When we talk about failure, the first thing most people will imagine is a company winding down and being liquidated. But from an investor perspective, startups can fail in different ways. The reason why investors put money in a high-risk startup in the first place is the promise of rapid growth and eventually, a lucrative exit (via acquisition or public listing) that returns the invested capital many times over. Everything less than that is a failure from an investment perspective. This includes companies that survive but stay small, even though they might have happy customers and provide their employees with decent work.

But what are the reasons that lead to such failures? Is it because the founders made the wrong decisions or because the assumptions on which the startup was built turned out to be wrong? Is it because of bad luck, bad timing, or just external factors no one could foresee like say, a global pandemic?

As it turns out, reasons for failure are manifold, and from an investor’s perspective, many of them have to be accepted as what they are: risks associated with backing a new and unproven business and technology. Investors keep this in mind and try to distinguish risks that need to be taken from those best avoided from the onset.

An analysis by CBInsights of 111 (US-based) now-defunct startups shows that “running out of cash and failing to raise new money” is the most prominent reason startups cited for their demise.

Now, this is a very obvious reason. Because when there is no money left in the bank account to pay salaries or rent, there is no alternative to liquidation. But in a way, it’s akin to naming a symptom and not the illness itself, as “running out of cash” fails to explain the underlying reasons why nobody believed in the company anymore and why no new investors could be found, or old investors convinced to invest additional money.

A more convincing reason is when startups declare that they failed to reach product-market fit. Product-market fit (PMF) means that a company can satisfy significant market demand with a product people are willing to pay for. (One could add that the market demand needs to be large enough. Being successful in a very small niche often means that venture capital is not available.)

Failure to achieve PMF itself can be the result of distinct problems. The most common one, and one that could and should be avoided, is building a product nobody needs or wants to pay for. As computer scientist and venture capitalist, Paul Graham wrote: “Perhaps you create wealth in proportion to how well you understand the problem you’re solving.” Many ideas sound great when you first hear them. But founders need to have a very clear understanding of the actual, not hypothetical needs of their potential customers. “Build it and they will come” isn’t great guidance for entrepreneurs. Generally, the best founders build their companies on an “insight” they have that few other people recognize – a “secret” as venture capitalist Peter Thiel would say. (As an example, Benoit Dupont, the co-founder of our portfolio company WeMaintain, worked for more than a decade at an incumbent elevator company. Based on this experience, he uncovered the insight that elevator maintenance is a large market ripe for disruption, which led him to create the elevator maintenance startup WeMaintain.) Furthermore, a problem worth solving is a pressing problem, one that needs to be solved “now”. As an investor, the question to ask oneself is if a product is “nice to have” or “need to have” if it is just a feature or a real product.

For deep tech startups that push the boundaries of physics or biology, failure to reach PMF can simply mean that a novel approach or a technology failed to deliver on its promise. Clinical trials can fail, unforeseen side effects can manifest themselves, and scaling up a production process can turn out to be much more difficult than expected. In such cases, these risks cannot be avoided. But one can be at least sure that such startups are trying to solve relevant problems.

Mike Maples, Partner at early stage VC Floodgate and host of the “Starting Greatness” podcast, says that startups are dead by default from their onset and stay dead for a while. Only once they achieve product-market fit are they given a new lease of life, an opportunity to stay alive by starting to sell their product. It is a fitting description of the importance of achieving PMF.

While pricing and cost issues were cited as separate reasons for failure, we view them as just another subcategory of missing product-market fit. If people aren’t willing to pay enough for services, they’re not relevant enough. The famous VC investor Marc Andreessen was once asked what words he would put on a billboard to reach the greatest number of entrepreneurs. “Raise prices” he answered laconically. Struggling companies are often not charging enough for their product, he said. This hinders them from spending enough on marketing and sales and leads them to lower prices even more to increase volume – a race to the bottom. If people won’t pay more for a product, it’s probably not good enough.

