When a start-up goes public or is sold for tens of millions of dollars, the high-tech crowd loudly celebrates. And when there is a giant deal, like Intel’s $15.3 billion acquisition of Mobileye last week, the entire country sheds a tear. But the fact of that matter is that even in Start-up Nation the great majority of start-ups quietly fail – a phenomenon that is hardly acknowledged.
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“Many people enter this world naively, because the discussion surrounding it is so overly positive – because this is the Start-up Nation and it’s cool and trendy,” says Adam Benayoun, a partner in the American 500 Startups venture capital fund and a former entrepreneur. “There are people who do it because they think that can build an app and after a year sell it to Facebook and make a fortune.
Even start-ups that managed an exit don’t always do so at a profit to their investors, says Benayoun, who joined a conference “Don’t Believe the Hype” sponsored by TheMarker on Sunday in Tel Aviv on the high-tech industry’s tendency of oversell itself.
“Often when someone sells a company he struts around the neighborhood like a peacock, saying he sold a company. He doesn’t say, ‘You should know that I didn’t earn a shekel from the sale Few people can stand up and say ‘I’ve been doing this for 15 years and still haven’t struck it rich,’” he says.
Glorious failures do get headlines, like Shai Agassi’s Better Place (an electric car network) and Dov Moran’s Modu (a pre-iPhone smartphone), which failed after raising hundreds of millions of dollars. But most of the start-ups die quietly in a dark corner, far from the public's eye.
According to figures prepared by the high-tech research firm IVC Online for TheMarker, 653 start-ups that had been in business for at least four years closed up shop in Israel in 2014 – the latest year for which there are figures – up from 630 in 2013. By comparison, the number of companies started was 1,290.
While companies hasten to announce fundraising rounds and product launches, few publicize when they go out of business, which makes tracking high-tech flops much harder. But IVC estimates that the number of start-ups that close each year is about half of the number formed, so that with big increase in start-up formations comes a big increase in failures years later.
Israel isn’t alone
Israel, of course, is not alone in the high rate of start-up deaths: A Harvard University study in America published in 2013 estimated that of 2,000 start-ups that received venture capital funding of at least $1 million in 2004-10, three out of every four failed to earn a profit for their backers. As much as 40% of the time, investors lost everything.
But the phenomenon in Israel is arguably more significant. Start-ups are a big part of the high-tech industry – a source of jobs and capital inflows – and the number of start-ups has grown, in part due to the dreams of success that giant exits like Mobileye encourage.
“There is a clear and logical correlation between the number of firms that are established and those that are closed – and we’re seeing an explosion in the number of firms being established in recent years,” says Koby Simana, CEO of IVC. “Over 10-15 years, the number of active technology firms in Israel has grown. Their number doubled from 3,700 in 2006 to 7,500 in 2017."
The acid test for most start-ups is whether they can pass through the seed stage when the founders are formulating their product idea and vision, and the research and development stage. According to IVC figures, about 80% of start-ups trip up during one of those two phases and close shop.
Only 20% shut down during the next stage, after they have begun marketing their product. Less than 1% of companies that died had reached the so-called growth stage, when they have sales of $10 million or more, says IVC.
That said, only a tiny percentage of start-ups even reach the growth stage, which explains why they account for so few of Start-up Nation’s body count.
"The point of failure in most cases is first contact with the market, when you’re trying to establishing what price you can sell you product or service,” says Simana.
“Very few start-ups close at the idea stage because it didn’t work or there was no interest in it. Unfortunately, this stage can last a long time, which is unfortunate because if they knew [it would fail in the market] they could shut the company quickly and save the entrepreneurs and investors a lot of grief.”
A study by CB Insights, a U.S. research house focused on high-tech, said that among 101 failed start-ups it surveyed, 42% gave up the ghost because the market wasn’t interested in their product, and another 19% reported losing out to competition. Another 29% that said they had simply run out of money and 23% said they failed because they never succeeded in assembling the right team. Smaller numbers cited problems about costs or pricing, and only 17% admitted they simply had a lousy product.
Simana warns entrepreneurs against getting swelled heads because they have raised capital from outside investors. While it’s true that many start-ups fail because they can’t raise capital, many that have raised tens of millions or more, like better Place, still failed.
Benayoun says the positive attitude that makes a good entrepreneur can often deter him or her from owning up to failure.
“Entrepreneurs learn that they should never give up, that around the corner something good is waiting, so we see people working three and four years on a product without any users or making any progress on it. Their families suffer all that time,” he says.
Benayoun says that when he meets with entrepreneurs he doesn’t want to hear about how well things are going.
“Even the most successful companies have problems,” he explains. “The good companies overcome them, but everyone has to cope with them. Successful entrepreneurs know how to look into the heart of the matter and say ‘there’s a problem that I have to solve.’”
He says there has to be a balance, which requires entrepreneurs to address a real need or problem, not to build their business on the idea that they have a fantastic product.
“I’m bothered that media has romanticized the start-up world,” says Benayoun. “Only someone who has started a company knows after several years at it how hard it is. On the other hand, if everyone talked about how hard it is, Mark Zuckerberg might not have started Facebook.”