Why do startups fail and what can we do to address the challenges that lead them to that point?

Hello friends, colleagues and co-consiprators!

This issue we’re going off the deep-end and examining a concept that traditionally makes us very uncomfortable – failure! We’ve looked back at the archives at some of the i2i companies that closed shop, talked to other local founders whose companies failed and dissected postmortem posts from founders that have been courageous enough to discuss openly what they did wrong (Spoiler Alert: there aren’t many of such posts out there). Experts and pundits in the Silicon Valley claim that nine out of 10 startups fail, a majority of them within the first year of operations. For the Pakistani ecosystem it’s hard to suss out this number because postmortem essays, considered a cliche for the Valley, are still a rare sight. If we are to thrive as an ecosystem we need to get better at talking about the missteps and wrong-turns (not to mention that in our explorations into the topic, we’ve discovered that there are many key reasons that force startups to close shop and you know what they say about repeating the same mistakes over and over!).

My first ever job was with a startup that failed within five months of hiring me. While I wasn’t a founder or co-founder, I was part of the founding team and that gave me some insight into what went wrong (full disclosure the founders may have a different take on this, but I still feel some of the reasons I’m going to distill are very relevant in our ecosystem). If I were to break down the reasons we shut down operations the list would go something like: 1) Failure to bootstrap for longer than we needed to – once we had our first major client/deal sorted out, we immediately moved into an office space that was pricey, bought furniture, expanded the team, hired administrative staff. Had we avoided all these fixed costs, we may have been able to keep our doors open for longer once the client decided to conclude our contract prematurely. 2) Not having the right people on our board – there was a misalignment in terms of vision for the future of the company between the board and the management team which led to a lot of time spent firefighting on this front, rather than being able to focus on our product and sales. 3) Not understanding the client needs and timelines well enough – I think the team could have been doing more to gather constant feedback from the client in order to test our product more. I remember being part of our first big demo and realising mid-meeting that some of the features didn’t work as they were supposed to and some didn’t meet client expectations. Part of this problem stemmed from the fourth reason which was 4) Not having the technology capabilities in-house – we had outsourced the development of our platform and we lost a lot of time getting changes deployed and delivery times were often pushed forward.

The recent closure of Travly and the subsequent press coverage also indicates that not owning/being able to acquire the technology stack was a key factor that led to failure. However, these reasons aren’t unique to the Pakistani ecosystem only. The first three reasons were also identified in CB Insights research into why startups fail (and considering that ecosystem is resource rich when it comes to tech I can imagine why number four isn’t on this list) and made their top 20 list with “running out of cash” being the 2nd most significant among them.

However, it’s not just founders that are to blame when it comes to problems related to financial management. The Pakistani market is notorious for being a tough market to raise investment in. A survey of the ecosystem for our Pakistan Entrepreneurship Ecosystem Report 2016 indicated that 84% of entrepreneurs consider raising investment as difficult or somewhat difficult. The stakeholders that we interviewed for this newsletter unanimously echoed this sentiment. The most obvious reasons remain the lack of VC’s and deals within the ecosystem. While some angel investment and venture capital initiatives, mainly by local players, have cropped up and made some investments in 2016 (23 reported deals) this activity has also slowed down in 2017 (11 deals) indicating that while the institutions exist the capital is still not being released. The recent GALI Accelerating Startups in Emerging Markets report also identifies mismatched goals between investors and entrepreneurs and cultural bias as potentially playing a role in limiting the positive effects that accelerators have in these markets. However, the report goes on to state that acceleration programs are in the unique position of levelling the playing field when it comes to helping investors and entrepreneurs better connect with one another.

This misalignment seems to have been a key factor in the downfall of Travly, a startup that had been riding a high since CresVentures invested in it, and is listed in the CB Insights as another factor in their top 20 reasons startups fail.

Government support and regulation around investment is another impediment in this regard. One example is that all foreign investors and shareholders must attain approval from Pakistan’s Ministry of Interior (MoI) prior to investing – an arduous process that can take upwards of six months – and must also apply for a Proceeds Realization Certificate (PRC) in order to remit funds from Pakistan. If an investor fails to apply for a PRC prior to investing, they will not be able to get their money out of the country (see i2i’s Investor Toolkit for more). In addition to issues related to taxation, payments and intellectual property also continue to be major barriers to innovation and improving access to capital. According to Federico M. Antoni, a pioneer in venture capital industry in Mexico and co-founder of ALLVP (the first VC fund in the country), the governments plays a critical role. “If you study the history of Silicon Valley, government participation was paramount to the building of Silicon Valley. People talk a lot about Elon Musk, his mission to go to Mars. They don’t talk as much about the subsidies that SpaceX has received that allowed it to be built”, he shared in an interview given earlier this year.

Another recurring theme in our conversations with mentors and investors when it comes to startups failing was the lack of commercial sense among Pakistani youth. In many ways, this is an accurate assessment. Compared to young graduates in Western economies, our youth typically does not have any commercial exposure and financial sense (due to lack of a culture of working while in school to raise money for our purchases, a typical Pakistani student usually gets pocket money from his/her family for this kind of expenditure). While trends are changing, it will take time for the effects to trickle down. Many thought leaders within the space feel that if we are to see a reduction in startup failure rates and greater success stories from the ecosystem, more mid-career professionals need to become entrepreneurs. The argument makes a lot of sense especially when we consider the greater experience, commercial exposure and networks that these professionals have access to. All of these factors would not only mean that they will be better able to leverage their networks for investment opportunities, but also posses the experience and grit to steer their companies through rough waters. One thing remains clear that while there are some common themes that all founders, experts and stakeholders identify as the key reasons behind the high rate of failure among startups, the solution will lie in all these pieces of the puzzle moving simultaneously to help cultivate an environment more conducive to entrepreneurship. The next section lists down some additional reasons that we came across while reading the blogposts and interviewing founders.