Getting outcompeted was mentioned as the third most important reason for failure in CBInsights’ survey. Startups usually have known competitors and unknown or potential ones. Take the current example of Buy Now Pay Later (BNPL) startups that allow customers at the point of sale to split their payments into smaller, more affordable installments. According to Dealroom.co there are more than 170 startups active in this field that have collectively raised around USD 15 billion (this number excludes Neobanks and Chinese super apps like Wechat that offer BNPL too, and have raised even more than this sum). That was the competition that was already known in the past, and it’s fair to say that it was already a crowded field even then. But the fate of many of these startups might be decided by Apple’s announcement to soon offer Apple Pay Later in the upcoming iOS 16 update (this Forbes article covers Apple’s motives in more detail).

Especially for investors in Europe, it is wise to have a closer look at the US competition of a European startup. More often than not, US competitors find it easier to raise bigger amounts of money and use it as a tool to outcompete their brethren across the Atlantic. If they’re offering services to price-sensitive customers, they can subsidize their offering until competitors run out of steam.

Disharmony among founders themselves or founders and investors can kill a startup. If founders or important early employees who are incentivized with shares leave their companies and take a significant stake of shares with them, this can be a reason for venture capital funds not to invest in such companies. There are “bad leaver” clauses that can remedy such situations by transferring shares back to the other shareholders but the void left by a co-founder can turn into a death spiral for a young company The bad blood between founders can be the result of a lack of personal fit between them, or because of differences of opinion. The conclusion that a single founder doesn’t need to deal with such issues and therefore enjoys an easier life is wrong. Co-founders are needed to brainstorm, weigh decisions together, and keep on pushing if times are tough, as they frequently will be.

Burnout is a real danger for founders, and mental health has recently become a more widely discussed topic in the startup world, rightfully so (this recent article in Sifted, for example, found that “87% of startup employees said that working at a startup had negatively impacted their mental health at some point”). Equally problematic is a lack of passion, which was also cited as a reason why startups failed. Entrepreneurs might enjoy their status, but without a burning desire to solve the problem at hand, the hard work might soon be seen as simply not worth it. Every budding entrepreneur, and every investor interested in what they do, should therefore ask why these individuals think that they’re uniquely positioned to solve this difficult problem, and what their intrinsic motivation is.

Investors can be the source of disharmony as well. They often pride themselves to be “smart money” investors, but the truth is that in some cases, investors can be annoying, distracting, or outright value-destroying. Battles between the founders and the board can cause a startup to lose valuable time or its clear direction. Bad advice from people who think they know better is more common than one thinks in the venture capital industry. This is why wise investors shy away from backing companies that count people known to be problematic or abrasive among their vocal shareholders.

Regulatory issues can sound the death knell for a startup, fast. Here again one can distinguish well-known regulatory hurdles, for example, all the detailed work that needs to be done to bring a medical device to the market. However, laws can and do change, which is why startups need a firm grasp of which way regulation is evolving. Other changes can come out of the blue, think trade wars or other politically motivated sudden changes in the environment startups must operate in. And it is not just lawmakers who can kill startups by changing the rules. If your startup is rooted deep into a technological ecosystem, those that control it can ruin your efforts as well. A prominent recent example is Facebook raising its prices for advertising, which destroyed many business plans that relied on gaining new clients at a certain acquisition cost. The latter “platform dependency” is one of the main narratives used by proponents of a more decentralized and user-owned infrastructure for the internet that they call ”Web3”.

Spending too much wasn’t cited as a separate reason by CBInsights, it can be seen as the other side of the coin of not raising enough money. Burning through a lot of cash by hiring too many people has become a habit of many large and lavishly financed companies in the past, but these times are certainly over. Throwing tons of money at a problem rarely works. On the contrary, it is often in situations of scarcity that unique and simple solutions emerge. (Read this interview with Thomas Vogel from our portfolio startup Yonder that explains how the Covid-induced crisis in aviation accelerated the company’s push into other industries, as an example.) The generally accepted mantra is no longer growth at all costs, but to extend the financial runway as long as possible, because things might get worse before they get better. Maybe one reason that will get enumerated as a cause of failure in the future might be “Didn’t cut costs quickly enough”.

As this certainly incomplete list of reasons why startups fail has shown, there are many of them, some of which are closely related. It hopefully also shows that analyzing failures can teach entrepreneurs and investors alike to become better at what they do. One almost wonders that some startups do prosper despite such a great number of obvious and less obvious potential problems. Maybe the reason for that is very simple, as the former CEO and chairman of Google, Eric Schmidt succinctly put it: revenue solves all problems.