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 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

February 7, 2011 • 1:29 pm 0

Growth – I Like Mine Non-Linear

My Partners and I at Meritage have always had an investment mandate with broad stage flexibility. We’ve often described our investment practice as “multi-stage”, ranging from early/venture through later stage opportunities. This is in contrast to our sector preferences which are tightly and highly refined. It should come as no surprise then that we’ve been doing some soul-searching about our stage preferences.

I this Meritage Blog post, we’ve announced a significant refinement to our stage orientation. Going forward, we intend to focus all of our energy on growth equity opportunities. Over the years, we’ve made many investments that meet the growth equity characteristics we outline in the post and we’ve had great success at that stage. We see this as not so much of a change, but as an important refinement to our stage preferences – one that is driven by many factors, but mostly by our read of the state of the private capital markets and where we can best deploy the capital, time, energy and knowledge of our team to generate attractive risk-adjusted returns for our investors.

With this refinement, I’ve also decided to change the name of this blog. Goodbye Non-Linear VC; hello Non-Linear Growth. Maybe this will be a catalyst to get me blogging regularly again; it has been much too long!

Filed under: Growth Equity, Investment Selection

January 4, 2010 • 11:23 am 7

Areas I’m most likely to invest in during 2010

I have always been fairly thematic in my investment approach. For me, the process starts with identifying big markets that are either 1) emerging (and will therefore be created over the next several years) or 2) undergoing some structural shift that will enable new entrants to grab market share from incumbents. I have seen Companies succeed in both types of markets and so I don’t have a preference for either approach. In 2010, there are a several big themes that I’m tracking which are likely to influence my investment selection during the year.

Everything is a service

For several years I’ve been spouting off about the notion that “everything is turning into a service”. I outlined some detailed thoughts on this trend in a post titled “The future is in services” last June. As I look several years out, I see several big value chains threatened by this trend, creating opportunities for upstarts. For example, I think there will continue to be pockets of attractive investments in SaaS. But where I see big opportunity is in cloud based services and platforms that enable the cloud to become a true utility to the enterprise, small business and even consumers. Transforming computing from a product into a service is a non-trivial shift that will take many years, but the march is on and the direction of the trend is undeniable. Computing, storage, etc. will all primarily be purchased as a service in the not too distant future.

Platforms

For me, 2010 will be the year of the platform. The notion of open platforms that enable third-party developers to innovate on top of the platform by consuming API is alluring to me. I’ve already put my money where my mouth is on this one as several of my investments have ”platform” as a core component of their product and go-to-market strategy. Communications is an areas that has largely been untouched by the platform trend. It seems to me that the time is ripe for the network to begin opening up. I’ve written about this in the past on my firm’s blog; you can find that post here. The post is a bit dated, but I think you will get the point. Location services is another area where I think there are platform plays emerging.

Payments

I have an inkling that innovation is finally coming to payments. There have been some big exits in recent months, including BillMeLater and Revolution Money. Neither is particularly reflective of the type of innovation I think is coming in payment, but both show the size/scale of businesses that can be built given the massive size of the payments sector. With PayPal opening up its platform to third-party developers, there is going to be a rash of new payment application development in the coming years. As an investor in IP Commerce, I have a special perch from which to watch this trend. I’m staggered by the diversity of payment applications being developed on top of the IP Commerce platform. Several have already caught my eye as potential new investments and I believe more will do the same in 2010. I’m also tracking some big last cash markets, which I think are finally opening up to electronic payment providers.

Mobile

Mobile is an area I have tracked closely for several years now. And while some would argue that the market has disappointed, I would counter that we are still in only the early innings of a very long game. I continue to believe firmly in the mobile web, or the web optimized for the display needs and the unique capabilities/properties of mobile phones. I’m less enthusiastic about applications being developed for the iPhone/Android/RIM and other operating systems; or at least less enthusiastic about investing in companies that create those apps. There is just too much OS fragmentation for application developers to manage effectively and it is difficult to make any particular app stand out in the crowd.. As 4G networks begin to roll out, more bandwidth may obviate the need for a downloadable app. In some ways, apps remind me of PointCast; remember that? I’ll continue to track this trend closely, but as it stands, my money is on the web, not the apps in the long-run. Regardless, I’m more interested in the infrastructure and plumbing in mobile than the consumer-facing application side. The fact is that the mobile use case is fundamentally different from the web and it enables usage paradigms that are not relevant on the tethered web. As a result, the capabilities of the plumbing for mobile need to cater to what is unique about the mobile experience, creating an opportunity for new players to stake out a dominant and differentiated position.

I’m likely to make two new investments in 2010. I am more likely to prioritize my review of investments that synch with the themes outlined in this post. I’m also more likely to make investments in these areas than other areas I’m not tracking as closely. Having said that, I think it is critical to marry a thematic (and therefore planful) approach to identifying great investments with an opportunistic approach. So I don’t rule out making investments in other areas in 2010. I know there will be several entrepreneurs with whom I interact who light a spark causing me to dig deep into areas not outlined in this post. Frankly, I look forward to having that spark lit; it is a great part of the process of discovery that the VC business requires.

Filed under: Cloud, Investment Selection, Payments, Platforms, Themes, Venture Capital, Wireless, , , , , , ,

July 1, 2009 • 5:26 pm 0

The turndown with encouragement

The lot of a VC is to turn down virtually every business plan we see. The list of reasons I turn down plans is endless; the plan may a) not fit Meritage’s investment focus, b) not fit my investment interests/thesis, c) require too much capital for our firm to participate, d) be too early or too late; or perhaps I just think the investment is doomed to fail. Again, the reasons are myriad and there are too many to list here. There is, however, a small subset of plans that I would put in a unique category; the “turndown with encouragement”.

If I review your plan and I give you a turndown with encouragement, you will know it, because I will tell you that you are in this special category. What I am saying is that the answer is no, but that there is a risk in the business, that I believe could be fatal, but if mitigated, could put you on a path to wild success. If I could mitigate the risk by investing in the business, and working with you to mitigate the risk, I would not be saying no now. Rather, I’d consider the investment further and begin working with you to mitigate the risk; maybe even before closing an investment. But I’m not taking that step, because I believe the strategy for mitigating the risk is unclear.

This often confuses entrepreneurs and frequently solicits the response, “but isn’t venture capital all about taking risk.” From my perspective the answer is yes and no. Successful venture investing is about taking risks that you are comfortable with and that you believe can be mitigated. But on the flip-side, it is also about avoiding risks for which the mitigation plan is unclear. This is particularly true of risks that, if not mitigated, could deliver a fatal blow to the business.

If you get a “turndown with encouragement” from me, take it for what I mean it to be; genuine interest combined with caution. If I’m right, and you mitigate the risk, you may have your pick of venture investors, including me; and before you know it, I’ll be competing vigorously to get into your deal.

Filed under: Investment Selection, Risk, Venture Capital

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