Non-Linear Growth

A glimpse around the next corner; mind the curves.

March 30, 2012 • 8:52 am 0

Introducing Digital Fortress

Today, my Partners and I at Meritage Funds announced that we’ve established a new platform in the data center colocation market. Headquartered in Seattle, WA, Digital Fortress operates nearly 50,000 square feet of data center colocation space, focused on delivering high-power density installations to enterprise customers. A  Meritage Funds blog post announcing the investment has much more on our thesis and goals for the investment.

Getting this transaction done was a long an arduous process. In earnest, we began evaluating the Pacific Northwest data center market in October 2010. What we found was a fragmented market that had great supply-demand characteristics. In addition, the market has great power-dynamics, meaning that power is cheap, stable and largely from renewable sources. It blows my mind every time I cite this statistic, but over 95% of the power in metro Seattle is from renewable sources, principally because of the huge hydroelectric energy production in eastern Washington state.

It was easy to see there was a great opportunity for data center operators in the PNW. But, finding an entry point into the market was a bear. Because the market is fragmented, there was no natural starting point. Rather than buying a platform, we would have to create one. In the end, we made that happen by completing the simultaneous acquisitions of two data center operators that happened to be located in the same building. In concept that sounds easy. From first hand experience, I can tell you it was really hard. There were an incredible number of moving parts here, including simultaneous negotiation, documentation and diligence processes on both acquisitions, a debt syndication, an equity syndication, and most importantly, the establishment of a new management team which has the chops to achieve our goals for the investment. In all, executing the transaction took the better part of ten months.

In the end, it was worth it. Overnight, Digital Fortress has become the leading independent colocation provider in its market. We’ve established a strong leadership team with the addition of Mark Hughes (former EVP of Operations at SunGard) as Executive Chairman and Tim Doherty (former CEO of Fortress Colocation) as Chief Corporate Development Officer. Already, the Company is executing its expansion plan with the announcement of a new facility in downtown Seattle. With our equity partners, Halyard Capital and Sweetwater Capital, we have dry powder to fund further organic and acquisition-based expansion plans.

If you believe that the hard things are the most rewarding, then our investment in Digital Fortress is sure to be a success.

For my friends in Seattle, please let me know how Digital Fortress can be a resource to you in your market.

Filed under: Growth Equity, Investment Selection, New Investments, , , , ,

September 8, 2011 • 3:08 pm 1

Working with Friends

Last week I wrote about the value of repeat relationships in the venture capital and private equity business. I used the example of a portfolio company that recently raised capital from a firm we have worked with on a repeat-basis. I intentionally left out the investor’s name as well as the companies knowing that this new investor wanted to more formally announce their investment after labor day.

Well… today, Intel Capital announced a significant investment in Meritage portfolio company IP Commerce. A couple of years ago, Intel joined our syndicate at Crisp Media. Our work there – at the Board and investor levels – has been constructive and collaborative. Crisp is better for it.

I’m excited that Intel has decided to join us at IP Commerce. Special recognition goes to Bavanipratap Rana and Vibhor Rastogi who spearheaded Intel’s work on the transaction. Both worked effectively and collaboratively on the financing all the while doing their jobs by protecting Intel’s interest. We won a few points to, but that is how it should be. In the end, IP Commerce gets more capital, a new supportive investor with lots of leverage points and another effective voice at the table to help the company navigate the huge opportunity it is pursuing.

Some might believe that corporate VC’s like Intel Capital are somehow lesser VC-lifeforms. That has not been my experience. I’d gladly have Intel join the syndicate at any of my companies. Welcome to the team guys and congratulations to IP Commerce for successfully completing this financing. On and up!

Filed under: Payments, Portfolio

September 1, 2011 • 2:18 pm 0

Finding the Proverbial Pony

Tech people use the phrase “there is a pony in here somewhere” to describe a tough situation where there is a hidden big opportunity. I hear it most often in the context of a stagnating business that can’t seem to break-out and needs a new catalyst for growth. For example, in businesses that need to make a pivot (btw, the most overused word of 2010/2011 in my mind).

I like the idea behind finding the pony, although not the specific phrase for reasons made clear below. Which leaves a very important question: How do you find the pony? I recommend the following process:

1) Deconstruct Your Assets/Capabilities/Resources: Pull every part of your company, organization, product and systems apart. Absolutely deconstruct each of these parts of the business into their smallest base elements.

2) Get Out of the Office: Plan a day out of the office with no agenda and nothing more than a white-board and the list of your assets/capabilities/resources. Bring in the most creative people you can find from within and outside of your company. Bring in people from spaces that are on the periphery to the space in which you current operate. You want to avoid groupthink so a diversity of backgrounds is better.

3) Evaluate Each Element: As a group, evaluate each of the elements you have isolated. Focus on the raw component parts of your existing product. One of those base elements might be the nugget of a big idea, but was too buried in a system view of your product for you to see it. Also focus your time on elements that are nearest in proximity to revenue streams. That is to say, focus on elements that enable other companies to generate revenue, as opposed to those that will require you to be a vendor selling a back-office product at a “cost”. Prioritize your top ideas.

