Capital and the survival of start-ups

On of the most important factors for the survival of start-ups is their capital. By survival what is meant here is the firm's exit from the market; exit by a closure, exit by a split, and exit by a merger. The 'exit by closure' is by far the most common form of exit, and the one that interest us in this context.

Now, a new firm's capital can be initial capital that the founder(s) had themselves or managed to secure at the startup stage, capital secured later by various sources of funding, or generated by the firm's own accumulation of resources from its early profits. Regardless, capital overshadows any other factor in its importance for early stage new firm survival. Of course, in the long term, other factors also affect survivability, such as growth and economies of scale.

Survival is non random and depends primarily on the stock of accumulated resources.

David Storey

The literature on firm survival points to the fact that survival, growth and profitability are linked, but their effects have a high deviation and affect the survivability of the firm in different ways. Firms that invest heavily in innovation and new technologies rely less on profitability in order to survive, while in contrast less innovative firms count on their profitability in order to survive. Firms operating in less innovative industries have higher growth and better chances of survival, since failures in the tech industry is more common, yet innovation intensity directly impacts growth.

On average, 86% of all firms survive from the first to the second year. In year five, 56% of all firms remain, and in year eight, only 35% remain.

Frédéric Delmar

Existing analyses clearly show that firm profitability greatly enhances survival, and also enhances growth and that the age of the firm is a most significant indicator of future survival. But how do start-ups survive in the short term, or very short term >5 years? How do they manage to stay in business for these crucial 3-5 years to be part of that 56% of survivors?

In the face of uncertainty, entrepreneurs use profitability to learn about their productivity and as an internal resource for investing in growth.

Frédéric Delmar

Let us make a list of what information we have untangled so far:

Profitability significantly impacts survival and growth
Previous sales growth significantly impacts future sales growth and profitability
Growth is predicted by previous profitability
Growth is predicted by past sales growth
Firm size has a significant impact on survival and profitability

It is a fact that some things are easier said than done, and any seasoned entrepreneur knows it. Sales growth allows firms to be able to earn positive returns to create future resource buffers in case of increased competition, waning demand, or to be used to create new combinations for subsequent expansion, but research finds that the average annual sales growth rate is close to zero and the probability of a new firm growing its sales in four consecutive years during its early life is only 7%. Taken that growth is predicted by sales growth, and previous sales growth impacts future sales growth, the likelihood that a new venture survives due to its continued sales growth is indeed quite low. Most firms will not exit immediately after start-up because their stock of their existing resources at that stage will allow them to endure an initial run of 'bad luck' and competition; exit rates will peak shortly after start-up. Firms with a larger start-up size and/or resources will endure for longer in the face of a run of 'bad luck' and competition. New ventures whose initial stock of resources is so small that is quickly depleted in the early rounds of competition and other negative shocks will exit the market shortly after start-up. That said, While start-up size may enhance survival in the early years, it appears that this effect fades as time goes by. In the medium-long run, large companies loose flexibility of operations and structural deficiencies start to kick in.

The role of resources is to enable the new business owner to survive the inevitable trading vicissitudes incurred by any new enterprise. The more resources they have, the more likely it is that their business will survive, stay in the game, and so have a chance of a future win.

David Storey

Thus if we want to enhance the survivability of start-up companies then access to funding and financial support is the way to go. Five-year financing plans linked with performance or growth would be an effective solution to support entrepreneurship, firm survival and firm growth. Policies should be in place to give new companies access to so much needed and vitalizing capital.