The word pivot is one of the most overused terms in startupland. Y Combinator’s Dalton Caldwell describes it as,

“…one of those terms that if I'm in a cafe and I hear someone talking about pivoting, I roll my eyes because it's one of those words that I associate with annoying startup people.”

A true startup pivot is something quite specific: to pivot a company is to change the underlying market hypothesis to such a fundamental degree that it requires a reset of multiple parts of the business. A genuine pivot typically requires offloading the majority of users and/or customers, abandoning a significant portion of prior R&D work and laying off multiple people whose skill sets don’t match the needs of the new idea.

Successful pivots are venerated within the startup world. They represent the ultimate hero’s story. David vs Goliath. The “Hail Mary” throw with time running out to win the game.

But for every Slack, there are thousands of startups that tried to pivot but didn’t pull it off.

In many cases, those failures weren’t because the insight behind the pivot was wrong. Pivots often fail because the company simply didn’t have enough financial resources to execute the new market hypothesis. They ran out of money.

Or did they?

It turns out that in many cases, the road to a successful pivot is cut short by a critical mistake: the founders failed to fully reset the business.

A Cautionary Tale

Recently, we looked at investing in a company that we had been tracking for a number of years. We first met the founders when they were raising their Pre-Seed round. We loved the team but weren’t in love with their original idea. Ultimately, we passed.

The company successfully closed their round and went to work. When the founders reconnected with us to talk about their second round of funding, we learned that they had pivoted towards a new idea — one that we were far more excited about. Now, we were looking at a team that we loved working on a new concept that we could get behind.

The problems came when we started to dig deeper.

After raising their Pre-Seed round, the company spent a year pursuing their original idea before they decided to pivot in response to customer feedback. The new concept represented a pivot in the truest sense: they needed to sunset their original product, offload the majority of early customers and start nearly from scratch in terms of product development.

To their credit, the company did all of those things. But they missed a crucial step: they failed to reset their cost structure.

In the months after closing their Pre-Seed round, the company increased their burn rate as they pursued their original idea. They hired more people, started spending money on sales and marketing, and generally did the things one would expect founders to do as they built the foundation for a company.

But after a year — when it became clear that the original idea wouldn’t work and the founders decided to pivot — they didn’t reset any of their cost increases.

The company’s marketing spend, which went from zero to $20K/month, remained at $20K/month after the pivot. Their payroll, which had tripled over the course of the year, not only remained the same but continued to increase — the founders hired additional new employees after the pivot. An so on.

As a result, by the time we saw the company for the second time, there was a mismatch between their capital requirements and where they were in developing their new idea:

The maturity of the “new” idea and the progress towards product-market fit were inline with a Pre-Seed company
The burn rate / cost struture / capital requirements of the company were inline with a Seed stage company

In other words, they were looking to raise a “Seed stage”-sized round at a “Seed stage” valuation for an idea whose development had only progressed to the level of a Pre-Seed company.

Sadly, this is a situation we see far too often.

Anatomy of a Pivot

To better understand why this matters, let’s dig into the cost structure of a company that pivots.

Consider a hypothetical company that raised a $1.5M Pre-Seed round with the following cost structure (these are meant to be example numbers that make the math easy, so don’t overthink whether or not any given cost is too high or too low):

At the time of their Pre-Seed raise, company X has a monthly burn of $25K ($20K for salaries and $5K for desks, software, etc.)
Over the next 12 months, salaries increase to $60K/month, sales and marketing go from 0 to $20K/month and other operating expenses increase to $20K/month

Assuming minimal revenue, by the end of the first year the company is burning $100K/month. If we further assume that their expenses plateau at month 12, then company X’s $1.5M Pre-Seed round should last them somewhere in the range of 18-20 months:

Now, let’s assume that after one year, the company decides to pivot.

Let’s further assume that it’s going to take them about 18 months to figure out whether or not the pivot works. After that, they’ll need 6 months to raise their next round. Company X’s new timeline is:

Month 1 - 12: Pursue initial idea
Month 13 - 30: Pursue pivot
Month 31 - 36: Fundraise (assuming the pivot was successful)

Let’s examine three scenarios in terms of how Company X manages its burn after deciding to pivot:

Company X maintains its burn after deciding to pivot
Company X resets its cost structure at the time of the pivot and maintains a low burn throughout the pivot
Company X resets its cost structure at the time of the pivot and slowly increases it as evidence mounts that the pivot is working

Scenario 1: Maintain Pre-Pivot Burn

Under this scenario, company X maintains a monthly burn of $100K through month 36:

In this case, the company will need at least $1.6M more in funding in order to pursue the pivot and have sufficient runway left to fundraise.

Scenario 2: Reset Cost Structure and Maintain Low Burn

Under this scenario, the founders agressively cut their cost structure at the moment of pivot. Let’s assume that they don’t completely reset it, but that they reduce salaries to $30K, eliminate sales and marketing entirely and cut operating expenses by half. This results in a starting point of $40K per month post-pivot:

In the most frugal of scenarios — wherein the company maintains this lower burn rate going forward — they can potentially make it all the way to the point where they know whether or not the pivot is going to work without any additional funding.

Scenario 3: Reset Cost Structure and Slowly Increase Burn

Under this scenario, the founders aggressively cut their cost structure at the moment of pivot and slowly increase their burn as they see signals that it’s working (for simplicity’s sake, let’s assume that they eventually get back to their pre-pivot burn of $100K/month):

In this case, the company can go for 13 or 14 months post-pivot without any additional capital. Moreover, they only require an additional million to make it to the full 36 months.

Is it Really That Easy?

There are obviously pros and cons to each of the above (overly-simplistic) scenarios. That said, you can probably figure out the underlying message in the above numbers:

If you pivot but don’t reset your cost structure (or, worse, if you continue to increase burn), it’s unlikely that you’ll to have enough runway to see the pivot through. Moreover, the amount of money you will need to raise at your next round (and the corresponding valuation that you’ll want in order to not dilute yourselves too much) are likely to be too high for the amount of progress you’ve made with the new idea.
If you pivot and aggressively reset your cost structure, you can potentially see the pivot through without any additional capital (or, alternatively, you put yourself in a position to only need a small, approachable amount of additional capital in order to fully prove out the pivot, depending on how careful you are increasing spending).

If resetting costs is such an obvious thing to do, why do so many founders maintain (or increase) burn rate after pivoting?

Because resetting your cost structure usually means laying people off. Good people. Hard working people. People who believed in your idea enough to join your crazy moonshot startup. People who’ve become friends.

It’s especially hard to lay people off when, deep down, you feel like they didn’t make any mistakes. When you close your eyes and know that mistakes were made by the founders.

So instead of taking the hard decisions and resetting costs, we rationalize and justify. We minimizing the impact of cost savings and overestimating our ability to “catch up”.

We’re not really saving that much money and we’ll have to hire a replacement in a few months anyways…

At the end of the day, pivots can (and do) frequently succeed.

But in order put yourself in the best position to succeed, you must accept that a true pivot requires a full reset of the company. Including its cost structure.

You have undoubtedly learned some things along the way, and you might even have some bits-and-pieces that you can reuse, but in terms of the marathon towards product-market fit, you’re back at the starting line.

So make sure you set yourself up for success.

The Problem with Pivots