Weekly Briefing Note for Founders 4/4/24

3rd April 2024

This week on the startup to scaleup journey:

  • Pivot - before premature scaling kills your startup

Pivot - before premature scaling kills your startup

Pivots are vitally important business-building devices for founders. They are used to ensure that startups do not pursue unrealistic dreams or indulge in premature scaling. When applied within certain constraints, they can totally transform outcomes.

Startups that pivot once or twice raise 2.5x more money, have 3.6x better growth, and are 52% less likely to scale prematurely than startups that pivot more than 2 times or not at all, according to the Startup Genome Report extra on premature scaling.

Whilst pivots are used to address serious business challenges, not all pivots provide equal chances of success. Those undertaken early in the life-cycle are part of the natural startup learning curve. But those undertaken later on can prove traumatic for founders, employees and investors.

Founders often look back 'post-pivot' and say they should have bitten the bullet much earlier. Delay can often mean that a pivot is just as disruptive as the problem the startup is trying to solve.

What specific factors influence these different outcomes? What steps can founders take to ensure that a pivot is a force for good?

Firstly, what is a pivot?

A pivot is a change in one or more of the fundamental aspects of the business model, such as the product or the target market. It implies a new direction for the company and, as a result, often has significant implications for strategy, product development, resourcing, and financing.

Such dramatic moves are only considered when the original plan is not delivering the success that was first envisioned. A 'do-nothing strategy' is no longer an option as the risks emerging could become existential.

The associated restructuring usually creates a major upheaval within the business. This is intentional. Significant change is required to reverse out of a spiralling situation and point the business in a new direction.

Factors that influence the outcome

There are 2 big factors that influence the scale of the pivot and the propensity for investors to support it: (i) Stage of evolution (of the business), and (ii) Stage of funding.

(i) Stage of evolution

Here it is useful to think of the main phases of early startup development as sequential:

  1. Problem/Solution thesis
  2. Product/Market fit
  3. Business Model (transactional model e.g. SaaS)
  4. Go to Market strategy

As the startup progresses through each stage, it is like building a house. The Problem/Solution thesis is the architectural design. Achievement of Product/Market fit (PMF) is like completing the foundations. The Business Model is the structure itself, and the Go to Market (GTM) strategy is the decor.

The big architectural decisions capture the entire purpose and vision. Then, with the foundations in place, the build can proceed at pace. Finally, the decor provides the emotional excitement. But if you are still worrying about architectural choices whilst selecting the paint colour, this does not bode well.

Pivoting during the development of the Problem/Solution thesis or on the journey to PMF is the most common and least disruptive. The decisions made here are all about ensuring the foundations are solid.

The more fundamental the pivot, the earlier the change the better. For example, pivoting from hardware to software is a thesis-level (architectural) event. This will impact almost everything about the business, especially the team. But transitioning from say a horizontal SaaS solution to a vertical solution, the mission, culture and competencies can largely stay the same.

Even established companies are sometimes forced to undertake pivots. These are big reinvention events and are very difficult to pull off. Classic examples include Amazon, Apple, Google, and Microsoft. PayPal even undertook 5 pivots to find its true market position!

(ii) Stage of Funding

The stage of funding is an additional factor as it heavily influences investor expectations.

  1. Pre-Seed investors, as well as early Seed investors, have an expectation that things are still very much in a state of flux. Changes in the underlying assumptions around the Problem/Solution thesis are taking place regularly.
  2. Later Seed rounds, especially Seed rounds in SaaS, assume that initial PMF (with the early adopters) will be driving early revenues. However, the journey to PMF in the mainstream market is still underway. To this extent the startup is still 'experimenting', so a pivot may be necessary if a major new discovery is made.
  3. Series A investors assume that PMF in the first part of the mainstream market (the beachhead) has been achieved. The structure is now in place to support the first phase of growth. Pivots are not expected here.
  4. Series B investors assume planned expansion and further growth. Again, pivots are not expected. Developments into adjacent markets can sometimes appear like a major shift in direction but they are often not complete pivots. The original core business usually remains.

It is clear to see why the scale of a pivot during the early stages of funding (pre Seed, Seed) is nowhere near as onerous as one undertaken post Series A. This directly aligns with investor expectations that the startup is no longer an 'experiment' and is now becoming a proper company.

At this point, unless the market dramatically and unexpectedly shifts (e.g. Covid), current investors will often take the view that if the business suddenly faces a serious predicament it's because of misjudgements made by management. They will be far less willing to finance the pivot and will look to extract their pound of flesh - usually via punitive terms.

Taking the plunge

In our earlier article, Why do some startup founders fail the pivot test? we discussed the reasons that pivots can be so difficult. First, the realisation that a pivot is even required. Founders are conditioned to strive for success even if it seems they are fighting against all the odds. Understanding the key signs that the course needs correcting is vital, so action can be taken before it's too late.

Second, is just having the courage to take the pivot on. You are about to press the big red button labelled "massive upheaval to our current plans" and this is never an easy step to take. Interestingly, founders often say the biggest challenge was not the pivot itself but selling the idea to investors. Why might this be?

Some investors will view a pivot as a path of last resort, a last-ditch effort to save the business, and in that sense an admission of failure. Whilst pivots are generally viewed positively in the US venture market, there seems to be less support across Europe. Founders say there is still a stigma attached to pivoting and they want this to change.

Ann-Tho Chuong Degroote is CEO of Lago, a B2B software startup with offices in both the US and Europe. Following a recent pivot, she experienced quite different reactions between her US investors (positive) and European investors (negative).

She found that the differences were especially marked with angel investors. She says"..some of the European reactions showed us that pivoting in this region is still seen as a definitive failure rather than a step in the journey. Clear answers and proof that we would “nail it this time” were expected immediately."

Even so, given that the status quo can no longer prevail if a crisis is to be averted, founders must at some point take the plunge. Current investors will then appreciate being presented with solution scenarios rather than just problem scenarios.

Experienced founders will often enlist an investor-director as an advocate for the proposed pivot. The aim is to give other board members comfort in aligning with this point of view. By doing this, proactive founders often find they are given more scope to execute the changes on their terms, rather than on terms imposed by the board.

Force for good

In summary, there are several key steps a founder can take to ensure that a pivot becomes a force for good:

  • Build in stages
    Be deeply cognisant of the stage of evolution of the business. Only transition to the next stage when you are truly confident the current stage is solid and complete. Redesigning the 'architecture' and relaying the 'foundations' is painful enough in the very early stages. This level of change can itself present an existential threat if left until later on when the GTM costs have kicked in.

  • Don't oversell
    As transitions from stage to stage are often punctuated by funding, overselling the progress of the business can set dangerous expectations with investors. In particular, if your claim is that PMF has been achieved in the first part of the mainstream market (the beachhead) but there is still uncertainty, you are now prematurely scaling. This is bad enough, but the added complexity is that you have now left 'safe' pivot territory. Any major company-level changes past this point - unless driven by sudden macro market disturbances that are clearly outside the founder's control - will likely be seen as failure.

  • Proactively manage
    The biggest takeaway from founders who have navigated difficult pivots is to start the process of communicating with the major investors at the earliest moment. Ensure they know that you are leading the thought process and are firmly taking ownership. Never let a pivot be their idea. Even if your contingency plan is not ultimately required it will demonstrate your diligence and proactivity as a leader.

Remember, pivoting once or even twice is a common attribute of successful startups. Used at the right time pivots are a key predictor of higher growth potential and a power tool for avoiding premature scaling.

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