A Bargain, or Brewing Bankruptcy?

I'm not a Maxinista, but I often liken myself as the "Big Lots" of the VC world. You can buy basically anything at a Big Lots - from furniture to food and everything in between. Hell, they even sold 100 Deloreans in the 1980s. While the inventory is always changing, everything is always priced as cheaply as possible. 

I don't really care about aesthetics, have a go-to industry, or maintain a consistent investment stage. I only care about finding the right deal at the right price - it could be a pre-seed health tech deal, or an A-stage cloud deal. Although I do have favorite industries, founder types, and stages - finding alpha is my guiding light. 

Big Lots had their own version of alpha in the retail world for many years - and even sported a $2B valuation just three years ago. Now, sales are declining, losses are piling up, and their debt/lease liabilities look like Mt Everest. In fact, revenue is actually below Great Recession levels, and its survival is now very much in doubt. While some meme traders are gambling on the stock, its $42m market cap is not exactly sustainable. 

Big Lots is not a startup, and not a software company. But, they’re in the throes of fighting for survival - on a sinking ship, without a life raft. Several heavily backed startups from 2020/2021 are in the same fight. And, the parallels are striking. Top heavy with debt, trying to patch leaky revenue, losing morale, and struggling to lower heavy burn rates. Most of these companies have pretty tangible revenue, but no viable path forward – and pretty limited acquisition prospects (outside of acquihires). It’s like a beautiful yacht that’s survived a hurricane, but is too badly damaged to ever float again. While it’s still a yacht, it’s an unusable one that’s probably not even worth the salvage value. 

I’ve encouraged portfolio company founders to explore small acquisitions for many years, especially in the last year or two. There is a huge number of mostly orphaned venture backed companies out there - including some companies that would create real shortcuts and synergies. From a new client flywheel to a cool point solution/product and even cheap revenue (to pass the $5m or $10m ARR thresholds) – the benefits (vs the cost) can be substantial. However, there are also plenty of dangerous deals…the stories might all be a bit different, but the culprits are almost always the same. 

The first issue is too many big liabilities - from unwieldy preference stacks to heavy unearned revenue and actual debt. If a company is thriving, and easily able to raise money or generate cash flow - debt can be an accelerant. But, if the growth reverses and metrics get ugly  - the company has to essentially find an immediate path to real profit. The second issue is that most startups cannot get profitable without destroying their business. And if they can’t generate cash flow, they encounter the third, often fatal issue - lack of investment and acquisition options. Once a debt saddled company desperately needs a white knight acquirer, or investor - they’re usually out of real options. Distressed venture investors are few and far between - and they know they can pay pennies on the dollar. Acquirers are no different, and often use this massive leverage to get the best possible deal (including letting the company file for bankruptcy and buying the assets). Insiders can occasionally bail out the company, but they’re usually looking for something new and shiny – not a badly damaged property with baggage. 

Big Lots is stuck in this vicious cycle - and though it’s tempting to chase a bargain basement deal, it’s a dangerous game. The business is currently swimming into a rip current - and pivoting might be impossible. Once a Company exhausts reasonably priced debt, and starts running out of runway, it loses all its maneuverability. And once a stressed Company loses its ability to shift and pivot, it really only has one option - pray for a miracle.Miracles do happen, but they’re not exactly selling them at your local Big Lots. I really do hope that Big Lots finds their own miracle, or meme movement - otherwise, I’ll have to find a new analogy. And, I don’t necessarily identify with Walmart or Dollar General.