Article: Failure Rates and Definitions of Entrepreneurial “Failure” and “Setback”

From my research notes, here are some comments on entrepreneurial (and venture) failure rates and definitions in this field.

Definitions of “failure” can be objective (e.g. bankruptcy and dissolutions) or subjective (interpretive evaluations of outcome versus objectives), but every failed venture is likely to experience “setbacks” along the way. Setbacks represent material disruptions to the business plan (loss of a key customer, failure of product delivery, loss of funding, etc.). Pretorius offers two other definitional terms: levels of distress and turnaround (Pretorius 2009): problems arising prior to terminal failure of the venture are defined here as “setbacks”. Although this lexicon may also be applied to a wider range of failures in innovation, the technology-based startup venture is the focus of this review.

Gulst and Maritz provide a comprehensive survey of failure definitions and causes, drawing a distinction between “entrepreneur failure” and “business-venture failure”. (Gulst and Maritz 2009). While business-venture failure can be identified by corporate bankruptcy and dissolution, the picture may be more complex: for example, if a company is acquired at a valuation below that of the capital invested, is that a success or failure? For the founder, business continuity through a loss-making trade sale may be seen as a success – perhaps a disappointment, but not a failure. Entrepreneurial failure may represent a deviation from the desired expectation of the entrepreneur (McKenzie and Sud 2008). This relativist position assesses failure through the motivations, desires and achievements of the people involved. Also, as Pretorius notes, scientific literature on business failure is spread over multiple disciplines, so that the first task of the scholar is to identify the various strands and tie them together (Pretorius 2008).

One perspective examines the “funnel” of opportunities and the rate at which ventures fail prior to, and after formation. Lerner suggests that only 0.5% – 1.0% of business plans submitted to Venture Capital (VC) firms are funded (Lerner 2009). Bhidé echoes this: in addition to the high failure rate in new ventures (50 – 90%), a larger number of venture plans never make it to incorporation (Bhidé 1992). For the habitual entrepreneur, these numerous un-funded “pre-failures” may also offer valuable experience.

Some authors are clear. “Most new ventures fail,” (Timmons and Spinelli 2004). Others offer different views on the rates of new venture failure, although some studies address entrepreneurship in general rather than just high-technology ventures. Longitudinal research by Delmar and Shane tracked the 30-month evolution of business for a random sample of 233 new ventures (Delmar and Shane 2003): 82 of these had disbanded within 30 months (a failure rate of 37% within 2.5 years). Another study of VC-backed venture failures finds that approximately 40% of ventures fail within the first year, and this number rises to 90% over ten years (Dimov and De Clercq 2006). This indicates that more startups are created than can be sustained: the high failure rate of market-entry decisions has been called the phenomenon of excess market entry (Camerer and Lovallo 1999; Wu and Knott 2006), and some of this unreasonable level of market entry has been ascribed to “egocentric biases in market entry decisions” (Moore et al. 2007: 440).

American studies indicate failure rates ranging from 56% (Kirchhoff 1997) to 90% (NVCA data – National Venture Capitalists Association). Pretorius documents a consensus that between 50 and 90 percent of entrepreneurial ventures fail. He suggests: “failure is probably the one thing that almost all entrepreneurs will face somewhere in their endeavors. At the same time, failure is probably the last thing on the mind of an entrepreneur starting out on the entrepreneurial process.” (Pretorius 2009: 1). This represents a paradox of entrepreneurial failure – although it is statistically likely they will fail, entrepreneurs never think they will be the ones to do so.

Stokes and Blackburn examine underlying reasons for failure in UK-based small companies (Stokes and Blackburn 2001). Although this analysis covers all small businesses, not just technology-based ventures, it concludes that business closure is not synonymous with business failure (Stokes and Blackburn 2001). In this study, only 20% of closures were regarded as “financial failures”, with the rest representing trade sales, technical closure or termination due to death or retirement.

Econometric and predictive approaches to failure require specific definitions of participant, assumptions and events. Cressy’s “Brownian motion” analysis (Cressy 2006) establishes a model for firm failure in which the entrepreneur balances return (profits growth) with risk (variance of profits) within many constraints. This model provides an elegant picture of likely failure patterns in new ventures (see Figure 1): the longer a firm survives, the more likely it is to continue to do so.

In summary, definitions of setback and failure are diverse, but overall studies of failure rates indicate a failure rate of 50% – 90% within several years.


About Keith Cotterill

After 25 years in finance and technology, I have returned to university to read for a doctorate at Cambridge. I am an active technology entrepreneur and investor as well as a researcher and divide my time between the UK and Silicon Valley.

Posted on June 13, 2011, in Definitions, Failure, Failure Rates, PhD Research. Bookmark the permalink. 4 Comments.

  1. Interesting to see some numbers. Is failure only ever treated as a binary? ie businesses pass or fail? or are there any attempts to put failure on a scale — something around metrics such as amount invested, sales, job-years, …

    So a PoC failure which spends say 100k, but employs people, who pay taxes, … goes under after 3 years. Any previous research looking at a failure metric?


    • Thanks David. Measurement of failure can be different for projects (internal corporate projects with lots of overhead) or startup Proof of Concept Ideas, or full ventures.
      There is some macro absorption costing to be done here – as you say, if a $100k POC fails, the money has actually been recycled as salaries, tax and purchasing for the wider economy. Investors lose, but does the economy as a whole? Furthermore, learning from the “failed” POC may well be the missing link in a subsequent successful project.
      Research interviews also revealed multiple cases where companies “fail” but do not close – the founders hang in because the cost of corporate failure is so high (e.g. Germany) in such cases there is a de facto failed venture, but the company survives.
      Several threads here I plan to examine. Thanks.

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