Starting in late 2020 and wrapping up in early 2022, Venture Capital was on fire. In 2021 specifically, VC total investment doubled to $361B in the US, according to KPMG.

The reasons for this funding surge will be discussed for years, but mainly it was triggered by massive government spending combined with zero interest rates in response to Covid.

This led to a dramatic increase in fund sizes, new funds, new investors, and new investing strategies. Money needed to be deployed, fast.

Unsurprisingly, this led to some pretty bad behavior.

Insane Valuations

Let’s start with the most obvious example - insane valuations.

Seed rounds were $5M+ on $20-30M valuations often on low or no revenue. Some deals were as high as $100M+.

Series A rounds were $15-30M on $100-300M valuations, with revenue under $5M. Also sometimes zero. Almost always overstated.

Late-stage rounds were even crazier, and companies were going public via SPAC at comically large valuations. Bird went public at a 2.3B valuation, today they are valued at $48M.

New Funds with Inexperienced VCs

New VCs and follow-on VC funds grew like crazy. Non-traditional VCs, or “Tourist Investors:”, entered the market in droves.

A strategy for a new investor to win deals against traditional VCs was easy - Price. Offer more money, at a higher valuation, and the founder would take it. Not good enough? Offer a secondary, even at Series A.

This drove the traditional venture capitalists nuts because they had to move outside their comfort zone of investing. And they did.

Venture arms of large tech companies joined the party too but often did little to support their portfolio companies after the raise. It was dumb money.

No Due Diligence

With the speed at which money was flowing into startups, due diligence was all but abandoned. Term sheets at times were sent often within a week after the initial pitch.

Startups with broken financial processes, no product-market fit, alarming customer churn, and/or little to no revenue were receiving investment cheques in the millions.

Certain investors such as Tiger Global were notorious for this. They were attempting to build a private index fund and throwing cash at startups with no due diligence and no requirement for a board seat. One of their partners notoriously suggested they know if they are going to invest “based on a feeling in the first zoom call.”

Even traditional well-respected investors such as Sequoia made mistakes. Most famously, they (another other top tier investors) invested in FTX, the failed crypto exchange. Losses are expected, but the scale of the investment combined with the apparent lack of DD are surprising. (Note they have stated they followed their process, but they are being sued so they have to say that).

With round sizes and valuations skyrocketing, any investor pushing for proper due diligence simply lost out on the deal.

Many startups that raised Series A or even B had no functioning product, let alone product-market fit. Investors never called customers, played with the app directly (vs founder demo), properly vetted founder backgrounds, or looked at user engagement metrics under a microscope.

Pre-Emptive Rounds

In real estate, you have bully offers. In venture capital, you have pre-emptive rounds. This is when investors approach the founder to close a new round before the startup is prepared to run a process.

Example: Startup XYZ just raised a $5M Seed on a $25M valuation 3 months ago. A group of investors like the company and the market thesis, so they decide to make an offer: $25M at $125M post-money valuation.

Startup XYZ certainly does not have the revenue or unit economics to raise at this type of valuation. The investor knows this, but they want in before anyone else can get involved.

Why would investors do this? Traditionally, it was because they had high conviction on the market and the founding team’s ability to execute at speed.

During 2020-2022 that changed. Existing investors pushed for pre-emptive rounds because they wanted to mark up their holdings so they could raise a new funding round.

Let’s say the seed investor of Startup XYZ invested the full $5M at Seed. This gives them 20% equity — or $6M post-money. After the pre-emptive Series A, now they (back of the napkin) own 16% equity — or $20M (a 230% increase).

Now the seed investor can go their LPs with a paper-money value increase and leverage this to raise a new, larger fund.

In most cases, the startup did not need the money. They certainly weren’t ready for it. Series A expectations are all about growth, while Seed expectations were about finding product-market fit.

The founders even knew they didn’t need the money, but guess why they took it? You guessed right - secondaries.

Fast-Talking Morally Gray Founders Were Rewarded

There are many very public cases of fast-talking founders who raised absurd amounts of money at insane valuations without having built anything much.

One of the more prolific cases is Domm Holland and Fast. This company raised $102M from Stripe, one of the most respected companies in the valley.

This story could easily be from 1999 and the first bubble.

The founder had a checkered past - including a legal battle where he threatened to sell personal data.

The company itself? Burning $10M (yes 10 MILLION) per month with $50k MRR. He literally lit $100M on fire in 10 months.

While Fast is a very public failure, there are hundreds, perhaps thousands of startups out there with equally morally gray founders. They knew the real path to making some money was to raise as large a round as possible, as competitively as possible. Why? Yup. Secondary.

