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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<\/a>. 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\u2019 time could also be focused on more productive endeavors, greatly improving their mental and emotional well-being.<\/p>\n It\u2019s a reasonable proposal. Working on something that isn\u2019t working can be soul crushing. Still, we\u2019re 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\u2019s 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 \u201cTiny Speck.\u201d Not last, if investors gave founders too much money in recent years \u2014 and more than $10 million for a company without product-market fit sounds like too much money \u2014 that\u2019s really their own fault.<\/p>\n Wanting to explore the issue further, we reached out today to renowned operator and investor Gokul Rajaram, who last night observed in a tweet <\/a>that \u201c[m]any founders who raised large amounts of money ($10m+) in 2020-21 but subsequently realized they don\u2019t have [product-market fit], are going through an excruciating psychological journey right now.\u201d<\/p>\n Rajaram \u2014 who sits on the boards of Pinterest and Coinbase \u2014 had added on Twitter that an early shut-down can be a \u201cgraceful way out\u201d for stressed-out founders, so we asked him whether it\u2019s also practical, considering the current market. He made the case for why it is in an email conversation, edited lightly here for length:<\/p>\n VCs aren\u2019t letting their own investors off the hook<\/a> by shrinking the amount they have raised, yet they want founders to give back some of their funding. Do you see a connection?<\/b><\/p>\n That\u2019s a great question. I don\u2019t 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\u2019t 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.<\/p>\n Do you think pivots are overrated or that there are only so many times a company can pivot before it\u2019s clear that there is something off with the team itself?\u00a0<\/b><\/p>\n 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\u2019t 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.<\/p>\n Each pivot does take a psychic toll on the company, and I don\u2019t 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\u2019s a two-person company that hasn\u2019t raised much money, they can keep pivoting infinitely. The more the people \u2014 and capital \u2014 involved, the harder it is to do pivot after pivot.<\/p>\n 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<\/em> product-market fit this were given so much funding in the first place.<\/b><\/p>\n In general, the rule of thumb has been that your seed round should be used to find [product-market fit]. So that\u2019s $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.<\/p>\n Second, there was FOMO\/excess capital chasing \u201chot\u201d deals. So during those 2 years, we went away from the fundraising stage gates that have been the norm for several years.<\/p>\n It\u2019s so much cheaper and easier to find [product-market] due to no-code tools \u2013 I strongly believe that for 95% of software products out there, you can figure it out without writing a line of code. That\u2019s a discussion for another time.<\/p>\n 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?<\/b><\/p>\n That\u2019s exactly right on the trust point. I do believe you win your investors\u2019 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.<\/p>\n I haven\u2019t 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\u00a0\u00a0I\u2019m unclear if it was correlation or causality. All that said, investors are clear-eyed about sunk cost fallacy, and I don\u2019t think [one\u2019s] funding odds change based on whether you return capital or not.<\/p>\n Do you think that going all the way \u2014 running out of runway \u2014 hurts a founder\u2019s chances of raising funding for another company later?<\/b><\/p>\n Not at all. If there\u2019s one thing investors love, it\u2019s an entrepreneur whose prior startup wasn\u2019t super successful \u2014 whether the entrepreneur ran out of money or returned money back is immaterial to the calculus \u2014 but still has the hunger to build something huge and ideally related to the first company.\u00a0\u00a0Returning 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.<\/p>\n Whether and when a company shuts down used to be a board decision, wasn\u2019t it? I wonder if VCs gave up so many of their rights as they were issuing checks in 2020 and 2021 that they can\u2019t shut down companies as easily as was previously possible.\u00a0<\/b><\/p>\n If there is something unethical going on \u2014 such as founders\u00a0 drawing crazy salaries \u2014 investors and board members have a fiduciary responsibility to step in and stop it. However, if it\u2019s simply founders putting themselves, their professional lives, on the line, and making bets \u2014 in other words, pivots \u2014 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.<\/p>\n What more investors could do better is to offer a safe space to entrepreneurs, to let them know that it\u2019s OK to return money or shut down the company, that the option is entirely theirs but that it\u2019s an option available to them, that they are not letting anyone down by doing so.\u00a0\u00a0It\u2019s not a scarlet letter on the entrepreneur in any way.<\/p>\n Do you think external pressure is growing on founders to give back money based on the conversations you\u2019re having with other investors?<\/b><\/p>\n It\u2019s 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\u2019t have [product-market fit] and have not raised much money, they\u2019ll have no choice but to exit since the company is out of cash. B.) If they don\u2019t 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]\u00a0 and raised a lot of money but the valuation is inconsistent with the traction, the company might need to do a down round.<\/p>\n Jeff Richards from GGV had an excellent post<\/a> stating that the companies with highest employee [net promoter scores] were those that raised a down round. Isn\u2019t that interesting? There is a palpable sense of relief once you no longer have the Damocles\u2019 sword of your crazy valuation hanging over you. I think that\u2019s the other conversation investors need to have with entrepreneurs \u2013 it\u2019s OK to take a down round<\/a>. It\u2019s not the end of the world.<\/p>\n I imagine many founders don\u2019t 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?<\/b><\/p>\n I\u2019m 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.<\/p>\n<\/div>\n