Panos Bethanis closed the front door of his house in Boston's South End at 2 o'clock on a bitterly cold January morning in 2007. Eleven friends and colleagues, exhausted after a marathon meeting, had just filed out the door. Bethanis had invited his buddies over that evening to pitch them his strategy for buying an online directory business called DirectoryM. He had founded the company five years earlier but had sold a majority stake to a pair of venture capital firms in 2005. Now, with the company struggling, Bethanis saw an opportunity to get his company back.
For Bethanis, then 31, regaining control of DirectoryM was partly a matter of pride. Though he still had a 3 percent stake and a seat on the board, the investors had removed him from the CEO post, leaving him with no meaningful management role. In fact, he had started a new company, Interaction Media Group, or IMG, that offered a similar product. Now he wanted to combine the two companies, which he believed would speed IMG's growth but would cost a bucket of money and pose big risks.
To get back his company, Bethanis would need his old team to join him. Of the friends gathered at his house that night, all were current or former DirectoryM employees, including the company's co-founder, Jim Woodroffe. Bethanis wanted their knowledge and experience. He would need them to work long hours with no pay and to help finance the deal. "I needed these guys," says Bethanis. "Plus, they are my best friends."
Friends or not, the team was not yet convinced. How would they come up with the money to acquire DirectoryM? How would they pay its $6 million debt? Why take all that risk? Unlike in the old days, some had mortgages and families. "Why don't we just take what we've learned and build IMG ourselves?" asked Steve Burr, now DirectoryM's head of partner relations.
It was a question Bethanis was wrestling with himself. He knew taking on all that debt would be a major headache. But in the end, his gut told him the deal would work. Plus, he wanted to prove he had it in him to fix the company he had put so much of his heart and soul into building. "I didn't want to link my name to a company that failed," he says. "You know how people say it's not personal; it's business? I'm the opposite of that. To me, it's always personal."
DirectoryM is a sort of online yellow pages that shows up on some 200 media sites. It sells ads to local businesses and places them on sites like Newsweek.com, NYTimes.com, and Kiplinger.com. (Inc.com also offers DirectoryM listings.) In the business's early years, when the online ad market was slow, DirectoryM grew steadily if not spectacularly. Its sales reached about $3 million in 2004 (though it hadn't yet turned a profit), and the company employed 50 people.
By 2005, DirectoryM was successful enough to attract $11 million in funding from two venture capital firms, BV Capital in San Francisco and Matrix Partners in Boston. The VCs became majority shareholders and brought in a new CEO, who focused on building the company with a large ad sales staff. Revenue grew to $8 million in 2005, and the work force shot to 150, but costs were out of control -- losses peaked at $600,000 a month. DirectoryM was soon forced to lay people off. In late 2006, the VCs decided to cut their losses and sell. Matrix would not comment on the record for this story, and BV Capital representatives did not return calls or e-mails seeking comment.
In 2006, as DirectoryM struggled, Bethanis's new company, IMG, started showing promise. Instead of simply providing a list of local businesses on others' webpages, IMG combined its directory with stories on relevant topics. So alongside a list of, say, accountants in Pittsburgh would be stories on tax and accounting topics. By adding content related to subjects that Web users were likely to search for on Google (NASDAQ:GOOG) and other search engines, Bethanis reasoned, IMG would be more likely to attract neighborhood businesses. Best of all, the ad sales process would be automated. Businesses that wanted to buy an ad could do it all online. That meant Bethanis would be able to do away with the cost of an expensive sales staff. To speed growth, however, Bethanis needed publishers that would agree to share their content in exchange for a cut of ad revenue. DirectoryM already had those partnerships.
At first, the thought of buying back DirectoryM seemed like a pipe dream. In November 2006, the investors were asking $30 million. But there were no takers. Over the course of the next two months, the sale price fell to just $6 million, the amount needed to cover the company's debts. Bethanis figured he and his team could offer $1.5 million in cash and assume the additional $4.5 million in liabilities. It would be a risky move, but Bethanis was determined to save his creation.
