The Best Ideas Are the Ones That Make the Least Sense
October 26, 2020

HBS on Why Startups Fail

With Harvard Business School Professor Tom Eisenmann & Michiel Kotting, General Partner at Northzone


When it comes to entrepreneurship, we talk about what to do to succeed, the keys to scaling or becoming the next unicorn. We rarely speak comprehensively about what not to do to avoid failing and too often reduce startup failure down to the founding team or the business idea.

Tom Eisenmann (Professor of entrepreneurship at Harvard Business School) interviewed and surveyed hundreds of founders and investors and studied scores of accounts of entrepreneurial setbacks. His findings, presented in his new book The Fail-Safe Startup, buck the conventional wisdom about the causes of startup failure. He found six patterns that doomed ventures. Two were especially common: Bad bedfellows —like employees, strategic partners, and investors— and false starts.

Join Michiel Kotting (Partner at Northzone and HBS99) and Tom Eisenmann to discuss his new book and uncover why two-thirds of startups never show a positive return.

Michiel will also share his decade of experience as a VC investor, what he learnt from his failed investments and how he helps founders succeed as a “good bedfellow”.

Failure will always be a reality for many entrepreneurs. Doing something new with limited resources is inherently risky. But by recognizing that many failures are avoidable and follow the same trajectory, we can reduce their number and frequency.

Speakers’ biographies

Thomas R. Eisenmann is the Howard H. Stevenson Professor of Business Administration at the Harvard Business School, Peter O. Crisp Chair, Harvard Innovation Labs, and Faculty Co-Chair of the HBS Rock Center for Entrepreneurship, the Harvard MS/MBA Program, and the Harvard College Technology Innovation Fellows Program. Eisenmann teaches the MBA elective Entrepreneurial Failure and the MS/MBA core courses Technology Venture Immersion and Launch Lab. In recent years, he has served as Chair of Harvard’s MBA Elective Curriculum—the 2nd year of the MBA Program—and as course head of The Entrepreneurial Manager, taught to all 900 1st-year MBAs. With colleagues, he launched the MBA electives Making Markets, which focuses on marketplace design, Scaling Technology Ventures, Entrepreneurial Sales & Marketing, and Product Management 101, in which students specify and supervise development of a software application. Eisenmann also created the January Term Startup Bootcamp for first-year MBAs and the MBA electives Launching Technology Ventures and Managing Networked Business, which surveyed strategies for platform-based businesses that leverage network effects.

He twice co-led a Harvard Innovation Lab course, Cultural Entrepreneurship in New York City, in which students from across Harvard spent a winter break week in New York exploring new ventures in fashion, food, and fine arts, and co-led four similar winter break trips to study entrepreneurship in Silicon Valley.

Professor Eisenmann received his Doctorate in Business Administration (‘98), MBA (‘83), and BA (‘79) from Harvard University. Prior to entering the HBS Doctoral Program, Eisenmann spent eleven years as a management consultant at McKinsey & Company, where he was co-head of the Media and Entertainment Practice. He currently serves as a director on the board of Harvard Business Publishing.

Michiel Kotting is a General Partner at Northzone, focusing on SaaS, marketplaces, healthcare and AI. He leads Northzone’s investments in Personio, Spacemaker, Kahoot!, Medwing, Disperse, Catawiki, Forto, and Aidence. Before joining Northzone, Michiel was an investor at Accel London.

Originally from the Netherlands, Michiel spent the early years of his career at BCG. He then founded Digital Jones, an artificial intelligence company in the Bay Area, which he sold to

Michiel has a graduate degree in physics from Delft University of Technology and an MBA from Harvard Business School.

Transcript and Audio

Play the 1 hour audio here:

