Shutting startups down: When to pull the plug?

IT IS a sorry fact of the startup life that 90 per cent of startups will fail, with 10 per cent dropping out in the first year. Failure to launch is not in the least uncommon. But in a hostile macroeconomic climate with the massive funding boom of the last five years burning out, fortune may not favour the bold.

High-profile startups shuttering are making headlines, with biotech startup Tessa Therapeutics the latest to close shop. Failing to raise the next round of funding, the board decided to pull the plug on the venture.

In a letter to shareholders, Tessa said: “We have witnessed an unprecedented value depreciation in public markets for biopharma as a sector. High interest rates and a sharp decrease in biotech valuations have reduced the risk appetite of investors. Investors now expect far more mature data than what we currently have.”

Startups breaking through after months or years of struggle make for happy endings. But LinkedIn today is littered with tales of shutdowns, with many founders taking to the professional social network to announce closure.

For Tessa, even hitting key milestones over the last 12 months failed to sway investors, the company said.

When the business model no longer makes sense

A high failure rate lurks in the back of most minds, and is something Dayana Yermolayeva, founder of JiPay, was acutely aware of.

JiPay provided a platform for employers and foreign domestic workers (FDWs) to manage money – with additional financial services for the workers – that shuttered in October 2022.

“I think I was always quite aware that my startup shutting down is a very real possibility,” she says.

The decision to shutter is not taken lightly. It can be a long-drawn-out process that may include dealing with regulatory changes, pivots and market timing. No one makes the decision overnight, say founders The Business Times spoke to.

In the case of JiPay, it was not a singular issue but a combination of factors, that led Yermolayeva to call it a day. There were issues with its payments provider, and differences between its target market of employers and FDWs.

“They both want this product but FDWs don’t want it on the same app, which drew me to a pretty clear conclusion that we have to kill either side of the product as they can’t really co-exist,” says Yermolayeva.

While the employer side of the business was larger and more stable, it was not monetisable. On the other side, FDWs mainly wanted remittances, which Yermolayeva felt was not a defensible business as payments were being integrated and margins were already slipping.

Then there are experiments and possible pivots, something Karl Mak, co-founder and chief executive officer of Hepmil Media, went through with his previous business, Televate. The startup was initially conceived to provide a callback widget for customers, rather than having callers stay on the line waiting to connect to customer service.

Mak’s venture had won a hackathon, with a bank CEO saying that if Mak built it, he would buy it. But it lasted only 10 months from January 2014 to October 2014, when a security breach at a bank resulted in regulators tightening up security requirements.

“Secondly, they needed software vendors to provide insurance in the event of a data breach, which was now a very high requirement to buy a multimillion-dollar insurance package, just to integrate our software with their systems,” Mak says.

To raise a funding round just to buy the S$3 million insurance did not make sense. So Mak pivoted away from enterprises to small and medium-sized enterprises (SMEs), retooling the product into a sales-ticket solution where customers could key in their phone numbers for businesses to call them back immediately. But charging just S$1 per call was not tenable, as costs quickly rose with integration with backend SMS and calling services.

“We just couldn’t see the light at the end of the tunnel. We looked at the team, we looked at the product and I thought, it’s better to call it a day,” says Mak.

For Yermolayeva, it was also the depleting energy levels she had, after dealing with one issue after another. Nor did she have the heart to pivot into something so far off from her original venture.

“I didn’t have the conviction that I could come to my investors with some new idea, and convince them knowing that truly from the bottom of my heart I believe in this, that I could pull it off with some new plan over the next six months to a year,” she said.

Others like Shaun Heng, founder of Eatsy, a restaurant ordering and payment startup, had to deal with market timing and unforeseen events like Covid-19. The pandemic was a death blow to many food and beverage businesses.

“We were running out of cash, and that decision came out of necessity more than anything else,” says Heng.

Weighing the costs

In coming to the final call, founders had to process and weigh up the alternatives – something that had to be done objectively.

Working out whether your startup is viable is not an easy discussion, even if you have a co-founder to sound off with. For Mak, there was a discussion from the product perspective, to work out if there was a way Televate could pivot to something else.

But the reality was that the startup was at the bottom end of its cash runway, and pivoting would have required them to start from scratch again. That would have meant spending more money that the startup did not have, to again retool the solution.

Then there was the opportunity cost, other outside opportunities that would have to be given up if Televate had stuck it out and tried to find another way.

Mak’s co-founder had an offer to run coding boot camps for the Malaysian Global Innovation and Creativity Centre. This turned out to be serendipitous timing for the co-founder, who accepted the offer.

“Obviously every founder wants to have some sort of hero story, turn it around, go through the death valley and come out victorious. But 99.9 per cent of the time, it’s probably better off giving up when it’s the right time,” he says.

Mak says that between his co-founder and himself, there is no regret in giving up.

