Monday

What Happens When a Tech Startup Fails?

Even universally acclaimed startups with strong leadership and great ideas can go under, if there isn’t enough demand or if the landscape changes. We’ve heard of hundreds of young tech companies, from the first dotcom legends to groundbreaking, disruptive startups of the modern era, utterly failing. But with up to millions of dollars at stake, the remnants of a new technology still lingering, and dozens to hundreds of people suddenly out of a job, what really happens to a CEO and investors after a tech startup fails?


Corporate Structure and Finances: Venture Capital and More


First, you’ll need to consider the structure of the company and the type of finances involved. For the most part, startups with any kind of money at stake are structured as a limited liability company (LLC), a corporation, or something similar. If you were to start a company as a sole proprietor and CEO, your name would be practically interchangeable with the company’s; if the company took on debt, you’d be responsible for paying that debt back.


However, LLCs and corporations are treated as separate legal entities. If you started “TechStart, Inc.” as a corporation, “TechStart” would be seen as a totally separate identity in the eyes of the legal system. If TechStart held $1 million in debt, and you personally owned TechStart, you would not be liable for TechStart’s $1 million in debt (in most situations). You could simply walk away to your next venture.


There are also different types of financing to consider. If the company was very profitable and had an excess of cash, it probably wouldn’t be in a position to fail or close; in most cases, the company has outstanding debts and liabilities to consider. Typically, a company does everything it can to make those debts whole as it closes. For example, it would collect on outstanding accounts, apply those payments to any outstanding debts, liquidate assets to pay debts further, then start paying back any and all investors who contributed money to the startup. In many cases, venture capital investors and other investors will end up with a loss.


In some cases, a business or individual involved with the business will need to consider filing for bankruptcy. Bankruptcy is a legal option that allows a business or individual to claim themselves unable to pay a debt. Usually when this happens, the entity must prove its current assets and debts in a court of law, and work together with owed parties to come up with a reasonable solution. Different types of bankruptcy, like Chapter 7 bankruptcy and Chapter 13 bankruptcy, may be viable options if an entrepreneur is dealing with personal debt, but the most common form of bankruptcy for business owners is Chapter 11; in some cases, you can continue running the business after filing Chapter 11.


The Closing Process for CEOs


Most business owners and CEOs involved in a struggling business will eventually need to follow a process to “close” the business or shut it down in a systematic way. First, they have to decide whether or not the startup is salvageable; this is a long and arduous decision process for many entrepreneurs. Many companies are able to lose money on paper for months, or even years, leveraging debt or new investment capital to keep going, and eventually become successful. Accordingly, most failure points are the result of a major impact to the business, and not just a reflection of financial performance; for example, you may note that sales and market interest are declining, or that there’s significantly more competition than you expected, or that your app simply isn’t working the way you thought.


At this point, an entrepreneur usually has conversations with the board of directors, venture capital investors who are financially exposed to the company, mentors, and other authorities. If multiple people seem to be in agreement, it may be time to close the business. Otherwise, the entrepreneur may step down in favor of new leadership, or collectively, the company may pivot in an attempt to revitalize the business.


If the decision to close the business moves forward, the founder must reveal the information in a deliberate and organized way. Typically, they’ll speak with decision makers and lawyers first, coming up with a high-level game plan. Then, they’ll begin to let their employees know, and if appropriate, may put together a press release.


From there, the company will move into shutdown mode. It will begin to collect money from outstanding accounts, alerting customers that the company is going out of business, and will file official dissolution documents—which will vary depending on the corporate structure.


After that, the business will likely begin liquidating assets in an effort to pay off its debts and simplify the end-of-life process; for example, you may sell off your computers, sell any commercial property you acquired, and get rid of any company cars. After paying outstanding debts, including tax requirements, founders typically distribute whatever money is leftover to shareholders in one way or another. There may or may not be any leftover money to distribute.


One by one, in order of increasing importance, employees are let go. The founder will cancel business licenses and permits as necessary, and close any financial accounts. From there, it’s important for the founder and other shareholders (like venture capital investors) to keep meticulous records of everything to do with the closure of the business in case they’re necessary to reference in the future.


Technology and Intellectual Property: What Do CEOs Do?


Many people start tech companies because they love the idea of introducing some new, amazing technology to the world. When that technology stops developing, or when the company runs out of money, it can be heartbreaking. But it doesn’t always have to end there.


During the asset liquidation phase, entrepreneurs frequently consider their tech product, possibly including their patent or their intellectual property, as an asset to distribute. In this process, they may be able to sell the in-progress technology to an interested buyer. For example, if you were developing a new app, you could talk to big tech companies in a similar space, and invite bids to acquire the technology for their own purposes. While this isn’t ideal for any entrepreneur or CEO, it can help the idea find new life, and introduce enough money to the startup that it can adequately pay off investors and shareholders.


The Post-Mortem: Communicating With the Market


Depending on the situation, the founder, board of directors, and other decision makers in the company may take the time to put together a post-mortem. This can take the form of a letter to shareholders, a short statement to venture capital investors, or even a press release. The basic idea is to explain, concisely, what went wrong with the company, how it could have (or couldn’t have) been prevented, and what’s happening next.


Post-mortems are especially valuable to CEOs in a similar space; it’s a good chance to teach your peers and/or the next generation of tech founders about the mistakes you made. It’s also a way to clear the air around your company, to squash any rumors about why the company really went under.


The Next Venture for a CEO


While it’s almost always heartbreaking for a CEO to watch their startup fail, they can usually take comfort in the fact that failure is incredibly common—to the point where most successful entrepreneurs have helmed at least one business that didn’t go as originally planned. Failure is, in many ways, a learning opportunity; it’s a chance for an entrepreneur to reflect on what went wrong, celebrate their successes, and consider how they can apply those lessons to the next venture.


Oftentimes, this is the period that defines whether an entrepreneur will be successful. Will they take the loss personally, fear the prospect of starting another business, and go back to a mainstream kind of career? Or will they channel this energy into another startup, and disrupt a new market?


Startup failure isn’t especially glamorous, and it’s not what we like to think about when we think about the prospect of entrepreneurship. However, it’s important to realize the important role that failure plays in the tech ecosystem. It’s a natural part of the cycle, and a common occurrence; but in addition to representing loss, it also represents learning and rebirth.





Frank Landman


Frank Landman





Frank is a freelance journalist who has worked in various editorial capacities for over 10 years. He covers trends in technology as they relate to business.