Stage Expertise is as Important at Sector Expertise

The Workhorse Capital team believes that successful investors differentiate themselves by contributing to the value creation process at each portfolio company. In order to do so, we keep close to our roots – focusing our investments in technology-enabled service businesses which leverage recurring revenue business models. We believe in sector expertise. Likewise, we believe in stage expertise. We’ve chosen to become growth stage experts. We believe that growth equity offers investors an asymmetric risk-return profile; the opportunity to derive venturesome return potential with much lower loss rates than venture. In our view Growth Equity investments exhibit the following return characteristics:

Proven Product-Market Fit and Economic Model

Candidates for Growth Equity investment typically operate in a quantifiably large market with a proven value proposition and economic model. These businesses know how to sell their product/service, how to identify their target customer and understand the economics of customer acquisition. With this foundation in place, growth-stage businesses can deploy investment capital at the use(s) of proceeds that generate the highest return on investment.

This cannot always be said of venture investments, which often wander in the woods and often must “pivot” before discovering a market, or leveraged buyouts, which must focus on repayment of debt to create equity value.

Attractive Risk-Adjusted Upside Potential

Growth and value are concepts that are inextricably linked in the financial markets. It is a well-known axiom that – all else equal – the faster a company is growing, the higher the multiple it commands, and vice versa. It is obvious but worth emphasizing that growth-stage businesses create incremental value by growing revenue and profitability. In a sufficiently large market segment, growth stage investments have the opportunity to drive meaningful growth and profitability.

The same can be said of venture investments, although the failure rate of venture-financed companies remains very high. While it is easy to recall high-profile acquisitions of venture-backed companies with unproven economic models, these exits are very much the exception to the rule. Growth Equity returns are more predictable because base exit value is tied explicitly to growth and financial performance, with the added upside potential of strategic value. Buyouts on the other hand often create value through cost-cutting and by reducing debt. As a result, traditional buyout returns are often bounded, as there is only so much cost cutting and debt repayment available to a given company.

Limited Risk of Capital Loss

We make Growth Equity investments in companies that have created a baseline of value and are typically un-levered, so that the preferred equity is not subordinate to debt. If the investment is priced right, the investment need only maintain its value in order to return capital to preferred shareholders.

This is distinct from both the venture capital asset class and the buyout asset class. In buyouts, the equity is typically subordinate to debt, creating a default risk that could wipe out equity. One need look no further than the 2007/’08 business cycle to see how leverage cuts both ways. In venture, the company must typically grow into its valuation by hitting development and/or performance milestones, which if not achieved can render the equity worthless. Venture is about harnessing home-run potential, but with that upside comes higher loss rates.

Being a stage expert (as well as a sector expert) enables us to better understand the challenges faced by growth stage businesses and to design our business around helping the entrepreneurs we partner with to stay ahead of those challenges. With a combination of sector and stage expertise, we are purpose built to execute on the promise of growth equity.

Workhorse Capital Invests in Datavail

DatavailWorkhorse Capital is pleased to announce the completion of its first investment; a $7.2 million investment in Datavail Corporation. Datavail is the largest independent provider of remote database administration managed services in North America. Workhorse’s investment in Datavail is part of a $47.0 million growth recapitalization led by new investor, Catalyst Investors. New investor, Lumerity Capital and existing investors, Meritage Funds and Boulder Ventures also participated in the financing.

My relationship with Datavail started through my work at Meritage Funds. Meritage led Datavail’s Series C financing in 2011. I became more deeply involved with the company in 2013 upon my return to Meritage after having run a portfolio company for 16 months. At the time, Datavail had executed several acquisitions of smaller database managed services providers. The working thesis at the time had been to scale the business primarily through acquisition based growth. The acquisitions that the company made were certainly worthwhile, particularly in helping the business to achieve minimum efficient scale. However, it was clear that acquisition based growth strategy would ultimately become limiting and expensive and that the company would have to execute on other growth vectors if it was to achieve its highest potential.

Early in my involvement, it became apparent that Datavail had developed an under-appreciated core competency, the ability to predictably and profitably acquire enterprise class database administration customers at low cost. Datavail has always excelled in customer satisfaction and delivery. Adding a repeatable and scaleable organic customer acquisition capability to the core operating and delivery platform had the potential to create significant value. Through Mark Perlsetein (CEO) and the team’s superb execution, the Company proved its organic growth capabilities, and was able to garner additional internal financing to invest more aggressively in organic growth initiatives. The results is that the company has grown meaningfully over the past two years and with an attractive LTV/CAC ratio.

My relationship with Mark Perlstein, Datavail’s very capable Chief Executive Officer was cemented during our work on the organic growth strategy. We worked together to put the metrics, measurements and decision-tools in place to support the company’s organic growth aspirations. Getting the building blocks right on the front end has helped the business to direct its organic growth investments toward the most productive channels. It is great to see that work proving its worth.

As exited as I am about Datavail’s recent performance, I’m even more excited about the company’s prospect going forward. There are a number of reasons to be optimistic.

