The drop-off in startup funding and a lack of exit options in recent years have left many startups on the brink of collapse.
In the wake of the VC downturn, a handful of new investors have cropped up to offer struggling startups a second chance. Firms like Resurge Growth Partners, Tikto Capital and Arising Ventures target startups that no longer fit the typical VC mold with the intention of turning them into private equity-ready assets.
We spoke to Eyal Malinger, partner at Resurge Growth Partners, about how this type of strategy is turning around overlooked VC-backed companies.
PitchBook: What is the opportunity in the VC market that firms like yours are trying to capture?
Malinger: There is a gap in the market between VC and PE, which represents a very big chunk of almost every VC portfolio. VC returns are based on the power law and they are looking for the big fund returners, so companies that don’t fit that mold become hard for VCs to justify putting more money or time into.
At the same time, they were brought up in an era of cheap money and are geared more toward rapid growth than profitability. They are loss-making, or maybe break-even, and they’re just not attractive to PE.
So these companies are stuck in this limbo between VC and PE, right? They’re not growing fast enough for a VC round and they’re not profitable enough for a PE fund to acquire. Our approach is to acquire controlling stakes in these companies and help them move from hypergrowth to a profitable model and getting them private equity ready.
Why aren’t VCs doing this themselves?
To execute well on this opportunity requires a combination of VC and PE skills. You need the VC experience, with deep understanding of how VC boards and cap tables operate to source, diligence and execute these transactions. But you also need deep PE operational expertise to help these companies reach their full potential, and you need the PE experience to get these companies PE ready.
A typical VC, owning 10% to 20% in many portfolio companies, don’t usually have the incentive, willingness or skill to engage in transformation, or more importantly they don’t have sufficient control over the company to effectuate change, while PE investors prefer to focus on profitable and larger businesses.
What type of strategies do you use to turn around startups?
At the end of the day these are businesses and face some of the same challenges or questions as any business: Is the strategy right? Is it understood by all? Is there an operating plan to deliver the agreed strategy? Is performance being measured properly? Are the organizational skills and capacity in place to deliver the plan?
Our approach is therefore multifaceted. We first reassess the core business strategy and ensure it’s value-based and well-understood across the organization. We then delve into operational details, particularly scrutinizing and understanding true fully costed unit economics, cost to serve and true customer acquisition costs and build processes to deliver the plan which are scalable.
A key aspect is also team evolution. We help transition from a startup team to one more suited for scaling, recognizing the continued value of founders in new roles which build on their strengths but mitigate their skill gaps. Also, we caliber team equity and incentive structures to reflect a realistic market valuation
The culture of a business is critical and that is often an area that needs focus. The whole feel of a business will be different and getting that right is key. Making the business fun and rewarding is critical after this pivot and that is an important area for us to get right.
How do you balance growth and profitability?
Our philosophy is earn the right to grow. We only invest in businesses with a clear path to profitability. It’s about smart growth. We do not invest in businesses we don’t believe we can grow.
It’s interesting that a number of the companies we are looking at right now are marginally profitable because they cut costs and under our plan, they go back to losing money as we invest in growth. However, there is a difference, under our plan, the product, channel, and market priorities may be different.
VC dealmaking is expected to rebound this year. How will this impact your strategy?
I think startups that are working on AI, impact, carbon neutrality, [and] energy transition will be in high demand and will be able to fundraise. But we’re not chasing the very hot, exciting startups, we’re chasing the ones that are growing but not interesting enough for venture capital and these companies exist in everybody’s portfolio.
We expect to see significant opportunity in areas where others are pulling out from such as fintech, proptech, and consumer. Some of the best opportunities are in areas that are cyclical in nature. During the last cycle such sectors were auto parts or house building. Investors pulled out of these areas causing liquidity crunch, but ultimately the demand for cars and construction is cyclical and those who bought at the right time reaped significant returns. We also see huge upside opportunity using our acquisitions as consolidation platforms in specific verticals.
[Furthermore] many struggling companies raised bridge or extension rounds the last couple of years and in 2024, we found out how many of those bridges were actually piers. For VCs, it’s not a good use of their time or capital to keep on supporting these companies that are unlikely to drive meaningful returns.
We expect a strong year for this strategy and investors like us just by virtue of people rationalizing their portfolios and doubling down on their better bets. This will leave a lot of great companies that deserve to be funded but just don’t fall under the typical VC model.
With exit activity likely to increase as well this year, does this represent a challenge for firms with similar strategies to yours?
The universe is so vast that I don’t see this creating much of a challenge for what we’re doing. By definition, the companies that we are targeting are not interesting to PE funds and some will have value for strategics but corporates will be looking for the top one or two in every vertical.
Corporate M&A is competition but for founders, our position can be more interesting even if a strategic is offering a higher price. We see that a lot of M&A is pure paper, so people are buying with shares and not cash unlike us. So, for founders looking for liquidity, our strategy is more attractive.
Ultimately, our goal is to buy a company, grow it, and send it to private equity or to a strategic acquirer within a three- to four-year time frame.
Featured image by MirageC/Getty Images
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