4) Groups: Break-up into groups, assigning each two ideas. Make sure there is overlap, so that at least two groups cover each idea. Assign each group to come back with a back of the napkin business plan idea for the high priority components you have identified.

5) Research: Take the best ideas and work them.

This exercise won’t automagically generate a whole product or write the business plan, but it might lead you down the right path.

An Aside:

So why don’t I like the phrase? Well, the genesis of the phase “there is a pony in here somewhere” is a joke. It goes something like this:

Once upon a time, there was a mom and dad that had two children. One of them was an optimist, the other a pessimist.   Wanting to understand why the two children were so different, they consulted a psychiatrist, who set up an experiment to help figure it out. The psychiatrist led the first child into a room that was full of brand new toys. Immediately the child burst into tears.   The psychiatrist asked why, and the child replied “all of these toys are new, and if I start playing with them I’m afraid I might break one.”   Obviously, this was the pessimist. So the psychiatrist led the other to a room that was full of horse manure. The child immediately dove in, scooping out handfuls of the disgusting stuff.   The psychiatrist asked why the child was doing that, he replied “with all this horse manure, there has to be a pony around here somewhere, and I’m gonna find it.”

I don’t know about you, but I’d much rather polish a diamond in the rough than find the pony.

Filed under: Random, , , ,

September 1, 2011 • 9:59 am 0

One Surefire Way to Screw up Your Lifestyle Business

Some businesses are designed – maybe even destined – to be owner operated. Industry parlance often refers to these businesses as lifestyle businesses. Wikipedia has a nice definition. They are typically small, profitable, generate cash and enable their owner-operator to sustain a well-above average lifestyle. In some circumstances, they may even make their owner-operator filthy rich over time.

Some people may think that the term lifestyle business is an insult. I couldn’t disagree more. Being the owner-operator of a lifestyle business should be a source of pride; a badge of honor.

As a growth stage investor, I see quite a few lifestyle businesses in our deal log. This type of opportunity finds us because they often meet our high-level screening criteria. They have paying customers, generate meaningful revenue and produce EBITDA and cash every year. They “fit the profile”.

But when I meet with an entrepreneur who is running a lifestyle business, I’m not shy about asking a most important question. It usually goes something like this:

I understand you wish to raise capital to grow your business. But if I’m hearing you correctly, today you own and control nearly 100% of your company. This enables you to lead a balanced life, generate meaningful personal wealth and take great satisfaction from your work. Why would you want to screw all of that up by raising capital?

I mean it too. Raising capital comes with loss of control, changes in lifestyle (read work flexibility) and other issues. More importantly, lifestyle businesses tend to lack one key ingredient that institutional equity investors (particularly growth equity investors) need to generate returns; rapid scalability. Bringing in institutional capital creates an incredible amount of pressure to generate top-line growth. In the context of most lifestyle businesses, that kind of top-line growth is either not achievable or if it is, will so fundamentally alter the character of the business that it will be unrecognizable to the entrepreneur at the end of the process. In short, that pressure will probably do more damage than good from the owner-operators point of view.

So if you are an entrepreneur seeking capital from me and I say something like “You own a great lifestyle business; why on earth would you want to raise capital and screw it up?”, please know I’m coming from an honest place. I’m not insulting you.  I am, however, trying to get you to come to grips with the fact that raising capital may be a surefire way to screw up the good thing you have going.

Filed under: Growth Equity, Investment Selection, Lessons Learned, Raising Capital

August 31, 2011 • 1:31 pm 5

Relationships Matter; Repeat Relationships Matter More

From what I’m told by my more senior Partners, the venture and private equity business used to be clubby. That is to say that business between firms was done on the basis of relationships and repeat interactions. Bad behavior was held in check by the small size of the industry. Financings and co-investment relationships got done on the basis of a handshake.

In pockets, that dynamic surely still exists, but with the industry having expanded so greatly both in terms of the number of firms and the number of professionals in the late ’90s, it has been harder to find. Two recessions in ten years hasn’t helped, nor has the dismal ten-year returns of the VC an PE asset classes, which has caused firms to scratch and claw for every ounce of return they can extract. All of this has caused the sharp elbows to come out. As my Partner Jack likes to say:

There is alot of schoolyard thuggery. The seventh graders think it is their right to beat up on the fourth grader. No matter what grade you are in, there is always someone bigger than you on the playground.

It is worth calling out when a transaction doesn’t turn into a knife fight. Without naming names (saving that for later), we recently brought a new investor into one of our companies. I have personally worked with this firm before. We don’t just have a relationship, we have a repeat relationship.  While there were terms to be negotiated, the process was filled with a couple of key ingredients; trust, respect, admiration and an understanding that our work together is multi-threaded and won’t end at this transaction.

The result: A speedy and fair transaction that everyone around the table is happy with and where everyone left a little something on the table. No sharp elbows; no fighting over nickels and dimes; the way it should be. It is the repeat relationship that made all the difference.

Filed under: Uncategorized

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