Noticing a theme here? Large secondaries before Series A shouldn’t exist. But that’s another post.

Venture Debt

Imagine you could walk into a bank, get $1M in almost free cash for some warrants, without any requirement for collateral or security?

That was Silicon Valley Bank. When a startup raised a round, often SVB would pop in to offer venture debt. They did look at financial data including invoicing, receivables, etc. The venture debt offered though was out of sync with the financials — for instance on $3M in sales with a $10M forecast, you could get $1-2M. With absolutely no collateral or security.

How much would you believe a startup’s sales forecast? Especially when their investors are telling them they must 4-5x this year?

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That’s all out the window today, and most startups need to find a path to profitability, or else they risk a down round or even death.

As an employee at a startup, it can be hard to figure out what is really going on.

Here are some tips to figure out if your startup employer is in trouble:

Executive Turnover

Some executive turnover is normal, but if the company is constantly turning over high-quality executives, there is a problem. Usually, this is an indication that the founder has behavior problems, impossible expectations, or frankly isn’t suited to be a CEO.

Town Hall Problems

There are a few key signs but the most important is whether the KPIs are constantly changing. It signals that the company doe have product-market fit and is pivoting. This is totally fine if the founder is upfront and honest with the team about it.

Another key tell is when town halls are constantly delayed or cancelled. Generally, this means the founder learned that targets weren’t met and needs time to spin up a new narrative.

Budget Cuts & Layoffs

Many startups raised too much money and hired far too many people. Layoffs and budget cuts do not mean your startup employer is in trouble, it means they are adjusting to the new funding environment. This is a really good thing.

If you are not growing like crazy (3-4x year over year), your 50-person startup doesn’t need a product management team of 4 people and a marketing team of 5 people.

Instead, ask yourself — were the budget cuts deep enough? Is the runway long enough with a believable, conservative sales forecast?

Many startups have not cut enough and are slowly dying. By the time they realize this, it will be too late. For the vast majority of startups, a 10% RIF (reduction in force) was not enough.

This is called a death spiral — Sequoia talked about it in the deck they circulated to their founders.

If your startup cut 10% but isn’t growing fast, it’s in trouble.

New Product Updates are Slow

There are many reasons why product development slows to a crawl, and none of them are good. It can be because there are too many product people - the Founder/CEO, a CPO, and Product Managers all participating in long meetings formulating product strategy. Notice that sales, marketing, and customer success are often excluded.

This costs time, and in startups, time is everything.

If a startup isn’t rapidly growing, and doesn’t have clear and obvious product-market fit, then the founder must be the CPO and there should be at best one (1) product manager to help execute. Only the founder can be the connective tissue between product and sales/marketing.

There should be weekly sprints, with experimentation and KPIs attached. Ship, learn, iterate.

The Obvious Stuff

There are many obvious tells that your startup employer is in trouble.

• The founder is MIA (yes, this happens!)

• Customers are cancelling/leaving

• Revenue is declining

• Sudden lack of transparency

• Non performers are still around

• Lack of obsession to grow customers

What Should You Do?

First, ask questions in town halls. Don’t be a jerk, frame your question in a positive way.

Bad Question: “We never hit our sales forecasts, why should we believe this one?”

Good Question: “As we learn more about our customers, how is this evolving our confidence in our sales forecasting?”

Second, step up. How can you help? What can you do to help grow revenue, increase retention, ship more product, create efficiency, reduce cost, and so on.

What Shouldn’t You Do?

When times are tough, sometimes people revert to poor behavior. They gossip in private slack channels and they mail it in.

If you aren’t all-in at a startup, you should quit. It’s not good for your mental health, and you are only increasing the chances of the startup failing. You’ll drag others down. You don’t want to be that person!

Take a break if you need to. Come back and see if you can flip your mindset.

If not, you should move on. If so, awesome!

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Today, there are thousands of startups that are in trouble. They have millions in the bank, but no product-market fit and are struggling to pivot into one.

We’ve got a post coming soon about the startup insanity from late 2020 through early 2022. Huge funding rounds, little due diligence, over-hiring, and so on. It wasn't good. Everyone lost their minds.

Here is what I would say to the founders struggling to find product-market fit that still have cash in the bank:

• Forget who you are “beholden” to, that doesn’t mean anything. You are accountable to your shareholders, full stop. Your board makes you accountable. Be honest and transparent with them.

• Yes, you raised too much without product-market fit. You learned how to build a great narrative and that fundraising is about momentum. You didn’t need to build something real with actual metrics. Now you do.

