Pivot

What is a pivot?

Pivot (strategic change of direction) denotes a planned, fundamental change in the orientation of a young company that is based on insights from the market. Essential components of what existed before are retained, such as the technology, the team, the customer relationships or the sales channel. The term is borrowed from basketball: one foot stays firmly on the ground while the player turns in a new direction with the other. The related verb in German is pivotieren; in English the term pivoting is also used.

A pivot differs from a fresh start in that it builds on existing results. It differs from an ordinary product adjustment in its scope: it affects the target group, the value proposition (the benefit the product promises the customer), the revenue model or the market. A pivot therefore affects management, shareholders, investors, employees and customers alike. It is reflected in the business plan, the financial model, liquidity planning and reporting to investors, and in the case of far-reaching changes also in the articles of association.

Forms of pivot

In practice, several basic forms are distinguished, which also occur in combination:

• Change of customer segment: The same product is offered to a different target group, for example companies instead of private individuals.
• Narrowing of the product: A single function that customers use particularly intensively becomes the actual product.
• Broadening of the product: An offering that is too small on its own becomes part of a more comprehensive product.
• Change of revenue model: One-off sales become subscriptions, licences become usage-based fees. The revenue model changes, the product stays largely the same.
• Change of sales channel: Instead of direct sales, sales take place through partners, marketplaces or a self-explanatory product.
• Change of technology: The same customer problem is addressed with a different technical solution.

Trigger and decision for a pivot

The trigger for a pivot is as a rule that the original direction shows no product-market fit despite adequate testing. That is, there is no lasting, paying demand in a defined customer segment. Typical signs are customer retention that falls sharply after a few months in the cohort analysis (analysis of customer groups by their start month), and customers who use the product quite differently from what was intended. Added to these are deals that come about only with special prices or individual adaptations, and rising customer acquisition costs with an unchanged target group.

A robust pivot rests on a justification recorded in writing. It names the assumption tested and the result, the parts of the previous work that are carried forward and the measurable criteria by which the new direction will be judged after a fixed period. Without this justification, it is more likely a change of opinion that can repeat itself after a short time. The new direction is often first tested with a deliberately small product, an MVP (minimum viable product).

Pivot in a GmbH: articles of association, contracts and funding

For a GmbH (German limited liability company), the first thing to check is the corporate purpose, that is, the field of activity that the articles of association describe under Section 3(1) no. 2 of the German Limited Liability Companies Act (GmbHG). If it does not cover the new activity, an amendment of the articles is required. Under Section 53 GmbHG, this needs a majority of three quarters of the votes cast and notarial certification. It takes effect only on entry in the commercial register (Section 54(3) GmbHG). Vis-à-vis the company, the management is bound to the corporate purpose.

In investor-financed companies, the shareholders' agreement is added. It often contains consent reservations (veto rights) for entering new or abandoning existing lines of business and for material deviations from the budget. Even without an express rule, the managing directors of a GmbH must, according to the prevailing view, put measures that depart fundamentally from previous business policy to the shareholders for decision in advance. The investors' contractual information rights require timely notification in any case.

Further points of contact are public funding and existing contracts. A grant award notice ties the funds to a specific project; if the project changes, coordination with the funding body is needed to avoid repayment claims. For the research allowance, it must be checked whether the certified projects still cover the new development work. Customer contracts with performance commitments and terms remain in place and must be performed, transferred or terminated by mutual agreement.

Liquidity and the investors' view

A pivot consumes time and liquidity. Until robust results of the new direction are available, two to three quarters often pass, during which revenue from the old direction may decline. The runway, that is, the reach of the liquid funds, must cover this period, including a subsequent financing round. A pivot that begins with only a few months of runway can hardly still reach its own success criteria. Liquidity planning should therefore be updated for both directions before the decision.

Investors judge a pivot above all by the quality of the decision. A comprehensible chain of assumption, test, result and decision speaks for a team that can learn. Several changes of direction in quick succession are viewed critically, because none of them can have been adequately tested. The company is then measured against the metrics of the new direction; revenue and user numbers from the old direction count only to a limited extent.

