In the past few weeks I’ve talked with several startups that are severely impaired by the pandemic. Before the pandemic their companies were doing well enough to raise venture money, but not well enough to be obvious winners in meaningful markets. Then, the pandemic hit and it exposed their businesses in a way that showed they weren’t great businesses to begin with, and raising money wasn’t the appropriate route to go.
Now, the founders are in the honorable zombie startup trap.
These founders aren’t willing to shut down their companies and move on. No, they’re too honorable and are going to do everything in their power to at least return the investors’ money. Only, the startup is a zombie.
There’s enough revenue and gross margin to keep the lights on, but with revenue declining there’s no clear path to reverse course and accelerate growth. Unfortunately, with declining revenue and a suffering business, if they were to raise money, it’d be a down round, if at all possible. Down rounds are almost always the kiss of death, due to a number of reasons.
While this desire to eventually return investors’ money is in fact honorable, it actually makes all parties worse off. From a time perspective, investors are better off moving on and focusing their energies elsewhere. Startup investing in its purest form is a game of maximizing upside, not minimizing downside. Some investors would struggle with recognizing the loss if they have limited partners or are trying to raise a new fund, but that shouldn’t be an issue with successful investors.
Founders are often better off shutting the startup down, or going into harvest mode, so as to return some capital to investors and prepare for their next endeavor. Time and energy are two of the most important components of successful founders, and running a zombie startup for years beyond what makes sense depletes both.
Look out for the honorable zombie startup trap, and ensure all parties involved are aware of what’s happening. The best path forward is often moving on from the startup.
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David Cummings, Khareem Sudlow
