There is one of those "universal truths" in the world of startups that, like almost all of them, is neither as universal nor as TRUE as we usually think, and that investors often repeat: 9 out of 10 companies fail.
But what is true about that?
What is considered "failure" for an investor, and what implications does it have for the entrepreneur?
A Debatable Truth
This statistic, which fills even the most painted with apprehension and fear, of course, contains a reality in itself, but it has two aspects that are enormously nuanced and about which I think it is worth discussing:
- What is Failure?
The issue of failure in startups really has to do with another element entirely: our definition of success.
Socially, in the entrepreneurial ecosystem, it seems that the commonly accepted definition is that success is getting investment from venture capital funds (the bigger and more foreign the better); and then selling the company for an obscene number of millions.
However, I think that this is just one of many options - perhaps the most extreme - with reference to the famous dilemma between being king or being rich .
But there are a huge range of nuances - each of which are absolutely personal for each founder - that should also be taken into account:
- To be successful is to have a company that makes money every month?
- To be successful is to create a business that brings enormous value to its clients/users?
- Is being successful doing something that you love, and that makes you feel good?
- To be successful is to be able to have a company and at the same time a "rich" private life?
All these definitions are as valid as winning an obscene amount of money, but not all have the same (obviously) interest for an investor . The problem is that, sometimes, even if you opt for the "be rich" option at the beginning, the market or the circumstances can make your business "only" a company without large growth that employs people, earn money at the end of the month and contribute value.
Although these things can happen along the way, I think it is key that no startup considers seeking money from private investors if it is not willing to try to execute and grow an ambitious and scalable business model.
- For Whom is it a Failure?
And with this question we get to the heart of the matter: for an investor the minimum aspiration is that the total of their investments (what we call portfolio) as a whole not only have a positive return but also generate a capital gains comparably higher than if they invested in other assets of lesser risk (because investment in startups carries a lot of risk).
And of course, if the standard is that of every ten investments only 1-2 are really successful (although it is not the only model at all), it means that only 1-2 are capable of generating sufficient returns to cover the rest of the losses and also generate profits. But the question we often don't ask ourselves is, what about the other 8-9?
So typically 3 or 4 close in a period of five years (don't pay much attention to the specific number), 4-6 become "bad investments" (as long as they don't generate enough returns to cover the assumed risk) and 1 or 2 generate those big returns we were talking about.
But the key is to understand who these 4-6 companies are: often they are companies that have not been able to realize that high growth potential, and that despite having achieved profitability, they do not have a way to return the money to their clients. Shareholders (beyond annual dividends) and perhaps they are in the grey zone.
That is to say; they are not companies that a priori is going to be bought, in which a large fund is going to be invested (buying shares from previous investors) or that are considering going public... but they are profitable companies and can even be growing, although not explosively.
But are these companies "failures" in the absolute?
The Problem: Non-Aligned Incentives between Founders and Investor
This brings me to one of the most controversial and least talked about issues: the real misalignment between investors and entrepreneurs.
INVESTOR: On the one hand, investors are interested in continuing to bet, investing and helping to promote the scalable growth of those companies in which they participate and which are doing well and the "failures" of others are assumed as natural (something absolutely consistent with their incentives as investors, eye).
ENTREPRENEUR: On the other hand the founders, depending on their definition of success (as we've commented before), may not be looking for an all-or-nothing approach and, although they initially aimed to create something big and big-growth, they may be happy with a profitable company that adds value, even if it can't scale.
In my opinion there is no good or bad in this film, nor is the investor a shark for wanting to defend the money that has cost him so much to win, nor the entrepreneur a failure to have not hit him .
It seems to me that there are no unique or correct answers on what is the best way to resolve this misalignment, beyond being extremely sincere among all partners (founders and investors alike) and periodically reassessing which model the company is going to follow.