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Private Equity Finds New Buyout Opportunities in Venture-Backed Startups

Private equity is finding a new source of deals: venture-backed startups. The recent shift in early-stage dynamics means that once out-of-reach opportunities are now in play, and sponsors are increasingly stepping in to acquire startups that have struggled to find traditional exits.

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Data compiled by tech-focused investment bank Clipperton show the volume of venture capital exits to private equity buyers has tripled over the past decade. From 2006 to 2010, only 8 percent of venture-backed startups exited to buyout firms. From 2021 to the first half of 2023, that figure jumped to 24 percent of total exits.

Such transactions have generally fallen into two distinct buckets: (1) high-performing startups that find an IPO less feasible in today's conditions or for whom larger strategics haven't come knocking with the same valuation premium they once might have; and (2) slower-growth startups who may have been written-off by their backers and are struggling to raise additional funding, but who have still built a sustainable business, or at least something of real value.

For the second bucket, in particular, tighter fundraising conditions can mean that venture's rejects are now a higher-quality group of targets than they might have been in years past—when they would have had no trouble raising their next round.

And, as we've covered in recent months, the general slowdown in exit opportunities means that venture capital may now be more likely to push for any exit they can get, even if those exits don't exactly hit the lofty valuations that they'd hoped for. This is especially true for their more middling portfolio companies, which may not have a clear path to a home-run outcome.

While many startups lack the requisite scale for a platform, they’re often interesting options for an add-on acquisition. This type of deal can be particularly appealing for sponsors with a services-first platform who may be looking for opportunities to unlock higher-growth and recurring revenue business lines (and an accompanying bump to their exit multiple).

The best-fit deals can provide interesting vertical-specific product synergies by leveraging underutilized (or not yet collected) proprietary data from the existing platform to build a differentiated SaaS offering that would not have been possible for either party on their own.

That said, these acquisitions still face the same fundamental hurdles they always have. Later-stage sponsors are not usually amenable to cash-burning purchases that re-lever their platform. Earnouts and other unique structuring options have become a popular workaround, though even if the seller is receptive, that may not be enough.

The upshot is that many venture-backed startups are finding themselves in a rush to hit profitability much earlier than they would have expected—either to increase the odds of a sponsor-backed exit or just out of necessity when additional fundraising is slow to materialize.

Sam Hillier

Sam Hillier is a reporter at Transacted covering private equity and investment banking. He previously spent time as an investment professional focused on middle market buyouts.