For solo founders, those discussions can be even harder, as they cannot discuss the situation frankly with employees. Yermolayeva turned to her friends outside the sector to talk through the issues and have honest conversations.

“That’s how I tried to handle it. I would just try to talk to friends,” she says.

Investors’ call

Some of JiPay’s more involved investors were listening ears for Yermolayeva.

While it might seem that venture capital (VC) investors will pull the plug on startups they find are underperforming, VCs BT spoke to emphasised that closure is ultimately the founder’s decision.

Justin Hall, partner at VC firm Golden Gate Ventures, stresses that it is the founder’s call to make. He says he would be supportive whether a founder wants to continue the fight, or decides that shutting is the right decision.

“Giving them that reassurance gives them the space and bandwidth to think about what the right course of action is,” Hall says.

How should founders deal with investors in approaching such a topic then? It boils down to being communicative and open about the reality of the situation.

Founders need to be transparent and communicative, say VCs BT spoke to. Regardless of what investors might say, founders should always be able to have these kinds of tough conversations.

“Don’t just keep quiet and do what you want to do, and be done with it,” says Jeffrey Seah, managing partner of MSW Ventures.

Being communicative with investors is a two-way street. The investor also needs to put in the work to build a relationship with the founder. Seah notes that accepting failure is also a big problem in Asian culture, with many struggling with failure due to losing “face”.

“I think that the face value needs to go away. The ability to embrace some form of vulnerability is a starting point,” he says.

There is not a “right time” for these conversations with investors, but Hall stresses the importance of acknowledging that founders can have that conversation. It is not necessarily an admission of failure.

“I think too many founders don’t pause to really consider what’s happening, and if their failures to date are really a fundamental reflection of the viability of the business, or simply another obstacle for them to get over on their path to succeed,” says Hall.

The danger is conflating hopelessness with grit, or faking it till you make it, but with stories of founders powering through to become billionaires, Hall says founders cannot be blamed for this.

Still, if the target market is not responding to a product or pricing models have stopped working, these could be signs to call it quits. Some questions investors like Seah might ask, to set the founder thinking, include whether the startup looks anywhere near what it started, and what the best outcome scenario might be.

“However this ends, what will you say to your first investor? Many might ignore the fact, but what they are trying to address in their mind is ‘What do I say to my first investor?’,” he says.

Then there is the added stress and anxiety of telling investors that their money is gone. Mak recalls the fear and worry: “They’re going to blacklist me... they are going to hate me for this. But I understand early stage ventures a lot better now, with failure rates significantly higher than any other stages.”

As Hall puts it, investors do not have the same skin in the game as founders, and are not shedding the same blood and tears. Portfolio company failures are painful, but not as traumatic to a founder whose business has failed.

“I’ve had, quite frankly, bizarre conversations with founders who actually worry most about their investors, more than their employees, customers or themselves,” says Hall.

Pulling the plug

Investors caution founders against taking a shutdown decision themselves. Founders should speak to the board and investors before going through with the process.

The last thing investors want is founders walking away without engaging them or the board, and announcing publicly that the startup is shutting down.

“Pulling the trigger unilaterally can cause serious issues that would only make a painful process even more so,” says Hall.

But investors are not without fault either. Hall notes that some are behaving badly right now.

“I’m seeing a lot of predatory behaviour in this environment right now, so I can’t blame founders for trying to do this themselves,” he added.

Ultimately, investors are looking for founders who are responsible to the end, and will wind down in a proper manner. There is a plus side to deciding to shut earlier rather than later, when the cash runway is not measured in days and employees that have stuck by the company can likely be paid a severance.

“It should be emphasised that if a company is doing poorly and the founder is trying to find a way to safely, rationally, shut down the company in a way that protects as many people as possible, good investors will often look very highly upon that behaviour, and will try to work with you,” says Hall.

The process of winding down a company also requires time and money. An amicable shutting is much preferred to one where the founders are hostile or missing when liquidators come in.

A non-hostile winding down is often a box-ticking exercise, said an insolvency practitioner on condition of anonymity. Costs, too, are much lower, compared to a long-drawn-out process when liquidators have to chase down the founders and assets.

A case in point: Honestbee’s liquidation only recently concluded in May, some three years after a winding-up order was filed in April 2020.

At the end of the day, founders who have failed, but acted responsibly, are more highly valued by investors. Failure can also be seen as a strength, especially in how founders handled stakeholders. Yermolayeva has had some of JiPay’s investors offer to fund her next venture.

“This is to test the mettle of the founder,” says Seah.

Mak’s advice for founders potentially going through this situation is that time is their biggest resource. They should also talk to other founders who have gone through the experience.

“I think it is important to disconnect emotionally and be very rational and objective, and that comes from talking to people,” he says.

Hall has some reassuring words: “Things might be awful now, but they will get better.”

“Don’t stress about the failure; people have already forgotten about it because they’re so fixated on their own issues, they don’t have the bandwidth to think about you,” he says.