Purchasing a Distressed Startup
May 27, 2020
by a searcher from University of Pennsylvania - The Wharton School in Philadelphia, PA, USA
Big preface here: I know this is the antithesis of the search fund model; buying stable cash-flowing businesses, but has anyone ever looked into acquiring a struggling or failed startup? The nature of the venture model leads to extreme outcomes, big wins, or big losses. A startup with a good product could inadvertently capsize their businesses by trying to grow too quickly. If their topline growth slows, they cant raise another round and its game over. In simpler terms; some of these businesses could be great 50-100MM a year rev companies but fail while trying to scale to 1B+ to satisfy the massive growth requirement forced by VCs.
Here is a case study I thought of: Brandless, the company raised $240MM from Softbank and abruptly shuttered this year. I remember reading a lot of customers were very disappointed to see them go. Hypothetically one could acquire their IP, manufacturing contacts, remaining inventory, and customer list and run it as an Amazon FBA business. At least some of their products have to be winners and you could double down on those. Might not ever be the multi-billion-dollar company the VC envisioned but you could be left with solid FBA business without having to spend the time and investment required to develop a catalog of unique products.
Im sure there are plenty of other examples in DTC and Saas business models although some of the more ambitious plays like robotics, AI, blockchain, biotech, etc. could be total losses.
from University of Nebraska in Austin, TX, USA
2. Take a look at Zombie PE funds. There are a lot of them and will continue to be more. There are many rational reasons why they exist but many times due to management fees / fund dynamics (why would I sell this company as a GP when the mgmt fee is worth more than I get by selling it, and outcome makes me look bad as an investor). If you could identify these older vintage funds with remaining unwatned assests/businesses there may be a play with the virus hitting (permanent change in investor expectations, oh we had to divest because of covid...). These types of businesses probably look more like search fund deals, but you'll need to understand PE and fund dynamics....that's where the opportunity is I think.
from Hobart and William Smith Colleges in Dorset, VT, USA
Turnarounds are very hard when there are historical profits that you can navigate back to. This assumes customers, a backlog, a trained workforce, some inventory and working capital. At least there is a model that worked and you just have to get back there. (like getting back in shape physically). Finding profits - where they never existed - because you're a search funder seems like lottery odds. Funding that without assets makes it tougher. Now take all the risk mitigation steps of a traditional SF (again as you said, momentum, customers, vendors, payment terms, etc, etc) and eliminate those. Yowza. Yes, it can definitely definitely work but it's the lowest odds of any acquisition play I can think of.
Good luck, and good for you for thinking outside the box.
Jeff