• Get rid of your entire product management team and most of your marketing team. Without product-market fit, the founders must own this!

• Cut the team in half. Yes, at least in half. If you raised 10M+ and don’t have product-market fit, you don’t need 50-100 people. You need 10-20.

• Step back and take a complete inventory of your assets and liabilities: cash, revenue, talent, commitments, etc. Write it all down.

• Create a weekly cadence of experimentation. Double down on what works, toss out what fails. This is where most of you fail. You don’t function with a weekly cadence and don’t hold your team accountable with metrics. If your team can’t do it, replace them. Talent is available. This is the time to fight so make sure you have a team of fighters.

• Cut non-productive activities. Trivia Thursdays, Bowling Wednesdays, etc. These are “peace-time” activities. Your company is at risk of death! They signal two things to your employees: everything is fine, and the work itself at the company isn’t rewarding enough.

• Get the team together in person. Rapid experimentation happens best in person - you need whiteboards, shoulder-to-shoulder collaboration, and the energy that comes with it all.

• Remember how progression and momentum drove your fundraising process? You’ve hustled hard in the past with discipline, so apply that mindset to experimenting your way toward product-market fit.

• Finally, instead of worrying that you have burned $20M out of the $50M investment, change your mindset to "I’ve just raised $30M, what is my plan?”. Round sizes pre-covid were less than half, so you have more capital left than a total raise in 2019.

If the founder just doesn’t have their heart in it, they should certainly consider returning the cash. Or they could sell their shares for $1 to someone who wants to take it over with board approval. Or find an acqui-hire. Private Equity.

There are ways out, and as Gokul says, founders shouldn’t be ashamed. The investor will absolutely appreciate their candor/honesty and will work with them. Or maybe they’ll step up and help the founder fight, re-igniting their fire!

Of course, there are some investors that will respond incredibly negatively. To be completely honest, that startup was probably fucked anyways because the investor didn’t fundamentally understand the risk that comes with early-stage investing.

Founder Secondaries

There is a dirty little secret - founders were incentivized to drive the largest, fastest rounds possible because they were driven by secondaries.

(Reader: a secondary is when existing shareholders sell existing shares to investors in the current round. From 2020-2022, many founders sold some of their own shares during these large funding rounds - even at Series A!)

Those secondaries are now gone, so the founder's motivation now needs to re-focus on longer-term objectives, which is a rather large head-space shift.

Startups aren’t a get-rich-quick scheme anymore. Sanity has been restored, and founders need to build.

Have feedback or thoughts? Let us know!

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Everyone in the startup world knows about (and mourns) the death of Silicon Valley Bank. They were a huge catalyst in the startup ecosystem, helping startups navigate financing, making introductions, and connecting the community. But this came with material benefits for both Founders and Venture Capitalists (VCs).

These material benefits are why VCs ignored that their startup portfolio bank balances were uninsured. VCs certainly knew that billions of deployed capital sat in a single community bank. Not only that, they encouraged it. Why?

What are Venture Capitalists?

Let’s quickly revisit the job of a Venture Capitalist - they take LP (limited partners) money, invest it in high-risk, high-reward startups, and create outsized returns.

Simply put, they are money managers and investors.

Money managers follow the stock market. They watch the Fed. They have podcasts where they talk about it. They are deeply knowledgeable on finance and have a team of analysts to help out. They certainly know that FDIC exists and what it means.

The VC is often considered the “adult in the room”. Founders rely on them to provide advice and mentorship on the business of company building, and most times the weakest area for a founder is finance.

How Did Venture Capitalists Benefit from Silicon Valley Bank?

Chamath on the All-In Podcast was pretty honest about the complexity of how intertwined the VCs were with SVB, and the benefits they received.

1. SVB is an LP in VC funds. In other words, they invest in VCs, who invest in Founders. They are the VC’s customer.

2. The VCs personally received friendly terms from SVB for lines of credit, loans & mortgages, often secured against assets that other banks wouldn’t consider.

3. SVB provided VCs with financial data on startups - how much was raised, valuations, and more. The more startups using SVB, the more data. You can find their public insights here.

4. SVB was often a (co) sponsor of VC-related events.

5. SVB was a lead funnel for deal flow.

Let’s add that up - SVB was one or more of: the private banker to VC partners, the bank for the VC company, an investor in the VC, revenue for the VC, provided proprietary data to those VCs, and brought deals to the table.

How did Venture Capitalists Fail Their Founders?

Many VCs instructed their portfolio companies to use SVB and the founders followed because they trusted their investors. They are the money people, right?

