with the name Real Business Revolution. As I’ve honed in on the past several weeks on what I’d like to do, ruminating over startup and business ideas, this came to the forefront for me again.

It’s said that Millennials are the most entrepreneurial generation ever (probably because the job market for college graduates stinks!), so there’s definitely room in the market for a podcast that emphasizes running a real business that makes a meaningful impact in your community, hires employees, and serves customers — one at a time.

I’m not making any promises yet on what I plan to do, but I can say that I keep coming back to this, so I plan to set up a studio and get some interviews going. I’d like to speak with investors as well about their perspective on this. Is there room for a cohort of investors who invest in cashflow businesses instead of typical “high-growth” VC investing? There seems to be opportunity written all over this–both for entrepreneurs and for investors. I’d love to encourage more people to start real businesses with cashflow, customers, and continued growth — and to emphasize that it’s perfectly OK to build that sort of business instead of the high-stakes poker game of VC-backed startups.