And that was disconcerting because in theory, I was a expert on entrepreneurship. But I was a failure at explaining failure. And if indeed, two thirds of venture capital backed startups fail to earn a positive return, failure is important. So here’s one of the most important phenomenon in my field. And I didn’t really understand that. So set out on a quest to learn everything I could fail your follow predictable patterns, were there ways to avoid that. And if a founder did fail, despite their best efforts, was there a way that they could fail less painfully, in this particular instance, I saw the pain up close, because I knew these founders very well. But every every time it hurts, it really hurts. Personally hurts the ego hurts financially. And, and so that’s set me out to learn everything I could. Lots of case studies. And this is really the spirit of Harvard Business School, and some survey work. And lots of interviews with failed founders and investors. Here we are, essentially, seven, eight years later, with the results. you’re mentioning, it’s studying failure requires talking to a lot of people. And as we have as a method at the school, you bring them into your classroom, you do case studies, you kind of highlight them. Normally, we put people on a pedestal with the successes that they’ve had. And now you’ve had those experiences of those founders. What was that like? Well, so the first few cases I taught about field companies didn’t work very well. I think MBAs are great at analyzing, and great. If you didn’t my case, on what happened, it’s pretty easy to look in the rearview mirror and say, well, kind of obvious why that didn’t work. You can undo the response, of course, as the instructor as well, you know, it’s a very smart person who launched this business, and the investors who put money in were very smart. And the team members were very smart. So they saw some potential here. You know, I’m glad you think it’s such a simple, but eventually, I learned how to how to how to get the stories across in ways that that I think there was more learning value, and eventually launched an entire MBA elective focused on entrepreneurial failure. I was a little worried about this, frankly, you know, so you can imagine class after class after class with with failed founders, I, I frankly, worried that I would scare off a generation of Harvard Business School students from entrepreneurship by just showing them the pain, so close. And, in fact, it was just the opposite effect at the end of profit course twice now. And at the end of the course, I actually surveyed students and ask if, if the experience has changed their view on how likely they are to be an entrepreneur, five within five years of graduation. And in fact, 20% do say, yeah, I’m less likely now I’ve actually I’ve seen it, it hurts, I don’t think I want to go through that. 40% say they’re more likely, they say thank you for showing me up close. What I’ve learned, I think I understand the stakes, but pain, and I think I can handle it. But most importantly, you’ve shown me these failed founders granted as a curated set of very thoughtful people. And most of them had terrific success in the wake of their failure. What I’ve learned in studying failure more generally, that is the pattern. In fact, most people learn something from the failure and can’t bounce back and do something very interesting. So these, these students said, 40% of them, that they’re more likely to do it and they know what they’re getting into. And then the remaining 40% said, I was likely to do it, I’m still likely to do it, I may wait till I have a great idea. And I may think twice before taking shell and venture capital, because the taking venture capital was at the root of a lot of the failures we looked at. And of course, the pressure for growth. You know, of course, if you’re going to succeed as a venture, capital backed startup, you must grow. But at the same time, growth can cause a lot of problems if the companies aren’t ready for it. That’s great. And what was the sort of experience of the failed founders have been in your classroom? How would the day take away from, from presenting it and discussing it with the students? I would say, they would say it’s therapeutic. You know, I think most of the folks on the call are alumni. So they’ll remember the typical pattern of an HBS class session we have a class guest is 60 minutes of professor and students talking and then 20 minutes of the guest but have a different rhythm in this course, where I bring in the protagonist, the failed founder, right from the very start and the students interact with that person throughout the class. And that actually has I think it has an interesting effect. So normally, if the person is sitting there, and they only come in, in the last 20 minutes, they’ve been listening to smart MBAs dissect their business and talk about the failings and faults and so forth. And they come up, and they’re sort of girded for battle. And, and it’s all packaged, and so forth. But actually, if they’ve come in throughout the class, they loosen up a little bit, and they actually get comfortable, they trust the process, they trust the students. And by the end, there’s there’s a lot of candor. And a lot of emotion tends to flow out in the course of the discussion. And I think the founders find it therapeutic. And the students just find it eye opening. So yeah, it’s, you know, and also, Michelle, the, at the beginning of the course, the first half, it’s all focused on business model analysis. So what went wrong with the business? By the back half? Where they want to know is, who is this person? Now? What did they learn? How did they react to the failure, so it becomes very, very focused on a person who experienced failure. It really sounds like a very beautiful experience. You’re kind of doing touching on such an important subject of how do you do a start up? And what can you do to avoid failure? But I guess, as a devil’s advocate, you could say, startups are inherently risky, they’re trying to almost be impossible. So you’re likely to fail? And can you actually avoid failure? And still, we shouldn’t try to avoid failure. In fact, you’re exactly right. We want entrepreneurs to try risky things. In fact, I mean, the very definition of entrepreneurship embodies that risk, right, and you’re doing something new without resources. So of course, there will be there shouldn’t be a lot of failure, what we want, and we have in the course, and in the book, a concept of a good failure. And they are out there, those are failures where the entrepreneur has a vision, that concept launches the business, if you can test the assumptions you’ve made about the opportunity, you’ve done that rigorously. And with as little waste as possible, this is the concept of the minimum viable product. And, and sometimes, the universe shows you that that concept was was wrong. And no shame in that. You know, it was it was worth the try for the team for the founder for the investors. And they’ll have learned something, they’ll move on to other opportunities. So those are good failures. And then there’s another set of failures where you’re neither good or bad. It’s just unavoidable, right? asteroid strikes, consider the dinosaurs hundreds of millions of years ago, it during COVID. Worldwide, you know, probably millions of businesses, certainly hundreds of 1000s shut down. And that