Why Are More Startups Going Bankrupt?

October 9, 2017

5:00 pm

It’s no secret that the vast majority of startups and small businesses eventually fail. The “8 out of 10 businesses fail” within the first 3 years statistic is commonly reported, but false. Still, more than half of businesses don’t make it past 5 years, especially when they’re small, fledgling companies still trying to figure out what they’re doing.

But what about the big, multi-million dollar companies that make investors drool and have taken over the tech industry? As it turns out, bankruptcy in Silicon Valley is more common than you might think—and there are dozens of examples of wildly impressive tech companies that ended up filing for bankruptcy.

So how can these big, seemingly stable businesses go bankrupt?

Biggest Paths to Bankruptcy

These are some of the biggest and most common paths leading to bankruptcy in the tech industry:

Lack of Revenue

One of the biggest reasons for going bankrupt is a simple lack of revenue. Without inbound cash flow, no business can keep growing forever. Tech companies often attract lots of funding and interested investors based solely on their product’s potential value; if your platform can attract thousands of daily active users, it’s a potential source of significant cash. But if that “potential” never becomes reality, the business will flounder. Some tech companies find success by instituting a better revenue model after building a user base, but it’s somewhat rare.

Expanding Too Soon 

Tech is an industry prone to volatility. Investors and consumers get excited about a new piece of technology, and the business is forced to expand rapidly to keep up with that demand and interest. Unfortunately, expanding too soon and too quickly can be problematic; not all company scale efficiently, and if you invest in resources before you have the revenue to support them, you could easily waste your budget.

Investing Poorly 

Some tech companies try to expand and improve by acquiring other tech startups, or by investing heavily in new technologies to make their products even better. Some companies, like Google, have done astoundingly well at this. However, when you’re pouring millions of dollars into new ventures and new enterprises, all it takes is one or two bad decisions to wreck your company’s profitability.

Facing Stiffer Competition

Tech moves quickly, and if a product starts to see success, it’s only a matter of time before a host of new competitors emerge to threaten its market share. When that competition comes, the original product must evolve or improve to keep pace with the newcomers, or else it’s going to lose significant market share. Many innovators aren’t sure how to respond to this highly competitive environment, and end up rapidly shrinking in the face of these new threats.

Becoming Obsolete

Though somewhat less common, it is possible for the new tech offered by an emerging company to become obsolete after the company expands. Personal digital assistants (PDAs), for example, quickly went extinct in the wake of the iPhone and resulting smartphones. Without a series of products and alternative offers to fall back on, all it takes is the demise of one core product to drive a tech company to bankruptcy.

Overvaluation

There’s also an overvaluation problem in the tech industry, especially within venture capital groups. If an appraiser values a company too highly, it may attract even more attention, pushing the valuation even higher, and resulting in a kind of mini bubble. When investors realize the company isn’t as profitable or as appealing as it was illustrated to be, they start bailing out, which causes capital to disappear, potentially ruining growth models and robbing the company of assets it was planning on for the indefinite future. To make matters worse, company leaders are often excited to see these high valuations, and are somewhat incentivized to push them even higher.

Why Bankruptcy?

So why file for bankruptcy in the first place? That depends on what type of bankruptcy the company is filing, but all of them have some advantage to the major stakeholders. For example, most bankruptcies end up liquidating the company’s remaining assets, which can then be used to pay investors back a portion of what they’ve already put into the business.

No business is exempt from the possibility of failure, even when they employ thousands of people or have been backed with millions of dollars of funding. Massive tech companies can go bankrupt just as small businesses and startups can.

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Larry is an independent business consultant specializing in social media trends, business, and entrepreneurship. Follow him on Twitter and LinkedIn.

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