Source: Getty Images

Top Hat Raises $22.5 Million to Go After Pearson, McGraw-Hill

  • Funding round values Canadian tech firm at $185 million
  • Rival textbook publishers have struggled to increase revenue

Top Hat, the Canadian education technology startup, completed a new round of funding to give it more firepower to go after textbook publishers like Pearson Plc.

The $22.5 million round is Top Hat’s biggest yet and brings its total funding to about $40 million, the Toronto-based company said in a statement Wednesday. New York-based Union Square Ventures participated, as well as previous investors iNovia Capital and Georgian Partners, among others. The funding values Top Hat at $185 million, according to people familiar with the deal.

Top Hat is one of a handful of startups trying to find ways to disrupt the traditional textbook publishing industry, dominated by companies like Pearson, Cengage Learning Inc. and McGraw-Hill Education Inc., which is owned by Apollo Global Management LLC. All of these firms have added digital educational materials to their range of products, but the transition has been rocky.

In October, Apollo put off McGraw-Hill’s planned initial public offering indefinitely after the publisher’s back-to-school sales were less than the company expected, people familiar with the matter said at the time. When McGraw-Hill initially filed to go public in 2015, competition from new entrants was the top risk noted in its prospectus.

Pearson followed up with its own bad news in January when it cut its profit forecast, reduced the dividend and announced plans to unload its stake in Penguin Random House to raise money.

Even as the big publishers work to increase the proportion of sales that come from digital products, they’re still largely dependent on physical books.

Publisher Weakness

That’s a weakness Top Hat Chief Executive Officer Mike Silagadze said he’s trying to exploit. He started by selling software tools to professors that help them engage their students, such as smartphone apps that let them tell lecturers if they understand new concepts in real-time. The company, which launched in 2009, has 2 million students using its products.

The next step is to go directly after the textbooks and digital course content made by Pearson and McGraw, Silagadze said in an interview. In November, they launched an online content marketplace, where professors can create course materials and sell it around the world. The idea is to cut out the publisher and let professors sell directly to students and each other, Silagadze said.

“It fundamentally breaks the publisher’s traditional model of producing content,” he said. “Our aim is to disrupt the paradigm the publishers have created over the last 100 years.”

The potential for building the go-to marketplace for educational content is what attracted Union Square Ventures, said Albert Wenger, a partner at the firm. Union Square manages more than $1 billion and is known for making early-stage investments in Twitter, Tumblr, Kickstarter and Etsy.

The industry “has been dominated by really traditional publishers that come exclusively from the content side and not the technology side,” Wenger said in an interview. His son’s Intro to German textbook cost $230.

“That era is coming to an end,” he said.

The content marketplace is still a small portion of the company’s overall revenue but is growing rapidly. Total revenue is in the "10s of millions,” and is expected to double in 2017, Silagadze said. Top Hat is currently profitable but that could change as the company spends heavily on growth, he said.

“Many people are going into the ed-tech space almost with these utopian misconceptions about what education technology is really like,” Silagadze said, referring to a perception that it’s a particularly risky business. “It’s actually just a really tough market and you have to go out there and grind it out.”

Before it's here, it's on the Bloomberg Terminal.