The Zugzwang Rule

–> Most startups fail. Before failure, the company is often in zugzwang. Unlike in the game of chess, entrepreneurs can choose to “not move” and return the remaining portion of the investment to investors.

First of all, what is “zugzwang”? It is a German word for “compulsion to move” and is most often used in reference to chess. A chess player whose turn it is to move has no move that does not worsen his position is said to be in zugzwang. Every move will make his position in the game worse, and he would be better off if he could pass and not move.

The concept is best described through an illustration. In the picture below, Black is in zugzwang because he would rather not move. Unfortunately, it is his turn so he must make a move. A king move (currently on f4) would lose the knight (currently on g5) while a knight move would allow the white pawn to advance.

In this game, the black knight moved to f3, white moved to h6, black knight went back to g5, and the white king followed with a move to g6. Black is again in zugzwang. The Fischer game ended shortly because the pawn would eventually slip through and “promote” (become a queen).

I’m not a chess fan, but I love the concept of zugzwang and recently discovered the term in a Marketing class at Tepper School of Business. I instantly began to think how this concept relates to venture funded startups. I have seen this play out a few times but will illustrate with a fictional example.

_______________________

Cougar Enterprises successfully raises $1m from a prominent VC. Cougar is a dating website that aims to connect women in their 40’s to men in their 20’s. After 6 months in the market, Cougar fails to catch on in the marketplace. They have only 500 registered users and website metrics are worsening. A new competitor has emerged, Puma Enterprises, which is the same idea and has significant early traction (1 million users and exponential growth). Puma just raised $30M in financing and no one (including current investors) is interested in an investment in Cougar. Cougar has $500k left in the bank and is in zugzwang.

_______________________

Here’s are Cougar’s choices:

1. Stay in business, make your next move, waste a bunch of time, eventually you will fail and kill a relationship with an investor as they will make a $0 return
2. Realize you are in zugzwang, return the $500k to investors and start over with a new idea. A smart investor will respect this decision and may even be willing to work with this entrepreneur on his next venture

I have heard of  a few examples where entrepreneurs go with choice 1. This is VERY RARE. Startups will often take the business down to its last penny or enter “hibernation” before calling it quits. Investors typically have no legal right to recall a venture investment, so admitting zugzwang is up to the entrepreneur. Sometimes the best move is no move – return the money to investors and move on to your next venture.

Side note —> This can be a very contentious issue with investors and entrepreneurs so would love to get your thoughts/feedback.