Why Most Startups Fail and What That Means for Anyone Who Invests in Them

How common failure is

Failure is the normal outcome for new businesses, not an exception. Government statistics in Canada and elsewhere show that a substantial share of new firms close within their first few years, and young technology companies that aim for rapid growth take on more risk than an ordinary small business, not less.

Failure is also not always dramatic. Some startups close when the founders decide to stop; others are bought for a price below what investors paid, so the company continues while early shareholders recover little. Statistics that count only bankruptcies understate how often investors lose money.

The most common reasons

Surveys of founders and studies of closed companies point to a recurring set of causes. The most frequent is building something that not enough people want to pay for: the product may work, but the market is too small or the problem not painful enough. Running out of cash is often listed too, though it is usually the result of other problems rather than the root cause.

Other common causes include unit economics that never improve, competition from larger or better-funded companies, disagreements among founders, poor timing, and changes in regulation that affect the model. Many failed startups experience several of these at once.

These causes connect to the business models described elsewhere on this site. A subscription product with high churn, a marketplace that never reaches liquidity, or a company whose payback period is longer than its runway each faces a specific version of the same problem.

How outcomes are spread

Returns from startup investments are highly uneven. In a group of young companies, most return little or nothing, a few return roughly what was invested, and a very small number account for most of the gains. Professional venture investors build portfolios around this pattern, expecting most of their individual investments to disappoint.

This uneven spread has an important consequence for individuals. A person who invests in one or two startups is not holding a small version of a venture portfolio; they are holding a few outcomes, most of which are likely to be poor. Averages published for the sector say little about what a single investment will do.

What is different about private company shares

Shares in a startup are usually shares in a private company. Unlike shares listed on a stock exchange, they generally cannot be sold whenever the holder wishes. An investor may have to wait many years for a sale of the company or a public listing, and neither may ever happen.

Information is also limited. Private companies are not required to publish the detailed reports that listed companies must provide, so investors often depend on what the founders choose to share. Later funding rounds can dilute earlier shareholders, and later investors often receive preferences that are paid first if the company is sold.

Valuations add a further complication. The price per share in a funding round reflects a negotiation between the company and a small group of investors, not a market where many buyers and sellers meet. A high headline valuation therefore says little about what an individual shareholder could actually receive.

The rules in Canada

In Canada, securities are regulated by the provinces and territories, which coordinate through the Canadian Securities Administrators. As a general rule, a company that sells shares to the public must file a prospectus, a detailed disclosure document. Startups usually raise money under exemptions from that requirement, which are set out in national rules.

Some exemptions are limited to accredited investors, who must meet income or asset tests intended to show that they can bear the risk. Others, including the start-up crowdfunding exemption, allow ordinary individuals to invest small amounts through registered funding portals, subject to caps on how much each person can put into each offering. Provincial securities regulators publish plain-language guides to these rules and warnings about common frauds.

These rules reduce some risks without removing the basic ones. An offering made under an exemption has not been reviewed or approved by a regulator in the way a prospectus is, and the risk of losing the entire amount remains.

Keeping perspective

None of this means that startups are not worth understanding or that no one should invest in them. It means that the reasonable starting assumption for any single startup investment is a high chance of losing money, and that only money one can afford to lose entirely belongs in such investments.

Before considering any private investment, it helps to read the offering documents in full, check the registration of any platform or dealer with the provincial securities regulator, and consider speaking with a registered adviser who knows your situation. This article is general education and is not a recommendation to invest or not to invest.