Secret’s collapse shows the traditional VC funding model is broken

The monumental failure of anonymous social app Secret and the closing of the company’s doors after a mere 16 months in business has fueled serious discussion among entrepreneurs and venture capitalists.

Concerned parties on both sides of the funding table are asking hard questions about what this development means to the future of venture capital funding and whether the well-funded startup’s demise might not in fact indicate that the traditional VC model is broken and badly in need of repair.

From the VC Vantage Point

The VCs that helped Secret raise a whopping $35 million in funding included Google Ventures (one of the company’s earliest backers), Kleiner Perkins Caufield & Byers, Index Ventures, Redpoint Ventures, a number of angel investors, venture capitalist Marc Andreessen, and actor Ashton Kutcher, among others.

Yet despite the significant chunk of capital invested in the firm, the app’s popularity peaked after 10 months and then quickly declined. In a desperate attempt to turn things around, the founders redesigned the app’s interface in hopes that it would hold its own against its more popular competitors — messaging apps like Yik Yak, Whisper, and Snapchat — to no avail.

The rapid rise and fall of Secret demonstrates that how well the VC funding dynamic works — or doesn’t work — can often be instrumental in determining the success or failure of a startup.

Secret and the Traditional Funding Model

The deal made with Secret followed the traditional VC backing approach. This approach starts with an entrepreneur, who we’ll call Jim. Jim has a friend, Jack, who happens to be good buddies with venture capital firm VCs ‘R’ Us. Jack introduces Jim to the firm and, in no time, Jim finds himself on the fast track to funding.

A slight variation on this method is what actually occurred in the case of Secret. As former employees of Google, both Secret founders David Byttow and Chrys Bader enjoyed a logistical advantage that gave them an “in” with Google Ventures, one of their early backers, which let them bypass the customary “introduction.”

Analysis and Relevant Questions

Many investments have failed before Secret, and many more will fail after it. So what makes Secret different? Or perhaps we should ask what makes Secret an example that can illustrate what’s wrong with the current VC funding model? The answer is, Secret was blown wide open by this mass influx of capital. As Byttow put it, “Unfortunately, Secret does not represent the vision I had when starting the company, so I believe (the shutdown is) the right decision for myself, our investors, and our team.” Byttow’s declaration does, however, inspire a few questions:

Question 1: Could he have conveyed a hidden message in the above statement, implying that problems among the VCs were the reason his vision had veered so far off course? This question is valid since it’s fairly shocking that he and Bader had been totally unable to prevent the downward slide from such an innovative and promising concept in messaging to a complete shutdown of the company despite having received nearly $35 million in capital during two rounds of funding within a three-month period.

By rights, such generous funding should have been more than sufficient to allow the right leadership — with the right product — to revive a flatline, a complication far worse than the mere hiccup of declining traffic that caused an otherwise robust app to fail.

Question 2: Since Google Ventures managing partner Bill Maris was one of Secret’s earliest backers, why was he unable to convince the two founders not to accept an additional $25 million in funding so soon after it closed its $8.4 million Series A round? As Maris, who was Secret’s Google Ventures contact, has said, “We advised them against it. We told them they didn’t need the money. And raising that much money that soon, it was going to be impossible to meet the expectations in the future.”

Question 3: If, after taking the $25 million Series B, Secret had continued to grow and expand, with its valuation multiplying a dozen-fold, would Maris have rewarded Secret’s founders for disregarding his advice not to seek additional funding?

From the Entrepreneur View

Obviously, hindsight is always 20/20. Yet, Secret’s unceremonious demise does also raise a few questions on the entrepreneurial side of the issue, especially given the fact that the two founders cashed out $3 million in shares as part of their Series B deal:

Question 4: Was cashing out $6 million worth of shares in opposition to a number of prestigious venture capital firms the founders’ fault? While one firm could easily make a mistake, would a number of firms combined be expected to make that same mistake?

Question 5: Was it right for the founders to cash out these shares? Probably not. However, Secret’s founders aren’t the first to have cashed out some of their shares. And while Secret’s scenario was unsuccessful, countless other companies would likely not have encountered any problems as a result.

Question 6: Should the founders keep the money or return it, as Maris has stated they should, according to a post on The New York Times “Bits” blog? Would the venture firms have given the founders a bonus comparable to the amount of their cash-out if, in lieu of failing, the company had grown exponentially instead, with through-the-roof valuations that let the VCs make a killing? If not, why should the founders return their money?

Question 7: Will the founders use that money to launch something new? The second time around, the founders would have the benefit of the greatest teacher of all — experience — to remind them of just what a recipe for disaster early VCs can be.

Takeaways

We can learn several lessons from the rise and fall of Secret:

Lesson 1: When it comes to investing, there is no crystal ball. As a rule, venture capital firms have followed their unwritten rule of “investing within” — or throwing money at an entrepreneur based on a known connection to the firm — and that unwritten rule has become a tradition. Clearly, Secret has proven the traditional method wrong.

Lesson 2: Most VCs take firm control of decision-making in the companies they fund, which can lead the founders down the wrong path — i.e. away from, rather than toward, their original vision. This is what Byttow indicated had happened in his announcement that he would be shutting down the company he had cofounded.

Lesson 3: We need to question why most VC firms intervene in company decision-making in the first place, when their original decision to fund these startups was presumably based on how effectively the founders had been handling decision-making up to that point. Secret has proved this to be a bad strategy, clearly demonstrating that if the founders’ buttons are pushed hard enough, they may decide to simply walk, allowing the house of cards to come tumbling down. As we know, when this happens, everyone loses.

Lesson 4: Rather than blindly funding entrepreneurs within a VCs’ own circles — only to later learn that in many cases the product was poor and the founders were not leadership material — VCs should invest in startups based on two core values: 1. advancing a revolutionary product and 2. supporting the demonstrated expertise and clearly articulated vision of the company’s founders.

Final Thoughts

Some view the failure of Secret as “just another day in Silicon Valley” — simply one more example of the uncertainty of venture capital investing. Yet, whether or not the failure was indeed part of business as usual in the Valley, the question still remains: Would we see fewer such days if the current VC funding model were overhauled? The answer is clearly yes!

Jenny Q. Ta is founder of Sqeeqee and has 15+ years experience in the world of VC funding and finance. She previously founded and managed two full service broker dealer firms on Wall Street, which controlled upwards of $250 million dollars in assets and were successfully acquired prior to her current transition into the world of tech.