The valuation of the last round was based on the old plan. If new shares are therefore issued in the follow-on round at a lower price per share than before (down round), anti-dilution clauses (anti-dilution protection) may apply. They generally compensate existing investors for the lower price through additional shares, at the expense of the other shareholders, above all the founders.

Practical example: pivot from the consumer market to the business customer market

A company has developed software for analysing energy consumption for private households. Registrations rise, but monthly use drops off after a few weeks. At the same time, property managers get in touch who want to use the software for entire residential complexes. The liquid funds are EUR 1.68 million, and the monthly net burn, that is, the excess of payments over receipts, is EUR 120,000.

• Runway before the pivot: 1,680,000 divided by 120,000 = 14 months.
• Management stops marketing to consumers and saves EUR 40,000 a month. Net burn falls to EUR 80,000.
• Runway after the changeover: 1,680,000 divided by 80,000 = 21 months.
• Success criterion after six months: ten paying property managers and EUR 30,000 of monthly recurring revenue.
• Use of funds in these six months: 6 × 80,000 = EUR 480,000, leaving 1,680,000 minus 480,000 = EUR 1,200,000.
• The corporate purpose “development and sale of software” covers the new orientation; an amendment of the articles is not necessary. The project agency responsible for an ongoing grant is informed before the changeover.

After six months, 1,200,000 divided by 80,000 = 15 months of runway remain. If the criteria are met by then, the follow-on financing can begin with two quarters of data from the new direction. The runway then lies within the range of 12 to 18 months that should be available at the start of a process. The investors were informed of the justification and criteria before the changeover and approved the budget change.

Distinctions: pivot, iteration, fresh start and product-market fit

• Iteration: an ongoing improvement of the product within the existing orientation. A pivot changes the orientation itself.
• Fresh start: the building of a new business in which product, target group, channel and revenue model all change at once. Anyone who changes everything should also describe it that way to investors.
• Product-market fit: the state that a pivot is meant to reach. Once it is reached, the focus is on growth rather than on changes of direction.

Common mistakes

• Deciding too late. Anyone who postpones the decision until only a few months of liquidity remain has no time left to prove the new direction.
• Changing too often. Several pivots within a year leave no direction enough time for a robust test.
• No success criteria. Without metrics and deadlines set in advance, it cannot later be judged whether the pivot holds.
• Informing investors late. A change of direction that becomes visible only in the quarterly report damages trust and can breach consent reservations.
• Existing customers not planned for. Ongoing contracts and support duties from the old direction tie up capacity and must be taken into account in the planning.
• Funding conditions overlooked. Earmarked funds that are used for a different project after the pivot can be reclaimed.

Frequently asked questions

How is a pivot presented in the next financing round?

As the result of a tested assumption, not as an emergency solution. A presentation that shows which assumption was tested, what result was obtained and which metrics have developed since the change of direction is convincing.

When should a company pivot?

When the previous direction misses its success criteria set in advance after adequate testing and the data point to a different target group, a different revenue model or a different channel. The decision should be taken while the runway still suffices for testing the new direction and a subsequent financing round.

How long does it take until a pivot can be judged?

As a rule two to three quarters. Shorter periods often show only initial effects; with business customers and long sales cycles it can also take longer.

Does a pivot need the shareholders' consent?

Often yes. If the corporate purpose does not cover the new activity, an amendment of the articles with a three-quarters majority is needed. In addition, shareholders' agreements often contain consent reservations for new lines of business and budget changes.

What happens to existing customers after a pivot?

They keep their contractual rights. The company must decide whether to continue performing the contracts, to transfer the customers to the new offering or to terminate the contracts by mutual agreement.

The Roemer Capital view

If a company that Roemer Capital accompanies in a financing round has been through a pivot, the pivot is disclosed in the documents. It is substantiated with metrics before and after the change of direction, showing which success criteria applied and how far they were met. A smoothed company history generally does not withstand the investors' examination.

The timetable of a round is determined above all by how many quarters of data the new direction can already show. If they are not enough, Roemer Capital recommends postponing the approach to investors and planning the runway accordingly, instead of entering the process with an unsubstantiated direction.