As the venture capital market cools, a different kind of startup investor prepares to jump in

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

In 2012, Morgan founded P2Binvestor, a small business lending marketplace. By 2019, the company had issued more than $1 billion in loans, and 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. It turned out that Mann had been perpetrating a $100 million bank fraud. When the scheme collapsed, P2Binvestor lost nearly $10 million that it could not afford to lose. Mann pleaded guilty and was sentenced to up to 24 years in prison, and P2Binvestor found itself on the brink of collapse.

“I went through this experience of being on the road with the company and I thought I was going to, you know, go all the way,” says Morgan. “And then it just ends.”

With his company in trouble, Morgan began working with Dan Frydenlund, the founder of a Denver-based investor called Stage that specializes in bringing back startups backed by companies that have fallen on hard times. Morgan eventually sold P2Binvestor; today, it is part of Aion, a larger provider of business software. But he impressed Frydenlund. He asked Morgan to join Stage, and in 2020, she joined the firm as a general partner.

Now Morgan works 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 in a venture capital fund can achieve that mythical unicorn status, and the rest fall by the wayside. That’s where Stage comes in. The firm acquires majority stakes in startups that have raised a Series A round from other firms but no longer show the kind of growth that would lead to future funding, let alone a $1 billion valuation or initial public offering. . Stage’s team of former executives and operators help such companies recapitalize their balance sheets and reorient themselves towards more financially conservative and hopefully profitable futures, serving as an alternative to startups that might otherwise go bankrupt.

“We’re taking a private equity model to a venture stage company and bringing them together,” says Morgan.

Stage has acquired 19 companies and registered nine exits since Frydenlund was launched in 2009, with many of those sales going to other private equity firms. But activity has picked up since Morgan and Alongi joined. Last year, Stage raised a fund of roughly $10 million, its first institutional vehicle after years of investing Frydenlund’s own money. It used that fund to buy six startups, including ThirdChannel, which makes software for retailers and e-commerce brands, and Haystack Mountain, a brand of artisanal cheese. Now, Stage is raising a $50 million successor vehicle.

That fund may be coming at the perfect time. After many years of a largely bullish startup market, things have changed in 2022, with funding totals trending lower in the wake of a record 2021. If valuations start to decline and venture capitalists become more cautious, it could create greater opportunities for an investor. as stage.

“I think valuations are going down and I think it’s going to be harder to move up the next round,” says Morgan. “What I think is interesting is that because there has been a lot more money in that early stage, you are actually going to have a lot more Series A companies that are viable, that have created a real product that people are using. ”.

It can be a challenging strategy to release vinyl records. If Stage is buying companies that other venture firms don’t see as worthy of future financing, what makes Stage think it can deliver the same kinds of returns those other firms promise?

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

But she has an answer. There have been more than 40,000 venture capital investments in the US alone in the last three years, according to PitchBook. And roughly half of all startups that raise a Series A round fail to raise a Series B, according to Crunchbase. Morgan’s pitch for LPs is this: Do you think all those thousands of companies that don’t raise a Series B are doomed? Or is it possible that they are not the right fit for the traditional venture capital model?

When it comes to these companies in particular, Stage believes it has a better approach. Instead of showering founders with money and setting them free to try things and fail fast, Stage works closely with management, with an eye toward building a sustainable business rather than hockey-stick growth. So far, Morgan says the company’s LPs have posted an average return on their investment of between 5x and 8x.

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

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