Innovation
Up to 90% of US high tech startups fail; System of failure by design? - Part 2
By Michael Hennigan, Finfacts founder and editor
May 13, 2014 - 7:43 AM

Up to 90% of US high tech startups fail and this estimate includes both venture capital (VC) backed and other firms that are not able to raise external funding. Meanwhile, with the cost of launching a startup plunging in recent times, it has been suggested that the Silicon Valley system is one of failure by design.

Harvard Business School research in 2012 as reported by The Wall Street Journal, showed that 3 out of 4 VC-backed startups fail while the National Venture Capital Association estimates that 25% to 30% of VC-backed businesses fail.

Shikhar Ghosh, a senior lecturer at Harvard Business School, said the discrepancy in part to a dearth of in-depth research into failures. "We're just getting more light on the entrepreneurial process," he said.

His findings are based on data from more than 2,000 companies that received venture funding, generally at least $1m, from 2004 through 2010. He also combed the portfolios of VC firms and talked to people at start-ups, he says. The results were similar when he examined data for companies funded from 2000 to 2010, he says.

Venture capitalists "bury their dead very quietly," Ghosh said. "They emphasize the successes but they don't talk about the failures at all."

The Journal says if failure means liquidating all assets, with investors losing all their money, an estimated 30% to 40% of high potential US startups fail. If failure is defined as failing to see the projected return on investment—say, a specific revenue growth rate or date to break even on cash flow—then more than 95% of startups fail, based on Shikhar Ghosh's research.

He said that VC-backed companies tended to fail following their fourth year when funding dries up.

Finfacts 2013: More US VC-backed new companies fail than succeed

Note that we said "up to 90%" at the outset as data isn't definitive but adding the startups (firms up to 1 year old) that cannot get external funding, we move into the ballpark.

General survival data from the Bureau of Labor Statistics (BLS), tracking startups from the number of years from the birth date, shows that about 35% of firms survive to their 10th birthday.

A BLS analysis of tech firms that were born in 2000, at the height of the dot-come boom, found that less that 1 in 5 had survived by 2009.

Companies without a revenue model like WhatsApp can survive until acquired but winning the lottery can also make any one of us rich.

"The share of young firms in the high-tech sector has exhibited a more pronounced secular decline in the post-2002 period than in the rest of the economy," according to US research.

Young firms are either acquired or grow fast to scale up -- as we argue in respect of Ireland with a small or no market for a product or service, the former is usually the only option.

We reported last week that Apple had acquired 24 firms in the past 18 months.

In other words, a grow fast or get acquired landscape has emerged. "That's different than it was 20 years ago, when organic growth was prevalent," said Dane Stangler, vice president of research at the Kauffman Foundation, the leading US entrepreneurship think-tank.

The average employment level at new high-tech and ICT firms has been on a steady decline during the last three decades, peaking between six and nine employees in the early 1980s to reach about 4.5 employees on average in 2011. In other words, high-tech and ICT firms are starting smaller. The entire private sector, on the other hand, has held steady with about six employees on average at new firms.

However, the surviving young high-tech businesses add jobs at a rate twice that of all surviving young firms, and the rate of job creation is so robust that it offsets losses from early-stage failures - - something that is not true for young firms as a whole.

It's not uncommon for some tech firms to survive without ever growing.

The oldest tech cluster in Europe is located in the area around Cambridge University in the UK, known as Silicon Fen.

After just over 50 years there are about 50,000 jobs in 1,400 high-tech firms in the cluster:

• 40% of firms are micro and employ 1-5 people;
• 20% of firms are micro and employ 6-10 people;
• Only about 2.5% of firms employ more than 200 people.

The biggest success of the cluster is ARM Holdings, a chip designer whose technology has been in 50bn products shipped, from phones and tablets to smart sensors and servers.

ARM is the UK's biggest high tech success but its global employment at end 2013 was just over 2,800.

A poster on the Silicon Valley Global Network blog wrote in 2001:

Silicon Valley columnist Tom Foremski makes a good point:  Steve Jobs would probably not get funded today because angels and VCs prefer to invest in engineers.

The irony is that 80% to 90% of VC-funded startups usually fail, while demand-driven startups like Dell and AOL tend to have a much higher survival rate often approaching 70% to 80% because they actually have customers. If that’s the case, why do Silicon Valley investors persist in investing in engineer-led startups?   Here are some reasons that I’ve noticed having worked in Silicon Valley over the past few decades as a market researcher, corporate strategist, and serial entrepreneur with 7 startups under my belt:

- Many angels and VCs are successful engineers and programmers so they naturally prefer to fund people like themselves..."

A contributor on Forbes attributes the high failure rate to sleep deprivation.

Last month Gideon Lewis-Kraus reported in Wired on trailing two founders in search of funding, who have a greater likelihood of being subcontractors than billionaires.

All the while, Martino’s ultimate warning—that they might someday regret actually getting the money they wanted—would still hang over these two young men, inherent to a system designed to turn strivers into subcontractors. Instead of what you want to build—the consumer-facing, world-remaking thing—almost invariably you are pushed to build a small piece of technology that somebody with a lot of money wants built cheaply. As the engineer and writer Alex Payne put it, these startups represent 'the field offices of a large distributed workforce assembled by venture capitalists and their associate institutions,' doing low-overhead, low-risk R&D for five corporate giants. In such a system, the real disillusionment isn’t the discovery that you’re unlikely to become a billionaire; it’s the realization that your feeling of autonomy is a fantasy, and that the vast majority of you have been set up to fail by design.

It is claimed in Silicon Valley that failure is no impediment to future success but that surely ignores the human toll on individuals and their families of effort and sacrifice going up in smoke, with nothing but debt and more to show for it.

See more from Finfacts here:

On the gig and app economies: Global Tech Cluster Rush: More failures than successes likely

Part 1 of this series: Imbalance in focus on tech and non-tech entrepreneurship in Ireland & elsewhere

Irish Innovation: Startup fever and Ireland's dumb enterprise policy - Part 1

Global Tech Clusters: Dublin's Silicon Docks - - marketing label or cluster? - Part 2

Europe's top ICT Hubs: Munich, London, Paris in lead; Dublin with rank of 16