Academics and first-time failure

 
Tom Welsh
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NOT all businesses are as successful as TransferWise. The London- based peer-to-peer international money transfer firm has just secured a $6m (£3.9m) investment round led by Valar Ventures, the fund set up by PayPal’s Peter Thiel. Founded in 2011, TransferWise now has 33 staff, has transferred over £125m, and reports growth of between 20 and 30 per cent a month.

But as John Mullins of London Business School points out, most new enterprises fail. And for good reason: the typical startup process is driven by poorly-conceived business plans, based on untested assumptions. “It’s an uncomfortable fact”, he says. If the founders of Google, Starbucks, or PayPal had stuck to their original plans, he argues, we would never have heard of them. Their success lay in radically changing their models in response to early failures.

The statistics bear him out. According to (admittedly US) figures from the University of Tennessee, 71 per cent of startups fail within 10 years. Incompetence (including emotional pricing and lack of planning) ruined 46 per cent, lack of managerial experience (leading to excessively rapid expansion) broke 30 per cent. Neglect, fraud or disaster caused a further 1 per cent to fail.

How can you avoid these traps? Mullins suggests a reductionist approach: question your model in five ways. First, who will buy, how often, and at what cost? Second, what is your margin on each sale? Third, what else must you spend to keep the lights on? Fourth, what is your working capital – how early will your customers to pay, or can you pay your suppliers later? Finally, how much cash must you spend up front before enough customers give you enough business to cover your costs? It’s deceptively simple, but unless all those figures stack up, your business doesn’t have a future.

Or you could take inspiration from another study, this time by academics at Harvard Business School. According to Paul Gompers, Anna Kovner, Josh Lerner and David Scharfstein, success comes with persistence. While first-time entrepreneurs have only 18 per cent chance of succeeding, second-timers tend to do marginally better.

Tom Welsh is business features editor at City A.M. @TWWelsh