TechTonics: Rackspace’s Original Founders Recall ‘Messy Process’ of Growing Their Business

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Rackspace Co-Founders (from left) Morris Miller, Dirk Elmendorf, Richard Yoo, and Pat Condon stand for a photograph in the early days of the company.

Courtesy / Richard Yoo

Rackspace co-founders (from left) Morris Miller, Dirk Elmendorf, Richard Yoo, and Pat Condon in the early days of the company.

“Congratulations,” said Richard Yoo’s lawyer on the phone, “you’re going to be a very rich man.”

A night of celebration ensued for Yoo, then in his mid-20s, after his attorney called to inform him the company he helped found, Rackspace, was set to be sold to a telecommunications company.

The next morning he woke up to a flurry of calls, his mobile phone buzzing and his home phone ringing off the hook.

More friends, family members, and colleagues calling to heap their congratulations on him, he thought. He ignored them at first. Then the calls kept coming – nonstop for 40 minutes until Yoo finally picked up the phone. It was Sept. 11, 2001.

After assuring the caller he was safe inside his San Antonio apartment, Yoo turned on the TV just before an airliner struck the second World Trade Center tower, the terrifying scenes unfolding in real time.

Not until nearly a week after 9/11 did things become clear: The deal with Allegiance Telecom was off. The company’s stock – like that of many other telecommunications companies – was tanking in the wake of 9/11, and the country appeared on the brink of an economic downturn.

It was the third time in just over a year that a potential deal for Rackspace had fallen through. Myriad buyers had courted the San Antonio company during its meteoric rise from 1999 to 2001. In 2000, Rackspace fell short in its attempt to become a public company, and later that year, the company was a week away from being sold – until the executive brokering the deal for the acquiring company was fired.

With every failed acquisition exit, jobs were lost, resources were exhausted, and momentum slowed for the company Yoo and fellow Trinity University alumni Dirk Elmendorf and Pat Condon built from the ground up. But the aborted deals forced the founders to focus more sharply on growing their business for its own sake, and serves as an example of the unpredictability of the tech industry and of entrepreneurship in general.

Richard Yoo

“Any number of things could have been just a little bit different, à la the butterfly effect, that the entire Rackspace story could have been very different,” said Yoo, now 44.

When Yoo began selling dial-up internet service out of his college apartment in the mid-90s, he never imagined building a company worth $1 million much less one worth $10 billion. Yoo’s small business, Cymitar Technology Group, began receiving requests from customers to build web pages for them. The requests became increasingly software-intensive.

Yoo heard about a computer whiz who built a “mind-blowing” two-player online chess game, back in 1995 when software for the web was developed largely from scratch. The builder was Elmendorf, who coincidentally lived a few doors down from Yoo and walked by his apartment every day on his way back from Trinity. Elmendorf dropped by one day, and the two chatted all afternoon. Working for Yoo bankrolled Elmendorf’s beer fund. The job started off as more of a diversion for him, but Elmendorf became more invested as he learned about the potential of the internet.

Before they started Rackspace, Yoo and Elmendorf were developing software to help people use their credit cards online. E-commerce was still in its infancy.

On the side, Cymitar had started to build web servers and sell them to businesses. The company was losing money, however, as it struggled to sell its e-commerce software. That’s when Condon, Yoo’s former Trinity suitemate, moved from California to San Antonio to help the young entrepreneurs with their books. They realized Yoo and Elmendorf were making most of their money selling servers. Condon’s financial acumen opened Yoo’s eyes to the potential of web servers as the central product of his budding enterprise. He registered the domain name www.rackspace.com, and Rackspace was born.

Two of Rackspace Co-Founders Pat Condon (left) and Dirk Elmendorf stand in front of the Weston Centre, one of the early locations of the budding tech company.

Scott Ball / Rivard Report

Two of Rackspace’s co-founders, Pat Condon (left) and Dirk Elmendorf, stand in front of the Weston Centre, one of the early locations of the then-budding server hosting company.

Business at Rackspace was booming, but the team was running out of server space and money to buy the materials needed to build them.

Yoo received a call from Morris Miller, the business partner of real estate developer Graham Weston. Miller and Weston wanted to pay them to install a high-speed internet network at the Weston Centre office tower downtown. They called it high-tech real estate, and it would be marketed to a high-end clientele. But Miller and Weston also wanted to invest in Rackspace. Deeply skeptical, Yoo worried his business was being stolen right from under his nose, but Rackspace was unlikely to survive without the $1.25 million injection of capital Weston was dangling. They signed the deal, contingent on Morris and Weston remaining as advisors to the 20-something founders. Miller and Weston became partners in the business, later assuming co-CEO roles.

