Wednesday, December 12, 2012

Should I short your startup?

I've been looking at some data on startups. For today, I'm just looking at one table that somewhat illustrates the uphill battle faced by startups (once again, I just call any new firm a startup; I've heard that's not the hip buzzword lingo the kids are using. Whatever.).

This forthcoming paper by Manju Puri and Rebecca Zarutskie is a fairly comprehensive analysis of startups and venture capital. Whatever one thinks of their research design, the paper provides a wealth of stylized facts about startups and venture capital. Its main advantage is that it builds on the Longitudinal Business Database, which includes every private nonfarm business establishment in the US. Take a look at Table VI; click for a larger image and spend a few minutes (I only include Panel A).

Click for larger image

I notice a few things.
  • Startups that don't get VC assistance often fail; about half will have failed by age 5 and two-thirds by age 10.
  • Startups that don't get VC assistance are unlikely to be acquired. Of course, for most startups getting acquired isn't the goal. But your Facebook friend who keeps talking about his Boston/Silicon Valley/Silicon Slopes/NYC startup is probably hoping for acquisition or something similar.
  • Startups that get VC assistance are much less likely to fail than those that don't. But even for VC-assisted startups, by age 3 the probability of failure is higher than the combined probability of getting acquired or having an IPO.
  • Almost one-third of VC-assisted firms fail within 10 years.

Nothing on this table is causal, of course. The table doesn't show that VC assistance causes lower failure rates. You'd expect VC-assisted firms to do better if only because venture capitalists are actively trying to invest in firms with good survival prospects. Read the paper if you want to think harder about causality.

Also, there is a useful distinction to be made between the guy who starts an oil change shop with no intentions of further growth and the guy who starts a tech company with hopes of conquering social media. That distinction is lost in this table, but other parts of the paper look at things like industry and firm growth.

The broader point this table suggests, though, is that lots of startups fail, particularly those that don't get assistance from venture capitalists.