Another Reason Friedman’s Wrong: Most Startups Bomb


Earlier, John Carney pointed out a major flaw in Tom Friedman’s plan to subsidise the VC industry and startups. Top investors aren’t wanting for cash, so any government money would flow towards lower tier investors, and lower tier companies, likely leading to a big mis-allocation of wealth.

Here’s another big problem. Innovative startups aren’t the cure-all they’re made out to be.

Sure, it’d be great to plant the seeds of another 100 Googles, but alas, most startups aren’t Google. Actually, most startups crash and burn. Just look over the last few years. Even in the absence of extra government money — just a normal market scenario — investors seeded way too many trash companies. Companies got funding despite ideas that were so half-baked you knew they were DOA the moment you heard of them. They still are, even today. And the data bears this out.

The American magazine looked at the ‘startup myth’ in a piece from January:

To get more economic growth by having more start-ups, new companies would need to be more productive than existing companies. But they’re not. A study by economists John Haltiwanger, Julia Lane, and James Spletzer, published in the American Economic Review Papers and Proceedings, combined data from the U.S. Census and other sources to look at the relationship between firm productivity and firm age. The results showed that firm productivity increases with firm age. This means that the average new firm makes worse use of resources than the average existing firm, which is not what you would expect if economic growth benefits more from the creation of new firms than from the expansion of existing ones. And you shouldn’t think that the typical start-up makes up for its poor productivity when it gets older, because the typical start-up is dead in five years.

This is not to say that we don’t need startups. Obviously we do, and some of our most significant quality-of-life enhancements come from innovative startups. But we suffer from mental selection bias, because we think of startups as though they’re all potential Googles (a rare startup winner), rather than their most likely outcome, which is a total time and capital sink that should never have gotten off the napkin.