Most founders treat VCs with great reverence, particularly when it comes to finance.

If a Venture Capitalist had a role on the board of a startup, and advised that startup to put all of their money into Silicon Valley Bank, you can reasonably argue they failed in their fiduciary responsibility to the company.

They placed their own interests above the interests of the company. The key point by Chamath was that the VC might have been receiving incentives from SVB, which were not disclosed to the founder.

SVB failure wasn’t a sudden and immediate surprise. There are articles that declared SVB effectively bankrupt last September, and a popular site calling out SVB as at risk in December.

In January a trader on Twitter wrote a 10-part thread on why SVB was in trouble.

Not a single VC read any of this? Not a single analyst at a VC firm identified this as a risk? VCs have whatsapp/signal/telegram groups, this was never shared?

The executives at SVB almost certainly would have read these articles, and certainly known they were underwater. None of them shared this at the private valley dinner parties with their VC friends?

That sounds like an abdication of responsibility, powered by drunken ZIRP/Covid excess.

Treasury management is a thing. Regular, boring old businesses do this. But startups and their boards in the Valley ignored it.

What are VCs not Disclosing in the Public Square?

The common refrain from VCs is that the average SVB customer is some scrappy startup working out of a garage eating ramen every day.

No, the vast majority of VC portfolio companies are incredibly well-funded startups that have raised millions in a Series A round (or later stage).

That is who the VCs were protecting when banging the drum for a full backstop of SVB depositors.

Sure, they share the cases of a scrappy startup in Ohio, a school board, a pension fund, and so on.

But the risk to the VCs was clearly their portfolio companies.

Let’s take the average Series A during Covid: a startup raised $15-30M at a post-money valuation of $75-300M, on $1-5M revenue, with little to no due diligence. 2021 was insane.

Then the VC would cheerlead the founder to rapidly drive growth at any cost in order to raise the next round, often called “pre-emptive”. This was great for the VC because they would mark up their TVPI - the paper value of their deployed capital. Then they would use the paper returns to raise their next, much larger, fund.

VCs make their money in two ways - a management fee (typically 2%) on the fund size, and a portion of the proceeds when a portfolio company exits. Imagine a VC that typically ran a fund of $50M, but during Covid they were able to raise a $150M fund. Tripled the management fee!

Fast forward to today and most of these startups are distressed. They don’t have product market fit, they massively over-hired, they are burning cash, and they won’t raise another round any time soon. The party is over.

If SVB was allowed to fail and depositors had to line up as creditors, VCs would have quickly saved their top tier portfolio companies. Maybe helped with payroll for a few of the rest.

But their low quality investments would immediately fail.

Rather than having the deaths spread out over the next 18-36 months, The VC would have to take the immediate write down.

Wouldn’t that give VCs an “out”? Blame SVB for the failure! Well, the question would turn to “why did you save that startup, and not this one?” And the answer would be “under today’s funding terms, we would actually do due diligence and there is no way in high hell we would give another penny to that startup”.

Which then would lead to the LP asking their VC: “Why did you invest in them in the first place?”

Messy.

What Should Founders Take Away?

So as a founder, what can you learn from this shit show?

1. When selecting an investor, don’t only focus on the best terms. Vet them. Understand their short and long-term goals. Back channel with other founders.

2. Finance is king. If you run out of money you are dead. Act accordingly.

3. Get independent experts. If you never heard of FDIC insurance until now, why not? Who in your company or on your board should have covered this?

4. Get a real CFO, at least part-time. Make sure this person isn’t connected to your board. Ask them about treasury management.

5. Learn! Just like you learned to code, learned to market, or learned to sell - learn finance.

This was an incredibly scary time for founders. Something that appeared outside their control was just about to kill their startup.

The best founders will recognize they got lucky, take accountability, realize that this was within their control, and learn from it.

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Fucked Startups is an evolution of that idea.

Why?

Startups are about to die, by the thousands.

There are many reasons why and I plan to share them with you.

But more than that, Fucked Startups is going to be a community.

A place where those of us in the startup community who haven’t completely drank (or digested) the koolaid can get together and chat about it. Be honest about it.

And, most importantly, learn from it and ultimately build great things.

Fucked Startups will:

• provide insight and content on what is really happening. For example, why SVB shouldn’t have been bailed out.

• share stories and rumors from the startup world including shutdowns, layoffs, and more

• talk about how to company build going forward in this new age of austerity

I want to hear from you. Share with me your news, thoughts, ideas, or feedback. Ultimately this is about you.

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