A growing number of investors have begun to suggest that certain VC-backed startups that have not yet found a so-called product market fit give up. His argument is that some startups simply raised too much, at valuations they’ll never grow to, and that clean, well-planned exits are better for everyone than messy ones. After all, the money could be spent on something more impressive. Importantly, the founders’ time could also be focused on more productive endeavors, greatly improving their mental and emotional well-being.
It is a reasonable proposition. Working on something that doesn’t work can be overwhelming. Still, we’re not sure many founders are leaving their companies right now for a laundry list of reasons. Among them: Fundraising is thin, so raising money for another startup is not a no-brainer. It’s a lousy job market, and most founders feel an obligation to take care of their employees. Some very strong companies have been born out of pivots, including the famous Slack, whose team initially sought to create a game called “Tiny Speck.” Last but not least, if investors gave founders too much money in recent years, and $10+ million for a company that doesn’t fit the product market sounds like too much money, that’s really their fault.
Wanting to explore the matter further, we caught up today with renowned trader and investor Gokul Rajaram, who last night watched at a cheep that “[m]Any founder who raised huge amounts of money ($10m+) in 2020-21 but later realized they don’t have [product-market fit]They are going through an excruciating psychological journey right now.”
Rajaram, who sits on the boards of Pinterest and Coinbase, added on Twitter that an early shutdown can be a “graceful exit” for stressed-out founders, so we asked if it’s also practical, considering the current market. He laid out why it is in an email conversation, slightly edited here for length:
The venture capitalists aren’t letting their own investors get away by reducing the amount they’ve raised, but they want the founders to pay back some of their funding. Do you see a connection?
That’s a great question. I don’t think the two behaviors are connected, at least not yet. Now, if you told me that VCs are starting to put capital back into LPs, I might see some parallels. VCs would return capital to LPs because they do not see attractive investment opportunities that are a good fit for their mandate, fund size, [and so forth]. The founders who give money back do so because they can’t find business ideas that are a good fit for their skills, team, customer focus, etc.
Do you think pivots are overrated or that there are a limited number of times a company can pivot before it becomes clear that something is wrong with the team itself?
Many great companies were formed from pivots. Twitter (Odeo) and Slack (Tiny Speck) are two examples of amazing products and businesses that were created as a result of pivots. In my experience, most founders, when they realize the initial idea has no legs, try at least one pivot, either by solving a different problem for the same group of customers, or by using their prior knowledge, experience of life and problem solving skills. different problem.
Every pivot takes a psychic toll on the company, and I don’t think a company can do more than, say, two pivots before employees start to wonder if there’s a method to madness and start to lose trust in the founders. If it’s a two person company that hasn’t raised much money, they can keep spinning infinitely. The more people and capital get involved, the more difficult it will be to make pivot after pivot.
How much is a reasonable amount of money to spend on the road to finding the right product for the market? In response to his tweet, many people noted his amazement that companies without product-market fit this got so much funding in the first place.
In general, the general rule of thumb has been that your seed round should be used to find [product-market fit]. So that’s $2 million to $3 million in capital at reasonable times. What happened is that during 2020-21, some companies wrongly thought or assumed that they had [product-market fit]perhaps due to a COVID-induced behavior change.
Second, there was FOMO/excess capital chasing “hot” deals. So, for those 2 years, we moved away from the gates of the fundraising stage that have been the norm for several years.
It is much cheaper and easier to find. [product-market] because of no-code tools – I’m a firm believer that for 95% of the software products out there, you can solve it without writing a line of code. That is a discussion for another time.
Other than perhaps some immediate relief, what are the advantages to a founder who throws in the towel and pays back some of the money they raised? Is the argument that they will earn the trust and respect of investors and thus improve their chances of raising money in the future?
That’s exactly right at the point of confidence. I think you earn the trust of your investors because the investors trust more that the entrepreneur can think clearly if he is multiplying the value with the time he is spending. Time is the ultimate currency for an entrepreneur. If they can’t turn the time into greater capital value, at some point the company must be liquidated or sold.
I have not been involved in return of capital scenarios prior to this cycle. I know of a company that returned 70% of its capital during the 2001 cycle after everything closed, and one of the co-founders was able to generate a successful round a few years later, but I’m not sure if it was by correlation or causation. All that said, investors are clear-eyed about the fallacy of sunk costs, and I don’t think [one’s] Funding odds change based on whether you return principal or not.
Do you think going all the way, running out of leads, hurts a founder’s chances of raising funds for another company later on?
You are welcome. If there’s one thing investors love, it’s an entrepreneur whose previous startup wasn’t very successful (whether the entrepreneur ran out of money or paid the money back is irrelevant to the calculation), but still has a hunger to build something huge and ideally related. with the first company. Cashing back shouldn’t be seen as a shortcut to raising your next round of funding, but rather as escaping the psychological toll the never-ending pivot takes on founders and other stakeholders.
If and when a company closes used to be a board decision, right? I wonder if VCs gave up so many of their rights while writing checks in 2020 and 2021 that they can’t shut down companies as easily as before.
If something unethical is going on, like founders charging exorbitant salaries, investors and board members have a fiduciary responsibility to step in and stop it. However, if they are simply founders risking themselves, their professional lives, and making bets—in other words, pivots—most investors will allow them to keep fighting until the entrepreneurs themselves decide to give up. After all, an entrepreneur only has one company, while the investor has a portfolio.
What else investors could do better is offer a safe space to entrepreneurs, let them know that it’s okay to pay back or close the company, that the choice is completely theirs but it’s an option available to them, that they won’t let anyone down. in doing so. It’s not a scarlet letter on the entrepreneur by any means.
Do you think outside pressure is growing on founders to give money back based on the conversations you’re having with other investors?
It is a self-imposed pressure on the part of the employer. The bigger the round that an entrepreneur has raised, the higher the expectations of him. I think companies will have some options in the coming months. A.) If they don’t have [product-market fit] and they haven’t raised much money, they will have no choice but to get out as the company is out of cash. B.) If they don’t have [product-market fit] but they have raised a lot of money, they can try to spin once or twice, but after that, everyone is tired. Likely exits in this scenario could be an acquisition-hire, liquidation, or a small acquisition. C.) If they have [product-market fit] and raised a lot of money, but the valuation is inconsistent with traction, the company may need to do a round to the downside.
GGV’s Jeff Richards had an excellent mail stating that companies with the largest number of employees [net promoter scores] they were the ones who raised a round down. Isn’t that interesting? There’s a palpable sense of relief once you no longer have the sword of Damocles of your crazy valuation hanging over you. I think that’s the other conversation that investors need to have with entrepreneurs: it’s okay to take a negative round. It’s not the end of the world.
I imagine a lot of founders don’t want to pay back capital because in this current market, that means more people might have a hard time supporting their families. Any advice for founders on this front?
I am a firm believer that companies have a duty, an obligation, to treat their employees well. And I think that making the early decision to close the company means that more severance can be given to the employees. The longer you wait, the less cash there will be to help employees during a transition period.
