A Few Thoughts on Recaps

This week I caught up with a VC investor. He shared that he’s working on a deal recap deal. The company raised in 2021 at an inflated valuation, hasn’t grown into that valuation, and is running out of cash. The proposed valuation is a material discount from the 2021 valuation, which the investor finds interesting.

I’ve pondered recap deals quite a bit in 2023. A few thoughts:

  • An investment being attractive because it’s discounted from an inflated valuation doesn’t make sense to me. A discount on an overpriced item doesn’t guarantee it’s a good buy—just that it’s less overpriced. It’s more logical for an investor to independently determine what the company’s worth given the current (not projected) traction. If the proposed price is less than (or equal to) the investor’s independent valuation, it could be an attractive investment for that investor. If it’s more, not so much.
  • It isn’t easy for CEOs who founded companies in the growth-at-all-costs era to adjust their mindset about how they’ll grow. That being so, for an investor, it’s critical to understand whether the CEO has really bought into efficient growth with a focus on eventually generating cash flow or rather still believes in growth at all costs and is waiting for things to “get back to normal.” I’ve found that many CEOs will say they’ve made the adjustment, but their actions tell me they still have the old mindset. I believe that efficient growth is significantly harder than growth at all costs and that significantly fewer CEOs are capable of succeeding at the former.

I suspect we’ll continue to see recaps in 2024, and as the earlier recaps succeed or fail, investors will start evaluating opportunities more deeply than just looking at discounts from inflated valuations.