February 28, 2024

Why VCs are investing in startups that help other startups shut down

Reading Time: 6 minutes

In one of the VC world’s greatest ironies, investors have lately been clamoring to back startups that are helping other startups shut down. So whether a VC-backed startup is succeeding or shuttering, investors themselves are finding ways to make returns for their limited partners while also helping founders move on more quickly.

And with an estimated 90% startup failure rate, there appears to be no shortage of potential customers for companies who specialize in unwinding other companies.

As one seed-stage investor recently bemoaned on X, ‘Wind downs are sad, emotional and hard enough. Add the legal, financial and logistics work and it doubles the pain. I feel for founders going through this.’

Sadly, in 2024, it’s an even bigger-than-typical pain point that needs addressing. While the market was flooded with venture capital in 2021, funding has since slowed globally. For example, Crunchbase News recently identified a sample set of 28 private companies that have a peak valuation of $1 billion or more but haven’t raised a round for years. Some 3,200 private venture-backed U.S. companies went out of business last year, according to Pitchbook data. So it’s safe to assume that 2024 will be another year where a lot of startups will shutter.

That’s clearly why investors have begun backing startups that help other VC-backed startups return unused capital, auction or otherwise dispose of their assets, or sell themselves off wholesale to shut down. Today alone, Sunset announced it has raised $1.45 million in seed funding — mostly from a group of angel investors. And, SimpleClosure, whose tagline is ‘Shutting down sucks,’ announced that it has raised $4 million less than six months after it raised $1.5 million in pre-seed funding. Both claim to make the process of closing a company more affordable, quicker and less complicated.

It’s not just new startups getting into the helping companies wind-down game. Earlier this month, equity management startup Carta revealed that it was getting into the game as well with a new offering called Carta Conclusions.

It’s important to note that this isn’t a new business. It’s just a more openly talked about one. And one that has recently become more attractive to investors.

Martin Pichinson, co-founder of Sherwood Partners, which has been helping startups wind down since the dot.com bust in 2000, puts it like this: ‘This industry is going to have more failure, but they [venture capitalists] are smart enough today to cut their losses.’

Infinity Ventures co-founder and managing partner Jeremy Jonker, whose firm just led SimpleClosure’s latest financing, notes that ‘we are seeing a meaningful increase in startups facing challenges.’

‘Historically, these startups raised at robust valuations and have not grown into the metrics necessary to raise an up round,’ he wrote via email. ‘As such, they are facing the question of raising at a meaningful down round, selling the company, and/or potentially shutting down the business. I think the addressable opportunity for SimpleClosure is sizable and increasing every day.’

What startup shutdown companies do

As is often the case, at least one of these startups was formed out of experience. The founders of Sunset — Brendan Mahony and Grant Rheingold — had themselves endured the pain of having to deal with a previously failed business and determined that there had to be a better way. Mahony started Toybox, a Y Combinator alumni company, in 2017 before selling it in 2020. He then founded another company, Contrast, that shut down a year later. Mahony and Rheingold started a company called Second Spoonful that ended up closing a year later. The pair teamed up to build Sunset in 2023 and recently raised money from a group of mostly angel investors in a nontraditional financing that involves offering a greater equity stake for referrals. Their goal, in their words, is to serve as ‘a one-stop shop’ for businesses looking to wind down by handling the legal, accounting and operational aspects that go into winding down. 

‘Sunset’s mission — to streamline the shutdown process and support founders in rebounding — resonates with me on a personal level,’ said Lee.

Dori Yona came up with the idea for SimpleClosure when building his last company after being tasked by a board member to create a ‘shutdown analysis.’ The process was so complex, Yona felt compelled to build a platform to help automate the shutdown process. Demand has been so great that the young startup has already crossed seven figures in annualized revenue, according to Yona. Since SimpleClosure’s launch in February of 2023, the startup has seen its revenue grow by more than 14x and its customer base by over 6x. Those customers include CRBN, Lance Global, Kripsy and Peak Health — all of which have completed the shutdown process.

‘I knew that there was something unique to build here, but I didn’t know how big it could be,’ Yona said. ‘We’re building a software technology platform to help automate and streamline the process. Think about it like a TurboTax for shutting down.’

Both companies typically work with VC-backed tech startups, but not exclusively.

‘Most are returning capital to investors,’ Mahony explained. ‘Several companies have potentially millions in debt and need to negotiate that debt obligation with their creditors so we work on doing that with them as well.’

Notably, he said, many companies have decent ARR but realized they just weren’t ‘venture scale,’ and thus had to wind down.

