The majority of entrepreneurial start-ups don’t survive. Why is that?

The failure rate is substantial: More than 30 per cent close after five years and about 50 per cent after 10 years. The failure rate is so high because, like all business leaders today, entrepreneurs have to make choices with incomplete information, while facing a high degree of uncertainty about the future. But many entrepreneurs also have limited experience, which makes the first two challenges even harder for them. 

The number one reason for failure is that start-ups bring a product or service to market that nobody wants. Successful entrepreneurs have to do a lot of experimenting, and that means making a lot of mistakes. Society still perceives failure as a bad thing, and it can be humiliating. The fact is, some entrepreneurs learn from their mistakes, and some do not. The latter group are the ones who don’t make it. Companies of all sizes have a lot to learn from failure, if they manage it well. To paraphrase Joseph Schumpeter, fail often, but fail well. And ‘failing well’ means learning from the failure.

You can learn many of the skills required to succeed as an entrepreneur in business school: how to write a solid business plan, how to identify terms, how to obtain financing. But one thing schools don’t teach is how to make mistakes and learn from them. This is a critical skill for entrepreneurs. Given all of this, I wondered, how accurate or biased are entrepreneurs’ beliefs about their business’s future prospects? And are enough  entrepreneurs learning over time from their past errors?

What are expectation errors in the realm of entrepreneurship?

Entrepreneurs make two kinds of expectation errors: Either they overestimate their prospects for success and are, in general, overly optimistic, or they underestimate their prospects and are overly pessimistic in their mindset. The hope is that making errors related to the business — experimenting, failing and learning from it — leads to updated expectations over time within the individual.

In my research I found that updating beliefs and recalibrating expectations about the future leads to fewer errors in the future. I also found that the likelihood of making errors actually declines over time within entrepreneurs — which is consistent with entrepreneurs learning from past errors. In addition, learning mitigates the adverse effect of making errors. Mistakes — and the ability to learn from them — have very real effects in the realm of entrepreneurship.

One thing schools don’t teach is how to make mistakes and learn from them.

Tell us more about your research.

In my study, I found that entrepreneurs correctly recalibrated their beliefs after making an error: Entrepreneurs who made "optimistic errors" were more likely to revise their expectations downward, and those who made ‘pessimistic errors’ were more likely to revise their expectations upward in the next period. Relatedly, I showed that after revising their expectations, entrepreneurs were less likely to make errors in the future.

Importantly, in this analysis, I compared the same entrepreneur over time, ensuring that risk aversion or unobservable individual abilities to learn did not confound my results. The evidence I found of entrepreneurs correctly revising their expectations after making an error was consistent with theories of adaptative learning.

The key takeaway here is that entrepreneurs who learn from their mistakes grow their business’ more, they grow faster and they survive longer than their peers who make mistakes but do not update their beliefs and expectations over time.

In other research, you uncovered some interesting aspects of the gender funding gap for entrepreneurs. Please explain.

Sadly, female-led start-ups receive far less funding than male-led firms. I examined gender differences in external equity financing using administrative data on start-ups in France between 2002 and 2015, and my findings were consistent with this. I found that female-founded start-ups were 18 per cent less likely to raise external equity, including venture capital. However, the gender funding gap reversed in female-dominated sectors, where female entrepreneurs were more likely to raise funding than male entrepreneurs.

Differences in education, past industry experience, prior entrepreneurial experience, motivation, optimism and initial start-up size did not fully explain the asymmetric gender funding gap across sectors. However, my findings show that highly educated, highly motivated, optimistic and serial entrepreneurs — both male and female — significantly increase their chances of raising equity financing, albeit with the effects being more moderate for female entrepreneurs.

I also found that, conditional on being backed with equity, entrepreneurs outperform in gender-incongruent sectors. That is, female entrepreneurs outperform in maledominated sectors and male entrepreneurs outperform in female-dominated sectors. This suggests that requirements for funding are higher for entrepreneurs that are the minority in a gender-incongruent sector. This finding is consistent with the existence of context-dependent stereotypes among investors.

Your analysis showed that entrepreneurs actually outperform in gender-incongruent sectors. Please explain why this might be.

As indicated, my findings are broadly consistent with context-dependent stereotypes, which are stereotypes based on biased beliefs about gender. They are similar to heuristics and they are useful when an investor has to make an investment decision or when an evaluator has to assess the type of an individual he does not know about.

According to the theory of contex-dependent stereotypes, investors/evaluators make decisions based on distorted mean performance by gender group that they can recall. For example, if ‘male’ is the representative/dominant gender of an activity, then the evaluator who has stereotypical beliefs will overestimate the average performance of male entrepreneurs relative to the true average and relative to female entrepreneurs, whose average performance will be underestimated because they do not fit the expected gender of the activity.

Although female-led start-ups are on average 18 to 27 per cent less likely to be financed by external equity investors, I found that this gap actually reverses in femaledominated sectors. Female-led start-ups in female-dominated sectors (i.e. gender-congruent sectors such as fashion, education and healthcare-related sectors) are equally three to five per cent more likely to raise capital relative to their male counterparts in these sectors and are significantly more likely to raise capital relative to female-led start-ups in male-dominated sectors (i.e. computer programming, engineering and food services). Therefore, both female and male entrepreneurs are more likely to raise external equity in gender-congruent sectors.

The average investor is likely missing out on valuable opportunities by overlooking entrepreneurs in gender-incongruent sectors.

The evidence also shows that start-ups backed with equity in gender-incongruent sectors outperform. I found that female-led start-ups in a male-dominated sector hired more employees, sold more products and services abroad, had a more productive use of assets and were more likely to exit by initial public offering (IPO) than either male-led startups in gender-incongruent sectors or female-led start-ups in gender-congruent sectors. This was also true for male entrepreneurs in female-dominated sectors.

The better performance of the minority group in gender-incongruent sectors suggests that requirements for funding of entrepreneurs who are a minority are likely set higher at the selection stage. Taken together, my findings suggest that the average investor is likely missing out on valuable opportunities by overlooking minority entrepreneurs in gender-incongruent sectors.

This has important implications from the perspective of entrepreneurs, the VC industry — and the economy in general. First, an entrepreneur’s access to external equity financing can make the difference between success and failure, given the advantage of these equity investors in advising start-ups and creating value.

Second, not financing the potential success of highgrowth-oriented entrepreneurs means that some VCs are deteriorating potentially better performance and are wasting the resources invested by their limited partners. Third, failing to finance minority-led start-ups may ultimately result in missed growth and missed job creation in the economy.

Although several sources of gender discrimination may coexist, the evidence in my research is consistent with investors who have on average miscalibrated beliefs about gender and behave according to context-dependent stereotypes.

Given your findings, what would you like to see change going forward?

My study could help to rationalize policy interventions designed to increase the participation of minorities in environments in which they are underrepresented. In this case, encouraging more female entrepreneurs in traditionally male-dominated sectors and more male entrepreneurs in traditionally female-dominated sectors. Over time, a more balanced representation of all genders entrepreneurs in gender-unbalanced industrial activities should help to attenuate the effects of stereotypes. Of course, this won’t happen overnight, but I hope my findings are a step in the right direction.

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This article first appeared in the Fall 2021 issue of Rotman Management magazine. Published in January, May and September, each issue features thought-provoking insights and problem-solving tools from leading global researchers and management practitioners. Subscribe today