When Your Startup Isn't Working
The harsh truth about startups is that most of them don’t work out. And that’s completely fine. Nearly all the reasons why startups die can be categorised into two: either the business isn’t working out (whether that’s product, or distribution, or economics), or you can’t raise the capital you need to build and scale.
Now, the tricky thing is that both of them are interlinked – they mostly occur together, and solving one can help solve the other. However, they’re still different problems, and hence, need to be solved differently.
Business Problem
When you aren’t able to grow revenue, that’s the single most telling sign that the business is not working. We’ve seen founders try many different things – product iterations, distribution channels, pricing strategies – and if after all of them, the revenue stays largely flat, it means that the value proposition isn’t valuable enough. Another telling sign is when you start to scale, the economics break – CACs shoot up, margins go down – that might indicate that the specific value proposition doesn’t have a large enough market.
The natural course of action in such a situation is to pivot. Now, iterations are a natural part of finding product-market fit. However, pivots mean a meaningful change in the product (solves a different problem), target customer, business model (like switching from B2B to B2C or vice-versa). In some cases, it’s adjacent to the existing business while in others, it could even be a totally different play.
In either case, it’s important to align existing investors on the future course of action that you think could be most productive. When founders want to make a hard pivot, a fair approach is to make a fresh pitch to the lead investor, and have them consent to it. However, we’ve seen a much cleaner way is to just shut the existing business, return capital, and raise fresh capital for the new venture.
Which is also the alternative course of action i.e. wind down and return whatever capital you have left. Frankly, we have seen few founders take this path – most try all they can with whatever money they have to figure something, anything out. In most cases, the startup runs out of money.
However, if we were to look from an objective lens, there’s a clean way to decide whether it makes sense to pivot or to shut down.
- It makes sense to pivot when your specific value proposition didn’t work out but there are still many other problem statements to solve. Often, founders start with a certain hypothesis, and as they interact with the market, realise that there are more pressing problems which are more valuable to solve.
- On the other hand, it makes sense to shut down when there are structural constraints in the market and/or headwinds. Things like the market not being ready enough, or regulatory uncertainties.
Now, when you have a business problem, the fundraising problem practically becomes irrelevant – how will you raise if the business isn’t doing well. But in rare cases, where founders have great pull with investors, and during a bull market, they might be able to raise capital even when the business isn’t doing well.
If founders can do that, they absolutely should. More capital gives them more time and resources to experiment and improve to build something that works. But, it’s important for founders to be honest about where the business is because with capital comes the expectation of growing, which will never work, if you don’t have a fundamentally sound business.
Fundraise Problem
For most founders, fundraising is probably tougher than actual building. However, the first thing that you must do is establish that the fundraise problem isn’t really a business problem.
Because you’re close to the business, you think it’s doing well but potential investors don’t think so. Now, it doesn’t matter who’s right or who’s wrong but in such a situation, the most important thing for you to do is aim for cash flow profitability – there’s no better way to validate that the business works.
But let’s say that the business is working (whether profitable or not); then there could be one of two cases: first is when investors don’t see that as a venture scale business, and second is when investors think it can be venture scale but need more proof.
After spending a couple of years building the startup, most founders can work out the potential of the business. I have seen several cases where they realised it can’t be venture scale so it’s better to turn profitable, and then work with different expectations of growth. Once the business reaches a certain scale, it could be worth exploring strategic investment, or taking more capital from investors with a longer time horizon or different return expectations.
Now let’s take the other case where you have visibility into the business satisfying the venture scale requirements but investors aren’t convinced, what can you do then? First, you should try to figure out what’s the minimum scale at which and the timeline within which you can turn profitable – that has to be the primary goal. Second, you need to work with existing investors to raise an internal bridge round. Because they’ve seen the business from earlier, they are likely to have more conviction. The alternative to that is to raise a smaller round than you’d intended (from external investors). In either case, you need to use capital judiciously and prove out the parts of the business model that can help you raise a larger round.
The other totally different path is for the startup to get acquired. Usually, acquisitions (at highly discounted prices) are seen as a last resort, especially when founders have exhausted all fundraising options. However, the most difficult thing here is actually finding the right buyer under whom you could grow the business. The Indian market isn’t mature enough for this but I do imagine this becoming a realistic option. I don’t think it’s a bad option at all if it gives you the right opportunity and resources to continue building what you want.
An important thing to understand for founders is that fundraising is a learnable skill. However, I’ve hardly seen anyone who hones it proactively. Almost everyone has to go through a difficult fundraising experience to realise the importance of it. Don’t do that. Please learn fundraising.
Mindset Problem
As you can imagine, it’s extremely difficult to decouple the two existential problems. The only way to do that is through intellectual honesty. Because you’re so close to your startup, you’ve spent so much time and effort in building it, it can be difficult to see things objectively. At times, it’s important to put aside your own perspective, and understand what the market is telling. Having people around you who can give you this honest feedback is absolutely critical.
Another common mistake that founders make is going silent when things get difficult – they simply stop communicating and sharing updates with investors. I understand the fear of negative perception. However, it only delays difficult conversations which makes them more difficult. The founders we admire most are those who continue to communicate with full transparency during bad times as they do during good.
Finally, I’ve seen founders feel the pressure of failure – of disappointing themselves and their investors. That’s arguably the most terrible place for any founder to be. However, it’s important for you to recognise that the failure of the startup is not the failure of you, as a founder. If you’ve put in honest and complete effort, and it still didn’t work, that’s totally fine. How many founders have built a large startup in their first attempt?
I’ve heard from many founders that investors completely change their behaviour when things don’t go well. That shouldn’t happen. As investors, we need to be more professional. We’re well aware of the risks with investing in startups and we shouldn’t let that come in the way of a great working relationship with founders. We must continue to treat founders with the same respect, irrespective of how things turn out with the startup.