Why do so many businesses fail? A new study suggests it has to do with when they’re born

Only 25% of new businesses make it to 15 years or more, according to data from the U.S. Bureau of Labor and Statistics. Despite vacillating economic conditions between and across markets, that statistic has remained consistent for 30 years. A new study from the Strategic Entrepreneurship Journal suggests an elegant explanation: a business’s long-term success  depends significantly on its founding conditions not just changes in its markets.

“A venture’s performance following environmental change depends on its internal processes,” says D. Carrington Motley, an instructor in entrepreneurship at Carnegie Mellon University and co-author of the study. “Environmental conditions at a business’s founding shape those processes, and they quickly become cemented and embedded in beliefs about how to operate.”

Motley and his co-authors, Charles E. Eesley of Stanford and Wesley Koo of INSEAD Asia, examined performance for more than 1,000 ventures founded from 1960 to 2011. The businesses operated in 19 industries ranging from agriculture to energy and utilities. The authors used data from the Bureau of Economic Analysis to quantify dynamism within each industry over time and within each venture’s founding year. They used alumni survey data to establish the composition of each business’s founding team as well as its longevity and ultimate outcome.

“Businesses founded in dynamic environments by a functionally diverse team show meaningfully more ability to survive during market change,” Eesley said. “However, they don’t necessarily have an increased likelihood of a positive exit.”    

Businesses founded in dynamic environments typically favor slower, decentralized decision-making and increased creativity and flexibility. A founding team with many distinct functional roles compounds these behaviors — they have broader strategic focus and seek large amounts of information. These risk-averse structures and strategies help businesses persevere during environmental change, but the study also found that these businesses where less likely to gain IPOs or acquisitions if their market stabilized.

“In stable, more predictable environments, being more aggressive can produce better outcomes,” Woo said. “The risk of untested assumptions is less, so continued use of risk-averse processes produces fewer benefits and may detract from a venture’s ability to respond to opportunities.”

The authors argue that the key differentiator for businesses founded in dynamic environments by functionally diverse teams was slower decision-making. They tested the theory by first examining their performance in industries where fast product development was critical to competitive advantage and second by determining how quickly they took to receive angel or venture capital funding. Businesses founded in dynamic environments by functionally diverse teams fared worse in both instances.

Whether an industry is in flux or stabilizing, the study indicates that typically businesses benefit from market change only if that change better aligns with their founding environment. Despite its premise that founding processes become entrenched, it offers an insight to entrepreneurs hoping to both survive chaos and thrive in calm. Businesses need to examine their founding structure and internal processes and consistently re-evaluate whether they are best suited to their market environment.

Find a full explanation of the study and how founding conditions affect performance in dynamic environments in the full text, available in the Strategic Entrepreneurship Journal.