“In order to win, you must first survive.”

-Warren Buffett

‍

‍

Silicon Valley is full of advice to find product-market fit. It’s the holy grail. You reach it, you’ve made it. You can raise a bunch of money. Pay yourself a nice salary and you’re a (paper) millionaire.

Anyone who has built a startup knows how hard it is. The ups and downs, fighting fires, winning customers, losing some, recruiting awesome people, and have them quit on you. The list goes on. But you stuck with it and built a truly great product. Customers are buying. Your revenue goes up. $1m. 10m. $20m. Wow this is incredible. Everyone wants to get on your cap table. It starts feeling easier.

So why do so many startups that have product-market fit never return money to common shareholders? Here are the top causes of death for post-product-market fit startups:

‍

1) Spending yourself off a cliff

You’re seeing early traction and raising a bunch of money. You invest in your product and build out the leadership team. Those senior execs have an incentive to hire a big team so they can say “I’ve scaled the team from 10 to 50!”. Your operating costs blow up, but you think it’s fine. You still have 18 months of run rate in the bank! Then revenue growth slows from 80% to 30%. You’re burning through your funding and miss your plan. You may still pull in another round or get an extension from your existing investors, but unless you can get to cash-flow breakeven or reaccelerate growth, you’ll eventually run out of funding options.

‍

2) Scaling bad unit economics

Product-market fit takes different shapes and isn’t always easy to identify. Telling yourself that you have it, when you don’t will lead to bad outcomes. Maybe your CAC is really high or you don’t have a repeatable customer acquisition machine. Or you have bad gross margins. If your basic unit economic model isn't working yet, throwing more money at it will not fix it. You just bury yourself under a huge stack of preference shares and devaluing your common equity.

‍

3) Not adapting fast enough

Nothing stands still when you run a startup. The macro economy changes, a new competitor comes on the scene, you lose product-market fit and so on. Some changes need to be ignored and you should hold the course. Others are life-threatening to your business. If you don’t identify those changes fast enough and adjust quickly, you’ll risk it all. Great founders can adjust on a dime. Their reaction time from identifying a problem to taking action is measured in days or weeks. If it takes you months, you’ll burn through valuable cash that could give you the time to fix what’s broken.

‍

4) Raising at too high valuation or raising too much money

This is a particularly frustrating cause of death. Founders easily brush this concern aside. They raise a bunch of money at a massive valuation and feel great about all the paper gains of their equity. But what they’ve really done is they have taken a lot of optionality off the table. They closed doors on potential M&A outcomes: the more you raise, the fewer potential buyers there are that can pay a price that clears the preference stack. They close doors on who they can raise from in the next round: if you don’t grow into your last round’s valuation, you will not find that next investor without doing a down-round. And down-rounds destroy equity value.

These aren’t hypotheticals. This happens all the time. And will happen even more now after the ZIRP-era of “free” money and big rounds. 

‍

5) Raising debt

Let’s say you have the option to raise $30M in dilution-free debt or $30M in equity. A way to think about the debt vs equity tradeoff is with equity there is 100% certainty you’re giving up some equity. With debt there is some chance you give up 100% of your company.

Preferred equity holders usually have the same incentives as you do: long-term value creation to increase shareholder value. Debt holders have a very different incentive: to not lose their investment. There are a lot of ways to default on debt, not only missing an interest payment. Technical defaults are just as common. Read your debt agreement very carefully, every covenant matters. Your debt holders might just be fine to shut down or recap an otherwise healthy business just to get their money back.

‍

6) Dependence on a few customers

For early startups landing a big customer is a massive win. Your revenue shoots up, you put that flagship customer logo on your website and new leads start flowing in. You invest behind that big logo win, grow the team and raise more money. Everything is going to plan. Then suddenly your flagship customer churns. Half of your revenue is gone. You need to raise more money with a bad story and let go half of your team.

Some big companies fully understand the control they can exert over startups if they create enough dependence. They use the leverage to negotiate pricing, defer payments, demand more service and custom features etc. It’s a form of abusive customer-vendor relationship.

The more exposure you have to one or a few customers, the more life-threatening that concentration can be. Companies should diversify their customer base quickly after product-market fit, even if that means slowing down growth a bit.

‍

7) Committing too many foot faults

This is a bit of a catch-all bucket also known as “not executing well”. Much of scaling companies is to run a really tight ship, establish world-class processes, hire top-notch operators and not screw up. This isn’t the sexy part of startups like coming up with a world-changing idea on a white board or closing that big contract. This is the boring part of business. The blocking-and-tackling. If you don’t do it well, you’re wasting money and - in the worst case - put the company in jeopardy. If you’re not good at it, hire an amazing COO and let them take it off your plate. This should not be a reason for failure.

‍

Final thoughts

Some causes of death for post product-market fit companies are out of their control. Others aren’t and should be avoided at all costs. VCs often sound like curmudgeons when they tell these cautionary tales. But they see it happen all the time. Silicon Valley has a survivorship bias so these failures aren’t talked about much publicly. But preventing self-inflicted wounds can protect a lot of value for common equity holders. No startup journey is up and to the right. Plan accordingly.

‍