3 Reasons Tech Firms Run Into Trouble
The numbers of companies that get off the ground are many, but the number that succeed is relatively small. While business in all sectors fail, tech startups tend to get more attention and media scrutiny, so when they do, their demise seems more notable. Think Napster, Friendster or Pets.com.
The statistics are pretty grim. “Maybe about a third are around after five years,” says Merrick Furst, Distinguished Professor in the College of Computing at Georgia Tech and founder of the anti-botnet startup Damballa.
The main cause of failure, he notes, is the inability to create a product or service that the customer simply can’t avoid. “Authentic demand is required for success,” says Furst. “It feels like a vortex that’s pulling the customer into your world.”
If their companies haven’t made that connection, it can be difficult for entrepreneurs to realize just when it might be time to pivot and change their approach to tap into genuine demand. “That’s the hardest thing to control for,” admits Furst. “It’s hard for people to change.”
Then There’s Money
Even the best of ideas can’t be put into play when cash is drying up. Adam Quinton, CEO of Lucas Point Ventures, an early stage investment and advisory company in New York, says many tech startups simply aren’t prepared to handle their cash flow properly.
“At the risk of being trite, they fail because they run out of money,” he says. “But why do they run out of money? They simply aren’t addressing a meaningful problem or fairly executing it.” Put another way, it’s all about getting adequate traction in the market to get to the next level, and to keep the cash register full.
Defining failure can be hard. While going out of business is the most obvious type of failure, some firms simply pitter along and end up as zombie companies, constantly getting bailed out by investors and struggling to get out of debt.
“How many tech firms actually return cash to their investors?” asks Furst. (Research from Shikhar Ghosh, a senior lecturer at Harvard Business School, suggests that up to three quarters of U.S. venture-backed firms don’t return investor capital.) “Can the founders actually say that it’s been worth all of the time and the money that they’ve put into it?”
Despite the risks, there’s no shortage of tech companies being started. According to the technology policy coalition Engine and the Ewing Marion Kauffman Foundation, “relative to their share of firms in the economy, high tech is 23 percent more likely than the private sector as a whole to witness a new business formation.”
The demand for tech products is one driver behind this, but ease to market might be a bigger motivation, says Quinton. “It wasn’t that long ago that if you wanted to create a software-based company, you needed millions of dollars and tons of groundwork, as well as VCs to fund you thorough a long development process and early stage losses to get to commercial viability.” But that’s not necessarily the case anymore. “You can easily outsource anything,” Quinton notes. “There’s software development in Romania. You don’t have to buy servers. You can rent computer capacity.”
But long-term success remains rare. So what makes a tech entrepreneur think they can be the one to beat the odds? “Believing you can be successful is the powerful part of being an entrepreneur and of the American psyche,” Quinton says. “There’s certainly a psychological piece to it. Millions can dream the dream, with a MacBook and a cup of ramen in hand, with an idea that was impractical five years ago.”