Statements made at Netpreneur events and recorded here reflect solely the views of the speakers and have not been reviewed or researched for accuracy or truthfulness. These statements in no way reflect the opinions or beliefs of the Morino Institute, Netpreneur.org or any of their affiliates, agents, officers or directors. The transcript is provided "as is" and your use is at your own risk.  

Copyright 1999, Morino Institute. All rights reserved. Edited for length and clarity.

mary macpherson: introductions

Good morning.  We certainly have a lively crowd this morning.  We're delighted to have two business leaders with us today who can share their experiences in netpreneurship and their business strategies with regard to a very prominent phenomenon in the Net world—business roll-ups.

          Drew Clark is president of Verio East (http://www.verio.com), a company that has grown through acquisition, including the acquisition of ClarkNet, the Internet service provider (ISP) that Drew founded with his cousin Jamie Clark.  He'll be joined on the panel by Nelson Carbonell, president and CEO of Alta Software (http://www.altasoft.com).  Alta is one of the region's Fast 50 companies, and Nelson has some interesting perspectives on the topic of roll-ups.

          Our panel will be moderated by a journalist who has been examining high-tech companies in the region for the last six years, Bob Starzynski, the editor of TechCapital magzine (http://techcapital.com).  We'll begin with opening remarks from Bob, followed by comments from Drew and Nelson, then we'll open the floor to your questions.

bob starzynski: background

Before we get started, let me take a minute to insult your intelligence and explain what a roll-up is.  A roll-up is not just the acquisition of businesses; it is taking a series of small businesses in the same or similar markets and combining them to create a large business.  It's been a popular model recently, and the people who have put these companies together have touted their benefits.  Among other things, they say that roll-ups afford a company the opportunity to attract bigger clients, to buy materials and services in quantity more cheaply, and to keep administrative and overhead costs down by eliminating the overlap of services.

          At the same time, other people say that roll-ups aren't all they're cracked up to be.  One of the things that spurred this morning's topic is a letter that I wrote in TechCapital, the basic message of which was "beware of the roll-up" (http://206.144.247.59/vol2_no6/department/92-1.html).  I don't think that roll-ups are inherently bad or evil, but I do think that roll-up strategies, if done for the wrong reasons, can be troublesome.  For example, if you roll up stagnant businesses, all you're creating is a larger stagnant business.  Once you stop acquiring, your top line growth is going to stop because you're acquiring companies that weren't growing in the first place.  That aside, if you're putting together businesses that are growing in a rapidly growing industry, you stand a good chance of continuing growth once companies are joined together.

          By the way, one of our speakers, Nelson Carbonell, responded to my column with a letter of his own (http://206.144.247.59/vol3_no1/department/105-2.html), expressing some of his concerns with roll-up strategies, primarily with the integration of cultures.  Let's hear from Drew Clark to begin with, however, for his first hand experience with Verio's roll-up acquisition of ClarkNet.

drew clark: "poof," you're a company

Thanks, Bob.  Good morning, everybody.

          The roll-up strategy dilemma is one that needs some fine tuning.  The early stage "poof" transactions we have seen implemented a number of times are different from building a business through the acquisition of strong players in a particular industry and gaining economies of scale, expertise or strategic advantages from those organizations.  There are some companies that go out and say, "We're going to sign up everybody to this great agreement and, in a certain period of time, we'll become one company, but it's all contingent on equity markets and raising a lot of cash."  That kind of "poof" transaction is different from building a company through a grass roots effort where you go out and identify the companies, do a lot of due diligence and decide that it fits into the vision you've created.  You may or may not ultimately go into the public equity or debt markets to get capital.

          My old company, ClarkNet, was founded by my cousin, Jamie, who got the idea to create a local ISP through some of his graduate school programs at Johns Hopkins University.  He had some very difficult times getting connected to the Net back in that period, 1992 and 1993.  When he first set up shop, he had a 56K line with Sprint, and thought he was the king of the world.  Clarknet was the first deaf-owned ISP in the country and only the second ISP in the Greater Washington region.

