Revealing Insights

Reveal_CT80DR
Earlier today SAIC announced that they had signed a definitive
agreement to acquire our portfolio company, Reveal Imaging.  This is an extremely positive outcome
for the company, its customers, employees and shareholders and represents an
import waypoint on a fascinating and successful entrepreneurial journey for the
team at Reveal.  Reveal Imaging is
a company that develops physical security solutions – primarily explosive
detection systems – for the aviation security market.  While there are plenty of case studies about successful
entrepreneurial stories, what makes the Reveal story uniquely compelling is
that it involved a group of larger company executives who came together post
9/11 with a genuinely patriotic mission to bring innovation to the world of
aviation security, a market segment that is normally outside of the purview of
traditional venture capital success stories.  That said, many of the lessons learned along the way apply
more broadly and I thought they would be illuminating on a several [a baker's dozen worth, highlighted in brackets below] dimensions for prospective entrepreneurs.

Before jumping into the story, the people and the lessons, I
should explain what the company does. 
Reveal Imaging provides threat detection products to the global
transportation industry.   The
company’s first focus was on explosive detection systems for the aviation
checked baggage market, and their screening system today can be found in 100s
of airports in the US, China, Israel, Mexico and other locations around the
world.  The founding vision of the
company was that in the post 9/11 world, the transportation security
requirements of customers had fundamentally changed, but the solutions had not,
and that this represented a unique and compelling opportunity.

We first met Michael Ellenbogen, Reveal’s CEO, and his 5
co-founders in January of 2003 at the suggestion of his CFO, Charlie Tillet who
was previously the CFO of a former portfolio company. [Point #1: a warm introduction
to a VC from a trusted source is always the best start]
.  At the time, while the company was a
raw idea with only a PowerPoint deck, I remember being extremely impressed with
the team, their deep domain expertise and breadth of experience in the market
and the uniqueness of their vision. 
As a group, they had been responsible for developing three of the only
five explosive detection systems approved by the Transportation Security
Administration (TSA) in the US, the key initial customer.  Each of the executives knew each other
from prior companies, but they had also had worked in different companies so in
many respects the best combination a founding team can have: prior working
relationships but a diverse gene pool. 
Further, they each had an important role to play in the new company:
Ellenbogen as CEO, Richard Bijjani as CTO, John Sanders as Business
Development, Elan Scheinmann as Marketing, Jim Buckley as Sales and Charlie
Tillet as CFO.  [Point #2: pull
together the best team you can, with unique market and customer insight, as you
launch your venture]
. 

While we loved the team from the outset, the market the
company was targeting, explosive detection systems for the aviation security
market, was by no means an industry segment we knew well.  In fact, after my initial positive
reaction to the team, my follow up reaction was why on earth would we invest in
a company building a hardware system that needed to be approved by a
certification body that would be sold to governmental customers.  Not the traditional VC recipe for
success!  That said, the team was
able to articulate a vision for their first product that made sense: driven by
a proprietary design and advanced software algorithms, it was going to be a
smaller, faster, higher performance checked baggage screening system that would
be lower cost from both a capital and operating expense perspective for the end
customer.  As a result, it fit into
airports where the existing solutions were not practical.  This IP based, better, faster, cheaper
value proposition was one we could wrap our arms around and, in conjunction
with the management team, we were able to build a market segmentation map that
outlined the size and scope of the opportunity which led to the conclusion that
there was the opportunity to build a company of significant size. [Point #3:
even for the most complex and arcane technologies, work to distill your message
into a simple, compelling, value proposition that translates into a large
market opportunity]
.  Also helpful
in this regard was that the company, through its network of relationships was
able to serve up as diligence resources prospective customers and industry
experts that had heard the company’s story and were able to validate this
perspective. [Point #4: always run your idea by key customers and partners looking
for both validation and ways to improve your positioning.  Also, if you are in an off the beaten
path industry, be willing to lead your VC by the nose through the due diligence
process].