  • World-class Team: Mark Perlstein (CEO), Datavail’s CEO has put together an A-quality team across the board. Mark, Keenan Phelan (COO), and Andrew Evans (CEO) do a fantastic job making the business strategically relevant while also making sure the trains run on time. Robin Caputo (CMO) and David Boyle (SVP Sales) constantly improve the customer acquisition process and drive the revenue generation machine with a high degree of precision.
  • High Quality Scaleable Service Delivery Platform: Datavail has built a world-class service delivery operation and infrastructure. With 24×7, global delivery, the Company can meet its customers needs in any location and in any time zone. The company has really differentiated itself in the marketplace in its ability to serve a broad array of needs of mid-market and large enterprise customers.
  • Repeatable and Scaleable Organic Customer Acquisition: Datavail has not only built a world class service delivery platform but also a machine-like customer acquisition engine. With an LTV to CAC in excess of 5.0x, Datavail is poised to continue to grow as it enhances its investments in organic growth.
  • Great Partners: I’ve known the team at Catalyst Investors for many years. Tyler Newton, who led the financing on behalf of Catalyst is a capable and thoughtful investor. Matt Kim of Lumerity is also a long-time friend and colleague in the business. I’m pleased to have Tyler, the entire Catalyst team and Matt as a partners in this investment. I’m also looking forward to continuing to work with Jack Tankersley of Meritage Funds and Peter Roshko of Boulder Ventures. The investor group shares a common purpose to support this management team in taking Datavail to the next level.

I’m really pleased that Datavail is the first investment for Workhorse Capital. I’d go so far as to say I’m proud of it. The investment nicely fits Workhorse’s core focus of investing in growth-stage technology-enabled services businesses. Less than six months after Workhorse Capital’s launch, I’m grateful for the opportunity to be an investor in such a high-caliber company and with the quality management and investment partners around the table.

Congratulations to the entire Datavail team!

A Pedestal for Bootstrappers

There are many ways to capitalize a tech-enabled service business in its formative stages. Angel capital and venture capital are frequently sought after, but sometimes difficult to come by sources of capital. Angel capital and venture capital are appropriate for many early-stage businesses, particularly in winner-takes all markets where an early product, user base or other competitive advantage can compound over time leading to a disproportionate market share.

As a growth-stage investor, we see a large number of previously venture backed businesses whose performance ranges from floundering to crushing it.  It is admittedly difficult for us to structure an investment in a previously venture backed company that “works” for the management team and the prior investors. In the case of a floundering venture backed businesses, the existing investors are more likely than not “under-water” on their investment, but reticent to recapitalize by converting preferred stock with liquidating preferences to common stock.  In the case of a venture backed business that is crushing it, the investors may have valuation expectations that are odds with ours.

It is no surprise that, over time, these dynamics have naturally shifted our investment efforts toward entrepreneurs that have – either by choice or lack of access to venture capital – chosen to bootstrap their business. We have tremendous admiration for all entrepreneurs, but bootstrappers have a special place on the pedestal we’ve reserved for entrepreneurs.

There are so many attributes of bootstrappers that we admire. A short list follows:

  • Engagement in Customer Success: I have consistently seen that bootstrapped businesses are engaged in the success of their customers at a very high level. After all, when your only source of capital is your customers, you will do anything and everything in your power to make sure that source of capital is well-served.
  • Focus: Bootstrappers typically have a maniacal focus on the small number of things that matter most to their business. Bootstrappers don’t have the time or money to do frills. But they get the basics that matter to their business really right.
  • Humility: Bootstrappers aren’t in it for the notoriety or glory. They are in it to build a fundamentally sound business. I’ve consistently seen high-levels of humility from entrepreneurs who have bootstrapped.
  • Respect for Capital: Well covered by Jack and David’s thoughts but worth repeating.

Many entrepreneurs exhibit these characteristics, whether they access venture backing or decide to bootstrap, so this isn’t an indictment of venture backed companies or entrepreneurs. However, when we engage with an entrepreneur that has bootstrapped their business, we find we spend less time qualifying the entrepreneur’s motivations and objectives than we would otherwise.

The other dynamic we like about bootstrapped businesses is that they don’t need to take capital. As a result, when an entrepreneur running a bootstrapped business considers taking growth capital, there is a wonderful built-in self-selection process at work. A bootstrapped entrepreneur will only take growth capital if they believe that the access to capital will help them create more value for themselves than if they pass-over the opportunity. A bootstrap entrepreneur who takes growth capital is saying:

I can create more value for myself with this capital than I could otherwise create.

Conversely, an entrepreneur who chooses not to take growth capital is saying:

I cannot create more value for myself with this capital than I can otherwise create.

These built-in “gut-checks” make our job evaluating investment opportunities a little bit easier.

A sidebar: The guys at Basecamp (formerly 37 signals) have been long-time proponents of bootstrapping, despite their proximity to the epicenter of the venture capital world, silicon valley. They even have a list of bootstrapped businesses that are Bootstrapped, Profitable and Proud.

Cheers to all entrepreneurs. And to you bootstrapers, you have a special place on our pedestal.