Why Startups Fail: Run Out Of Cash, Run Out Of Commitment

February 28, 2008

One thing I've been pondering this weekend is figuring out why startups fail.  But, in order to figure that out, I had to first decide what constitutes failure.  The more I thought about it, the more I realized that a definitive failure is when the startup simply stops trying.  And, the only reasons to stop trying are that you run out of cash, or you run out of commitment -- or both.

Let me elaborate a bit.  Lets say your startup had an unlimited amount of cash (hypothetically).  Whenever you needed money, you'd go to the money tree, pick some more cash, and go back to your business.  If this were the case, it's likely the number of startup "failures" would be vanishingly small.  Why?  Because you haven't failed yet, you simply haven't figured out the model that works.  As long as you still had commitment, you could keep going indefinitely.  Of course, there's no such thing as unlimited cash. 

Similarly, lets say you had a day job, and your startup didn't really require any cash.  And, you were fanatically committed to your vision or idea.    In theory, you could run your startup for decades and still never really "fail".  You'd just keep going and rather than being a failure, you'd be a startup that hadn't succeeded yet.  As long as you were committed, you could just keep going.

So, with that set of abstract concepts in place, let's dig in a little deeper.

Constraints On Cash and The Paradox of Venture Funding

Given that you have a finite amount of cash, how long your startup can survive is a function of how much cash you put in (revenues + funding) and how much you take out (expenses).  You'd think that a venture-funded startup would be more likely to succeed, because it has longer to "figure it out" (i.e. more time to get to success).  But, I'm not sure that's true.  What ends up happening is that VC-funded startups tend to increase their expense-base such that their time horizon is actually pretty short (about 1.5-2 years on a Series A funding).  On the flip-side, a bootstrapped startup might not have a large influx of cash, but might actually have more time to figure things out.

As an example, my first startup was bootstrapped.  No VC funding.  We did things the old-fashioned way.  We charged people money, and spent less than we made.  We were profitable from our first year of existence (and remained that way for 9+ straight years).  We were profitable, because we had no choice.  How much we spent was always a function of how much we made.  In the long run, we didn't grow as fast as we might have otherwise, but overall we succeeded

Contrast this to a couple of venture-backed competitors of this bootstrapped startup.  They had each raised $25MM+ in venture funding.  Of course, this was in the midst of the bubble, but the lesson is still similar (it's an issue of magnitude).  These companies ran through their cash, and couldn't get funding to keep going.  They failed.

This is just one data point, and it would be silly to try and generate any conclusions from it.  But, it does generate an interesting idea:  Perhaps startups should simply be trying to give themselves enough time to figure out what will work.  And, the time available is not a function of the amount of cash raised, but the amount of cash being consumed.  Profitable startups don't consume cash -- they generate it.  Hence, they've got more time.

For the record, my current startup, HubSpot, is venture-funded.  This means I have some work to do to figure out how to get to the point of having an infinite amount of time to figure things out (otherwise known as becoming profitable).  The good news is that profitability is something we actually talk about (which you would think would be a common conversation in startups, but it's not).

In a follow-up article, I'll discuss the tradeoffs between bootstrapping and venture funding a startup.  Having seen it from both sides, I'm beginning to form an opinion (always a dangerous thing). 

Topics: strategy funding

Written by Dharmesh Shah

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