Winners and losers take time to sort themselves out in Private Equity, testing our patience and our investors�. The key is picking good management teams, not just good �companies�, and giving themtime to mature.
Consider Texterity, one of our portfolio companies that in 2001 we invested in. Shortly thereafter the recession affected their market as the E-book phenomena fell flat. Management stayed the course, providing their conversion services to major publishers who have long respected the company. By Winter, 2001-02, they were running low on funds, and management took a 30% pay cut without telling us. (that�s unusual!). We later recommended a 50% reduction in the size of their tech group and suggested redeploying that payroll to hiring more sales personnel.
By Spring two new institutional investors and we put in additional capital, and management began adapting their technology to the emerging digital delivery market. That Fall they began testing a new product that enabled a prominent electronics catalog producer to digitally deliver a catalog over the web. It also enabled troops in Afghanistan to download portions of large repair manuals on-line, requiring very little bandwidth. In Spring 03, Texterity introduced the new product and offered a free conversion utility on their website enabling users to convert up to 25 pages into the new format for free.
Now it gets exciting. In May they did a test emailing for a major wholesale shopping club soliciting new memberships. They received 10,000 signups at $30 each, or a $300,000 return on their marketing investment of less than 10% of that amount. Needless to say the customer is very pleased and has signed up for an expanded program.
Are you getting the picture? This one-time �loser� was now hitting their stride, having adapted their technology from an e-book conversion software service into a digital delivery service.
It gets better. We introduced a terrific sales VP to the company who was subsequently hired and began calling on medium and large magazine publishers, touting the new product. The publishers were impressed, and many have put their current digital delivery vendor on �hold� while they run side-by-side tests of the Texterity product. The competitor is upset we�re told, and has called Texterity�s president to arrange a meeting. I wonder why?
It gets even better. A prominent software company is also working with Texterity to see how Texterity�s tool could be integrated into their software product, which is very widely used. This could be huge.
Our fund will be leading another funding round this month to help them position themselves for an �up round� this coming Winter. This round will be �flat� in valuation, and relatively small so it will not be very dilutive to management. The next round will be led by an outsider and should have a high valuation, allowing us to �mark up� the value we carry Texterity at on our books, and boost our return.
Why did this company survive the recession whereas nearly all of their competitors failed? Answer: management. Second answer: patient and supportive money.
You cannot invest in Texterity, which is privately held, but you can invest in private equity funds like Brook which invest in companies like Texterity. As an investor in Brook, you also are offered the opportunity to co-invest directly into portfolio companies alongside Brook. Next month Brook investors will be invited to invest alongside Brook in the forthcoming round if they�d like.
How do you tell a good company manager? That�s a subject for another article. In short, we look at character, inside and outside the company. Before we invest, we break bread with them, often meeting their families, and asking others what they think of them. They may not be the most experienced or the snappiest executives (sometimes a false indicator). But they know how to slug it out in the face of adversity, and keep their team together and motivated until the big �pay day�.
Andrew Clapp is a founding partner with Boston-based Brook Venture Fund, which invests in private companies, and attempts to practice the ideas discussed in this column. He can be reached at [email protected] when not working with portfolio companies facing challenges, or slipping out to a Fleetwood Mac concert.
