Why Startups Fail

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Hey friends 👋 ,

Happy Monday and welcome to Through the Noise!

If you follow me on Twitter, you know that I'm sharing what I learn as we dive into the world of startups and venture capital.

One of my all time favourite podcast episodes that set my passion for startups on fire was Episode 181 of Invest Like the Best by Patrick O'Shaughnessy.

This particular episode he interviews Charlie Songhurst (who I wrote about before here), the former head of strategy at Microsoft and a prolific investor from the UK, having invested in 500+ companies throughout his career.

Today, I'll save you an hour of your time as I pull out the key lessons on business, investing and people.

It’s time to strap in and enjoy.

Read time: 4 minutes

Why Startups Fail

This is what Charlie looks out for across each stage:

Pre-seed to seed: Failure to achieve greater productivity

• The team doesn't gel, come together and produce good output

• A team that produces good work creates enough kinetic energy to get funding

Seed to Series A: Failure to get product market fit

• On the search for the demand curve– either you find one or you don't

• There is a nexus of serendipity at this stage

Series A - Series B: Its about labour productivity

• When you scale to 30-90 people, you no longer have personal connections and have to move to more formal management techniques

• The collapse in the labour productivity per person wipes out a lot of startups. There's a term in microeconomics called managerial diseconomies of scale. The angle of the decline in productivity per person is the difference between the great startups like Stripe and those that fail

Series B Onwards: Institution building

• A good entrepreneur is a combination of street smart and book smart

• When you hit product market fit, you're repeating a process at scale, you need to build an institution

Managing the Declining Curve of Productivity

• There is a declining curve in peoples productivity as the startup scales. You may have a start-up that produced more output with 10 people than it did with 100 people

• Small startup: Low level politics, people go in, do their job, and go home. You have to have tight management

• As it scales: Level of politics increases. Reducing e.g. CFO controlling spending so tightly that you don't have a positive return on capital investment through sales

Traits of Successful Investors

• Success is very idiosyncratic, there is no cookie-cutter mold of what creates a successful investor

• Successful investors focus on leveraging their unique talents to maximum effect

Interesting vs Complex Businesses

• Any business can be mapped onto a Boring / Complex set of axes. This can be further split into four quadrants

• Boring - Complex quadrant, there is a deficit of entrepreneurs because it's not interesting or sexy

• The absence of psychological appeal is a source of alpha, e.g. Datadog, Salesforce and accounting software (invest in this sector)

• Simple - Interesting quadrant there's high competition, like moths to a flame

• Complex - Interesting quadrant there's lots of smart people tackling challenging problems (lots of competition)

Evaluating Business Strategy

East coast investing

• East coast is traditionally more quantitative. Quantitative analysis is great at evaluating unit economics and seeing if the firm can be profitable.

• Highly quantitative analysis will always miss the expansion of a market and disruption

• Quantitative analysis of the iPhone would say the market size is all phones rather than phone, communication, mobile computing, games, streaming, etc. You’ll miss the boat

West coast investing

• West coast is traditionally more qualitative. Qualitative analysis can overestimate the size of the market

• Most companies never, ever achieve the network effects or multi-sided market they needed to make their business work

What is the Most Mis-Valued Asset?

• Investing in entrepreneurs in markets that are not obvious is a source of alpha. You very much have an investing edge

• People who are addressing global problems in secondary cities in e.g., Romania have a cost and talent advantage

• Something strange about finance is that it is demarcated by nation state borders when it’s a pure electronic good. It’s just numbers in the sky. It should be globally scalable and it’s being hindered from doing so

Studying Failure Over Success

See my last piece here for a deeper dive.

• Most people have a tendency to study success rather than failure

• After studying mistakes and finding a commonality amongst them, it will lead you to your own success. Work out how not to be that

• Similarly in startups there are common mistakes, not wanting to raise capital, diluting share capital, etc

• Not making catastrophic mistakes and just surviving places you so far up the experience curve. Stay alive until you get good!

Through the Noise Podcast

Since last week, we had:

• Grace Isford (Principal at Lux Capital) on Making Long-Term Bets on Contrarians

• Sieva Kozinsky (Founder of Enduring Ventures) on Buying Beautiful Businesses and Holding Them Forever

Both of these rocked, catch the next episode wherever you listen to podcasts.

That’s all for today friends!

As always feel free to reply to this email or reach out @thealexbanks as I’d love to hear your feedback.

This was a slightly longer one today, I'd love to hear your thoughts:

Thanks for reading and I’ll catch you next Monday.

Alex