          Jamie had a vision which he wanted to build up over time.  As most of you know, the technology in this space is changing so rapidly—hardware, operating systems, compression technologies at the local loop level and throughout the Net.  As time passed and technologies changed, we had to keep asking ourselves, "Can we continue to invest in the company to provide the level of service and the level of products that the marketplace is demanding?"  At some point, the answer became, "No, we probably can't."

          We could give it another three to five years, maybe, if we were lucky, but what would we have had at the end?

          Could we attract the kind of people we had brought on in the early stages of ClarkNet and continue to have the level of expertise from an engineering perspective and from our sales folks?  Could we be competitive in the human resources component? The answer was, "Probably not in the long run."

          There were a host of other issues.  Could we be attractive to local, regional or national banking institutions to provide us with working capital?  In the past we had been fortunate, through Jamie's skills and his recognition as Small Businessperson of the Year in Maryland, to have attracted some Small Business Administration financing which helped us build from the milking barn to a real facility, operating as a true business.

          We looked at those types of issues.  They are the kind of challenges most entrepreneurs face every month.  Can I do payroll next month?  Will our people walk down the street to work for competitor XYZ which has more resources, a more attractive benefits program or more stability than we have today?  Entrepreneurs are constantly struggling with those decisions each and every day—keeping the company afloat, maintaining the organization, driving the company to the next level.  You overcome those hurdles and you feel good about it.  At the end of the week, you know you'll catch up this weekend and start over on Monday.

          The Verio deal had risk associated with it.  It was a venture capital-financed private company.  Fortunately, one of the things we also evaluated was the culture and the management team that had been put in place at Verio to take the company to the next level.  We felt very comfortable.  We felt there were a lot of opportunities to grow with Verio.

          That's another fork in the road where people must stop to consider.  If you're going to participate in a roll-up strategy or become part of an acquisitive company, what's the role for you in the future?  Will you have a place in the company?  Can you commit to that organization?  Does it have the same values and beliefs that you do?  That's important.  At some point, you may make the decision that you're interested in selling your company, but not staying with it.  Hopefully, you make enough money that you can go off and do another entrepreneurial activity, or just go off and play golf.  There are a lot of decisions you have to make in arriving at the right exit strategy for you.  If you're in the technology marketplace today, and you have any type of success whatsoever, chances are pretty good that somebody is contacting you, interested in having you participate as part of their team.  They want to acquire you and let you go on about your way, or they want to acquire you and have you become an important contributor.

          We were fortunate with Verio.  They've been very successful in growing organically as well as growing through the acquisition process.  It's been an interesting and very rewarding experience, much different from being an entrepreneur in the barn at ClarkNet and worrying about rebooting modems at 2 a.m.  It's been a good experience for our folks and it's provided a lot of different opportunities for our people to grow both intellectually and financially.  We have a benefits package and a set of solutions that we can feel good about each and every day, and not have to worry about some of the hurdles we all face as entrepreneurs.

          I'm a proponent of an acquisition strategy that makes sense.  As Bob said, if you acquire stagnant companies or businesses that don't have future potential, what's the point?  Perhaps there are some economies of scale you gain, but if you're not going to build a company for the long term, then I'm not sure the roll-up strategy is one that makes sense for an entrepreneur.  If, at the end of the process, you have paper value that isn't rock solid, it's not necessarily liquidity for you.  You have to consider the situations of cash versus equity or some other compensations when you sell your company.

Mr. Starzynski:  Can you tell us how many companies were rolled together with Verio and how big the company is now?

