A growing number of investors have begun suggesting that certain venture-backed startups that have yet to find so-called product-market fit throw in the towel. Their argument is that some startups simply raised too much, at valuations into which they will never grow, and that clean, well-planned exits are better for everyone than messy ones. After all, the money could be invested in something more impactful. Importantly, the founders’ time could also be focused on more productive endeavors, greatly improving their mental and emotional well-being.

It’s a reasonable proposal. Working on something that isn’t working can be soul crushing. Still, we’re not sure many founders would give up on their companies right now for a long list of reasons. Among them: Fundraising is tight, 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 of pivots, including, famously Slack, whose team initially sought to make a game called “Tiny Speck.” Not last, if investors gave founders too much money in recent years — and more than $10 million for a company without product-market fit sounds like too much money — that’s really their own fault.

Wanting to explore the issue further, we reached out today to renowned operator and investor Gokul Rajaram, who last night observed in a tweet that “[m]any founders who raised large amounts of money ($10m+) in 2020-21 but subsequently realized they don’t have [product-market fit], are going through an excruciating psychological journey right now.”

Rajaram — who sits on the boards of Pinterest and Coinbase — had added on Twitter that an early shut-down can be a “graceful way out” for stressed-out founders, so we asked him whether it’s also practical, considering the current market. He made the case for why it is in an email conversation, edited lightly here for length:

VCs aren’t letting their own investors off the hook by shrinking the amount they have raised, yet they want founders to give 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 were to tell me VCs were starting to return capital to LPs, I could see some parallels. VCs would return capital to LPs because they don’t see attractive investment opportunities that are good fits with their mandate, fund size, [and so forth]. Founders who return money are doing so because they cannot find business ideas that are a good fit with their skills, team, customer focus, etc.

Do you think pivots are overrated or that there are only so many times a company can pivot before it’s clear that there is something off 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 the result of pivots. In my experience, most founders, when they realize the initial idea doesn’t have legs, try at least one pivot, either solving a different problem for the same set of customers, or using their prior knowledge, life experiences and skills to solve a different problem.

Each pivot does take a psychic toll on the company, and I don’t think a company can do more than, say, two pivots before employees start wondering if there is a method to the madness and start losing trust in the founders. If it’s a two-person company that hasn’t raised much money, they can keep pivoting infinitely. The more the people — and capital — involved, the harder it is to do pivot after pivot.

How much is a reasonable amount of money to burn through on the path to finding product-market fit? In response to your tweet, a lot of people noted their astonishment that companies without product-market fit this were given so much funding in the first place.

In general, the 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 in reasonable times. What happened is that during 2020-21, some companies thought or wrongly assumed they had [product-market fit], maybe because of a COVID-induced behavioral change.

Second, there was FOMO/excess capital chasing “hot” deals. So during those 2 years, we went away from the fundraising stage gates that have been the norm for several years.

It’s so much cheaper and easier to find [product-market] due to no-code tools – I strongly believe that for 95% of software products out there, you can figure it out without writing a line of code. That’s a discussion for another time.

Aside from perhaps some immediate relief, what are the advantages to a founder who throws in the towel and gives back some of the money she or he raised? Is the argument that they will win the trust and respect of investors and so improve their odds of raising money in the future?

That’s exactly right on the trust point. I do believe you win your investors’ trust because investors are more confident that the entrepreneur is able to clearly think through whether they are multiplying value with the time they are spending. Time is the ultimate currency for an entrepreneur. If they are unable to convert time into increased equity value, at some point the company needs to wind down or be sold.

I haven’t been involved in return-of-capital scenarios prior to this cycle. I do know one company that returned 70% of its capital during the 2001 cycle after everything shut down, and one of the cofounders was able to raise a successful round a few years later, but  I’m unclear if it was correlation or causality. All that said, investors are clear-eyed about sunk cost fallacy, and I don’t think [one’s] funding odds change based on whether you return capital or not.

Do you think that going all the way — running out of runway — hurts a founder’s chances of raising funding for another company later?

Not at all. If there’s one thing investors love, it’s an entrepreneur whose prior startup wasn’t super successful — whether the entrepreneur ran out of money or returned money back is immaterial to the calculus — but still has the hunger to build something huge and ideally related to the first company.  Returning money should not be seen as a shortcut to raising your next round of funding, but instead escaping the psychological toll that endless pivoting takes on founders and other stakeholders.

Whether and when a company shuts down used to be a board decision, wasn’t it? I wonder if VCs gave up so many of their rights as they were issuing checks in 2020 and 2021 that they can’t shut down companies as easily as was previously possible. 

If there is something unethical going on — such as founders  drawing crazy salaries — investors and board members have a fiduciary responsibility to step in and stop it. However, if it’s simply founders putting themselves, their professional lives, on the line, and making bets — in other words, pivots — most investors will let them keep fighting till the entrepreneurs themselves decide to give up. After all, an entrepreneur only has one company, while the investor has a portfolio.

What more investors could do better is to offer a safe space to entrepreneurs, to let them know that it’s OK to return money or shut down the company, that the option is entirely theirs but that it’s an option available to them, that they are not letting anyone down by doing so.  It’s not a scarlet letter on the entrepreneur in any way.

Do you think external pressure is growing on founders to give back money based on the conversations you’re having with other investors?

It’s self-imposed pressure by the entrepreneur. The larger the round an entrepreneur has raised, the higher the expectations. I think companies will have a few choices over the next few months. A.) If they don’t have [product-market fit] and have not raised much money, they’ll have no choice but to exit since the company is out of cash. B.) If they don’t have [product-market fit] but have raised a lot of money, they can try pivoting once or twice, but after that, everyone is tired. Likely exits in this scenario could be an acquire-hire, wind down, or small acquisition. C.) If they have [product-market fit]  and raised a lot of money but the valuation is inconsistent with the traction, the company might need to do a down round.

Jeff Richards from GGV had an excellent post stating that the companies with highest employee [net promoter scores] were those that raised a down round. Isn’t that interesting? There is a palpable sense of relief once you no longer have the Damocles’ sword of your crazy valuation hanging over you. I think that’s the other conversation investors need to have with entrepreneurs – it’s OK to take a down round. It’s not the end of the world.

I imagine many founders don’t want to give back capital because in this current market, that means more people might struggle to support their families. Any advice to founders on this front?

I’m a firm believer that companies have a duty, an obligation, to treat their employees well. And I think making a decision early to shut down the company means that there is more severance that can be given to employees. The longer you wait, the less cash there is to help employees through a transition period.


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