What Are “Living Dead” Investments in Venture Capital?

Table of Contents

• Introduction
• What is a “Living Dead” Investment?
• Can These Companies Be Saved?
• What Happens After Restructuring?
• What is an Acqui-hire?
• How Do VCs Get Out?
• The Reality of Living Dead Investments
• Interested in Learning More?

Introduction

When we think about Venture Capital (VC), we usually picture high-flying startups or unicorns hitting billion-dollar valuations. But the truth is, not every investment ends up a winner—or a complete failure. A large chunk of VC investments, around 20-30%, fall into a gray area known as “living dead” investments. These companies aren’t exactly booming, but they’re not crashing and burning either. They just sort of… exist, stuck in limbo.

These living dead companies can keep going, but they don’t offer much growth or returns, which becomes a big headache for investors. Let’s break down how VCs deal with these kinds of investments and why they matter.

What is a “Living Dead” Investment?

A living dead investment is a company that has positive cash flow but isn’t growing. It’s not making enough money to be exciting, but it’s not losing so much that it’s going under either. It’s just… there 🤷‍♂️. These companies weigh down VC portfolios because they eat up time and resources without delivering the big returns VCs want. If no one steps in to fix things, living dead companies can slide further down the path of underperformance, stress, and eventually insolvency.

Can These Companies Be Saved?

Restructuring 101

When a startup lands in the “living dead” zone, VCs sometimes try to turn things around through restructuring. This involves making some tough calls to squeeze whatever value they can out of the company.

Here are a few strategies VCs use to try and save a sinking ship:

• Refocus and Sell: They might sell off assets like intellectual property (IP) to bring in some cash. They’ll also lay off staff to cut costs and maybe even pivot to a new business direction.
• New Leadership: Sometimes, the original founders just aren’t the right people to save the company. In these cases, VCs bring in a new CEO or CFO to clean things up and make smarter decisions.
• Renegotiate Costs: This could mean cutting salaries, renegotiating leases, or trimming down on service costs like rent.

Restructuring doesn’t always save the day, but it can help prolong the company’s life and make it more attractive for a potential buyer.

What Happens After Restructuring?

Once a company has been restructured, VCs have a few options for what to do next. Here are the most common:

• Let it Drift: Sometimes, the company isn’t worth putting any more money into, so the VC will just let it operate on its own without any more investment.
• Merge with another company: The VC might merge the company with another in their portfolio to create something bigger and hopefully better.
• Sell to LPs: VCs can sell their stake in the company to Limited Partners (LPs), giving them an exit and letting the LPs handle it.
• Management Buyouts (MBOs): In some cases, the company’s management team might step in to buy the company from the VC firm.
• Acqui-hire: If the team behind the company is great but the business model isn’t, a larger company might acquire them just to get the team. This is called an acqui-hire, and it’s a way to salvage some value from a failing business.

What is an Acqui-hire?

An acqui-hire happens when a company buys another one just for its team. Maybe the startup didn’t have the best product or business, but it had talented people. In these deals, the acquiring company might pay a decent price per engineer or product manager.

Acqui-hire deals usually include:

• LOIs and Asset Purchase Agreements: The paperwork needed to make the deal happen.
• Lock-up Periods: The team usually has to stick around for a couple of years, and there’s often a four-year vesting period for any equity they get.
• Retention Bonuses: Engineers and team members might get bonuses to stay with the new company, but these are often paid in cash rather than stock options.

How Do VCs Get Out?

The Secondary Market

For VCs, one of the most appealing ways to exit a living dead investment is to sell it on the secondary market. This is where other players in the investment world come into play.

Here are the most common buyers for living dead companies:

• Other VC Funds: Sometimes, other VC funds will buy living dead companies at steep discounts, often as part of a consolidation play or acqui-hire.
• Fund of Funds: These funds usually allocate 15-20% of their money to secondary deals but are cautious about investing in living dead companies unless they get a really good discount.
• Dedicated Secondary Funds: Some funds focus specifically on buying these types of companies. They have the resources and expertise to manage them better.
• Family Offices: These buyers are becoming more common. They’re interested in potential M&A targets and sometimes use the opportunity to turn into Limited Partners (LPs) in VC funds.

The Reality of Living Dead Investments

Living dead investments are a part of the VC game, like it or not. Not every startup will be a unicorn, and many will end up somewhere in the middle, just hanging on. Managing these companies properly, whether through restructuring, acqui-hires, or selling on the secondary market, is crucial for minimizing the drag on VC returns.

At the end of the day, living dead investments might not be exciting, but they don’t have to be a total loss. Knowing how to handle them can be the difference between getting some value out of a company and writing it off entirely.

Interested in Learning More?

If you’re curious about the stages of funding in Venture Capital, check out our post on Financing Rounds in Venture Capital. It breaks down the different stages—like Series A, B, and C—and explains how startups progress (or sometimes stall) during each phase.

On the flip side, if you want to dive into the more challenging side of VC, don’t miss The Dark Side of Venture Capital. This post uncovers the harsh realities that founders often face when dealing with investors, from the pressures of high growth expectations to the risks of losing control over their companies.