Something Ventured, Nothing Gained?

If you feel the urge to pour your money into a venture-capital-backed, high-tech startup, you might first consider whether you’re better off playing a corner bet in roulette.

The Wall Street Journal reported recently on research by a senior lecturer at Harvard Business School, Shikhar Ghosh, who has found “evidence that venture-backed start-ups fail at far higher numbers than the rate the industry usually cites.”

Specifically, about 30% of firms eat up all the money and return nothing; about 75% of venture-backed firms in the U.S. don’t return investors’ capital; and about 95% of firms fall short of meeting the targets set by investors.

Now, to be sure, an innovative idea is a good start for a business, and if you’re in the right field, it’ll see you a long way. In his book Innovation and Entrepreneurship, Peter Drucker observed that, in many industries, “time is on the side of the innovator.”

But this is not so in what Drucker called “knowledge-based innovation,” for which there’s only a short time window and little room for error. “Here innovators do not get a second chance; they have to be right the first time,” Drucker wrote. “The environment is harsh and unforgiving. And once the ‘window’ closes, the opportunity is gone forever.”

These challenges, in Drucker’s view, are “particularly pronounced in the high-tech industries.” Because “such industries are in the limelight and thus attract far more entrants and far more capital than more mundane areas,” high-tech tends to be a riskier game “in which a middle hand is considered worthless,” he explained. With so few missteps permitted, “very few businesses in the industry have the financial resources to outlast even a short storm.”

So what is an investor to do?

Look for a start-up with indications of good management. It’s no guarantee of success, but it’s a minimum requirement. “Unless a new venture develops into a new business and makes sure of being ‘managed,’ it will not survive no matter how brilliant the entrepreneurial idea, how much money it attracts, how good its products, nor even how great the demand for them,” Drucker warned.

What are your thoughts? If you’re looking to invest in a startup, what’s the best indication it’s well managed?