How many times have you heard this? “I passed on the deal – too much hair on it.” It’s a bizarre expression and an overly descriptive one at that. Yet it’s been used time and again to describe companies – restarts, turnarounds, the living dead – that are in the market for capital but have far too much baggage to make them worth any effort.
I’d offer, however, that those same hairy companies we may have passed on before are actually now worth a second look.
They’re the survivors of the boom and bust; creations once of our own making that have faced washout rounds, scrapped products, lost customers, a string of investors and perhaps even several changes in management. But they were once good enough for venture investing and might just be good enough again, if they are given close enough inspection.
Scratch the surface of some of these companies, brush back some of that hair, and there’s value to be had. Indeed, despite a venture capitalist’s job to have a predisposition to the negative – to search for the deal breaker rather than the dealmaker – the fact that many of these companies have endured so much pain, so much change and so much adversity is a positive.
Also, the fact that much of the technology still offers value in nascent markets (and has already been bought and paid for), the fact that the founders and managers have been flexible enough to search for new opportunities, new business models, and new customers, and the fact that they have already garnered the support of other investors who’ve stuck by them through thick and thin are all factors in the plus column.
True, in 1999, we only wanted clean deals. We wouldn’t even look at anything that was not fresh, hot or clean. Anything less was like paying full price for San Francisco real estate after it had been on the market for three months.
But among a select few investment candidates that hair now translates into experience, into perseverance, into opportunity. Granted, for lack of a better description, there’s good hair and there’s bad hair and there’s a rigorous checklist for taking on what could easily be more of a burden than an opportunity.
Stop Signs Before Go
There are some basic warning signs to watch out for. In terms of capital structure, if onerous liquidations preferences still exist, if there’s too much dead wood in terms of investors who’ve moved on yet who still own big chunks of the company, if valuation can’t come all of the way down, then pass!
In terms of a management team, if you can’t look these guys in the eye and trust them with their current business model – not the old one – if the technology development team hasn’t retained some intrinsic loyalty, some valuable institutional knowledge and isn’t willing or capable of learning newer development concepts, then pass!
In terms of the financials, if the company is too weighed down with debt, has liabilities that cannot be restructured or simply waved off, and has contracts with multiple vendors who aren’t willing to take new equity in lieu of old payments, then pass!
And last, in terms of customers, if there aren’t any that have embraced the new model or new technology, or if there are legacy customers who must be serviced as a means of honoring previous contracts, thereby taking resources away from developing new business opportunities, then pass!
That still leaves a universe of “good hair” deals we should be taking a closer look at.
A company recently walked through my door offering a case in point. Metapa Inc., a Sherman Oaks, Calif.-based data collection and data management software company, was clearly on its second, perhaps even third, life. But it had a story to tell. The company started in mid-2000 as a managed services play around digital media, a market segment that never materialized.
Though Metapa had closed an initial $13 million Series A round from Soundview Technology Ventures (now called Dawntreader Ventures) and Impact Venture Partners, the company made the decision to transition from a services to a software play. Lesson No. 1: If the company is flexible, has a sense of urgency when change is needed and is mindful of blowing as little money as possible, that’s a major plus.
Much of 2001 was spent shifting the company, scaling back resources and trimming the burn. It hired a new CEO, David Powell. And there’s no question Metapa went beyond a 180-degree turn. “It was more like a 360, maybe an 840,” says founder Scott Yara. To its credit, Soundview stuck with Metapa through the transition. It never asked for its capital back, it approved the new shift toward software, and most importantly, it trusted that the team could execute even on a new mission far different than its original one. Moreover, the venture firm recognized the strides Metapa had already made with a major Internet service provider as a potential customer, strides that could likewise transition into a new customer for a revamped Metapa.
