Leverage is a powerful tool when you’re looking to make a deal. Steve Potash had it in spades when he began to explore the market in 2011 for potential investors at OverDrive Inc.
“I had a track record of several years of strong year-over-year earnings,” says Potash, who founded OverDrive in 1986. “We also took the step to invest in several years of audited financial statements. So when we entered the process, I was in a strong position. This allowed me to pretty well dictate that process.”
Potash’s commitment to his strategic plan paid off in 2015 when OverDrive was acquired by Rakuten USA and became Rakuten OverDrive. As CEO, he delivers his industry-leading digital reading platform of e-books, audiobooks and other digital media to a network of 40,000 libraries and schools in 70 countries.
We caught up with Potash at ASPIRE to talk about the challenges he faced launching OverDrive in the pre-digital world of the 1980s and the pros and cons of debt vs. equity investors. What follows is a transcript of the above video, edited for readability.
Today’s climate for startups, especially in technologies, is unparalleled to anything we had in prior decades. Born and raised in Cleveland, Ohio, and trying to start a software company in the 80s was something that no investor in Northeast Ohio had any appetite for. I would go home and tell my wife, ‘If I was opening a retail strip mall, there’s all kinds of partners that want to help. But opening a software company?’
So what I actually did was I went out to Seattle and OverDrive opened a small office in Bellevue, Washington. Because there was so much success around Microsoft and other technology firms in the area, we did our first private placements and raised money from accredited investors. There was already an education and understanding and many investors had already seen returns and success.
Anyone who is starting a technology or software business or a dot-com, especially if it’s a true disruptive opportunity for legacy or other non-digital or non-mobile businesses, I believe has unparalleled opportunity to go shopping for partners in investment.
Debt vs. private equity
When an entrepreneur or a significant founder or owner is looking to bring in new partners, it could be a partner such as a private equity investor. It could be debt through a variety of debt instruments and facilities. It’s important to try to see what is the cost and what is the impact? Now obviously, when you work with debt instruments and you work with local banks and lenders, usually you’re going to have less voices at the table on a day-to-day basis. But you are adding to your balance sheet and your income statement these burdens to now service the debt and disclose and be mindful of leverage you’ve now added to your operations.
On the other side, going out for private equity or smart money, while it may have less impact on your income statement month to month, you’re now in many cases going to have an active investor who has their own agenda and their own thoughts on how you should be operating the business. They may want a voice in all key hires and possibly even bigger strategic directions that may not always align with the founder’s thoughts on going forward.
Who has the leverage?
When an entrepreneur, founder or significant equity owner of the current business is at that point of possibly giving up a significant equity or a majority stake in the business, it is really important to realize who has the leverage. I was fortunate that when we went out for our large equity round in 2011, I already had many years of strong double-digit growth. We had recapitalized the business in prior years so that we had all the preferred, no debt, everybody was in common shares.
And I had a track record of several years of strong year-over-year earnings. We also took the step to invest in several years of audited financial statements. So when we entered the process, I was in a strong position. This allowed me to pretty well dictate the process. Who we would interview as potentially representing us as a boutique bank to help us get a process. Being able to even articulate only the companies that I approved that I wanted to provide either a teaser or information and certainly, protect access to our information.
I really wasn’t excited to have one or two direct competitors sign a nondisclosure agreement and then have access to some of our confidential deal book information. It all depends on the position of the company. We did this specifically, we waited a few extra years to be in a very strong position, then knowing we could command a much better set of terms, valuation and the ability to set the framework. If we are going to bring in a private equity or venture partner, these are our criteria. I was fortunate we were able to and it resulted in a great outcome.