ABSTRACT
Living dead” investments represent the middle ground of venture capital investing outcomes, lying between “winners” that produce adequate multiples of return on investment and “losers” that result in loss of invested funds. Living dead investments are typically mid- to later-stage ventures that are economically self-sustaining, but that fail to achieve levels of sales growth or profitability necessary to produce attractive final rates of return or exit opportunities for their venture capital investors. This article reports the results of a survey of 80 U.S. venture capital firms that investigated the living dead phenomenon and strategies used by venture capital investors to deal with living dead companies.
Venture capital managers reported that living dead conditions were usually caused by deficiencies in investee management, particularly in responding to market conditions, as well as markets that were too small or two slow growing, missed opportunities, and unanticipated competition. The timeframe of this phenomenon is typically after product development and initial sales have been achieved and during the “rollout” stage of pushing for rapid growth and market share. The key characteristic of living dead companies in the eyes of their investors is their very poor prospects for producing a successful exit for their investors, usually because of more limited growth than originally anticipated or inadequate profitability. Although the rate of return boundaries for living dead companies were wide, ranging from a rate of return (ROR) of 0% on the low side to 10% on the high side, most were described by venture capital managers as economically self-sustaining in the near term, and a number of living dead companies had reached $5 M to $15 M in revenues. Thus the concept of a “living dead investment” is specific to the context of venture capital-backed investing, and represents primarily a failure of investor expectations as distinct from an economic failure of the venture. Overall, the 80 venture capital firms projected that 20.6% of their investments would end up as “living dead” companies by the point of final distribution.
When living dead situations occur, venture capital managers use a number of strategies to 350attempt to turnaround these companies or to achieve an exit. The most-often-used strategy was to attempt to sell or merge the company, but usually only after one or more preliminary steps to turnaround the company had been attempted first, including replacing investee management, “repositioning” the product, and making revisions to the venture opportunity strategy. Firms that projected lower percentages of living dead investments at distribution, as well as firms using high rate-of-retum targets for their portfolios, were slightly more likely to use active intervention strategies to turnaround or liquidate living dead investments than firms that expected higher percentages of living dead companies at distribution or firms that used lower rate-of-retum targets. Overall, venture capital managers were able to achieve a successful turnaround or exit in only 55.9% of living dead situations, and these results were unrelated to the age of the venture capital firms, their size, or the relative availability of investor personnel for monitoring investees. This result, in conjunction with the high number of causal factors identified for living dead situations that involved adverse market factors, suggests that successful or unsuccessful outcomes with living dead investments may be largely determined by the underlying causation of the living dead problems, and whether or not these causal factors are controllable by the venture capital investors. Inadequate investee management and internal operational problems can potentially be remedied by venture capital investors, whereas markets that are too small or too slow-growing, or severe industry oversupply conditions are largely outside of their control.
