Adallom was formed in 2012 with what an idea its founders quickly learned was no good. But three years later the company was sold to Microsoft for $320 million.
Adallom’s meteoric rise can’t just be chalked up to a bubble in the field of cybersecurity or to extraordinary luck. The process of building the company was careful and methodical from the start, relying on a network of connections and on the experience of Sequoia Capital, one of the world’s leading venture capital funds.
That is why company CEO and co-founder Assaf Rappaport and Gili Raanan, the Israeli partner who led the investment for Sequoia, chose to be interviewed together for TheMarker to tell the story. The former took a personal risk and developed a product that would quickly reach hundreds of millions of users throughout the world; the latter identified the potential at a very early stage and helped it take off, turning a $4.5 million investment into more than $100 million in a matter of months.
“I met my partners in the army,” says Rappaport, who served in the 8200 intelligence unit of the Israel Defense Forces, a breeding ground for tech entrepreneurs. In 2012, he and two partners left their jobs to start something on their own.
“We told ourselves that even if we didn’t find an idea right away, we wouldn’t give up, we would keep going for the year. What was clear that the idea would come from the computer security field, which is our area of expertise.”
The first thing the three came up with was a security product for the Microsoft work-sharing program SharePoint. It was tailored to meet a specific security need for large Israeli tech companies, which paid the developers tens of thousands of dollars for it. With that success under their belts, the three began to look for outside financing.
“I was wary of venture capital funds in general and American ones in particular,” recalls Rappaport. “I thought their goal was to replace the developers at an early stage with managers they would bring in, so that the company’s success is no longer the developers’. We wanted to remain a smaller company and run it ourselves. So in the beginning we were trying to raise money from angel investors and not from VC funds. This was in 2012, before the really big hype began over cybersecurity, so there was a lot less money being directed into the sector than there is today.”
Nevertheless, Sequoia began to court the members of the team. “I heard about Adallom’s team through the network of former 8200 guys,” says Raanan. “I was told they were really talented and I have to meet them. They had no interest in meeting me, but I finally managed to set something up. Assaf didn’t even come.”
After finally meeting with Rappaport, Raanan convinced them that Sequoia wouldn’t take the company away from them, and would instead give them the resources they needed to grow and develop it.
Before Sequoia put in the money, Rappaport and Raanan flew to the VC fund’s Silicon Valley headquarters and give a presentation to managing partner Doug Leone. “After the presentation, Gili had us going for about 40 minutes. He said our presentation was lousy, and the product was no good. I expected them to toss us out, but at the end of the meeting he put a $4.5 million term sheet on the table — three times more than we were looking for. When I left the room I thought it was some sort of Sequoia inside joke,” recalls Rappaport.
“We decided to invest not because of the product, but because of the team. We saw that this was a team with amazing abilities. We signed the deal without knowing for sure what the final product would be,” says Raanan.
Rappaport was able to play hard-to-get because Adallom had developed a working product even before its first funding round and, due to one big Israeli customer, was generating sales of tens of thousands of dollars.
But when Sequoia came into the picture, the three Adallom developers realized that they’d do better to give up the customer and alter the product. It was a difficult decision, but it came after a thought process called Sunrise that all startups in the Sequoia portfolio undergo, whose main goal is to find a match between the market need and the product the company will develop.
For two weeks, Rappaport and Adallom Chief Technology Officer Ami Luttwak sat at Sequoia offices in Palo Alto and met with dozens of Silicon Valley folks.
“The fund has a network of ties with people we’ve known for a long time,” explains Raanan. “Many people in the industry, some from our portfolio companies, meet with our developers. It’s an open process. We’re not trying to sell them anything, just to hear what they need. By the end of this process you can get a good signal from the market and start developing a product in accordance with existing need and demand.”
From one place to another
Occasionally the process leads to an overnight success, but usually success depends on extensive market and technology analysis, Raanan explains.
“Adallom began in one place and three months later the company was in another place. It’s a natural process, but for it to happen you need a lot of trust between the fund and the developers. Assaf could have insisted on their original product, but the developers themselves thought about how to change the product and adapt it to the market. That was the last moment when it was still possible to change the product relatively easily.”