I know, their circumstances would have been viable. And same thing happened with the great recession of 2009. So we can’t, we can’t dwell on those failures. They’re tragic. But there was nothing that nothing that the entrepreneurs could do to avoid those, well, we want to do is isolate the failures where there was some mix, always a mix of misfortune, not controlled by the entrepreneur, and mistakes that the entrepreneur made. And we want to minimize those mistakes and, and boost the odds of survival of healthy and promising confidence. And you start the book with, actually, what is the definition of failure, which is probably good to mention here, so people understand what we’re talking about. Yeah. You know, I think listeners may think of it like, how could you possibly ask a visa? Isn’t it obvious what we mean by failure, but not at all? And this is not just a case of professors wanting to torture definitions, which we do love to do? You know, is it a failure? Do you need to have a shutdown of a business? No, because actually, many bankrupt companies continue operating? Do you need to go bankrupt? Not necessarily. There are many businesses that will never return. Cash return the capital that was originally invested in, they generated enough cash flow to survive, but but not enough to yield a positive return to the investors. That’s actually the definition I use in the book. Some people might say, Well, what about the founders goals, the entrepreneur, and that’s important, of course, and, and it goes beyond finance, beyond beyond personal wealth or the return to the business. The founder may want to change the world may want to build a great team leave an enduring legacy. It’s possible to accomplish some of those things and still have the business via financial failure. So that’s the reason I don’t focus. I keep the founders Hold on radar throughout the work. But it is important to remember that if we look at later stage startups by series D, so, perhaps five years into the life of the company, maybe more, only 40% of venture capital backed startups are still run by a founder CEO. And basically, it’s often the case that the role outgrows the individual and you can add up somebody new to come in there. So for that reason, there’s many more stakeholders than simply the founder. In any kind of startup, we should still also look at society at large. So I use a financial definition, investors did not or never will make money. But there are businesses that make money that we as societies would wish they would go away, they exacerbate income inequality, they pollutes, they have addictive products that that we’d sooner be rid of. And so, so it’s important to keep negative externalities to society on in view. And likewise, there’s some failed businesses that generate positive spillovers that that never go back to the investors. We’ve learned what not to do, from this failure and other entrepreneurs may may pursue a better idea is learning from from the failure. Individuals who worked in the company may pick up really valuable skills and go on to leverage those skills elsewhere. So the answer, like so many things academics like to talk about is it’s complicated. Failures complicated? Yeah. And the other thing that sounds complicated as well, is to determine the reasons for failure. You looked at a lot of different companies. But obviously, it depends a lot on who you ask and how you want. Yeah, I mean, the simple explanation for why startups fail is they run out of money, and they can’t raise more. That’s true. Although it’s worth noting, some startups fail because they raise too much money and do crazy things with it. But that’s a special case, but it is out there. That the reason, you know, of course, we want to focus on cash flow as entrepreneurs, it’s it’s a cardinal sin to run out of cash. But it’s it’s not really a good explanation for failure, because you just have to ask why like a coroner saying, this person died from loss of blood? Well, why? And you keep asking why, and what I found with both early stage, and later stage startups that were some recurring patterns? And is that very different in startups in general business owners? Yeah, I would say a world of difference, especially if we look at big companies, public companies, corporations, you know, they do fail. And they fail from hardening of the arteries, right. And there’s, there’s inertia that they, they can’t respond quick enough to changes in the environment. I mean, that happens to startups too. But but most startups fail for reasons that don’t have to do with with inertia. And I’d say it again, even some big companies and some small businesses that aren’t necessarily startup style businesses fail, due to causes not really under control of the business people involved in a bad economy. You know, it’s an end in the book, you kind of differentiate between sort of early failures and later stage failure. So why don’t we kind of touch a little bit on the early failures? First, you give a number of great examples and different sort of mechanisms, or so why don’t we touch on a couple of those mechanisms and what you’ve seen happen there, who are the an early stage, in the book, I have three chapters devoted to re release stage failure patterns. And I think a lot of early stage failures couldn’t be explained, either by one of the one of the patterns or in unfortunately, in some cases, combinations of the patterns. The most common one is probably what I call a false start, just like in track and field or, or swimming, where the athlete literally jumps the gun trying to get an advantage. These entrepreneurs are so eager to build and launch the product. They’ve got a vision burning bright of what they want to do. And the self image of an entrepreneur is somebody who makes it happen. So let’s build it and get going and we’ll get feedback and we’ll iterate and improve the product in response. And that’s all good. That’s actually very important part of the Lean Startup concept. What these entrepreneurs have done though, is they’ve skipped another part of lean startup, which is the whole less fun part than actually building and launching. It’s the upfront research where you talk to a lot of potential customers to explored demand is have we found an unmet customer need that’s worth solving. And have we explained there’s, there’s, there’s almost always multiple ways to solve a problem. And an entrepreneur needs to explore those different solutions, and then figure out which one is most promising. And this work, it might take four weeks to do it well, and the entrepreneur who skips this work and goes soon, as soon as they found a problem, a solution of care, and goes right at it is much less likely to have a product that will hit the mark, that will work. And they can pivot away, they can iterate in response to the feedback. But this whole process probably takes four months of building, launching and figuring out if it’s working, and then figuring out what to do what next. If you if you’ve forfeited if you sacrifice wasted four months, to save four weeks, you’ve made a bad trade off as an entrepreneur. So that’s when it’s very understandable. I would say, technical founders are vulnerable to this pattern, because they love to build their engineers, what do engineers do? They love to build what entrepreneurs do they make things happen? So if you’re an entrepreneur who’s an