LayerOne: My Biggest Failure!

I was interviewing a candidate for Big in Japan and I asked him what his biggest failure was. He answered the question thoughtfully and at the end of the interview, as I always do, I asked the candidate if he had any questions for me. His first question, “what was your biggest failure.”

Most of us (well mainly me) have a hard time talking about our failures. I had to think for a minute and then the answer was obvious. In 1999 I founded a telecom company called LayerOne. It was the hieght of the private equity - venture capital funding wave and I caught one of the last waves. The idea was to create pooling points of local haul, local and internet connectivity and charge carriers for connecting between each other. I ran around the country (Sandhill Road, New York, Austin and of course Dallas) looking for private equity. Almost 100 venture capital and private equity groups were not interested in my idea…

I was only 28 years old so I had no idea how bad the odds were that I could raise the money to fund my idea so I rented a loft near downtown Dallas right above the Genesis Hair Salon (you could smell women getting permanents in the afternoons). I polished off my business plan and hired a lawyer from the Austin office of Wilson Sonsini and a secretary. Finally I found a group of investors willing to fund my idea. My series A was $11,000,000.00 on a $22,000,000.00 premoney valuation (not bad for a first time CEO with a business plan and a loft). The round was led by Crest Communications with additional investments from Soros Private Equity, Cabletron, and ADC Telecom. Soon I was off to the races hiring a team to help me build my dream. One of my key hires was detailed in Money Magazine here. I found a small, under funded competitor that was willing to sell and jump started our rollout.

I made every mistake in the book (I had a lot of help making the mistakes). By the summer of 2001 we were well on our way to meeting our goals for the completed ‘pooling points’ but we had not been able to raise the second round that would enable us to complete our nationwide buildout. We had leases across the United States (even a few options on spaces in Europe), but not enough money to build them out. Our original investors were trying to raise their second fund (a fund they never closed) and everyone was scared of the telecom space. We managed to raise another $9,000,000.00 to ‘bridge’ us to the ‘big’ round. Our lead investor, Crest Communications, had a relationship with First Union and suggested that we use their bankers to help us raise our second round. Their effort was extensive (scores of meetings in New York, Chicago and San Francisco), but ultimately unsuccessful.

So I reverted back to my old strategy, call everyone myself and set meetings. Most everyone turned us down, but finally we got a term sheet from TL Ventures for $40MM ($60MM short of the total amount we would need to get to breakeven). Everything looked like it was going to work out. But soon it became apparent that there was a big catch in our termsheet? TL would need to find (actually I would need to find) other investors to fund $30MM of the $40MM. Our existing investors would come up with $10MM bringing our total to $20MM, but finding the other $20MM seemed impossible. Nortel blew up in the summer and of course Enron crumbling did not help. We were in big trouble. Neither TL or us could find the last $20MM needed to close the round (and no they would not close without the total $40MM).

El Paso Energy had started a telecom business and talked to us about acquring the company. It seemed like a good option should the fund raising effort fail - something I was getting more and more worried about. We received a term sheet from El Paso that would return 100% of the paid-in equity our investors had made and provide jobs and options to the management team (i.e. me). This was not a great option, but as we would be out of cash by July it seemed like the prudent thing to do. Our investors (Crest) decided that the deal was unacceptable and that we should pursue other options (including the TL deal still on the table). Next, we were contacted by Universal Access about a potential aquisition. We finally came to terms, but the deal did not make sense to us. The deal was for stock (UAXS was traded on the NASDAQ) worth around $5MM and out of the money warrants valued with Black Schoals at something like $20MM. It seemed to me that the warrants would NEVER be worth anything, but on paper this deal looked better than the cash deal offered by El Paso. We signed the deal and Universal Access covered our payroll in June. The deal never closed. By the time the deal was dead El Paso was out of the market - they were paralyzed by the Enron debacle.

