Why Startups Fail

‘’The failure rate for new startups is currently 90%. 10% of new businesses don’t survive the first year. First-time startup founders have a success rate of 18%’’ This data has been referenced by Failory & other ecosystem players in highlighting the failure rate of startups globally.

As someone whose career has revolved around investing in and building companies, I have found myself constantly thinking and having conversations with people about what it takes to build a successful company. For context, I have worked for the largest pre-seed investor in the world (a global venture fund and accelerator) as well as an African Fintech pioneering OpenBanking.?

I had a conversation with a friend who works in a Private Equity Firm, some time ago. We spoke about how several years of analysing several startups and seeing multiple trends in the industry as an investor give you an edge in predicting the success rate of a startup but is not a substitute for actually doing the work of building a company. More skills are required in building a company than analytical skills. Fine, the argument could be that an investor, especially in venture capital, is expected to have domain expertise and industry knowledge, which are valuable skills, but in the end will not be enough to build a successful company.?

About a year ago as well, during a conversation at an investment dinner, I clearly remember an investment principal highlighting Grit as an important attribute of a successful founder. ‘Building a startup is hard and there will be times where you will be backed against a wall. What the founder does during the challenging times is what differentiates a founder who will build a successful company or not.’ Ultimately, resilience, adaptability, and the ability to navigate uncertain times primarily are attributes that a founder is expected to have. A founder develops hands-on experience as well as learning actively from mistakes which are inverse to the relatively detached perspective of an investor who is not directly involved in the day-to-day operations and challenges faced by founders.

All this is to say that building a startup and being a founder is not an easy task. How else do you explain that 9 out of every 10 startups fail? The essence of this article will be to speak briefly about several common reasons startups fail based on trends I have identified with a focus on Africa. This will be a good read if you are a startup founder, prospective founder or work in a startup. It will help you identify common pitfalls to avoid. It will also be pretty helpful if you are an investor, especially in identifying red flags in companies you shouldn’t invest in. Generally, it will be informative even if you are just looking to learn about the startup ecosystem.?

There are several reasons why startups fail. While it may be surprising to find out that some startups fail in their growth stage after gaining traction and raising multiple rounds of investment, a startup’s growth & investment stage has little to do with guaranteeing its success in the long run. This brings me to my first reason why startups fail - the ‘Funding Gap’.

Funding Gap

Part of starting a company is raising capital to cover operational costs. Funding is the lifeblood of a company. It can also be raised in several ways. Equity & Debt are two common external funding sources, with Venture Capital being the most common way of raising equity funding. It is also prevalent for founders to bootstrap - using personal money to fund and grow the business while cutting costs. Shuttlers for example bootstrapped for four years with just personal funding and a grant before raising equity funding.

One thing to note about the Venture Capital model of investing is that these firms invest with the expectation that most of the startups they invest in will either fail or not yield their desired returns. Ultimately, they are on the lookout for which startup will be their fund returner with every round of funding. This is technically an investment that can return an amount to the VC around the size of their entire fund, or more, at exit. Technically, this explains why startups still fail even after raising funding from Venture Capital investors.

As I mentioned earlier, it takes more than just funding to guarantee startup success. However, funding still plays a part as there have been several startups particularly in Africa that have failed due to funding-related issues. This could either be the inability to raise money at the idea stage, running out of cash, or not being able to raise follow-on investment.

Last year, a Ghanaian health tech shut down after raising 2.5 million dollars in total investments because it couldn't raise follow-on investments. A Kenyan Logistics company shut down in the same year for the same reason, after raising 26.5 million dollars and could not get more funding from Investors. There are connected reasons why startups will find it difficult to raise follow-on investment. There could be mismatched expectations either with valuation, expected projected growth, or even insufficient proof of concept. Investors may not just be convinced that giving the founders more money will be a good/profitable use of their investments.

Other factors that could cause funding drought could be stiff competition or unexpected activity leading to a higher level of market uncertainties. This could be said in the case of a Nigerian crypto payment gateway that shut down in 2023 because it could not close a successful funding round, after raising 1.1 million dollars. FTX had just shut down and this had a ripple on the global crypto market. According to TechCabal, they were also trying to raise funding at a valuation investors did not agree with.?

Another connected reason could be the high burn rate and mismanagement of funds which several founders have been guilty of. Startups should not overpay their employees or themselves especially when they have limited funding. Oftentimes, it is because they lack financial acumen and are unable to manage the cash flow & burn rate of the company. Other times, some founders have fraudulently mismanaged funds which has led to the business running out of funds quickly before their next round or even before the business could break even. One example is a Ghanaian fintech that shut down in 2023 after internal audits revealed that the founder misused funds, exaggerated user numbers and engaged in other fraudulent practices. Its total investment at the time was 86 million U.S. dollars.?