engineer, you are vulnerable. But it even turns out many of our colleagues in the NBA many students in the MBA program are not technical. They but they’ve heard correctly, that you must have great product to succeed as an entrepreneur, and how do you get great product? You get a great engineering team? How do you do that you exercise the fantastic networking skills you’ve developed as an MBA and you go out and find a technical co founder, or Vice President of Engineering, somebody who can build the thing. Once that talent is on board, you feel tremendous pressure to keep them busy, because what do they do they build. So both technical and non technical founders are vulnerable to this false start pattern. That’s the first one. And like you said, that is sort of kind of fits nicely with the Lean Startup philosophy, but at the same time, is a bit of the result of people diving into the being started. Most of you What do you think then? Eric Rees received, like insane of your findings? Yeah, I think they both agree. Steve Blank would really agree. Because he’s the champion of what he calls customer discovery, his exhortation is get out of the building. Now before you start the engineering work, go talk. And he makes in the courses he teaches he makes the students in the courses do 100 interviews, I think it’s too many. I think you’d probably hit diminishing returns after 20 in any given customer segment. But so blank would absolutely. I think Reese is more complicated issue, because he’s been so focused on build, measure, learn this in the rhetoric that comes out of the Lean Startup movement, fail fast launch early and often, actually, I think in some ways, exacerbates the problem I’m talking about. Now, Eric, is nobody who understands lean startup, like I agree. So he absolutely understands the importance of the upfront research. But But, but but I think many founders think they are running lean, when they’re actually headed for a false start. So and I think the rhetoric of the of the movement actually reinforces that. Yeah. Another one you mentioned, which I thought was really telling and for a venture capitalist for an important one to take into account. The idea of bad bedfellows? Yeah, this is this is a pattern. And it’s also tragic, because these entrepreneurs have the preface to bad bedfellows is good idea, comma. Good idea. Bad bedfellows. So the entrepreneurs have a good idea, but but when we think of the bedfellows, all of the players involved in the venture, we tend to focus too much on the founders, the founders are absolutely crucially important, and their abilities, their attitudes. But we need to look at the rest of the team, we need to look at the investors, they’re going to contribute not only capital but contacts and advice and support. And most startups, many startups will rely on partners, often bigger corporations, because definition of a startup is somebody who’s doing this without resources, who has the resources, some big partner, they’ll have technology, they’ll have distribution channels. And and there are unfortunately businesses out there that have a pretty good idea but they can never get that constellation of players aligned with the right capability. And so if you’re deficient or dysfunctional in one of those areas, partner, team founder investor, you You’re much less likely to succeed. Now that the case study here In the in the book that illustrates this is the, it was the catalyst as we talked about at the beginning, at the beginning of the call, Quincy apparel. And my former students had the concept of creating, they wanted to create a pair of professional work apparel for young professional women. That was affordable, stylish, and here’s the key, better fitting, they were both tall and had trouble finding clothing that fit well. Turns out to be murderously difficult to design and manufacture apparel, especially if your promises better fit. And these these founders didn’t have prior experience in the fashion business in the apparel business. And that just cascaded through their ability to get the players in place. So to compensate for their lack of domain expertise, they hired specialists out of industry, unfortunately, big company, people who didn’t adjust to the rhythms of startups very well. And so these folks would, you know, quite literally sit on their hands when the fire was burning. Normally, in a startup, everybody would shift over to help put out the fire. These people said, I’m the pattern maker, I don’t know how to help with with fabrics sourcing. And so the team didn’t do the job, the investors were, they thought they were investing in a direct to consumer concept at that point was early in DTC. And this was a direct to consumer concept. But it’s also an apparel company, a lot of direct to consumer, companies don’t actually have to design and make the thing they’re selling. And this turned out to be really difficult. And so the investors neither brought deep expertise, nor were they able to follow on when the Enbridge the company provide more financing when the team got in trouble. And in the factories, it’s quite common for an apparel company to outsource manufacturing to third party factory, the factory is ignored this game. And basically, they would push their orders to the back of the line when someone a bigger customer came in with something that needs to be expedited. No reputations, no relationships, small orders. And so they were making progress, they actually had strong demand for the product, they had good repeat purchases, but it just wasn’t coming together fast enough to save the business and no one would put more money in. Do you think there is a good method of validating that you have the right people around the table? And is that sort of at the start? Or is that something you repeatedly do? I think he continues to evolve, of course. And so it is it is a repeated part of the process. I would say what this research in particular gave me new respect for is how crucially important domain expertise is, and particularly industry expertise. In some ventures, but not others. I mean, there are many, many startups where, where you just don’t need to have spent 10 years working in the industry to understand it the opportunity. But apparel design and manufacturing is not one of those, by the way, if anyone on the call is an entrepreneur and food or beverage, wow. You know, that is a place where every single decision you make, you know, has to be informed by, by by, by careful consideration of the options and experience. And so the package, so how you how you how you contract out the manufacturing of the items, how you sequence distribution into the chains and pay this doesn’t make sense to pay for slotting allowances. You know, there’s dozens and dozens and dozens of decisions that you can make wrong if you if you lack experience, or lack people on the team who could bring that experience. Good. Let’s jump maybe to the later stage lessons and failure. And I think the one I really recognize and have seen happen a number of times is would you call the speed trap. Because this kind of happens to very well finance companies. The app, the speed trap is growing too fast. And one of the reasons the venture grows too fast as people have pumped a lot of money in and they expect the growth. So it starts with a great idea. An idea that early adopters embrace spread the word so you have word of