Malik Khan, chief executive of NexTone Communications Inc., was expansive in an interview last week, laying out plans for hiring 100 more people in the next year, forming a "VOIP interoperability lab" and starting a "NexTone University" to train 10,000 engineers on the company's brand of Internet networking software.
Khan, who was named chief executive of NexTone in August, had good reason to be upbeat. The Gaithersburg company, which nearly crashed and burned in 2001, just raised $35 million in one of the largest telecom venture financings in the Washington area in the past three years, a deal that brought in a well-heeled backer that could fund his grand plans.
The deal was led by One Equity Partners, a private equity fund better known for buying major companies than providing venture funding for start-up telecommunications software companies like NexTone.
"It takes us to a whole new level," Khan said. "If we choose to, we could do some acquisitions. Or if we grow faster, then we may end up needing more capital. And OEP is a $3.5 billion fund and we're the smallest investment in that fund."
One Equity Partners began as the private equity fund of Bank One in Chicago. Now it's funded by the third-largest U.S. bank because of Bank One's merger with J.P. Morgan Chase & Co. last year. It is best known for its $60 million buyout in 2002 of then-bankrupt Polaroid Corp., which One Equity sold early this year for $226 million. One Equity has a diverse portfolio of telecom, industrial and health care companies.
"What we try to specialize in is identifying trends that are transforming industries, then identifying companies that will benefit from the change," said David A. Walsh, the former Global Crossing Ltd. president and OEP partner who led the NexTone deal. "Our investments do tend to be larger than the one we're making here, but the investment definitely fits our profile."
NexTone develops software that resides on Internet networks. The software helps move the data, voice and video traffic traveling on these networks as efficiently and quickly as possible. Khan thinks that as more people use the Internet for their telephone service, demand for such "session management software" will explode. NexTone sells the software to telecommunications carriers, Internet infrastructure companies and companies that use the Internet for their own networks. Its closest competitor is Acme Packet Inc., a Massachusetts company funded by a group of venture investors led by Silicon Valley's Menlo Ventures.
NexTone probably could have raised more money, but Khan and other investors in the company said it shouldn't need to. The OEP round gave a "very attractive" valuation to the company, said Thomas A. Smith, a partner at Mid-Atlantic Venture Funds, which was the earliest investor in NexTone, back in 1998. That means NexTone could expand through acquisitions using shares in the privately held company. Also, NexTone's growing roster of customers -- it has 370 -- means that much of its internal growth can be funded with the cash it is generating.
Khan would not disclose NexTone's revenue or other financial information.
Since it was founded in 1998, NexTone has raised $67.5 million in several rounds of venture financing, each bringing in new investors. Reston's Mid-Atlantic Venture, one of the most dogged early-stage investors in the region's telecommunications start-ups, is the only fund to have stayed with NexTone from the beginning, renewing its investment at each stage.
Smith said NexTone in 2000 and 2001 was too reliant on business from the numerous telecommunications carriers that surfaced in the 1990s to compete against the Baby Bells. Then, NexTone's business was focused on providing access equipment so a small carrier's customers could use voice over Internet protocol (VOIP). When that business collapsed, NexTone had to reconsider its entire strategy.
"It was a tough time," Smith said. "We went back to the drawing board and figured out what we could actually sell. We identified what at the time was a fairly narrow solution, a small market niche. We were able to carve it out from there."
In 2002, the District's Core Capital Partners LP led a new small round of financing for NexTone that allowed it to rebuild its business around what is now its core software product. Previous investors that also participated in the $35 million round were BCE Capital, a Canadian fund, and Safeguard Scientifics Inc., a fund based in Wayne, Pa.
Walsh and Smith said that there is no clear strategy for how and when the venture investors will cash out. A sale is possible, though Khan thinks NexTone will be an acquirer, not an acquiree. An initial public stock offering is a possibility but isn't planned right now.
All Walsh is thinking about is growing the business, which employs 180 people in Gaithersburg, Europe and Asia.
"We're expecting big things to come from this company," Walsh said. "It has the potential to become the market leader in something that's hugely important to the future of [telecommunications]. It was but a few years ago that people didn't know what a router was. In a few years everyone will know what this software is."
American Capital Hires Adviser
The march of top defense and intelligence brass into the private equity world continues.
Last week American Capital Strategies Ltd. hired Les Brownlee, former acting Army secretary and a former staff director of the Senate Armed Services Committee, as a consultant and adviser to help identify -- and serve on the boards of -- defense contractors that American Capital invests in.
American Capital, a public company in Bethesda, is a business lender and equity investor in mid-size businesses. In recent years it has increasingly become a controlled buyout business.
"He won't be a lobbyist," said David Ehrenfest Steinglass, American Capital managing director. "He'll make us a smarter investor. First and foremost, he can bring the perspective of the customer, and where national defense is headed. There's no substitute for that."
Terence O'Hara can be e-mailed at email@example.com.