The Decision Shortly after that late-night meeting, Bethanis received text messages from three of the guys: "I'm in." Within 24 hours, nine of the 11 had agreed to join him. What persuaded the group to go along with Bethanis and take the plunge? A deep trust in his judgment helped, and so did the camaraderie of the closely knit team.
But there was still a lot of money to raise. The deadline for closing the deal was February 27. Bethanis convened another meeting to squeeze cash from his enthusiastic but not very flush partners. Initially, the group's members were able to come up with a mere $18,000. Over the next few weeks, they scrambled to find more. "I was getting phone calls from these guys saying, 'I've got another $2,000,' " says Bethanis. They brought the total to $60,000; then Bethanis decided to mortgage his house, adding another $120,000.
He spent the next three weeks pitching 100 or so potential angel investors on the deal. Bethanis traveled to New York, Miami, Greece, Denver, Los Angeles, and Germany. He eventually got commitments from six investors. The last chunk of money was wired to him 90 minutes before he was scheduled to sign the contract. "Everyone was celebrating -- for about an hour," Bethanis says. "Then we realized we had hardly any money in the bank."
Soon, however, the strategy of combining the two companies started paying dividends. Traffic on the regional pages picked up, and the ad dollars followed. More came in when DirectoryM began running ads sold by Google, Yahoo, and SuperPages. DirectoryM was able to start paying salaries four months after closing the deal. It also helped that of the 25 remaining employees, only one other than Bethanis's team decided to stay with the company, leaving it with a lean staff. By the end of the year, the company was turning a profit. "It's like a kid who breaks his favorite toy and gets to buy another one," says Ruy Cuadra, vice president of operations. "It's been an answer to some of my dreams."
Bethanis couldn't agree more. He has been chasing the entrepreneurial rainbow since he arrived in the U.S. from Greece at 16 to attend Brandeis University. By the time he turned 25, he had a law degree and an M.B.A. from Boston University. And he had launched four start-ups. But none of them took off, including an unfortunately named line of jewelry, Vergina (pronounced ver-heena, after a Greek town famous for its ancient gold artifacts). "Imagine a 16-year-old trying to sell a brand called Vergina in the U.S.," he says.
Now that he's got his second chance with DirectoryM, Bethanis appears to be hitting his stride. The business is on track to reach $4 million in revenue in 2008. That's half of 2005's take, but the company expects 20 percent net profit margins for 2008, compared with a loss last year. Still, paying down those millions in debt is a slow and painful slog. Bethanis still sometimes wonders if he made the right decision. He could have allowed DirectoryM to fail and simply built his own relationships with publishers, unburdened by debt. Says Bethanis: "I'm still paying for the sins of 2006."
The Experts Weigh In
Don't try to be Google
The original vision of DirectoryM sounds eerily competitive with another company whose sights were set on yellow-pages revenue -- Google. Taking on the highly automated search giants seems Herculean. Bethanis's new business vision seems to be a more automated version of the original idea, which makes DirectoryM a small ad network in a rapidly consolidating world. That may prove successful for a while, but I doubt the long-term value of his middleman position for acquirers or for the public equity markets.
Bethanis and his team should have used that $1.5 million to reconnect with their publishers instead of taking on $4.5 million in debt. That said, they have the right model. Tying together geography, relevant content, and advertising is the next step in the evolution of online advertising. I have not seen anyone set the standard for relevant content matched with advertising like DirectoryM is doing. If the landscape starts to change, they will need to adapt and shift, which they have a great track record of doing.
Compelling Capital Solutions
Why not start fresh?
There are a lot of red flags here. I would not have gone out of pocket one penny for this business. The team should have started a new company and gotten right in the face of DirectoryM. Presumably the team members had all the contacts they needed to succeed. Launching the new company would have given them a chance to start with a clean slate financially. By taking the course they did, they started with serious debt and with significantly diluted equity interests as a consequence of the outside capital they had to raise.
Bryn Mawr, Pennsylvania
What do you think?
Was it wise for Bethanis to take on debt to buy back DirectoryM? Or should he have focused on building IMG more slowly but debt free? Write to us at firstname.lastname@example.org and tell us what you would have done.