And that’s exactly what happened. The ISP had specific problems with data management and data reporting and was willing to entertain a Metapa software solution based on some of the technology the company had already developed in its digital services past life. Lesson No. 2: If other name VCs are willing to stick with and believe in the company’s founders, if the company is able to shift its technology toward a new application, and if a vetted customer is willing to shift with the company as well, consider it another big, big plus.
It was that first deal that opened Metapa’s eyes to the large-scale data reporting opportunities in the market. The company saw it could offer data clustering software at nearly one-fourth the cost of current solutions. It went with a plan that focused on data collection and interpretation and built its first generation of products. By landing DreamWorks SKG as its next major customer, the company found traction. It then was able to raise additional funds based on that validation of its new model.
Realizing that its only option was an insider round, the company raised $3.7 million by July 2003 from Soundview, Hudson Venture Partners and a number of angel investors who previously helped finance Metapa. The company also did a small acquisition that offered further data reporting technologies to merge with its own.
With a year’s runway of capital, Metapa had the opportunity to build a high-end data warehousing and reporting system to offer as proof of concept. In prospecting to its previous customers, and obtaining new validation from AT&T, the company and its investors realized it had finally found its new niche – one with significant potential. Lesson No. 3: If the original VCs re-up to invest in the new business focus, if the company can struggle for a year with barely more than $3 million, and if it can further make a technology focused strategic move (in this case an acquisition) that proves itself out with new customers, that’s even more of a reason to look beyond an uncertain past.
An Xalted Example
Metapa is now in the market for more capital and has seen strong interest from Sand Hill Road. Look beyond the hair, and you can see that the team, the technology and the current positioning offer a strong proposition. In full disclosure, Metapa is not a Charter deal; and it may never be. I offer its story and its subsequent lessons for two reasons. First, to prove the point that hairy deals are often far cleaner than we might first expect. And, second, as a way of understanding from a different perspective what one of Charter’s own companies, Xalted Networks, experienced on its path toward resurrection.
Xalted, mentioned here before, was – like Metapa – a company in search of a new identity. This, too, was a classic case where other investors had said there was too much hair on the deal. Yet, there was enough good that had been built into the company – a switch, router, aggregator all in one box – for us to look beyond what might be a challenging restructuring.
It had the classic elements of a company with too much baggage; and when we shopped the deal a year ago, the mindset of VCs was that it was too battle scarred. Financially, the company needed to shed liabilities, cut its burn and even look for entirely new markets to sell to – geographically as well as strategically. It was too much work, and too much risk for other investors, so we took the risk ourselves. We threatened bankruptcy to shed liabilities, we cut the burn 90% and we moved operations to India while placing one of our own GPs as the new CEO.
Xalted was a case where good minds can disagree. Other VCs thought the telecom market, at least here in the United States, wasn’t happening in the time frame they needed, and they didn’t believe that we could re-launch and sell into other countries such as India and China. Others didn’t believe in the team or they weren’t comfortable “fixing the space shuttle in mid-air.” They simply didn’t think it was possible to move the company across the world and switch out 80 to 90% of the development staff in the middle of launching a new product. This type of box had never been built in India before, so there was no local expertise to draw from; the technology would again have to be built from scratch.
In spite of all the challenges, Xalted is thriving, living out a successful adolescence as it grows fully into its second life. The strategy paid off and Xalted scored its first major win with the incumbent carrier in India. As the Indian economy continues to boom, the government-owned carrier is handing out some of the largest telecom orders in the world- 15 million GSM lines worth over $1billion – doubling the GSM network in India in less than five years to over 25 million lines.
Other VCs may look more fondly toward Metapa than they did with Xalted – it’s a different time, with a more positive economic outlook and a more forgiving feel to the industry. However, if that is now the case, I’d offer that we go further than we have in the past when presuming that uncertain company histories might not yield highly successful outcomes. This time, hairy deals just might turn to gold.
Ravi Chiruvolu, a general partner of Charter Venture Capital, is a regular technology columnist for VCJ. If you’d like to send him feedback or ideas, email him at