As VC's Cull Startups, Investors Take Ownership Of Some Turnarounds

As venture capital firms have become more discerning - and tougher - about continuing to fund some startups whose valuations or operational risks became too great, some investors, many with private equity backing, are taking ownership positions in those companies whose futures may be resuscitated with better management and oversight. 

The risk is significant, but with so much unallocated capital available, some investors see an opportunity to put money to work with the prospect of eventual payouts at higher returns than leaving investors' cash at money market rates. JL 

PYMNTS reports:

Investors are raising money to buy out the startups that venture capital firms have rejected. Investment groups are raising tens of millions to gain majority ownership and operational control of startups to turn those companies around, yet another indication of how tough it has gotten to land traditional sources of venture funding. The companies they purchase (are) in need of a turnaround, either because a past valuation was too high or because the company needs operational changes. “There’s an opportunity to help companies transition from venture ownership to private equity ownership.”

This year’s rising interest rates have led venture capitalists to curtail their startup investments.

However, this shift has led to a burgeoning new trend, the Financial Times (FT) reported Sunday (Nov. 12): investors who are raising enough to buy out the startups that venture capital (VC) firms have rejected.

These investment groups are raising tens of millions to gain majority ownership and operational control of startups to turn those companies around, the report said. The FT noted that the trend is new, but yet another indication of how tough it has gotten for many firms to land traditional sources of venture funding.

The report uses the example of Resurge Growth Partners, launched this year by investors Oren Peleg and Eyal Maling with the goal of raising $137 million to buy startups. These investors say they’ve noticed a gap in the market and will make average investments of $10.6 million to $32 million, the FT said.

The companies they purchase will be ones in need of a turnaround, either because a past valuation was too high or because the company needs operational changes.

“There’s a real opportunity here to play a very important role, which is to help companies transition from venture ownership to private equity ownership,” Peleg said. “No one is willing to send the hard message of saying this needs a reset, and that will be the role that we play.”

An example of the difficulty facing startups can be seen in the decline in funding for supply chain technology firms, which are laying off staff and cutting costs. Convoy recently ceased operations a year-and-a-half after achieving a $3.8 billion valuation, while companies like Flexport have laid off staff due to dwindling shipping demand.

VC firms completed 404 deals totaling $5.7 billion for logistics companies in the first half of this year, a significant decrease from the 727 deals totaling $22.7 billion in the same period last year, per the report

The news follows a separate report last week by The Wall Street Journal showing that investment in private FinTechs had fallen 46% during the third quarter compared to the same period last year, while the number of deals fell to levels not seen since 2017.

PYMNTS looked at the pressures facing the FinTech startup sector earlier this year in the report “FinTechs Look to M&A for Profitability as Economic Shake-Up Continues.”

The sector hit a bump in 2022 as “the forces of pandemic-fueled transformation and economic stimulus began to wane,” the report said.

The situation isn’t much better in 2023, as climbing interest rates, steep inflation and a decline in consumer spending “have put pressure on FinTech companies’ trailblazing models, requiring some painful adjustments,” PYMNTS wrote.