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.

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!

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.

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.

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.

Well, it closed, despite really testy public market conditions, which would have derailed lesser companies from completing a sale. ABRY bought a fine, fine business here and will now have the opportunity to work with what I think is one of the most capable management teams in the communications segment. Masergy’s CEO, Chris MacFarland is a stud. He’s supported by a fantastic team, including Rob Bodnar, the Chief Financial Officer, who helped navigate the Company through some pretty choppy financial markets over the past six years.

Masergy has been a real pioneer in the communications segment; one of the first to virtualize the network by separating ownership of transport infrastructure from the services and management interfaces that overlay the network. The platform they have built will scale really well, no matter how they choose to continue to grow the business; organically or via acquisition.

As for us investors; we did alright on the deal too. We’re proud of the Masergy team, of the company they built and of the outcome we were able to achieve for our limited partners. Good luck to Chris and team under new ownership!

We investor types juggle a lot of tasks on any given day and given that time is limited, we have limited time for any one task. This can be a real detriment during the diligence process, which requires concerted effort, open-mindedness and an awareness of our own biases. It is all to easy to pick up on a headline we hear and ignore the story behind it.

When we hear a headline delivered as a statement of fact, we are at risk of taking it as gospel truth, particularly if the statement comes from a trusted source. This is particularly true when the headline confirms our own bias or if the statement is delivered with overwhelming intensity. In either case, we may not take time to understand the story behind the headline. If the headline confirms our bias, human nature is move swiftly to the next task. Likewise, human nature overweights headlines delivered with gusto.

I view diligence as a process of gathering facts, filtering them and making sense of them by applying analytical thought models that I trust. I trust those models more than I trust myself, because I’m acutely aware of my own human biases enough to sequester those biases from the decision-making process. And I don’t trust headlines, because they are written by humans who have their own biases.

So ignore the headline; read the story. Give me the facts; I’ll write my own conclusion.

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!

We were excited about both investments. We offered a fair-valuation and structure in both cases; on market with other proposals the companies had received. In both cases management communicated that we were their preferred investor. In neither case did our proposal require investor control of the Board, but in neither case would management have had control either; each Board would be balanced between investors, founders, management and independent directors who could act as a swing vote. Pretty good landscape for a deal to come together, right?

I thought so too. But, in the end, both groups of entrepreneurs chose not to take our money or any institutional money for that matter. In the first case, the entrepreneurs wanted to prevent dilution and were protecting a prior, too-high price per share that had been set by high net worth individual investors and an unwieldy gridlocked board structure. They decided to raise a small insider round with their existing high-net worth investors at a price per share that is above market. In the second case, the entrepreneurs wanted to prevent dilution and a loss of control at the Board level. They decided to raise a much smaller round from friends and family; also at a valuation that is above market.

I’m a huge fan of entrepreneurs who bootstrap their business to success without institutional capital. I recognize that raising institutional capital is risky business – new investors, new board, etc. I encourage entrepreneurs to choose their investors wisely. But, unfortunately, capital-intensive businesses can’t be bootstrapped. Eventually, capital-intensive businesses must raise capital and grow or whither. There is no future as a sub-scale player in capital-intensive sectors. These are not lifestyle businesses; staying small is a recipe for slow failure. Eventually, the market passes these companies by as larger, better capitalized competitors crowd out the small guys.

Entrepreneurs in these situations face a difficult choice. They have two things they can sell; one obvious, one hidden and difficult to quantify.  What do I mean? It is obvious that if you raise capital, you are selling stock. Via the sale of stock the company gets capital and with that capital, the company funds growth initiatives creating the opportunity to grow and become more profitable. To simplify, such a company has sold stock and bought growth. By choosing not to raise capital or to raise less capital, the reverse is true; the company has essentially sold future growth potential by not selling (essentially buying) stock.

If the company has great growth prospects and management is confident in those growth prospects, it’s better to sell stock and buy the growth. In that case, management will get a smaller piece of a bigger pie and come out ahead in the end. If the growth prospects are uncertain or management does not have confidence in its growth projections, it may be better to “sell the growth potential” and keep more ownership. After all, if management is not confident in its growth prospects, why take the dilution from selling stock (and the associated loss of control) to capture growth that may not materialize.

I sympathize for entrepreneurs that face this choice. There is no right answer here; much if this should be left to personal preference. But make no mistake, in capital-intensive businesses, entrepreneurs that choose to raise insufficient capital may be unwittingly selling something of tremendous hidden value – the future growth prospects of the business. And although it is counterintuitive, I’d argue there are greater risks in under-capitalizing a capital intensive business than the risks inherent in an institutionally financed deal (lower ownership, less control). In any event, the old big piece-small pie, small piece-big pie conundrum is alive and well.

When we made the investment in NewPath 16 months ago, I blogged about it in a post titled The next generation of towers.  I was proud of having made the investment. I’m even prouder now. This was a great outcome for everyone involved, management, employees, customers and shareholders alike.

All credit goes to the NewPath team, including Mike Kavanagh (CEO), Sean Cooprider (COO) and Palvi Mehta (CFO). They focused on building a sustainable enterprise, executed well and took advantage of a market exit window when it presented itself. Congrats and thanks to all!

Best wishes to Mike and Sean as they continue to build the DAS business on the Crown platform. With Mike and Sean’s capabilities, relationships and knowledge and Crown’s balance sheet, Crown is destined to be a strong player in this segment.