One of the biggest myths of angel investing is that angels lose money on nine out of ten deals. The problem is that there is no data to support this assertion and yet even those who should know better can be repeating this falsehood.
Before we dive into the data, let’s examine some of the narrative causes of the myth.
The “Power Law”
In Silicon Valley, home of the power law, and land of unicorn hunters, a good return is one that at least “returns the fund”, meaning that it hits thirty times the original investment or more. Anything less than that, even a 10X return, is considered to be a failure. When 5X and 10X returns are considered failures, then yes, nine out of ten companies “fail”. Somehow, along the way, people have translated a failure to hit the unicorn target as a failure, even huwhen, taken together, those lower performing returns will, in aggregate, often return more capital to the fund than that one moon shot.
Small Business vs. Startups
Other failure folklore comes from a failure to distinguish between small business and startups. While startups are indeed small when they start, they share few characteristics with what we would traditionally consider small businesses. Startups are primed for scale and are designed to grow quickly to tens, hundreds or even thousands of millions of dollars in revenues. They feed on venture capital to stoke that rapid growth and they protect their advantage with patents, technological advantage, brand, and other “moats” that keep competitors at bay. Small businesses, in contrast, may grow to be big, but are often mom and pop operations, seasonal companies with landscape services, restaurants, professional services such as legal and accounting firms, construction and more. These companies are often called “lifestyle companies” because they create wealth and income for the founders, but rarely scale to startup outcomes which could include M&A or IPO.
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Funded vs. Unfunded Startups
Some data includes startups, but does not distinguish between startups that have received angel or venture capital funding and those that have not. Survivability of unfunded copanies is significantly lower than that of funded companies. Given that running out of cash is often listed as the #1 cause of failure, this should come as no surprise. Performance data from copanies who have never raised capital is largely irrelevant for the purposes of angel and venture capital investors who want to assess the risk of investing in this asset class. Presumably we want to know how well they might do statistically, if an when we actually invest in them, so comparing those that failed to raise capital is less than useful.
Vintage Years
Angel and venture capital investments are not immune from macroeconomic trends and survivability of companies will vary from year to year. Some research will run across five or more years while others will be more granular, providing data for returns on afollow periods of several years or on an annual basis. So, picking years or ranges that include the great financial crisis, or that include vintages that follow periods of irrational exuberance (such as 2021), or periods in which interest rates increase rapidly from near-zero to 5% or more, will all produce outliers that may not be suitable for use in making broad statements about survivability of venture deals.
For example, Robert Wiltbank (Willammette University) shows an overall failure rate of about 52%, but shows as much as 70% in one dataset around the GFC. Cambridge Associates has done a nice job of producing annual reports that show failures ranging between 50-60% in various years, with no years exceeding 60% failures in their history.
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Are Exits Failures?
Perhaps one of the most misleading research techniques used in many business survivability studies is that the researchers track companies that are “still in business” after some period of time, typically five to ten years. They will report companies that are operational vs. those that have gone out of business or exited (meaning they were acquired in an M&A transaction). This data gathering method that counts exits as “failures” is highly deceiving for investors who are looking to exit their investments, usually within five years!
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