mouth referrals you haven’t spent anything on marketing yet. That’s good. And and there’s repeat purchases. The growth attracts investors who come in at a high share price high valuation, and it also attracts typically clones. So fast moving other entrepreneurs will see the opportunity. They will put upward pressure on costs and downward pressure on prices. The the investors pay high price expecting continued growth and push for it. The entrepreneur doesn’t need to have her arms. was the entrepreneurs love growth, how many keep score, so, so they try to acquire the next wave of customers. The next wave just isn’t as interested in the product is the early adopters, right? that they’ll buy, they’re interested. But But you’re by definition a little further away from the sweet spot. So again, you have to market harder, you have to engage in paid marketing, to now the cost of acquiring a customer is rising, you don’t get repurchases, like he did with the early adopters. And you may have to reduce your price either because of competition or just to attract the customers. So the lifetime value of a customer is diminishing, while the cost of acquiring a customer is rising, you’re getting a squeeze on LTV, lifetime value, CAC, customer acquisition costs, squeeze. And everybody will look the other way for a while because you’re getting the growth and there’s some expectation you can improve both of these things. But the reality is a lot is going on inside the company that could be dysfunctional. So if it’s a business of secure software business, you’re lucky if it’s a business that requires human beings to do things at boxes, answer phones, answer emails, customer service, etc. And you got to recruit all those people, you have to train them that is difficult, you’re doing all this in a startup where no management systems at the beginning exists that we have to put in place, inventory management systems, budgeting systems, customer service, management systems, etc, etc. and entrepreneurs may resist what feels like the imposition of bureaucracy. So they may be slow to move on, you’re bringing in legions of middle managers and specialists, and you can get cultural conflict between the old guards a team that was present at the creation, loves the idea loves the founder, you know, who are these new specialists? What are they really doing? What’s my job in this company, meanwhile, the specialists don’t feel appreciated, and they look at these people that are sitting on, at least for the moment stock options and look like they’re worth millions of dollars. So there’s cultural conflict, sometimes it leads to an ethical slippery slope, where you do unethical things to sustain the growth usually not. But eventually, the investors, new investors, like look at the economics of the business and say, This isn’t getting better, and they stop and then the existing investors have to figure out whether to bridge they started to get very nervous. If you do get more investment, it’ll be a down round a lower share price than the earlier round. And boy, that’s a terrible signal for a startup. Employees leave because they’re worried about the future about their stock options, etc. And any kind of run unravel very quickly, that management team can slam on the brakes and stop the market and refocus on profitable customers. But it’s often too late. speed trap. Yeah, if you if you read it in the book, and I recommend that everyone knows its its hair raising to going to read this play out in real time, especially because it starts with a century success. And I think in my own experience, it’s sort of the abundance of capital that is kind of hiring a product market fit. And like you’re saying, a team that is chasing top line growth over everything else. So I think installing the right kind of KPIs early on to see that everything else is diminishing. Yeah. And what’s what’s vexing to your point is this is a business that actually had product market fit at the outset, but lost it over time. It’s It’s It’s not a permanent thing, product market fit, you actually can lose. Another one you you mentioned in the chapter, there is something that is very close to what we’re all really admiring in entrepreneurship, which has been the cascading miracles. So So what is the difference between a better place and a Tesla, if you will? Yeah. So I’m sure everybody knows what Tesla does. Better Place, in many ways was after the same opportunity. This is a company that raised $900 million dollars in the 2010 timeframe. Before electric vehicles got going. They wanted to deploy around the world, a network of charging stations for electric vehicles, including battery exchange stations, where you drive in with your depleted battery, a robot would pull the battery out and put in a fresh, fully charged battery all in five minutes, the amount of time it takes to refill a tank of petrol. And they build this in Israel. And in Denmark, it was deployed. But it didn’t work. And and this is an example of the cascade of miracles By the way, so is Tesla. So the cascade of miracles that concept is many many things have to go right, each of which is very ambitious goal. So in the case of better place, fundamental change in customer behavior, driving electric cars. Those cars had to be designed by the automakers to have the replaceable batteries, big deal to get to get OEMs the auto manufacturers to design their cars to split the startup specifications. We needed government subsidies for electric vehicles, we needed to raise a billion dollars. In order to deploy the network. We went and on and on like then some of the some of the miracles actually happen, things work, but not enough of them. But the tragedy of cascading miracles is, if anything goes wrong, the entire venture cannot if you don’t raise enough money, but everything else goes right, you lose. It’s like a mathematical equation where you’re going to multiply a bunch of things together. And if anything is zero, the whole equation goes to zero. And and that’s what happened. And that didn’t happen with Tesla. So you know, many things had to go right for Tesla to work. And so far, at least, Ilan has been lucky. You are very, very, very talented. Probably both. Yeah. Probably. Let’s, let’s kind of jump a bit to the the consequences. I’m an entrepreneur, I’ve read your book, How do I need to revise? Well, the last part of the book, so the book is divided into three parts, early stage failure patterns, how to anticipate and avoid later stage failure patterns, how to anticipate and avoid, and the third part of the book, brings it back to the entrepreneur, and asks the following questions. How do How can I know whether and when to pull the plug on a struggling startup? It’s very difficult come back to why but it’s a very difficult decision. If I do shut the business down. How can I do so let’s call it gracefully, in ways that will preserve my reputation, my relationships with everybody involved? And and essentially, the answer to that question is, everybody who’s owed money is paid back in full employees, customers who may have left to deposit vendors who sold you something, etc. And then the investors don’t get all their money back. But 10 cents on the dollar invested is better than zero. And then and then having failed. The crucial question is how to heal it hurts. So what do we learned about about the process of healing, we then explore how to