The startup strategy “pivot” … there is a hidden cost

The startup strategy “pivot” … there is a hidden cost

The business strategy “pivot” is common with tech startups. Typically the startup’s founder/CEO implements a “pivot” when the initial strategy of the startup isn’t working out … so a different strategy is pursued. This short article is not referring to the scenario where a software development company is working on 5 projects then decides to “pivot” 1 of the 5 projects in their portfolio. Rather, I am referring to typical startups where there is one focus, one initial strategy that is clearly not working out and a strategy pivot is executed.

First a logical question. Why would a founder/CEO prefer to “pivot” as opposed to shutting the business down and creating a new startup AKA “reboot”? The most significant reason is, it is very difficult and time consuming to assemble a cohesive development, engineering and marketing team. Once this team is in place, it’s almost magical, fragile even, and not to be messed with, so the pivot keeps this team intact (if they are lucky). Another problem with the reboot is, the post pivot strategy might be based on the existing company’s IP (intellectual property), so a reboot of the company’s equity ownership with the intent of using the same IP might not be possible (at least not inexpensively).

So why would it ever make sense to reboot as opposed to pivoting the startup?

I know of one very real reason … the psychological weight of the sunk cost which will eventually cloud the financial analysis of a future transaction.

Scenario A: “The Pivot”

  1. Investors contribute $1.5mm cash into hiring staff and development cost
  2. then 6-18 months later the initial strategy is obviously not working out so they think of a slightly different strategy and pivot the company, and invest another $1mm cash into the company to proceed toward the new product/service strategy
  3. then 2-3 years later they either want to raise capital by selling equity or sell the entire company. The problem is, if they find a buyer who offers $2mm (or values the company at $2mm for an equity investment), the original investors could have the mindset that they have $2.5mm invested into the project and they are not likely to agree to the $2mm valuation, because that would be a loss.

This “mindset” kills proposed transactions all the time, hence kills startups because later the original founders realize that the proposed $2mm offer was their only life-line … yet is no longer available. It is unfortunate in some cases because the post pivot strategy could have been “the next best thing”, and all it needed was a little more growth capital and maybe that next level executive to step in and take the helm.

Scenario B: “The Re-Boot”

As opposed to pivoting the company, if they would have admitted “this idea didn’t work” and closed the business (and maybe taken a tiny tax write off), they could have started a new company and only had $1mm cash invested into the new strategy … then the $2mm buyout (or next round investment valuation) looks a lot better and would likely be accepted … then the startup is off to the next level of growth.

You might be thinking … if it’s the same original investor(s), what does it matter if they pivot or re-boot … it’s the same money so why not pivot.

The psychology of investing is complicated. Over time investors get what is called “investment fatigue”. As more and more time passes they contribute more and more cash into the startup, hence they become tired of the investment that hasn’t yet paid off. With a business closure and a fresh start, the investment fatigue hasn’t built up because the first business was written off as a loss … financially and mentally.

I ‘m not suggesting the reboot is always the way to go, because more times than not the pivot is the smarter path for a startup because of the cohesive team in place. I just wanted to bring up this phenomenon as a discussion point for those decision makers who are contemplating a pivot.

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