A friend of mine, Jed White, recently asked on a post a great question. When do you pull the plug on an investment and walk away. He is has a blog at http://spaces.msn.com/myelectricmayhem/
Hi Matt, great to see you in the blogosphere! I'm also writing a blog, which occassionally concerns the difficulty of being a young entrepreneur in the midwest:
But your post today brings up a different issue. How do entrepreneurs know when to pull the plug? Is it "never say die", or are there some more rational markers that would suggest even to Steve Case or Steve Jobs that enough is enough?
My partner, Ed, has always said that it is hard to kill a company. It is not often that one wakes up and realizes that a recent deal was a mistake and shuts it down. Companies and management are resilient, and often, if faced with a dire situation, dig deep, drop the burn and can muscle their way forward for some time before either succeeding, getting sold or going out of business. VC's, loath to take the financial and emotional hit, will generally work with the company to push off the day of reckoning. But why?
You try to keep a company alive until the market turns in your favor. I would argue that the number one macro factor that determines success is market acceptance and readiness. It is very difficult to predict when a market turns (remember "right product, wrong decade"), and, in fact, it is usually not until a company has landed a few customers that one can determine a trend. Until this happens, you are best off dropping your burn dramatically while accelerating the number of product/service permutations to see which work or don't.
A company that can get its cash burn down, can be the master of its own fate. It can usually pull together small amounts of capital to stay alive while it experiments and waits for the market to turn. Investors, however, are best off setting short-term milestones for the company (e.g. landing a pilot, getting a beta launched, closing 3 deals in a given vertical, etc). This is the only way an investor can get feedback that the company is or is not making progress.
When do we pull the plug on a deal? When we lose confidence in both the market opportunity, and more importantly, the team. A good team will find a way to reorient the company in a new direction. A bad team will complain that they do not have enough capital, it is not their fault and that they need more options or salary to make it worth their while. A decisive team that proactively takes aggressive action to stretch out its runway (and acknowledges its dire reality) will engender confidence in its investor group. If things are going poorly and the team can not show any kind of credible vision, the investor has a very difficult decision to make. If the company is also burning considerable cash, then this usually seals its unfortunate fate. It is the failure to attract third party capital (read validation) that often deals the company a death blow.
Resilience is a key factor in the venture business. I have been amazed by how often teams manage to survive. They will say that they can not manage the business with less than 50 people and a $600k budget. However, as things get dire, they somehow manage to get the budget down to $300k and 20 people, stabilize the business and then ramp it on the other side. Never, say never and recognize your reality early...