learn, you actually can’t learn much as long as you’re in pain, but grief, literally the pain and the grief will cloud your your ability to, to draw lessons. But then how to actually maximize the learning. And it turns out too many failed founders end up at one extreme or the other. There’s a very natural human tendency, tendency, ego defensive tendency to blame others, my co founder dropped the ball, my investor pushed for the wrong strategy. The regulator’s did something irrational, etc. And, and those founders haven’t learned much they, they chose the co founder, they chose the investor so that they need to own the mistakes they made, and put them in perspective. Sometimes it is everybody else’s fault. Sometimes the founder is indeed playing less, but not not as often is, as the attribution suggests. The other extreme is even sadder. These are entrepreneurs who just beat themselves up, they take too much responsibility, they say, I am hapless, and hopeless, I never should have been an entrepreneur, I never will, again, be an entrepreneur, because I just wasn’t suited for the role. And I made nothing but bad decisions. Again, there are some people that fit that description, and they probably should never do it again. But but more people feel bad than probably is true. And that’s sad, because those folks actually could be great entrepreneurs and society can get the benefit of the jobs and, and the ideas they have. So we want entrepreneurs to end up in the middle with a little bit of distance from the pain, where they can actually put in perspective what they did, right what they did wrong, what they would do differently the next time. And that then gets to the last part of the of the process, which is how to figure out what to do next, I was surprised to find that half of if you look at venture capital backed startups in the US, half of failed founders come back and do it again, very high fraction. And, and some of them are the ones who were in denial and just you know, it wasn’t my fault. So I’m going to do it again. And they will ride the horse over the same Cliff next time. And but but I think the founders that are, are, are best equipped. Now there is a stigma associated with failure in all societies. I think it’s weaker in the United Kingdom and in the United States, in some parts of the world. You go to other parts of the world, meaning you don’t want to be a failure in Japan. You know, and in some countries, the financial consequences the bankruptcy laws are such that the entrepreneur is actually personally liable for, for the losses of the business and that’s that can be brutal. So but the entrepreneurs who are best equipped to do it again, failed gracefully So so the reputations are intact, the relationships are intact, and in and they can explain why it happened and what they learned and what they will do differently next time, especially in the UK, or the US an entrepreneur who looks like that, I think is very bankable, again, by a team by by co founders by investors. Do you feel it’s sort of people running into the traps that you’ve seen? Was it more a lack of awareness of the risks that you were describing? Or is there a strong correlation to certain personality traits that lead you into certain trouble? Yeah, we desperately want there to be personality predictors of entrepreneurial success and failure. And people we’re all sure that it’s something about risk tolerance, and persistence, and so forth. And I think there is some of that I have to say, a lot of other academics have spent a lot of time trying to stick the scientific thermometer into personalities, and they don’t get a lot back. It turns out that entrepreneurship is a very big tent. And a lot of people can fit under that tent, the different kinds of people with different values and motivations. I myself did a survey of, of late stage, excuse me, early stage founders who failed and and succeeded 470 founders have both successes and failures. And I asked them every kind of question you can imagine about how they ran the venture and organized it and so forth, including some self assess personality predictors, where they care what other people describe you, as charismatic, as visionary as as persistence, etc, etc. So the only personality trait that came out as statistically significant in my survey was, was methodical, the entrepreneurs who are more methodical were more successful. And take it or leave it when you ask about 20 things if your statistical confidence interval is 95%. You know, it’s often the case that you might expect one of them to show up as significant, even if it’s not. So I think I have a lot of noise. And what it says is, don’t obsess about whether you’re listening, whether you’ve got the right personality to be an entrepreneur, pretty much everybody does in personalities change in, in, in circumstances, right. There’s a lot of our behavior that is situation dependent. So, you know, face a nasty negotiation with a partner, and you’ll find out how tough you are, you’re probably tougher than you think. Now, I guess it also tells us we have to go and invest in Germany. Yeah. Last kind of question. On this. There’s a bunch of people I’m sure in the in the in the audience that are either angel investors or professional investors, from what you’re describing here? And are these traits are these kind of suit of circumstances and settings? That we can identify the bowl and reinvest? Or is it mostly post investment? You know, be the right partner and help to help people avoid these pitfalls? Yeah, no, I think the good news and this is true for for co founders or team that Yoast, early team members who might join, certainly true for seed stage investors, is I think, the fit the early stage patterns are visible, right from the start, even before the seed money comes in. If you are headed for a false start, if you skip the upfront research, the investor should be able to see that absolutely. A pattern we didn’t spend as much talking about early stage failure pattern is a false positive, just like in COVID. Testing. You know, you in this case, the entrepreneur thinks that she has strong demand. And she may have it with early adopters, but it doesn’t extend to the mainstream. So the business won’t grow as fast or as successfully as she thinks. And a smart investor will ask a lot of questions about the differences between early adopters and mainstream customers, which again, if the if the entrepreneur has done thorough research, that is that that could be understood. And then lastly, the the bedfellows pattern, bad bedfellows. I think it’s true that some businesses require domain expertise more than others. And I think a savvy investor will understand the types of businesses that require that and again, can look at the team as the evolving team and see if in fact they have access to the industry expertise that they’re going to need. So I think on all three fronts, an investor can anticipate some problems. Yeah, that just sort of kind of kind of, to be too close before doing the q&a. You you end the book with what I would kind of describe as a love letter to enterpreneurs where, clearly your passion for the for the subject and People, starting companies and building a future kind of go comes through. And one of the things you you, I think very strongly and nicely pointed out is that there’s all these traits and all these behaviors that we all recommend