So the only option seemed to be Chapter 11. Ug! I was sick to my stomach - bankruptcy was not a good thing to have on your resume. So I started running around looking for capital to fund a reorg. I found two groups who were interested in the deal. We figured it would take $2MM to buy the business in a 363 asset sale and $2MM to get it to breakeven. We were going to take the sites that were cashflow positive (or near positive) and a reduced staff 12-15 employees and run the business. By the end of August 2001 we had the sale and successfully bought the business out of Chapter 11. We were in bankruptcy for around 30 days - one of the quickest in the history of our jurisdiction. So on September 11th 2001 I was headed to Hughes and Luce to sign the closing documents with our investors so the money could be transferred to the court for the sale. You might recall that the most deadly terrorist attack on our country happened on that day. I figured the deal was dead… But the next day we closed and LayerOne II was born.

The impact? Most of our investors (only three stayed in the new deal) lost everything - $20MM down the drain. LOTS of employees hated me (I assume they still hate me). This was the lowest point in my life. I was able to salvage the business for our clients, a few original investors, a few key employees and my family - but the majority of our investors and vendors paid the price of MY failure. I can blame a lot of folks, but ultimately it was my failure. How did it turn out?

Actually, fairly well. We were able to turn a profit in a few months and grew profits by around $20-30K per month for a couple of years. By 2003 we had made several investments outside of LayerOne and I made the decision (with more than a little help from our investors) to take over operation of Architel and LayerOne was positioned for sale. It took about a year, but LayerOne sold to Switch & Data for a 600% return for the investors ($4MM to $22MM in less than four years). It wasn’t Google but it was a big swing for me. I learned a lot, made a lot of mistakes and ultimately became a better businessman and hopefully a better person as a result.

8 Responses to “LayerOne: My Biggest Failure!”

  1. Martin Zacarias Said:

    Great story. And what was your return out of the deal at the end of the day? (presuming your personal cash investment was negligible).

  2. Alexander Muse Said:

    Well, there is something called the absolute priority rule in bankruptcy. So I did not get any money out of LayerOne I. With regard to LayerOne II - the reorg (i.e. the 363 deal) I negotiated 25% of the equity for management and 75% for the investors for the $4MM.

  3. Jonas Said:

    I think it’s great that VCs blog about things like these. My field is comic books and mobile content but you tend to pick up lotsa great lessons from stories like yours. :)

  4. Martin Zacarias Said:

    Not bad considering that you survived what we still refer to here as the “Nuclear Winter”.

  5. Jason McMinn Said:

    Nice war story! It is always great to hear other people’s experiences.

    I have been a Layer One customer since 2002. All I can say is that the people at Layer One from 2002 - to Switch & Data acquisition where a lot better their current staff.

  6. Alexander Muse Said:

    Jason - which site? Sorry to hear about the decline in the quality. I suspect that it has to do with scale - in 2002 we only had sites in Dallas, Miami, Chicago and St. Louis so we could spend more time on each client. I think Switch & Data now has more than 30 sites…

    In late 2002, early 2003 we bid against S&D to buy PAIX - we offered $30MM to S&D’s $31MM - had we won I suspect our service would have declined too…

  7. frederic tubale Said:

    Great story! I am learning a lot from this site. After all those experiences I am sure that it made you a better man . God bless :)

  8. Jason McMinn Said:

    Alexander - we have had a couple full cabinets over at Layer One since 2002 to run our casual game / advergame site

    The facility is awesome and have nothing but good things to say about it. Ever since Switch and Data has taken over, the customer service has decreased and the prices have gone through the roof.

    I miss the old guys that were on site as part of Layer One (pre S&D) - Patrick, Jason, Jeff, etc. They got stuff done!!

    We hopped around co-lo facilites for years because everytime we moved into one they went bankrupt - so at least Layer One has been around a while. I hope S&D doesn’t price it out of the market. There are still a lot of empty cabinets (at least it appears that way) over there.

  9. Texas Venture Capital Web 2.0 Blog » Blog Archive » Best Corporate Turnaround: LayerOne Said:

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