Witnessing so many companies go through that problem made Mahony and Rheingold a bit reluctant to raise a lot of venture funding. So when Sunset recognized it needed some capital to scale its team, the pair decided to mostly take money from ‘a lot of prominent angels,’ working closely with Hoover on a structure ‘that will potentially pay out dividends to investors over time.’

‘We also purposefully really wanted to raise from folks who had strong distribution networks in the tech world,’ Mahony said. ‘To potentially incentivize them to send companies our way, we opened up a stock option pool solely for our investors and when they refer us customers or channel partners, we issue them further stock options based on the contract value of those customers.’

Meanwhile, Infinity Ventures led SimpleClosure’s recent ‘oversubscribed’ fundraise, which also included ‘strong’ participation from Anthemis Group, Foxe Capital and existing backers. A number of new angel investors also joined the round, including executives from software companies such as Deel and Intuit, as well as venture firm partners. 

Infinity Ventures’ Jonker believes that SimpleClosure is building a platform ‘around a process that has historically been manual and cumbersome.’ Plus, its mission benefits the whole venture ecosystem, in his view.

‘At Infinity, it is our passion to support entrepreneurs and foster the entrepreneurial spirit. The faster we can help these builders to close one chapter, the quicker we get them back to their next endeavor,’ he wrote via email. ‘This benefits all stakeholders involved, including entrepreneurs, investors, employees and governments.’

Carta did not respond to requests for comment about its new product. But in a blog post, CEO and co-founder Henry Ward wrote that Carta Conclusions was aimed at helping founders ‘who have decided they want to dissolve their company.’

Helping startups auction their assets or their whole company

One thing that many of us wonder about is what exactly happens to a company’s assets and intellectual property when it is wound down. Surprisingly (or not), some of these startups still have some positive outcomes for the main stakeholders.

For example, many companies turning to Sunset so far have approached the company while currently in the process of selling their assets.

In many cases, ‘they’re already talking to potential buyers, doing an asset purchase sale or drafting an asset purchase agreement,’ Mahony said. ‘But even in those cases, you’ll still have a stay-behind entity that needs to get wound down.’

Sunset recently partnered with Acquire.com because, as Mahony puts it, many acquisitions that happen on that platform are also asset purchase sales or acqui-hires.

‘So we do work with companies that have really happy endings,’ he said. ‘It’s not all doom and gloom.’

In some cases, instead of doing a stock purchase, where an acquirer would buy all the stock of a company, some startups opt to sell just the intellectual property, code base, trademarks, the name and domain name.

‘We’ve helped companies auction their IP,’ Mahony said. Those auctions can either be closed, where it’s only stockholders that can have a shot at buying it, or they can be more open, where ‘everyone can put in their bid for the IP.’

In other cases, founders are going the stock purchase route and then Sunset can help with tax implications and any ‘potential liabilities,’ Mahony said.

‘You can imagine there are a lot of folks out there who are interested in buying up some of these startups,’ he added, ‘who again, may be doing really well and are a great business but aren’t necessarily venture scale. We’ve helped initiate introductions [for founders] to those types of buyers.’

Most startups are Delaware corporations, and based on Delaware law, Yona said, founders are supposed to try and monetize those assets. SimpleClosure too also helps founders that are trying to sell the company’s code base, platform or team.

‘They’re really, really trying to exhaust asset sales,’ he said. ‘But the interesting thing is that even if you do go through an asset sale, you still need to wind down the shell entity or the corporation that created it.’

In some cases, founders or investors purchase the IP.

‘We don’t always know the intent, but we have seen cases where’ using that IP to potentially start another business ‘was the plan,’ Yona said.

While SimpleClosure is mainly focused on tech startups (bootstrapped to Series C stage) in industries such as crypto, real estate, healthcare and fintech, Yona noted that the company has been ‘getting a lot of demand’ from non-startups.

Notably, though, when it comes to fintech, it appears that ‘a lot of consolidation’ is happening, Yona said.

‘A lot of companies are doing asset sales that you just don’t hear about,’ he added.

For Infinity Ventures’ Jonker, SimpleClosure is tackling a historically ‘opaque, manual and cumbersome process that changes meaningfully by state and by industry.’

‘Also, shutting down a company is somewhat taboo, despite the fact that more than 1 million businesses fail in the U.S. each year,’ he said.  

Reference: https://techcrunch.com/2024/02/27/vcs-back-wind-down-failed-startups/

Ref: techcrunch

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