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The Startups Of Broken Dreams

Most startups fail and entrepreneurs go broke or end up in debt. The chances of success of startups are low, some say less than 1 in 10. But more than 45% of random traders of SPY ETF profited last year. Although most traders fail too, if one wants to gamble, trading may offer higher chances of success.

An article in Forbes magazine not long ago detailed some of the key reasons startups fail and what the 10% that make it does right. It is a good article but I may have to add that unless there is a trade secret or a patent, failure may be inevitable due to competition and diminishing returns.

Actually, most speculators might be better off trading the markets than with a startup that tries to compete in a space controlled by a few big names. Below is a simulation of 20,000 random traders using daily data for 2015. The random traders used a coin to decide when to go long or short. Long positions in SPY ETF were initiated at the close of a day when heads showed up and reversed to short when tails showed up. The starting capital of each random trader was $100K and the equity was fully invested. The commission rate was set at $0.01 per share. Below is the distribution of net returns of the 20,000 random traders:

SPY_2015

Although 2015 was a rough year for the markets, more than 44% of the random traders profited. Actually, more than 22% made above 10% and some lucky ones made as much as 90%. The unlucky ones lost as much as 48%.

Startups are the new virtual boulevards of broken dreams. Most entrepreneurs would be better off becoming school teachers or engineers. The chances of succeeding without specific and solid intellectual property rights are low and the probability of becoming the next Gates, Zuckerberg, Musk or Bezos is for all practical purposes zero unless luck plays its role.

I am not trying to discourage anyone; I am only taking a pragmatic stand. If someone has a new formula for a drug that can cure a disease or a patent, then trying the startup route may be justified. Same holds for someone with a good product design that can serve specific needs. But trying to create another virtual reality headset, another game for social media platforms, an application for finding the best restaurant or hotel, or even a space travel company with toy rockets, will probably not lead anywhere. Same holds for ambitious self-driving cars and robot designers. Note that most robo-advisor startups have already failed and this is because there is no barrier to entry, resulting in competition and lower profit margins.

If someone wants to gamble, then a startup may not be a good bet. As shown above with a simulation, there are markets that offer high chances of success even for players without an edge. Arrogance and detachment from reality usually lead to failure. Most startups will fail the same way that most aspiring actors and actresses never make it. Those that push young people to take the startup route are not gamblers; they are like the casinos that take advantage of the law of large numbers. Those “financiers” know that if one in 100 startups does an IPO, then they will profit many times. They will not share the profits with the 99 that never made it but provided the diversification hedge. This is not fair but it is how things work. And ambitious entrepreneurs who look for angel financing but have no tangible edge should realize that. At the same time, those who have the edge should pursue their goals because their chances of success are higher. Knowing when one has an edge is the key. Otherwise, trading the SPY ETF with a coin may offer higher chances of success.

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