Having come to the conclusion that we liked the team, their
vision and the market opportunity, we had two remaining questions and
challenges.  First, could the
product be built (technical risk) and second, could we raise the necessary
capital to fund the development effort (capital risk).  Capital risk proved to be a bit
challenging for the Reveal team, as many VCs they spoke with turned down the
opportunity to invest based simply on the fact that it was outside of the areas
they knew well and was selling to governmental customer, although in the end,
the team was able to build a strong syndicate including ourselves, General
Catalyst and Greylock Partners. [Point #5: it pays to be a contrarian and don’t
let conventional investor wisdom discourage you]
.  The size and scope of the technology development effort,
especially as explosive detection systems need to be certified by the
government and at the time there were only two companies with certified
solutions, remained the last open item. 
In the end, despite significant technical diligence from outside
experts, this was the leap of faith that we decided to take.  That said, we structured the initial
$10M commitment to the company in two pieces, where the second slug of capital
would only come in once the first machine was certified.  The discussion around this point also
led to one of the best lines in the entire diligence process when Michael,
having been asked by a prospective investor what would happen if the machine
could not be developed and certified in a timely manner, responded “Well then,
I guess you and we are f#*$ed”. [Point #6: honesty and a sense of humor are always appreciated].

Armed with the initial capital, the Reveal team set out on
developing the system.  This was a
complex product development effort involving hardware, software and critical algorithms.  Soon after the initial VC financing
closed, the company also raised capital in the form of R&D dollars from
their target customer, the Transportation Security Administration.  This proved to be hugely beneficial as
it both provided a non-dilutive financing source and established an early
dialog with the customer to ensure that their needs were met.  [Point #7: early customer engagement
and buy-in is critical to success and it is even better if they will help fund
development]
.  Despite this, as is
often the case in complex systems development, the product took longer and cost
more than anticipated and we reached the end of the first round of venture
capital money without being certified by the TSA – thus failing the previously
agreed to milestone.  This was the
first gut check for the team and investors, but we believed the technical problems
were solvable in a relatively short period of time and the market feedback we
were receiving continued to be positive, so we pushed ahead and put more
capital into the business.  Helping
this decision along were two other facts: first, the team was incredibly
transparent through the process, so we always felt like we knew where things
stood and second, given we had three investors, the incremental commitment from
each of us was relatively small. 
[Point #8: keeping your investors informed on all issues in an open,
transparent way, especially in challenging times, is critical] [Point #9: if
you face capital risk, syndicating early, even if the dollars are small, pays
dividends later] [(Self-serving) Point #10: having supportive, well-informed
investors always helps]
. 

In December of 2004, 6 months later than planned, the
machine was certified and first revenue shipments began in early 2005.  After that, given the company’s success
in building pipeline, the company was on a steep growth trajectory.  Early in this growth, we received our first
inbound acquisition interest, which was turned down and the investors provided
more capital to fuel the growth of the business.  Given the team and Board were aligned around building a
large company, this decision was relatively easy and in hindsight while the
“quick flip” might have generated a nice IRR, it was far more satisfying
emotionally and financially, to build a large company. [Point #11: ensure the
founding team and each of the investors have aligned objectives around the
eventual outcome]
.

By the end of 2006, the company was on a revenue run rate
north of $50M per year and was profitable when the TSA, the company’s largest
customer at this point, went through an internal re-organization and re-prioritization
of their activities, leading the order flow to dry up for the next 4-5
months.  These were challenging
times for the company, but the team’s belief in the mission, ability to manage
expenses through the trough and a willingness to look for new strategic
indicatives to reduce customer concentration and expand the company’s product
footprint, got them through the dry-spell [Point #12: as an entrepreneur,
resilience is a requirement, and don’t declare victory or defeat too early]
.  In the end, the TSA did come back on
line as a key customer while many of the new initiatives launched in these
tough times around international markets and new products, began to pay dividends
in 2009 and 2010 when the company’s revenue run-rate exceeded $100M while
remaining profitable, a milestone they achieved in 2006.  [Point #13: being cash flow positive is
the only way to control your destiny]
.

So we take our hats off to the Reveal Imaging team for the
success they achieved and for teaching us, again, some key lessons along the
way.  Working with groups like this
remains the most satisfying aspect of what we get to do very day.

3 thoughts on “Revealing Insights

  1. DesignNotebook August 2, 2010 / 5:59 pm

    One of the best (value= content*clarity/length) case studies I’ve read.
    Thanks for taking the time to do this.

    Like

  2. JP Tucker August 6, 2010 / 3:13 pm

    Great analysis – and congrats to the team and investors on the outcome!
    I could go either way on your #6. If a less experienced team issued the same response, many investors would probably consider it shortsightedness on their risk analysis rather than humor!

    Like

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