From: myfirstmillionpod
Special situations investments, particularly in venture-backed companies, present a unique opportunity in the current market. These situations arise when businesses with strong fundamentals are hampered by misaligned capital structures or investor expectations, rather than inherent operational problems [00:28:35].
The Opportunity in Distressed Venture Assets
A significant opportunity exists in a specific class of venture-backed companies, particularly those that raised substantial capital in 2020 and 2021 [00:28:38]. These companies can appear to be “distressed” not because their core business is failing, but because their capital structure, or “cap table,” is broken [00:29:50].
Characteristics of these Businesses
- Strong Revenue and Growth: A typical example might be a business generating $10 million in annual revenue and growing at 30% per year [00:28:50].
- Overcapitalization: Despite strong performance, these companies often raised excessive amounts of funding, sometimes as much as $50 million [00:28:57].
- Misaligned Incentives:
- Founders: Due to a high “pref stack” (preferred stock stack), founders might find themselves in a position where they will not make any money, despite the business’s success [00:29:02].
- Venture Investors: Venture investors, who typically seek fund-returning investments, may not see sufficient returns from these companies given their capital outlay [00:29:08].
- “Worthless Asset” Paradox: A company might be a fundamentally “great asset” but, due to its cap table, is effectively “worthless” to its current investors and founders in terms of desired returns [00:29:18].
- Waste of Venture Returns: This situation is seen as a “weird kind of vestige” of periods with exceptionally high venture returns, leading to “waste” in the form of 20 million, or $30 million annual revenue companies that aren’t generating profit for anyone [00:30:33].
Addressing the Discrepancy
The strategy for these special situations involves acquiring these businesses at a lower cost than otherwise possible due to their complex incentive structures [00:30:49]. The goal is to restructure the ownership to create a scenario where:
- Founders gain a significant stake (e.g., from 10% to 30%), allowing them to run the business profitably [00:30:06].
- Venture investors can divest themselves of non-returning assets that consume their time and resources (e.g., board responsibilities, audits) [00:30:20].
This approach creates a “win-win” where everyone is better off because the puzzle of misaligned incentives is unlocked [00:31:48]. This contrasts with traditional distressed businesses where the underlying operations are typically broken [00:30:56].
Tiny, a company known for its investment strategies and venture creation, has successfully executed these types of deals [00:29:38]. Initially, Tiny found opportunities in bootstrapped businesses, which were once considered a “special situation” [00:31:12]. Jeremy is particularly interested in pursuing more of these “special situations” personally [00:29:43].