As the venture capital market cools, a different type of startup investor is preparing to pounce

Krista Morgan knows how difficult it is to create a startup. She also knows how quickly everything can fall apart.

In 2012, Morgan founded P2Binvestor, a lending marketplace for small businesses. By 2019, the company had issued more than $1 billion in loans, and its annual revenue exceeded $10 million. Then disaster struck: one of P2B’s clients was a subsidiary of another company owned by Michael Mann, then CEO of MyPayrollHR. Mann, it turned out, had perpetrated a $100 million bank fraud. When the scheme collapsed, P2Binvestor had lost nearly $10 million that it could not afford to lose. Man pleaded guilty and was sentenced to 24 years in prison, and P2Binvestor found itself on the verge of collapse.

“I had this experience of being on the adventure path and thinking that I was, you know, going all the way,” Morgan says. “And then it ends.”

With her company struggling, Morgan began working with Dan Frydenlund, the founder of a Denver-based investor called Stage that specializes in turning around venture capital-backed startups that have fallen on hard times. Morgan eventually sold P2Binvestor – today it is part of Aion, a larger enterprise software provider. But she made a strong impression on Frydenlund. He asked Morgan to join Stage, and in 2020 she joined the firm as a general partner.

Now Morgan is working with Frydenlund and a third general partner, Ingrid Alongi, to help other startups avoid the fate that befell her.

The typical venture capital model is based on a few home runs and a lot of strikeouts. One or two companies from a venture capital fund might achieve that mythical unicorn status, and the rest would fall by the wayside. That’s where Stage comes in. The company acquires majority stakes in startups that have raised a Series A round from other companies but no longer show the kind of growth that would lead to future funding, let alone a billion dollar valuation or an IPO. Stage’s team of former executives and operators helps these companies recapitalize their balance sheets and reorient themselves to a more financially conservative and hopefully profitable future, serving as an alternative to startups that might otherwise close their doors.

“We bring a private equity model to a venture-stage company and we put them together,” says Morgan.

Stage has acquired 19 companies and recorded nine exits since Frydenlund launched in 2009, with many of those sales going to other private equity firms. But the activity has accelerated since Morgan and Alongi arrived on board. Last year, Stage raised about $10 million, its first institutional vehicle after years of investing Frydenlund’s money. He used that fund to buy six startups, including ThirdChannel, which makes software for retailers and e-commerce brands, and Haystack Mountain, an artisan cheese brand. Now Stage is raising a $50 million successor vehicle.

This fund may come at the perfect time. After many years of a largely bullish startup market, things have changed in 2022, with funding totals downward trend in the wake of a record year 2021. If valuations start to fall and VCs become more cautious, it could create more opportunities for an investor like Stage.

“I think valuations are down, and I think it’s going to be harder to rise next cycle,” Morgan said. “What I think is interesting is that because there’s been so much more money at this early stage, you’re actually going to have a lot more Series A companies that are viable, that have built a real product that people use.”

This can be a difficult strategy to pitch to LPs. If Stage buys companies that other venture capitalists don’t find worthy of future funding, what makes Stage think it can generate the same kinds of returns that other companies are promising?

“That’s 100% the point,” Morgan says with a laugh.

But she has an answer. According to PitchBook, there have been more than 40,000 venture capital investments in the United States alone in the past three years. And about half of all startups that raise a Series A round fail to raise a Series B, per Crunchbase. Morgan’s pitch to LPs is this: do you think all those thousands of companies that don’t create a Series B are doomed? Or could they simply not fit the traditional venture capital model?

When it comes to these particular companies, Stage thinks they have a better approach. Instead of flooding founders with money and letting go to try things and quickly fail, Stage works closely with management, with the goal of building a sustainable business rather than achieving hockey stick growth. So far, Morgan says the company’s LPs have seen an average return on their investment of between 5x and 8x.

“The VC model has created some amazing businesses, and there’s absolutely a place for it,” Morgan says. “The problem we have in the tech world is we’re kind of like, it’s a unicorn or nothing, right? It’s this binary, like you’re good if you were getting venture capital and bad if you’re not. And that’s what I want to change.

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