fissara to farmers that are good in moderation, but not extremely. So what made you kind of come with that as a as a closing and must be close to your heart and for saying that? Yeah. So thank you for calling in love letter. I think that’s exactly what it is. It’s a letter to a first time founder. And the advice is, there’s a lot of conventional wisdom on what makes an entrepreneur successful. It’s good in moderation, good most of the time. But be careful. It’s advice, like, be persistent. We should be persistent, right? If you if you throw in the towel too quickly, you’ll never build a business. But on the other hand, that persistence turns into stubbornness. You may not pivot when you need to, and that’s a surefire way to burn through capital, and boost your failure odds. Grow. It’s how and again, I said before, how entrepreneurs keep score. But if you’re too focused on growth, you may skip the upfront research and just try to get going. The frugal entrepreneurs must be frugal, and it’s true, you’re you’re dealing with limited resources. If you’re so frugal that you don’t, you aren’t willing to pay the appropriate market rate for the expertise, you need to run the business. If you skip some hires, you may boost your failure odds. So again, in moderation, and I think the most important one is we tell entrepreneurs to trust their gut, right? That’s, that’s your big advantages. You can move fast, you should trust your instincts. And again, an advantage much of the time, but there’s some decisions where you just need to slow down. Think once think twice, sleep on it, sleep on it another night, talk it through with lots and lots of people, you know, and and because your gut when you’re making these big emotional decisions is going to be racked by all sorts of all sorts of things it’ll keep you from from thinking clearly. So slow down a little bit is my advice to the entrepreneur. I would say my advice to everyone here present is read the book, read it, it is the best investment you’ll make. Whether you were starting a company, investing in a company, join a startup or are interested in the space in general, because because it’s very thoughtful, clearly, you base it on a lot of research. And we’re really grateful you you took the seven or eight years to work on this, this topic. Let’s jump in on the q&a. So there’s a whole range of questions there. I’ll pick some from it. I think an interesting one, especially as a VC to ask for someone says, is the system broken? Is the VC model one where older it is on the entrepreneur? And the model doesn’t fit all businesses? Should we all be shooting for breakeven first, rather than the growth metrics that our VCs are putting on us? Yeah, what a fantastic, thank you for the question, whoever asked it. You know, many of us are from Harvard Business School. I’m an MBA on top of being a faculty member, we lionize venture capital. Michelle and his colleagues are heroes, where we go to school. And I think there’s an assumption too often nailed by HBS entrepreneurs and folks from other top business schools that if you’re going to be an entrepreneur, you must raise venture capital. And I think a big lesson from the course that I’m teaching is, there are other ways to finance a business, not every business should be venture capital backed, not every entrepreneur is temperamentally suited for the pressure that comes with it, I don’t think the system is broken. I think venture capital is what it is, it’s a business model where you make all of your profit from from a handful of investments in the portfolio 10 times 20 times 100 times returns on the initial investment. And then another 30% kind of goes sideways, you know, they double the money or triple the money, which over 10 years is not particularly exciting on an IRR basis, you know, and a lot 60% of the investments, something like that might lose most or everything. And that just is what it is. There are businesses out there that can grow like rocket ships, and somebody wants to fund them. And, and, you know, if the rest of the portfolio is good failures, then then I don’t think we have any problem as society. The problem is when and by the way, the entrepreneurs who who come to my class as failed founders, they, one after the other, they say I knew what I was getting into. I know I understand that beside me. I understand the VC business model. And I understood it intellectually. I didn’t understand emotionally, you know what, what kind of pressure I was going to feel and I’m not sure All right, we’ll do it again. So that’s I think that’s the message is that every entrepreneur really needs to soul search before they take the money. Are they willing to take the kind of risk that comes with shooting for hypergrowth for taking the kinds of business risks that come along with that many are? My I’m going to be joined in the book features a company called baru where the founders started out wanting to grow from internally generated cash flow, she deliberately avoided venture capital because of the pressure for hyper growth. She had early success, a false positive grew too fast ran out of money. And her assessment at the end is, say some so you made mistake race, you should have got you should have stuck with the original plan. She said, No, I should have gone off and raised $40 million of venture capital that was that’s what I really should have done. So. So it just depends. It depends on what you want, as a founder. And venture capitalists are not going to change, and they shouldn’t. Here’s another one, which is kind of critical of academia, it says, Tom, what do you think of business education may help to avoid some of the pitfalls? And perhaps which ones do you think it makes me make us more susceptible to? Are you being creating new problems? tries to help us avoid the ones who describe? Yeah, you know, I get this question. I don’t think you’re like as likely to get an HBS alumni club. But there are a couple of versions of the question that they run along the lines of why in the world, would you go to school to be an entrepreneur? And my answer to that tends to be you know, an entrepreneur needs to understand a lot about marketing a lot about finance, you know, something about organization design, about technology management, go right down the list, what we teach in the core of the MBA program, the first year is essential counting. So but but that’s not the question here. The question here is, are there predispositions? And I’ll point to a couple, I think the very smartest MBAs, the folks who often we’ll head off for a few years to BCG or someplace like that. Our have an incredible ability to connect the dots to sort of see complicated patterns. And you know, and I would say, there’s probably a predisposition to launch an over complicated business, you know, and again, it gets to cascades of miracles that there’s a lot of moving parts and a lot of complexity partnerships and, and assumptions and, and platform technologies and artists and network effects and so forth. Just many more things that could go wrong. So I do think there is there’s that, and then I think there’s a general MBA tendency, I spoke about it before to analyze and overanalyze. And, and indeed, I think there are some founders, that if they’re tentative, they can fall back on the on their ability to analyze and look and look and look and slow themselves down, and then maybe vacillate