In the third of our article series on business tropes, we’re looking at the ‘Slam Dunk, Home Run!’ (SDHR) company. This trope is often found in interesting markets and can provide outstanding investment returns, despite being characterized by a management team with little, or even no interest in the equity value of the business.
If your firm fits the SDHR trope, it will be a mature company with an operationally focused management team. Business founders often leave at an earlier stage and if the company was previously unsuccessful, the ‘new’ investors may well have replaced the management team. Generally, the SDHR business is owned by shareholders who are not operationally involved in the business.
Prolexic
Founded in 2003, Prolexic – a Cloud security provider – is a great example of the SDHR model and the exceptional investment returns this trope can deliver. I was involved with the company around 2011, as part of an investment committee at Kennet that approved an investment in Prolexic. The company was sold in 2014 to Akamai for around $370 million, with Kennet’s investment realizing a very attractive return in just a few years.
Building a SDHR business
How did this remarkable ROI happen? As expected of the trope, the management team at Prolexic were very focused on building the business, but not interested in equity value. By bringing in managers with experience in raising the equity value of companies, Prolexic’s performance outlook improved dramatically.
At the time of Kennet’s investment in 2011, Prolexic had little presence in the US market. This is surprising, considering the firm provided technology solutions to prevent DDoS (distributed denial-of-service) attacks and cyber espionage, both of which US banks are subject to. Being an ‘undiscovered asset’ is another familiar trait of the SDHR trope.
Market opportunity
SDHR companies address very clear market opportunities. As these businesses are often more mature, the holding periods tend to be quite short; perhaps three or four years. Additionally, there is an active M&A market for firms with ‘strategic value’ that are forward looking in terms of the company’s potential.
Raising capital
Normally, SDHR firms are sufficiently mature to have positive cash flow. New investors will inject any working capital which may be required into the business and additional investors may invest more capital once the company is ‘on the radar’, at a later date, as a result of the new investor’s transaction.
Following Kennet’s 2011 investment in Prolexic, the firm received $8 million in Series B funding from Camden Partners in 2012. An additional $30 million Series C investment came from a collective led by Trident Capital and Intel Capital, including Kennet and Camden Partners in 2013.
Expectations
The SDHR model offers very healthy investment returns, with an opportunity to buy at a good price. Investors expect an extremely positive outcome from this trope as existing shareholders – that are selling the business to new investors – may not be aware of the real or potential market value of their company. Also, the operational management team are likely to perform even better when they have significant equity incentives.
If you fit the SDHR bill
To trigger this trope with investors, you will act like you are very focused on execution, generating cash flow and you may also diplomatically hint you are not concerned about the price of your company. If you find yourself in this situation, you have to work out how to replace your existing shareholders with those who believe in equity incentivization of your current management team, which could be achieved through a MBO (management buyout) transaction. Additionally, there could be obvious markets, to investors, that you will not have considered developing into.
We think it pays to have shareholders that are interested in managing and improving their equity value. By doing so, these shareholders look after the founders’ equity value too. At Vie Carratt, we can help you understand your equity value potential and find active and engaged shareholders who care about it and the development of your company.
By David Carratt, Founder and Director, Vie Carratt