Stratify: A Post-Bubble Success Story

So Iron Mountain, the world’s biggest record management company, announced today that they are going to acquire Stratify, the leader in legal eDiscovery,  for $158M in cash. Stratify just happens to be the first early stage investment I ever made and I thought I would write a bit about the deal because I think it’s an interesting story of a “bubble” company that went through some very tough post-bubble times but ultimately achieved success thanks largely to the perseverance and flexibility of a great team. This is a long post but I think VCs, entrepreneurs and investors will find many of the details interesting.  Before I get into that though I just want to congratulate all the people at Stratify, especially George, Meena , Joy, Sanjeev, Hakan, and Ramana.  You guys hung in there in the face of a lot of adversity and you deserve all your success. 

A Bubblicious Beginning…
I made the original investment in Stratify back in September of 2000, although it wasn’t called Stratify then it was called Purple Yogi and it wasn’t focused on legal eDiscovery back then either , it was focused on a “widget” that automatically categorized news and information in a way that enabled consumers to discover related information easily.   Underneath the widget was an incredible unstructured data management platform built by a team of technology “rock stars”.  While Purple Yogi had undeniably amazing technology (man was it cool!), its business model was a little less impressive in that it really didn’t have one, which kind of explained why it didn’t have any revenues at the time either.  I am embarrassed to say it now, but I invested what was clearly a crazy “bubble” era valuation in their first round of VC funding. That said, 2.5 months after we put that money in, the company raised another round of capital from a new lead investor at an up-round valuation and I was looking at a nice mark up on my first early stage deal in less than 3 months.  I had gone from crazy to genius in 3 months!

Reality Sucks
Reality soon set in though.  As the consumer advertising market collapsed in the wake of the bubble bursting it was clear that Purple Yogi wasn’t going to be making any money selling advertising alongside its widgets, so we decided to focus the business on building an enterprise version of the technology.  This had been part of the plan all along, but it now became the sole focus of the company.  In conjunction with the new focus, we brought in a very accomplished enterprise-focused CEO, made a lot of painful staff reductions, and changed the name to a more corporate sounding “Stratify”.

The newly christened Stratify focused on building a world class unstructured data management platform and thanks to its fantastic tech team it quickly had an awesome product.  For the next two years Stratify tried its hardest to make this business work and it actually had a good deal of success selling to some of the most sophisticated buyers of information management software in the world.  The only problem was that every sale was like fighting trench warfare because Stratify was selling a very “heavy” traditional enterprise software product that not only required customers to write a very large up front software license check, but also required them to make significant investments in ancillary software and support services.   What’s more, because Stratify’s software was so sophisticated and so high-end the addressable universe of potential customers that could A) understand the value it brought and B) had a big enough problem to justify buying it was actually pretty small. The reality was that they had a fantastic product in what was effectively a very small market.  Everyone put their heads together to try and figure out how to build the business faster, but in many ways the company was stuck.  And then something totally unexpected and very fortuitous happened:  I got sued.

Thanks for Suing Me!
In late 2002 I got sued because I was on the board of another company that was embroiled in a legal dispute with its founder who decided to sue the board and company.  As anyone who has had the pleasure of getting sued knows, one of the first things that people do after getting sued is that they collect all the information, typically mostly e-mails, surrounding the issue(s) in question and review them to try and see what the facts of the matter are.  Shortly thereafter you are usually required to give most of these e-mails to the person suing you in a process that lawyers call “discovery”.   As I tried to sift through the morass of e-mails related to this case, I immediately thought of Stratify and asked the CTO if it might be possible to use Stratify’s system to review the e-mails.  The CTO told me that it was in fact possible and that the crack tech team had actually been working on some skunk projects that could be adapted to this purpose.  They quickly cobbled together a makeshift solution and after some initial tests we were all uniformly amazed at how well the system performed and how much easier it was to review e-mails when Stratify’s technology had been used to filter and classify them first.  I was even more amazed when I asked some lawyer friends and they told me that large law firms can easily pay $500K to review e-mails for a single large case.  That sounded like a very promising market.

As it happens, at the same time that we were just starting to think about legal discovery as a potential market for Stratify’s technology, a large software company, who had been flirting with the company for awhile, made a surprise offer to acquire the company as they sensed that due to investor frustration with the slow growth of the enterprise business they might be able to acquire the deal on the cheap.   While I personally thought that there couldn’t be a worse time to sell, practically every other investor wanted to take the deal. They were fatigued and generally freaked out by the market, which at that point in early 2003 was just about reaching rock bottom after almost 3 years of declines.  We settled on a compromise where we took the existing cash in the business and bought out everyone that wanted to sell, which turned out to be almost everyone but us.  After closing that transaction, I set out to try and raise another small round of funding from other VCs and despite a few months of trying I didn’t get a single taker, despite the fact that the legal eDiscovery business had quickly moved from product concept to making a few large sales in less than 6 months.  Nobody was in the mood to take a risk back then.

A Perfect Match
As it turned out though, the legal discovery business not only began to pick up steam, it was quickly becoming clear that the opportunity was even larger and more attractive than we had hoped.   It was like night and day from the enterprise software business.  Instead of 9 to 12 month sales cycles we now had 2 to 4 week sales cycles.  Instead of having to get internal IT to sign off on a laundry list of integration and implementation issues, we sold the product as a fully hosted SaaS solution that was up and running in a matter of days.  Instead of making one big sale per customer, we could make numerous small sales, often to the same partner at a law firm.   Finally, instead of having a very small set of potential large enterprise customers, we now had every law firm in the world and any person or company that had been sued or was suing someone as a potential customer.  Business was so good that Stratify stopped trying to raise the extra capital from VCs and in fact never raised another dollar of equity financing.

I had to resign my board seat at Stratify when I left Mobius, but for the next few years, with the able assistance of Jason and Chris, the team kept building the eDiscovery business to the point that it was clearly a very successful business.  I stayed in touch with the team and tried to offer encouragement and assistance, but they didn’t need any help; they finally had a market and a business model that took full advantage of their fantastic technology.  With growth and success came multiple suitors and it was inevitable that one of them would offer a deal that made too much sense to pass up and that’s exactly what happened today.

Lessons Learned
I learned a lot of investment lessons from Stratify, the most important of which are:

1. Don’t underestimate the value of a great technology team.   Great tech teams can quickly adapt a product to suit changing markets and priorities.  They also create products and technology with lasting value that can be leveraged in multiple ways.
2. If at first you don’t succeed, find a new market and/or a new business model.   It’s often said that very few start-ups achieve success with their original business plan and after my Stratify experience I believe it.  Start-ups should always keep an open mind about potential changes in business model or market focus that might increase the chances for success and should be honest with themselves when it is clear that they are “stuck”.
3. When everyone else is selling, it’s not a bad time to think about buying.  In the public markets they call it capitulation; in the private markets they call it fatigue.   It’s hard to fight the urge to run with the herd, but if you can, you can often make a lot of money.

Venture investments can be real roller coasters.  Stratify went through two business model changes before they found the market, model and product that clicked .  Through it all a core team of people stuck it out and ultimately built a great business that everyone can be proud of. Congrats again to all involved!