between options and so forth. And I think that is out there. And it’s probably true that MBAs are more prone to that behavior. Another question that’s coming up in a number of different ways and phrases is, you’re seeing differences between male and female founders, and maybe perhaps abroad in the in general? Are you seeing the influence of cultural differences on the research you’re doing? And what are you seeing in terms of what is being funded? From the outside perspective? perception? Yeah. So on the gender question, the book sidesteps it because I didn’t have for that survey that I mentioned before the 470 founders, it turned out that a disproportionately high fraction of the female failed founders were likely to respond to the survey, which says something about egos and and and in a willingness to help. So they were overrepresented in the sample. And I didn’t want to draw conclusions about gender differences. But I’ve since gone in and looked at the whole universe, their you know, their databases that track every venture capital back. Michelle will be familiar with pitchbook. And so with a couple of colleagues who are very interested in these gender issues, looked at 14,000 startups that had raised in the US at least $500,000, between 2010 and 2015. And then looked at how many of them are said by pitchbook the service in question to have shut down and then looked at gender differences. Turns out the female founded firms were slightly less likely to fail than then the than the ventures with male founder CEOs. There were only 11% of the firm’s had a female founder CEO. So it’s been well documented byesies in in, in the availability of capital to female founders. So that’s there but When they do raise the capital, they their businesses don’t fail at a higher rate. In fact, it might I’m not sure it’s statistically significant but slightly lower right. An interesting gender difference that’s that’s kind of a little disconcerting is this question of doing it again after you fail. And it turns out, again, from this data, not in the book, but but subsequent data, I’ll get it published at some point, females are less likely to found again, after a failure. So the male rate is is a little bit over 50%, the email, the female rate is a little bit under 40%, that’s a it’s a pretty big difference. By the way, there’s very little difference between first time founders, all of that differences serial. So if you’re a male serial founder, and you do it over and over and over again, if your last one failed, you’re just going to keep doing it. If you’re female serial founder, you’re you’re less likely to keep going. So anyway, lots of differences. If people are interested in this, I would refer you to fascinating work by my colleague, Laura Wang, h, u, a n g, who has done amazing work on the kinds of questions that female and male founders get in the fundraising process. Turns out that females regularly both from female investors and male investors get questions that are focused on prevention, how are you going to protect my money? And male founders are more likely to get questions focused on promotion? How are you going to launch this thing to the moon? And it’s strange, but really, really, I think, important for for folks of all genders, who are investors to understand these patterns, and certainly for female founders to understand the kinds of questions they’re going to get. And Laura has good advice on how to sort of with this, to this, this adversity into advantage. And what are you what are you seeing sort of on another dimension, sort of more versus less privileged commerce and what’s happening there and success rates? Yeah, I’m, I’m embarrassed to say I haven’t looked at it deeply enough, yet. That’s a priority as we take the course forward, underrepresented minorities in the special challenges they face. Likewise, you’d asked a minute ago about the cultural differences, haven’t spent enough time trying to understand especially the stigma of failure, and how it how it varies in different societies and what that might do to, to the kinds of risks that entrepreneurs take. More to come more income, it’s a it’s a topic that probably will no exhaust. As long as there’s entrepreneurship, there’s ways to fail. And another interesting one here, where there’s a lot of movements in the business world to see sort of businesses as forces for good and where societal goals, impact goals are embedded in organizations. Have you seen any impact of companies that take that more into account in terms of rate of failure? Or, or sort of trajectories on the company? It’s, again, a great question. I haven’t looked at it yet. I will say for folks who are sort of hoping that Harvard Business School is tuned in to these pressures. We are and it’s coming. I look actually the inspiration Stanford engineering, you want to find a place that’s doing a good job of teaching about the ethics of entrepreneurship, and the ethics of emerging technology? We’re actually a lot of my colleagues are spending time with folks there. And we’re trying to figure out ways to sort of move it throughout the HBS curriculum. It’s an it’s a natural question to ask sort of, if, if ESG is a is a priority, and we know that they’re, they’re positive returns for big corporations. You know, surely it must be the case that it’s true for startups, too. I will say, colleagues at the Kennedy School, Harvard Kennedy School, who have observed that already, the private equity players that deal with big, big private companies have worked ESG at the insistence of their limited partners into the decision making process about what to invest in, these are the black stones and KKR is of the world it. And the folks at the Kennedy School have observed that it hasn’t hit venture capital yet with as much force. And they’re actually working pretty hard. And we’ve been helping them to sort of think about how do you how do you come up with a process for figuring out whether a venture is a sound on ESG grounds? Yeah, I must say that sort of from our daily practice, we see that a lot more it is beauty coming off. And it comes at every level, whether it’s from the founders, finding it important to people working in venture firms, and then the end sort of customers. Final question. There’s a large group of people here. Is there anything we can do to help you for your further research give you in But is there anything you would like to receive from the group? No, uh, you know, at some stage we’re going to keep the course was a half course though we’re extending it expanding into full length, that means more cases. So in, and it means more international cases, it means I want to do family business, I want to do low tech, a lot of what I do, because of what I’ve done in my career is higher tech. So I’m looking to broaden, I’m looking to do something with a social impact focus, you know, because I think failure in that context that failure plays out for different reasons in different ways. So case ideas and, and just spreading the word would be fantastic about the research in the book. And everyone by the book, read it. I hope you guys found the conversation and success. Tom, thanks so much for for taking the time and yeah, your insights to us as a as a group. Thank you so much for hosting. And thanks, everybody for listening. They Oh, well. Thanks. Bye bye.

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