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Investors are shaking up the venture capital market by raising money to buy out start-ups that have been shunned by venture capitalists, taking advantage of economic headwinds to acquire promising companies at a discount.
In the years running up to 2022, VCs took minority stakes in new businesses with growth potential even if they lacked a quick path to profitability. Steep rises in interest rates over the past year have changed that, hammering private valuations, forcing VCs to pull back and leaving a swath of start-ups at risk of collapse.
New investment groups are raising tens of millions of dollars in funding with the intention of acquiring majority ownership and operational control of start-ups in order to turn the businesses around.
While still in an early phase, the trend is a further sign of the difficulty many companies face as traditional venture investment chills.
In one example, investors Oren Peleg and Eyal Malinger started UK-based Resurge Growth Partners this year with the aim of raising €120mn to buy start-ups.
The veteran investors, who have previously worked at companies including Howard Marks’s Oaktree Capital Management and VC firm Beringea, say they have spotted a gap in the market and plan to make average investments ranging from €10mn to €30mn.
Resurge Growth will acquire start-ups with the goal of providing a turnround, either because a previous valuation was too high and did not reflect the new market reality, or because operational changes are required.
“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.”
Other investors, such as Matthew Bradley, are also leaving venture capital to pursue start-up takeovers. Bradley, formerly chief investment officer at London-listed VC firm Forward Partners, launched Tikto Capital last year in order to buy up start-ups.
Another firm, San Francisco-based Arising Ventures, has been looking to buy up start-ups with viable business models but slowing growth since its founding in 2020. Chief executive Kjerstin Erickson said that in the past year, the number of potential deals has grown fivefold.
Opportunities came up when “the company has raised more money than they are worth in the market”, she said. “We’ll do the deal if we think there’s a real business underneath.”
This year the group — which is structured as a holding company rather than fund — took out a billboard in the heart of San Francisco with the slogan: “We invest in second chances.”
Venture capitalists have dramatically scaled back activity this year, investing just $73bn in the third quarter across the world. That is down from $106bn during the same period last year, according to market researcher PitchBook.
At the same time, the number of venture-backed start-ups that sell to private equity groups has grown to 24 per cent of total exits over the past couple of years, tripling as a proportion of such deals since 2006 to 2010, according to data from the European tech corporate finance advisory Clipperton.
However, even as pressure mounts on start-ups to sell, deals are stalling as VCs squabble over whether to cash out, according to Scott Driggs, who covers private equity at Jefferies.
“Once the door closes and you crystallise those losses there’s no going back,” he said Driggs.
Investors expect that the demand for such buyouts will rise as the slowdown persists and more companies face a potential cash crunch.
“In 2024 we will see a lot more demand for our capital because on the one hand, entrepreneurs are going to be faced with an option; Should I sell this company for scrap, should I shut down?” Resurge’s Malinger said. “Or can we provide an alternative option for this company.”