How do angel investors/VCs deal with “zombie companies”?

[mdnich]

If it's clear that a portfolio company won't be able to reach venture scale, but founders refuse to sell/shutdown the company (maybe because it has already become a lifestyle/cashflow business), how do angel/VCs deal with this situation?

From the Internet, I've found a few data points:

1) "I don't care. No need to return money to me/us. Keep the money. Do whatever you want. Good luck."

- Seems Y Combinator and some good investors go this way [4]

2) "I'll sell our shares back to you for $1."

- KPCB sold their shares back to Gumroad for $1 [1]

3) "Return my/our original investment back. 1x return. No need to worry about inflation over the past 5 years. Just return the original dollar amount. Let's both move on."

4) "I'll sell our shares back to you for 120% ~ 500% returns. Pay me/us back within X months using your cashflow or just borrow money to pay me/us back."

- Buffer used cash to buy back investor shares [2]

- Wistia raised debt to buy back investor shares [3]

If you are an angel/VC, what did you do?

[1] https://sahillavingia.com/reflecting

[2] https://buffer.com/resources/buying-out-investors/

[3] https://wistia.com/learn/culture/taking-on-debt-to-grow-our-own-way

[4] https://share.transistor.fm/s/43dad61e

 

[613jono]

@mdnich Almost all of my investors told me that they don’t care about the money and that they have written off my company already.

But I would have really liked the YC investors where they offer their shares back for $1. That could have helped me clean up the cap table and consolidate.

But I understand why most of them wouldn’t. Even if a startup has turned into lifestyle business with limited customers, or slow or no growth, there’s always a chance that startup pivots and turns into a high growth engine. Some founders have pulled it off after 5-10 years of being in operation.

 

[heaven1me]

@613jono How do they write-off the investment from a tax point of view if the company has not dissolved?

 

[feelinglost7896]

@mdnich I put a "put" clause in the term sheet that gives me the right to force founders to buy my shares back with 8% interest after 7 years. I don't fund lifestyle businesses

 

[matchfox]

@feelinglost7896 So you want a risk free angel/ venture investment

I’m not sure that is reasonable.

 

[feelinglost7896]

@matchfox The people down voting aren't angels. I just did this and the put option was one of the most often cited reasons for 85 investors to like the term sheet. People obviously don't understand how or why the put option would come into play.

Now be good little iggits and down vote this also. Or you can ask Qs.

 

[matchfox]

@feelinglost7896 Of course the investors would like that term.

Unless the company goes dead they get their money back with 8 percent interest.

If the company hits. You win . If it doesn’t you get your money back. Eliminates almost all risk. So yeah. They investors love that.

Also not sure I know a founder that would accept it without being desperate.

 

[feelinglost7896]

@matchfox Put options are not in every deal, but they aren't uncommon. They are more common in VC deals than angels bc most angels are amatuers. Why do you think a founder wouldn't like that deal?

 

[matchfox]

@feelinglost7896 Put options on angel and VC are rare to my knowledge.

They are often tied to market value of the company and do not ensure a return. They are more used to protect investor liquidity options. Again. From what I have seen.

They generally also have restrictions around trigger events and balance sheet requirements as to not damage the company.

The put option as you mentioned it is extremely one sided in favor of the investor.

 

[feelinglost7896]

@matchfox

The put option as you mentioned it is extremely one sided in favor of the investor.

The SPA is 156 pages. What I mentioned in one sentence is 100% true but hardly the whole story.

 

[feelinglost7896]

@matchfox When would it be triggered and why would founders not want it?

 

[matchfox]

@feelinglost7896 I’m not sure I understand the question.

I answered why a founder would not like it already. There is no benefit to them only risk. If the companies value is lower (not all that uncommon… most companies that received investment have had no change in outlook but valuations have dropped considerably) would have to buy back at a non market rate. Why would they want this? What advantages are there for the founder?

 

[feelinglost7896]

@matchfox You're hung up in a paradigm of your own creation. A founder who is on a track of go big or go home doesn't care and hopes people give them an 8% loan. Cheap money for a startup.

Without a put option, what do you do as an investor if the biz is doing good but not great? The founder is making $1-2M a year in profits and has reached an age that getting several more mil over the next few years till the tech goes stale is a good option for the founder. As an investor you can't force dividends, without a put you can't force a sale. Who you gonna call besides ghost busters to get your money out?

If the company can't afford the buy back, the investor would be stupid to force a rebuy bc then every one loses.

 

[matchfox]

@feelinglost7896 I’m not hung up. It’s one sided. You keep saying it protects the investor… I agree it’s one sided.

No one goes for funding hoping for anything else than a big win. That doesn’t mean I’m gonna take a bad offer.

Generally a company going for funding that is deserving funding will have multiple options for funding.

A VC who wants to put that in is not as attractive as a VC who wouldn’t put that in.

 

[feelinglost7896]

@matchfox Of course it is reasonable. And of course I want a risk free investment but it's not risk free. The company could be insolvent when the option is due. If the company is doing well, I of course won't exercise.

 

[nizz]

@mdnich We have what you would call a “lifestyle” business and pay our angel investor his share of the net profits every month. He has more than 10x’s his initial investment at this point. We arent keeping any of the net in the bank. Are we a “Zombie” company? Maybe we are but why wouldnt any investor be thrilled with this setup? He gets a dump of free cash every month that has grown every year and has long since paid off his initial investment. Not every company needs to become huge to be a win.

 

[613jono]

@nizz What is it that you guys do?

 

[nizz]

@613jono We own and operate a network of garage, yard and estate sale listing sites. See estatesales.org and treasurelistings.com

 

[613jono]

@nizz Wow very nice

 

[symone]

@nizz You are not a zombie company if you are returning dividends to your Angels. I am in a Zombie company where my investment just sits there (16 years and counting) and not one penny returned to me. They have cash flow to keep business going but will never be bought out. Owner basically uses it as a way to 401k fund his personal retirement. So annoying