Title: Financial failure of a startup: a simulation approach

Authors: Erkki K. Laitinen

Addresses: Department of Accounting & Finance, University of Vaasa, P.O. Box 700, 65101 Vaasa, Finland

Abstract: The objective is to develop a simulation model of a startup to assess the ceteris paribus effects of (16) different parameters on the likelihood of financial failure. The deterministic growth path is described by a second-order Pascal distribution. Uncertainty is incorporated assuming a random variable proportional to sales. Three criteria for financial failure are developed to assess the likelihood of different failure types (profitability, solidity, and liquidity failures). Finnish data from 9,066 non-failed and 118 failed startups are used to approximate the value range of the parameters in non-failed and different types of failed startups. For each parameter, effects are analysed for 25 different values based on 1,000 simulation rounds each. The findings strongly emphasise the central role of internal rate of return in the likelihood of each type of failure. They also emphasise importance of early generation of sales for the likelihood of profitability failure and the strong effect of fixed expenses, size of initial investment, and initial equity capital on failure likelihood.

Keywords: bankruptcy; failure probability; financial failure; liquidity crisis; profitability; simulation; startups; startup failures; uncertainty; Finland; internal rate of return; sales generation; fixed expenses; initial investment; initial equity capital.

DOI: 10.1504/IJMED.2016.079851

International Journal of Management and Enterprise Development, 2016 Vol.15 No.4, pp.282 - 307

Received: 03 Mar 2016
Accepted: 01 Apr 2016

Published online: 18 Oct 2016 *

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