A Look at Investment Failure Rates by Revenue and Platform

It’s no secret that investing in startups is a high risk, high-potential reward investment strategy. While investors strive to create a diversified portfolio that will result in a few big winners according to the power law, it’s almost certain that there will be failures along the way.

While the typical angel investment may take 5-7 years on average to realize a positive exit, the failures tend to occur earlier in a portfolio’s lifecycle. Thus, while it hasn’t yet been long enough to have a successful outcome dataset to analyze for equity crowdfunding, today we’re going to look at the negative investment outcome (i.e. failure) data to date for online startup investing to see what trends we can glean from the data. In particular, we’re going to analyze three questions:

1. Does an investment opportunity become any less risky as a business generates more revenue?
2. Do failure rates vary across funding platforms, and if so, how?
3. Is there a difference in risk of investing in high-growth startups vs. small businesses?

Here at Kingscrowd, we believe that transparency and honesty are essential – even if that means discussing the taboo topic of companies that fail to return capital to investors.

Remember, higher failure rates do not necessarily mean that certain deals or platforms are better or worse than others. Because startup investor’s returns are governed by the power law, it isn’t the failures that will determine an investor’s portfolio performance; instead, it is the magnitude of the successes in a portfolio that will drive overall portfolio returns. That being said, investors can still learn a lot from failures.

Are Pre-Revenue Companies More Risky than Higher Revenue Companies?

Investor intuition would typically lead one to believe that pre-revenue companies are more risky than post-revenue companies. After all, a lot can go wrong before a company has paying customers. In fact, even if customers say that they are interested in a product, that doesn’t always translate to meaning that they are willing to pay for that product.

But what about going from the first $50K to $500K in annual revenue? Or from $1M to $10M? Does higher revenue tend to correlate with lower company failure rates?

The data seems to indicate that higher revenue tends to correlate with lower failure rates.

Here, we define a “failure” as a negative outcome for investors, either via a shut down business, bankruptcy/liquidation, or an asset sale where investors get less than 1X capital returned. The latest Kingscrowd dataset tracks nearly 500 exits and failures to date (you can view them here).

Comparing Negative Outcome Rates for Startups vs. Small Businesses

Analyzing the data for equity crowdfunding (i.e. excluding debt and revenue share deals), there have been 386 company failures across 501 separate offerings that have resulted in less than 1X (often zero) return of capital to investors. Across the 6,325 Reg CF and Reg A+ equity offerings since 2016, this works out to an average deal failure rate of 7.9%.

A few assumptions to note:

• The actual market failure rate is likely somewhat higher than 7.9%, since failures are not always publicly reported and it can take months (sometimes years) for companies to fully dissolve.
• This 7.9% number is the total number of offerings that resulted in a negative outcome. Since companies can do multiple offerings online, the overall average failure rate among companies (not offerings) is 6.1% from the chart.
• Companies that are raising capital via equity crowdfunding may have been founded significantly earlier – so even if this is the first online funding capital round, the company may in fact have been operating or even raised capital in the past.
• We also need to take the macro picture into account for the time period in question. Equity crowdfunding exploded in popularity in 2020-2021, right before the Fed hiked interest rates in 2022 and caused a much tougher situation. So we may have seen many founders and issuers come into the market thinking that building a business would be easy, only to see capital dry up, and thus many of those businesses to shut down.

All that being said, a failure rate of 7.9% is much lower than the typical average failure rate cited for startups.

For example, Small Business Administration data suggest that 75% of VC-backed startups never return cash to investors. And on the small business side, according to Bureau of Labor Statistics data, 20% of small businesses fail within the first year and up to 50% fail after five years.

Equity Crowdfunding Investment Failure Rates by Funding Platform

Equity crowdfunding platforms all have different processes and teams for screening deals. Some intermediaries simply abide by the minimum Regulation Crowdfunding bad-actor checks and other minimum mandatory compliance checks, while others have more thorough due diligence processes, trying to present only the most promising investment opportunities to investors.

So, how do the funding platforms compare in terms of failure rates of offerings to date?

The data in the chart is presented in decreasing order of the total number of offerings.

A few key takeaways from the data:

• The three platforms with the lowest known failure rates to date were Dealmaker Securities (0.8%), PicMii (1.8%), and Silicon Prairie (1.8%), each with only 1 failure out of their 50+ offerings.
• The investment outcome failure rate of deals on the top four platforms (by deal count) was:
  • Wefunder: 5.3%, 106 failures
  • StartEngine: 6.4%, 107 failures
  • Republic: 7.6%, 58 failures
  • Netcapital: 3.9%, 17 failures
• Numerous funding platforms that have been shut down or disqualified (according to FINRA data) had much higher failure rates

Are Small Business Offerings as Risky as Startups for Investors?

As discussed in our prior analysis of the debt interest rate required for investors to break even, even debt and revenue-share investors need to consider the potential of failure for companies when making investments in debt deals. It isn’t all-or-nothing like it is with equity, but a company that shuts down can still result in a complete loss.

Are debt and revenue-share deals any more or less risky than their startup counterparts?

• Equity Crowdfunding: 386 failures across 6,325 deals = 7.9% failure rate
• Debt Crowdfunding: 94 failures across 1,984 deals = 4.7% failure rate

Thus, it does appear that higher-growth startups tend to be more risky than small businesses offering debt or revenue share notes.