Team Fundamentals

Startups fail due to reasons connected to the team more times than is being recorded. A popular fintech shutdown in 2023 after raising 2.6 million dollars due to unresolved founder conflict. Hiring incompetent people falls under this category as well. Fred Swaniker, founder of African Leadership Academy spoke recently about how the real secret to success is the quality of workplace talent in a startup.

Founders need to carefully consider the right skill set, level of experience & culture fit when hiring. They need to also be intentional about the culture of the company and how they treat their staff. Hiring people who are the wrong fit as well as being unintentional about the culture of your company is a recipe for failure. The last thing you want as an early-stage company is to deal with scandals in the mainstream media due to workplace culture-related problems. I know many Venture funds that evaluate the Team as a top metric for startups they are willing to invest in.

This is also a good place to mention that the team should have founders and top management with a balanced and diverse skill set. Being a software engineer and building a cool tech product is not enough to build a profitable business. Having a clear founder agreement as well as maintaining an advisory board as early as possible are important factors in reducing founder conflict. Knowing that a cofounder relationship is similar to a marriage, helps an entrepreneur to be intentional about who they’re building a company with. Having a pre-existing relationship helps, where you have had the chance to see the other person's work ethic and become familiar with their values.

Setting clear legal terms is still important, but knowing what to expect when things get tough is crucial because things will get tough. Interacting with the cofounders of Max.ng made me understand the value of having a pre-existing relationship before starting a business together. Other things to consider which I won’t address, border on, startups run by a solo founder or a business run by a couple.

Business Fundamentals?

When building a company, it is important to fall in love with the problem you are solving and not the solution, which in this case is your product. This helps with having an objective view of your business. Entrepreneurship is a marathon, and oftentimes, there are business decisions founders will make from learning on the go. Paying attention to customer feedback and interaction with a particular product can inform whether to pivot and focus on a product that is actually in demand or is generating a larger percentage of company revenue.

Companies fail first when they don’t listen to the customer and get too attached to the solution they are building. Having a raison d’etre is crucial. Evaluating the rationale behind solving the problem and the leverage a founder has in building the solution is also critical. This usually should happen at the idea stage, when a proper analysis is done to define the strategic objectives of the company. This is where the unique value proposition is defined and ensures that the market opportunity is realistic.

Startup founders often pride themselves sometimes in their ability to execute fast, but conducting market research is important because building a business means considering factors like market gap, customer needs, and competitive landscape. Other reasons why startups fail that fall under the business fundamentals category are failure to validate the idea, building a business that is not scalable, compromising on excellent service delivery, building for a wrong market, having wrong metrics in evaluating progress, overestimating growth potential, and failure to innovate and adapt.

Macroeconomic Factors & Market Uncertainties?

These are the broad, overarching economic conditions and trends that influence the economy at a large scale. These factors affect the entire economy rather than specific industries or individual businesses. Think about trends as well as a scope of variables that analysts and stakeholders use to understand the health, performance, and future direction of the economy. Interest rates, inflation, and unstable exchange rates can drastically affect the growth & projected growth of startups. Inflation will affect startups with fixed pricing models especially if they are unable to pass on increased costs to their clients quickly.

Quite recently, the volatility of the naira has also shown the impact of an unstable exchange rate on import-dependent businesses as well as fintechs that are focused on cross-border payment services, lending & investment. A deep understanding of the regulatory climate of a startup’s industry and country of operation can be very helpful. Banking is heavily regulated in Africa and this extends to fintechs as well. One of the easiest ways for a company to fail is to operate without a license. Purchasing accurate licenses is just one step, being compliant with other industry-related regulations is another. This includes fraud management, anti-money laundry rules, data protection, cyber security, and other related rules. Interswitch reportedly lost 40 million USD due to chargeback fraud while Flutterwave reportedly lost about 11 billion naira due in 2024 due to a security breach.

In 2022, a popular fintech company was forced to shut down its operations in Ghana after being accused by the Bank of Ghana of operating without regulatory approvals. Similarly in 2023, a cross-border remittance fintech suspended its operations in Ghana, because it was on a list of unapproved money transfer organisations released by the Bank of Ghana. Earlier in the year, a fintech company lost its Microfinance Bank Licence from the Central Bank of Nigeria for violating guidelines. This resulted in disconnection from other banks, preventing customers from transferring or withdrawing funds. While navigating regulations can be complex, failing to do so can be fatal for African fintechs. Embracing compliance builds trust with regulators, and clients, safeguards against financial crime, and paves the way for a secure and thriving African fintech future.