Read on for more on trends and statistics around failure rates among startups in Pakistan. I’d also like to take this opportunity to thank Shehryar Hydri, Secretary General at P@SHA, Owais Zaidi, Founder & CEO CreditFix, Madeeha Hassan, Previously Founder & CEO Savaree (which was acquired by Careem) and the founders who opened up in blog posts about what went wrong with their startups for their input and insight while researching this piece.

Have more to say on the topic? Or just share some interesting research/articles with us? Give us a shout!

Cheers, 
Anusheh Naveed Ashraf
Head of Insights, Invest2Innovate

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Reasons Why Startups Fail Continued

Taking too long in product/app development – In the postmortem post by Mujtaba Ayub of Kamata Pakistan, he wrote that they realised that experimenting and pivoting quickly was a crucial target that they’d missed. As Mujtaba states there is no time to lose in startups, and in retrospect they felt that they could have done things much faster and really nailed what worked and what didn’t. Madeeha Hassan of Savaree echoed the lesson and felt that the team had spent way too much time trying to perfect the product. Given a redo, she shared that she would choose to release features periodically. That goes in vein with our earlier conclusion about testing things to see what sticks and pivoting away from bad decisions, hires and/or products quickly. Wajahat Karim of Approkers Limited also stated this in his list of reasons. Trying to do everything and/or trying to do it all on your own – After 6 years of running an Accelerator program we have seen startups fail because they are  trying to do everything on their own. An example is Blue Saint, an online marketplace for handcrafted products, where the founder was trying to do everything from product design to artisan on-boarding to packaging. Similarly, trying to do everything on your own without co-founders who have complementary skill sets is also an issue. This is even more relevant for startups working on technology-driven products/solutions, where not having a technical co-founder is cited as a critical misstep by mentors, investors and founders alike. Part of the problem lies in a lack of technical talent available within the ecosystem. It’s also extremely hard to find co-founders that buy into the vision of the company and the space is filled with tales of co-founders having falling outs and departing from the startup at key make or break moments. Lack of big success stories – When trying to attract top talent to not only join your team, but also to retain them, it is integral that we see at least one big exit/acquisition within the ecosystem. A majority of the experts we talked to mentioned that your team needs to be able to see what happens after they create a successful Minimum Viable Product (MVP) and the kind of success, future they can imagine for themselves if a local startup makes it big. Right now one of the primary reason startups close-shop is because they lose their team to more lucrative and steady income jobs. Many times the usual refrain we hear in connection to this is that Pakistani youngsters lack the commitment and grit to stick-it-out through the tough times. However, we must recognise the privilege of safety nets that are associated with founders/team members who can continue working through tough periods of not making any/enough income to support themselves. Being attached to your solution rather than the problem – Many entrepreneurs become too attached to their proposed solution and fail to pivot their model in a timely manner. Mentors always tell our startups to be attached to the problem they are solving rather than their solution, be accepting of the feedback and criticism and willing to change up their solution/model entirely in service of the big problem they are addressing. Investor attitudes – Pakistani investors still take a very aggressive approach to investment where they want majority control of the startup, which essentially turns the entrepreneur to an employee (and in my opinion defeats the purpose). Many institutions are currently also structuring deals as an almost barter arrangement where startups get office space, resources that help them develop various ends of their business etc. (i2i also authored a nifty investor toolkit which helps investors navigate how to invest in the Pakistani market context)

A fusion of the Babson College framework and the Brad Feld Model (click image for complete infographic) seeks to evaluate the strength and health of a startup ecosystem. An ideal or healthy ecosystem, i.e. one which is more conducive to the growth of startups, would be one that performed well in all these dimensions. This blog post is a great case study to understand how you can use this tool to visualize the ecosystem and various networks at play. Being able to map this out will help you gain deeper understanding of the health, strengths, assets and weaknesses in any ecosystem and design better interventions.

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Talking Data

40% – i2i Accelerator Programs failure rate. Out of 25 companies that we have graduated so far, 10 have closed shop. LUMS Center for Entrepreneurship’s (incubator) failure rate is 33% (57 graduated out of which 19 are inactive – info available on their website). Representatives from Plan X reported a failure rate of 9.67% (31 graduated startups, out of which 3 are now inactive). We were not able to get numbers from Nest i/O, Plan 9 and 10xC.

11 – The number of reported deals in the Pakistani ecosystem in 2017. Companies that raised investment this year are Cheetay, CreditFix, Finja, EcoEnergy, CarChabi, Marham, Nearpeer, ProCheck, CarFirst, LabCloud.pk and Readup.

3 – The number of deals that were post-seed stage. Finja and CarFirst both raised a series A and Cheetay raised a series A-1 round of investment.

$2.8M – total reported investment raised by Pakistani startups in 2017 so far. Three deal amounts, namely CarFirst’s series A, a seed round by Nearpeer and angel investment by Marham, remain undisclosed.