Why Two-Thirds of the Fastest-Growing Companies Fail

March 7, 2016, 3:00 PM UTC
Stressed young man sitting at office desk
Photograph by Getty Images/Image Source

Hundreds, maybe thousands, of aspiring entrepreneurs will show up this month at the SXSW festival in search of funding for their startups. Some will succeed and go on to create fast-growing, promising companies.

Most of those companies won’t last.

The Kauffman Foundation and Inc. Magazine conducted a follow-up study of companies five to eight years after they had appeared on the magazine’s list of the 5,000 fastest-growing companies. What they found was startling: about two-thirds of the companies that made the list had shrunk in size, gone out of business, or been disadvantageously sold. Why? Because they failed to make it through the fourth and final stage of enterprise maturity, where a company finally becomes self-sustaining.

In stage one, startups find a real customer for their idea. In stage two, they establish processes for reliably delivering their product and for finding new customers. Virtually all Inc. 5000 companies are past stage two since, without basic processes in place, they would have been unable to sustain the high growth rates required to make the list.

In stage three, new challenges appear. To become financially viable, the enterprise must rely upon even more sophisticated processes, and it can no longer risk having the company’s fortunes depend upon the special talents of any one person. Even having successfully passed this point, most enterprises are then unable to solve the central challenge of stage four: creating processes for developing entirely new products for new customers. Without processes in place to continuously reinvent itself, a company is on a slow trajectory to irrelevance and failure.

Typically, leaders of our fastest-growing companies make one or more of these mistakes:

  • Remain essential to the day-to-day execution of some aspect of running the company
  • Falsely assume that financial viability is the end of the journey
  • Use R&D to produce only incremental improvement to existing processes and products
  • Acquire innovative companies and then drive their innovative talent away

Ultimately, these are all failures of leadership that can be avoided by consciously creating a culture that simultaneously values the competing ideals of innovation and efficiency.

Of course, this is easier said than done in companies that rely upon the efficiency of their processes to achieve the fleeting emotional highs that come with rapid growth. The risks and distractions associated with the innovations required to develop entirely new products and markets seem to run counter to what has brought success to that point. A culture dedicated to efficiency and growth will not tolerate these risks unless a strong leader has an exciting vision of long-term success based upon innovation that critical stakeholders find convincing. Long-term survival and prosperity requires a leader who can also craft a culture that rewards equally those who bring efficiency and those who innovate. Such leaders are rare and that is why so many companies see their growth evaporate and decline. Forewarned is forearmed.

Derek Lidow is the author of “Startup Leadership” and teaches entrepreneurship, innovation and creativity at Princeton. He was the founder and former CEO of iSuppli Corporation.