At the end of the day, actions spell out the real meaning of contracts.

Staff Writer

What happens if a founder fails a startup? Should he give back the money to investors? originally appeared on Quora – the place to gain and share knowledge, empowering people to learn from others and better understand the world.

Answer by Bonnie Foley-Wong, CEO Pique Ventures, Pique Fund, author Integrated Investing, on Quora:

I was re-introduced to a founder who was running her second startup. Her reputation in the community is mixed. Some people remember her for running her first startup into the ground. Others, who might not know about her past or don’t care, like the civic mission of her new startup. She contacted me to discuss an opportunity for Pique Fund to invest in her second startup.

I asked her what happened to the investors of her first startup. She told me she had done nothing, that they were still invested in the failed startup.

I’ve seen founders re-position their failing startups for sale. I’ve also heard examples of founders allocating shares in their new startup to previous investors. Although it may require some explaining for future investors, a strong motivation for doing this is to value and continue building the relationship with previous investors.

It is a bit of a consolation, along the lines of “sorry the first startup didn’t work out, but I’d like to try to make you whole (i.e. help you recover some of your original investment)” or “I learned so much from the first attempt, the next attempt will be better. I want to show you that I value and appreciate the risk you took on me. Had I not had that opportunity, I wouldn’t know what I know now to take a better stab at my second startup.”

In this particular example, the founder had not wound up the previous startup. If there was any money leftover, it wasn’t and didn’t have to be distributed to shareholders. In my conversation with her, it was as if she shrugged it off and didn’t care that she left her investors hanging.

Maybe her investors didn’t care either, I don’t know their side of the story. But if she didn’t care about her investors in bad times, the thought of investing in her and her second startup made me feel very uncomfortable. My evaluation of her was that she’s willing to take the money and run.

With high-risk equity investments, there is no legal contractual obligation to wind up and distribute money if there are any funds leftover. As investors, we know we’re taking that kind of risk and might not get our original investment back. The social contract, however, is more difficult to define and is based on trust and goodwill. It may differ from person to person and is why a focus on relationship is so important.

Some people think social contracts can’t be trusted and that they are willy-nilly and precarious. Alternatively, I’ve experienced some social contracts that are more powerful than legal ones. Social contracts may capture terms and meaning that are missed in legal documents. They may endure far beyond the term of a legal contract.

At the end of the day, actions spell out the real meaning of contracts. You can say, “I’m going to value your investment, your trust, and your risk-taking” or you can demonstrate it in your actions.

If your startup fails, think about whether and how much you value the relationships with your investors. It’s a good idea to ask your investors, in your particular circumstance, what they want. Aim for a fair and reasonable outcome that would leave you and your investors feeling good, and leaves relationships in the best position possible for future collaborations.

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