Rackspace co-founder Graham Weston speaks at the ScaleUp Summit at the San Antonio Marriott Rivercenter.

Bonnie Arbittier / Rivard Report

Rackspace co-founder Graham Weston

“We consider them co-founders of the business,” Condon said. “Between the three of us, if any of us had been missing it wouldn’t have worked. Once they joined, and it was the five of us, if any of us was missing it wouldn’t have worked. It was just that important.”

Rackspace was formally incorporated in December 1998. That year, Yoo, Elmendorf, and Condon hauled in about $166,000 in revenue. By the end of 1999, Rackspace was raking in $1.7 million in revenue. The company nearly equaled that haul in the first three months of the following year. Rackspace’s earnings climbed to $5 million by the end of the year, Condon said.

Rackspace filed its Form S-1 with the U.S. Securities and Exchange Commission in March 2000, one of the first steps to formally launching an initial public offering. But the economy showed signs of slowing after the late ’90s dot-com hysteria. Condon remembers a similar tech company’s stock falling 30 points after its IPO, the death knell to any hopes Rackspace had then of going public.

Later that year, Rackspace was nearly sold to the Virginia telecommunications firm MCI Inc., but the deal fell through when the executive leading the talks was fired. In addition to letting staff go, the company had to significantly scale back its sales and marketing expenditures, Condon remembers. No more splurging on flashy $25,000 ads in Wired and other national tech publications. It was time to put the company on the path to breaking even, which Condon said happened nine months later.

Rackspace was left at the altar again when the Allegiance acquisition broke down in 2001. Reeling after a nearly signed agreement and a national tragedy that not only sent the stock market plummeting but also claimed the lives of two Deutsche Bank investment bankers who worked on the Allegiance deal, said Yoo, it took a few weeks for the company to collect itself.

With the collapse of a third potential acquisition deal, Condon said the executive team realized that perhaps these deals weren’t meant to be. They needed to hunker down and build a company for the long haul.

From 2002 to 2008, Rackspace would experience some of its best years, Condon said. It was no longer distracted by the lure of selling or going public.

“Everyone at the company had the same focus and clarity, really for the first time in a while,” he said. “In those years we really pulled ahead of our competitors.”

From 2003 to 2007, the company grew its revenue by an average of nearly 60 percent every year. Its profit margin soared. In 2007, Rackspace posted a $17.8 million yield, according to a 2008 filing with the SEC.

By 2006, the company began operating like a publicly traded entity – in preparation for its 2008 IPO. On Aug. 7, 2008, then-President and CEO Lanham Napier rang the opening bell at the New York Stock Exchange when Rackspace opened for trading. The company raised $187.5 million ahead of its initial public offering.

“This time, we did it when we were ready to [go public],” Condon said. “We had built all the appropriate muscles.”

Today the 20-year-old company headquartered in the San Antonio suburb of Windcrest has more than 6,600 employees globally and just over 2,600 locally. It’s reported to be worth in the neighborhood of $10 billion, according to a 2018 Reuters report.

Just one of the many sections of desks at Rackspace. Photo by Scott Ball.

Scott Ball / Rivard Report

Rackspace headquarters, also known as “The Castle,” is located in the former Windsor Park Mall in Northeast San Antonio.

“You kind of go, ‘Wow, how did that happen?’” said Condon, now 43, looking back on Rackspace’s 20-year journey from a small business Yoo started with the modest aim of just making a living. “Looking back now, it’s hard to believe we got from Point A to Point B. When you’re in it you don’t think about that often. All you do is do the next thing you need to do.”

Elmendorf said he and his co-founders, none of whom are currently involved in the Rackspace enterprise, walked the entrepreneurial tightrope between success and failure.

“We are living proof that actually operating a business is a messy process, and any mistake can be the mistake that undoes your business,” said Elmendorf, now 44.

“When people look at Rackspace now, they see what it has become and they immediately think, ‘Well, I can never do that,’” he continued. “I can tell you I thought the exact same thing the whole time. … People think you know – that you have this plan that you know it’s all going to work. At no point did we know it was going to work out.”

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