Why Buying a Stalled Startup is Better than Starting From Scratch (Now)

After a long stretch in the venture-backed startup world, I eased out a few years ago to work on turnarounds — finding stalled companies and breathing new life into them.

If you’ve ever considered distressed companies as an investor, entrepreneur, operator or employee, this post outlines how I got to that decision and how the process has gone so far. Future posts will discuss picking the right companies and how to transform them from within.

Please let me know what content you find most interesting. I love writing on the topic, but want to make sure it’s exceedingly valuable to ambitious entrepreneurs and operators.

The Turnaround

Background:

I love the idea of venture capital, but from my angle, it had gotten out of control — too much money chasing too many startups, and rampant failure (2017 appears to be a decade-high year for investment).

The best venture firms seem to find good deals, but I kept seeing the same opportunities to get engaged as an investor and operator: overly-optimistic, over-financed, money-losing beasts.

Even startups with “exits” rarely make money for the investors because so much was raised to get there. But it’s especially rare for the hard-working employees to get paid — I would estimate 5–10% of companies hit that goal currently, based on conversations with venture investors.

Swinging for the 1-in-10 fence is fine in your twenties. But I’m not. I’ve done that. And being the gray-haired COO to “get things on track” sounded painful: all the responsibility, little control, and a crowded and anxious cap table.

Startups are raising too much because it’s there, and VC’s are happy to oblige. But that level of fundraising leaves little room for error, like a six-foot Jenga tower (A Round) built by a caffeinated 5-year old (B Round) on a floor above a thumping night club (C Round). You get my point.

Most failed startups tried to scale prematurely (falsely assuming they had product / market fit) or hired the wrong team and failed on execution. When they can’t raise more money, the company becomes an “orphan,” forced to get profitable or find a buyer.

So I wondered if we turn these failing billion-dollar wannabes into the profitable $50M or $100M company they should have been in the first place — a needed pivot, but with a new outlook, lean team and control of the company.

What did we find?

After several years, I learned that the companies are out there, but the stars have to align to make a deal work. Ideally…

  1. You have a personal connection to the business, including founders and investors.
  2. The board is ready for a move like this.
  3. The core R&D team is excited about this move.
  4. You know and love the category.
  5. The business stalled due to go-to-market failure, not lack of demand.
  6. It’s not a competitive M&A process.
  7. You can move quickly.
  8. You’re ready to roll up your sleeves and run the business.

The pool of companies is large. And it’s not just venture-funded companies. In fact, my first purchase was from a private equity firm that needed to divest and the second was owned by a holding company. Both acquisitions had been around since the 90’s. There are also spin-outs, bootstrapped companies and other creatively structured investments to be had for a good price.

There is competition for orphans. However, it’s mostly small groups and individuals who I found to be collaborative and supportive, with only a few exceptions. And if you’re looking at small deals, the meager “check size” keeps the institutional investors away.

In some cases you acquire the company outright, and in some cases you buy a majority stake to gain control. The latter may give you a better price since the investors can “leave chips on the table.” But gaining control is incredibly important — you can’t be held back by investors.

Figuring out if it’s the right deal to do is a different post….or book….or career. Stay tuned.

What does success look like?

Good outcomes vary: grow the business and then sell it to a larger company or investment firm, build a profitable / enjoyable annuity stream, merge it with similar businesses to run more efficiently, sell it to an individual. Or maybe you even take it public.

That said, we don’t go into these companies with the exit in mind. To me, that’s the tail wagging the dog. Each business has its own unique path in the world and forcing a playbook or exit model can often ruin it. I found that the road becomes clear after six months or so of running the business.

Doing the Work:

Our particular method of value creation is to run the business for 6–12 months during the turnaround phase. We apply growth engineering, brand repositioning, cultural resuscitation and a data-driven operating system for the company. We aim the business at the right market and rewire it using modern principles. Or said less lamely: good people enabled by good tech.

Turnarounds are not for everyone: PTSD among the employees, rounds of cuts to get profitable, seemingly infinite amounts of cleanup work, 2am realizations of what you got yourself into, looks of concern for my wellbeing from friends for pursuing this line of work.

You often question if it would be easier to start from scratch.

But so far, I have enjoyed it. The work satisfies my blue-collar New England itch to get my hands dirty and my Silicon Valley desire to bring data-driven problem solving to old categories. And hitting profitability feels like summiting Everest.

And maybe it’s too many painful baseball memories, but I love hitting consistent doubles and triples, instead of the occasional home run.

But there’s also something deeper about turnarounds.

There’s a power and freedom that comes from cleaning out the past mistakes while still embracing the history and soul of the entity. In fact, the more you can involve the founders in the process, the better the outcome turns out to be (assuming those founders are good, hardworking people).

It’s remarkably similar to a personal turnaround. In both cases, you have to accept the error of your ways, find a higher purpose, surround yourself with great people, let go of the negative patterns that hold you back, focus on others instead of yourself, and do the incredibly hard work of rebuilding.

I’ve been through a personal turnaround, and watched friends and family transform themselves. It ain’t easy. And it’s unsexy. But there’s a lightness and authenticity that comes out of it: you’re no longer trying to be something you’re not. You’re just creating you.

Business turnarounds have that essential nature: the company has accepted the failure of their “we’re gonna change the world forever” ego-driven approach and must now embrace a more honest path. Unrealistic expectations no longer serve the company’s interests.

These days, the infrastructure is plug and play, so anyone can start a company in five minutes. As a result, it’s incredibly crowded and hard to be seen. Re-igniting a company with existing customers and the sandpaper of experience is like getting a leg up on that journey. You just need to figure out if the baggage outweighs the benefits.

So before you think about joining the exploding ranks of startups-likely-to-fail, consider adopting an existing one. You might enjoy the redemption story a lot more.