Venture Capital “Orphans”: Exploring an Emerging Search Fund Investment Thesis
August 03, 2023
by an investor from Harvard University - Harvard Business School in Toronto, ON, Canada
Over the past few months, I’ve observed a new profile of target company popping up with an increasing degree of frequency, particularly from prospective searchers seeking out new and creative ways to generate propriety deal flow. I refer to this emerging profile of company as the “VC orphan”. That is, a healthy and modestly growing company that has raised at least one round of institutional venture capital, has achieved product/market fit, but has failed to produce the triple-digit growth rates and exponential scalability potential that’s all but required for them to continue to command the time, attention, and capital of their VC-backers.
Might searchers also consider this very different company profile, in addition to that which has served as the foundation of the Search Fund investment vehicle over the past three decades? This week's blog post attempts to explore this question, presenting observations that both support and refute the thesis.
Venture Capital “Orphans”: Exploring an Emerging Search Fund Investment Thesis
from Roosevelt University in Boston, MA, USA
Why I think acquiring a venture-backed company is unlikely for searchers (even though it is theoretically possible):
-Fundamentally, VCs make a plethora of bets and only need a handful of those to make the fund (like Uber). This means most of the time they are fine waiting until you run out of cash if there if there is even a remote possibility you could be the winner in the fund.
-The company's most recent valuation at the last round anchors the price for future conversations. On average Series A companies are valued at ~$20M while only making ~$2M in revenue.
-Acquiring a VC-backed startup requires extensive negotiation and due diligence to navigate the complexities of existing investor agreements, equity structures, intellectual property rights, and other legal and financial aspects.
-By definition, these are founder-centric businesses. Not sure I would quite call it key man risk but similar challenges. The options the employees have are worth way less if its not run in a high-growth way and employee attrition will likely result.
Nevertheless, I'd be open to an acquisition of this kind but it's just messier -- just not sure a new operator would thrive in that kind of environment.
from Erasmus University Rotterdam in Berlin, Deutschland
https://meetings.skift.com/hopin-fire-sale-confirmed/
https://www.crunchbase.com/organization/hopin-8ff6/company_financials