After Sequoia invested in late 2012, Rappaport moved to Silicon Valley and began working out of a room at Sequoia where he kept abreast of the changing market and stay ahead of it by at least nine months.
“Toward the end of 2013 sales began to accelerate, and I knew we were in the right place. When a client who has followed the company throughout the development process finally signs a check, that’s excellent feedback,” says Raanan.
In April, five months before the sale, Adallom raised $30 million based in a funding round that valued the company at approximately $100 million. “It was a relatively big round, but I didn’t have to convince the investors to invest. Most were clients who basically wanted to acquire a kind of option, so they wouldn’t be left out of the game. We didn’t really need the money, but you raise investment when you can, not necessarily when you need to. This money gave us two or three years of breathing room and later it gave us power in the negotiations with Microsoft,” says Raanan.
All this time Adallom was being approached by multinational companies and customers who wanted to buy it. “I didn’t meet with them. We really weren’t looking to sell the company. At that stage, we already had two million paying users, and an annual income stream of $10 million,” Rappaport says.
“At the time we had 15 employees, and I told myself I want to have a big company. Maybe we weren’t thinking about a company with 1,500 people, but we could see the next step — a company of 50 people. I know I have a good thing in hand, good technology and maybe the possibility of starting another Check Point,” he says, referring to Israel’s biggest cybersecurity company, Check Point Software Technologies.
“You’re confident that you have a strong business and the right infrastructure to build something big, but day to day you’re focused on building the first floor of the tower and not thinking that far ahead,” says Rappaport.
In the end, Adallom sold itself to Microsoft, which was a natural because its product is relevant to Microsoft Office 365 and the company effectively became one of its distributors
“At a certain point, they decided to shift strategy: Instead of working with several different partners who would supply security for Microsoft Cloud they decided to form a strategic connection with a single partner,” Rappaport says. “Our market is very competitive, and there are many security solutions. They chose us and so we essentially became their only partner in the field. In the midst of talks about our partnership, they surprised us and put a buyout offer on the table. I wasn’t even at the meeting. We saw them as a very important partner, but we didn’t want to give up other clients, like Salesforce and Google Project Zero.”
Rappaport and his team agonized over the offer. “I was afraid that if they bought us out, they would turn our product into the security solution for Office 365 and that would be it,” Rappaport explains.
New phase for Microsoft
“But Microsoft switched to a new phase. It’s going to build its world development center for cybersecurity in Israel. It viewed this as the acquisition of a working business and not just technology. It plans to increase Adallom’s sales team and our product will remain alive. Now the best security product for Google Zero will actually be owned by its competitor Microsoft. We’re a subsidiary of Microsoft. Our sales and headquarters will remain independent and our organizational culture will be preserved,” says Rappaport.
You turned your employees from startup developers into Microsoft employees. How did they take it?
Rappaport: “You’re looking at it from the user’s perspective, but in the development world it’s different. Microsoft is one of the best buyers for developers. It has an excellent reputation in the development world. Maybe it’s not as strong a consumer label as something like Google or Apple or Facebook, but in the field of big organizations, it has an excellent reputation. Adallom is aiming at big organizations.”
Raanan: “You have to understand what interests developers: Aside from wages and benefits, they want the code they wrote to run on as many computers as possible and to reach as many users as possible. The tie to Microsoft can give them that.”
The buyout of Adallom is part of Microsoft’s broader strategy in Israel, led by the company’s director of mergers and acquisitions and business development for Europe and Israel, Yair Snir. In October Microsoft bought the Israeli startup Secure Islands for over $100 million. A year ago, it acquired Aorato for $200 million. The Adallom deal brings Microsoft’s combined investment in Israel to more than $600 million in the past year. It’s all part of Microsoft’s plan to concentrate its cybersecurity development in Israel.
Some people might wonder whether Adalom’s breakneck growth points to a bubble, but not Raanan. “Demand for security solutions is real. Big organizations encounter many security problems that have no solution and are willing to pay a lot for one,” he says, but adds: “There’s tremendous competition among cybersecurity companies, since many of them offer similar solutions. It’s clear much of the investment won’t pay off and many startups will close, but I wouldn’t say there’s a bubble in terms of company valuations.”