Mr. Clark:  Verio was formed in March of 1996 with venture capital from Centennial Funds and a few other folks who participated in the initial seed financing.  The idea was that the ISP space was very fragmented, and there were opportunities to pool these local companies together.  If you look at some of the leverage points, economies of scale and opportunities to create value in that market, it lends itself well to that strategy.  You're talking about backbone and infrastructure, things you have to buy from somebody.  The larger your capacity requirements are, the more economies you can get with the long-haul providers.  At the time of Verio's public offering, I think we had acquired and incorporated about 36 companies that were predominantly regional ISPs.  We've also done a number of acquisitions subsequently in the Web hosting environment.  Today's count, I think, is close to 50 companies that have been incorporated into the Verio family.  That public offering was in June of 1997, for about $150 million, and we did another high yield debt offering last May.  It's been a fairly aggressive acquisition strategy, and, I will tell you, it's not been without a lot of bumps in the road.  You start talking about trying to get people unified on administrative platforms, on billing platforms, on customer care platforms.  There are times when you're trying to establish software functions across 40+ companies.  The challenges of culture and the challenges of integration are absolutely there.  We've been pretty successful in handling most of them, but we certainly had our bumps in the road.  We continue to look to improve our economies of service and our networks.  It's been a plus for us and a plus for Verio.

nelson carbonell: exit (strategy), stage left

Thank you.  At Alta Software, we basically build custom applications for the Web.  We're a Web engineering company, which is different from building Web sites because we rarely work on front-end content.  We usually work on putting together the back-end applications to make something like an E-commerce system work.  Our claim to fame is that we built and deployed sites last year for major Fortune 500 companies, such as First Union and Equifax.  Alta was started about six years ago.  Over those six years we've had dark days, bright days, ups and downs.  I'm sure those of you who are entrepreneurs can relate to that.

          During one of the dark days, I started thinking about exit strategies.  I can tell you that my perspective on exit strategies ebbs and flows with the numbers.  Whenever things are bad, I'm always thinking about exit strategies.  Maybe I can get out of it what I put into it.  When things are going well, I never think about exit strategies.  Right now we're in heady times, so I haven't thought about exit strategies for about 18 months.

          All of the Internet professional services roll-ups have approached us over a period of time, some of the famous  public ones and some of the ones yet to be public.  Research is an unbelievable thing.  Every single one of them found us.  I was impressed.

          I sat in a room with one of them who said, "Why don't you tell me a little bit about your company?"  Two minutes into my talk about how great we were, he said, "I want to buy you."  I just sat there for a second.  The only words that could come into my head were, "Can't you kiss me first?"

          See, when I look at our business, there are two constituencies we have to serve.  One is our customers who come to us based on trust.  How does someone trust you that's never met you?  They trust you based on reputation and how you interact with them.  Our customer gets delivery of the product we built for them after they pay us.  Maybe they have a little bit left at the end, but, for the most part, there's a leap of faith that they have to make. For many of our customers, we are the second, third, and in one case, I think the fifth try at actually deploying something significant on the Web.  We're dealing with people who have a lot of experience, who have hit all the bumps, including some they never thought they would hit.  That's one constituency.

          The other constituency is our employees.  We are only as good as each person that we hire and their ability to execute a job with a customer.

          When I think about a roll-up strategy, I imagine that I'm one of my customers who picks up the newspaper and reads that Alta Software has joined roll-up XYZ.  I wonder how that makes him feel.  Does it make him feel good?  He's thinking, "Most of the people are going to be independently wealthy, so that means they're going to give me better service, right?  Not likely."

          From an employee standpoint, we spend a lot of time talking about how to build a culture.  Our turnover rate has been below 3%.  How do we retain those people?  We have a value proposition with them that they don't have just a job; they're working and building a company that's going to last a long time.  Our strategy has been to look at the big players in the professional services industry, the Andersen Consultings of the world and so forth.  Those weren't roll-ups.  Those were organically built cultures.  You've heard about the Andersen culture.  The reason for that notoriety is that they provide a consistent quality of service for their customers—whether you think it's good, bad or indifferent.  We believe that's a successful strategy and we employ it.  If we can make sure that every one of our customers succeeds, that every one of our customers gets the best quality of service we can possibly provide for them, then we believe that's going to lead to more customers and growing our business.

          Some data points.  Our run rate is over $20 million now, and we've been growing about 25% quarter-to-quarter, so, by the end of the year, it should be up to about $45 million.  We've done that without acquisitions and without outside capital.  I think, fundamentally, that the people in our company believe we can build a business one person at a time, one customer at a time.  Right now, it's kind of hard to read the paper and find out about people going public and raising $500 million, but, three years from now, maybe it won't be so hard when we have a business that's built to last.

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