11/03/2020

What I Learned Working at a Startup That Didn't Have a Unicorn Exit

“We learn wisdom from failure much more than from success. We often discover what will do, by finding out what will not do; and probably he who never made a mistake never made a discovery,” Samuel Smiles once said.

Many people make the jump from startup operator to VC investor after a successful exit. I’m proud to say I did the same thing, except my startup was far from the textbook definition of successful. I’m proud because this experience has shaped my perspective and made me a better investor and partner to entrepreneurs today.

My startup story

I joined a New York e-learning startup (let’s call it Company A) shortly after their Series B raise. I was on the business operations team where we ran special projects and reported directly to the CEO. What follows is a story that is all too common in the industry: highflying early days, multiple large fundraises—then growth problems, a complete rebuild of the product, and ultimately a “peace with honor exit” in which the company was sold for about a third of the total capital raised.

While it was unpleasant at the time, seeing up-close what can go wrong at a startup can be more valuable than being part of an unmitigated success.

Here’s the reality: The failure rate for VC-backed startups is around 90%. So the odds for any startup are that things won’t go well. Being in the “failure” category gives you a front-row seat in what not to do. It can also impart an appreciation for just how easy it can be to take a wrong turn.

Here’s what I learned from my startup experience and how it shaped my outlook as an investor.

A big VC raise isn’t an achievement in and of Itself

“Congratulations!” is the common reaction anytime a company announces a new round of funding. Yes, a VC investment signals that someone believes in your vision and trajectory enough to tie their own success to it. But that check also comes with strings attached:

• A ticking clock to meet the projected milestones
• New board constituents to appease
• A higher bar for a viable exit

Take a company that has grown modestly but profitably, funding its trajectory through sales. For that team, a $50 million acquisition could be a solid outcome. On the other hand, for a company that has already raised $50 million or more, that same $50 million acquisition won’t even be entertained by VC investors unless the situation gets dire. (The team at Founder Collective does a great job talking about these dynamics). Even if the company takes the deal, the investors — not the founding team or its employees — will likely be the first ones to get paid out, thanks to liquidation preferences.

Company A brought in a sizable Series C round from name-brand investors in early 2016. Raising this funding dialed up expectations and timelines when we hadn’t solidified our go-to-market motion or truly proved product-market fit.

For startups that are growing steadily but not earning TechCrunch funding headlines in the process, it can feel like missing out. But my experience has taught me just how dangerous it is for startups to seek external funding before they are truly ready to deploy that capital and execute against the larger growth expectations that come with it.

This experience attracted me to Elsewhere’s approach. The team here believes in investing in somewhat “under the radar” but more consistently successful software companies, often located outside of flashier geographies. We believe this is where real value and opportunity lie.

If a company has funded their growth primarily through bootstrapping and value-led growth and hasn’t wasted money on bells and whistles, that’s a good sign they are ripe for investment. There is always opportunity for the right amount of capital at the right time, supplemented with the right expertise, to have a transformative impact.

Small problems can become big problems, fast

Company A’s Series C round press release included a number of impressive accomplishments: rapid ARR growth, doubling headcount, and a slew of blue-chip customer accounts.

But, just like any startup, we had problems that we needed to address: scaling our sales team efficiently, managing customer churn, and building additional features in the product.

Given the hefty investment and resulting exit valuation expectations from our investors, we needed to continue this explosive growth while managing all the obstacles above, which became extremely difficult. Eventually, our founders (and my close friends) moved on and the beloved startup culture I joined years before was gone. It was time to look for my next move.

While it was uncomfortable at the time, I credit this experience with helping me develop a healthy skepticism that I bring into every deal evaluation. Churn rate, acquisition cost, and NPS scores are all metrics that should be taken into account alongside whatever appealing growth numbers we’re shown.

I don’t take the salesy route that many investors do when meeting with potential portfolio companies. If we’re not a good fit for each other, whether because of flawed fundamentals or a different outlook, I’d rather let founders know than have them sign on for something they aren’t set up to succeed at. It’s also why we include a rigorous product demo as a key component of the deal evaluation.

Product problems are the worst type of problems

Some challenges within startups can be turned around rather quickly. Marketing strategy is one. Fine-tuning a funnel to shorten the sales cycle or improve conversion rates requires plenty of testing and iteration but ultimately less resources than completely rebuilding a product. Unfortunately that’s exactly what Company A had to do. This rearchitecture took valuable time and effort away from sales and impeded our ability to maintain our revenue growth.

Rearchitecting a product is onerous and causes gridlock across the company. It requires significant time from key team members: engineers, product, QA, and design. It puts a severe damper on sales efforts, too. Once you find out your product isn’t stable or scalable, selling it to new customers before it’s fixed will only create more problems down the line.

This is why Elsewhere’s biggest criteria in evaluating companies is value-led growth — in other words, a product that delights customers and gets better and better with time. Growth fueled by happy customers (who in turn recommend you to new customers) is far more sustainable than sky-high paid acquisition costs, which can temporarily mask a faulty product.

Turning lemons into lemonade

I came out of the Company A experience with some battle scars, but it’s well worth it for the perspective and real-world learning I gained.

I believe startup investment needs to move away from this “billion or bust” mentality. Getting the timing and amount of capital right can pour plenty of fuel on the fire without burning the house down. This is why we’re so focused on finding alignment with entrepreneurs. Sharing a vision for how the company should grow, what resources it will need, and how we can best support them along the way enables us to add way more value than the check we sign.