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“You Can’t Stop the Waves, But You Can Learn to Surf!”

“You Can’t Stop the Waves, But You Can Learn to Surf!”. Larry Kubal – Labrador Ventures May 31, 2007. “You Can’t Stop the Waves, But You Can Learn to Surf!”. 34 minutes, 34 slides to answer two questions:

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“You Can’t Stop the Waves, But You Can Learn to Surf!”

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  1. “You Can’t Stop the Waves, But You Can Learn to Surf!” Larry Kubal – Labrador Ventures May 31, 2007

  2. “You Can’t Stop the Waves,But You Can Learn to Surf!” • 34 minutes, 34 slides to answer two questions: • Part 1: The Market Where are we in the VC wave cycle? • Part 2:The Investment Opportunities Where are the opportunities today, created by cultural & technological waves that are transforming our world? CONFIDENTIAL

  3. PWC’s Cascading Technology Waves Source: PricewaterhouseCoopers CONFIDENTIAL

  4. Gartner’s Hype Cycle of Emerging Technologies VISIBILITY TIME Technology Peak of Trough of Slope of Plateau of Trigger Inflated Disillusionment Enlightenment Productivity Expectations Source: Gartner Group CONFIDENTIAL

  5. Kondratiev Waves – Components of the Economic Cycle Wave Form Steam Engine Railroads Electrical Engineering Petrochemicals Information Cotton Steel Chemistry Automobiles Technology P R D E 1800 1850 1900 1950 2000 P: prosperity R: recession D: depression E: improvement Source: Wikipedia, Labrador CONFIDENTIAL

  6. Mathematics of the Kondratiev Wave Николай Дмитриевич Кондратьев Nikolai Kondratiev (1892-1938) CONFIDENTIAL

  7. A More Conceptual Approach Waves of change / growth Disappointment Market values Growth Hype Realism Time Source: Morgan Stanley Dean Witter & Co., Labrador CONFIDENTIAL

  8. Liquidity Cycle in Venture Capital • $7B in Q1’07, best in 5 years VC / Angelinvestmentsin companies • Up rounds exceeded down rounds for 13th consecutive quarter Company growth LP investment in VC • $30B+ 2006 commitments best in 5 years Angel Shortcut Company liquidity events • Q1’07 IPOs raise $1.2B – double Q1’06 CONFIDENTIAL

  9. Annual Progress Along the Curve Waves of change / growth Growth 2006 Disappointment Market values Realism Hype 2000 2005 1999 2001 2004 2003 2002 Time Source: Morgan Stanley Dean Witter & Co., Labrador CONFIDENTIAL

  10. Potential Divergence For Different VC Models Waves of change / growth Growth 2007 2006 Disappointment ? Market values Realism Hype 2000 2005 1999 2001 2004 2003 2002 Time Source: Morgan Stanley Dean Witter & Co., Labrador CONFIDENTIAL

  11. “I’ve been telling our investors for three or four years, I don’t think this is a good asset class to commit money to right now.” • Paul FerriFounding Partner Matrix Partners (1982)Private Equity Hall of Fame (2003)quoted in Private Equity Analyst, March 2004

  12. “Technology finance has turned rational – so I’m outta here.” • Howard AndersonWilliam Porter Distinguished LecturerMIT Sloan School of Management(co-founder Battery Ventures)quoted in Technology Review, June 2005

  13. “The traditional venture model seems to us to be broken.” • Steve DowGeneral Partner, Sevin Rosen Fundsquoted in the New York Times, October 7, 2006

  14. Why Are Smart, Experienced People Saying This? Case for the venture model being broken: • LOTS OF MONEY: lots of funds funding lots of deals – 10,000 over the last 4 years • “Capital overhang” has become a “company overhang” • VENTURE FRATRICIDE: excessive competition funded within market segments • EXIT MARKETS CONSTRAINED: getting liquidity at good return multiples is tough • EXTENDED HOLDING TIMES: from initial investment to a liquidity event – M&A and IPO are at historic highs ( > 5 years) “There is a pig in the python and the python is constipated.” CONFIDENTIAL

  15. "It's a great time for investing in early-stage companies that will mature in three to five years." • Larry KubalManaging Partner, Labrador Venturesquoted in the Los Angeles Times, July 13, 2003

  16. So who is right? What accounts for the divergence of opinions? Most Important: What does the future hold? CONFIDENTIAL

  17. Fund Size ($ Millions) Fund Size: A Defining Difference OPTIMISTIC PESSIMISTIC $500 $450 $400 $350 $300 $250 $200 $150 $100 $50 $0 Labrador Ventures Matrix Partners Battery Ventures Sevin Rosen CONFIDENTIAL

  18. Case Study to Support the Broken Model Thesis… • $400M fundTarget 20% IRR (3x return over 6 years)20 company investment portfolio • Must create $1.2 billion of exit value • If 20% of a company owned at liquidation, then portfolio needs to create $6 billion of value • If ALL are winners (aggressive) = $300 million per company • If 50% winners = $600 million per company • CHALLENGE: In today’s environment, assumptions > $150 million average for winners is very optimistic Thanks to Josh Kopelman, MD First Round Capital for the example. CONFIDENTIAL

  19. What Does This Mean For the Early Stage Investor Today? The venture business is experiencing a sea change … and the earliest stage VC or angel investor is well-positioned. Key Positioning Factors • Small “fund” size • Low $ / partner • Earliest stage focus – small investment, very early at low valuations • Experienced, consistent, disciplined investment team & strategy • Capital efficiency a core value • Manage company growth and cash to fundable milestones • Well-networked with larger VCs that are potential follow-on funders CONFIDENTIAL

  20. IRR increases with experience IRR (%) 25 20 15 10 5 0 1 2 3 4 5 6 7 8 9 10 11 Fund # Supported by Data: Experience & Small Size are Success Indicators IRR increases with more partners & fewer dollars IRR (%) 25 20 15 10 5 0 0 0.2 0.4 0.6 # Partnersper $100M Source: Lerner & Schoer 2005 CONFIDENTIAL

  21. Early / Seed VC Returning to Historic Pre-eminence Returns to investors as of 12/31/2006 20 years 10 years 5 years 3 years 1 year Early / seed VC Later stage VC NASDAQ S & P 500 20.5 14.0 10.1 9.2 36.4 9.0 6.4 6.7 (3.0) 3.7 4.3 4.3 6.5 9.4 6.3 8.2 9.9 25.2 4.8 10.8 Source: Thompson Financial, NVCA CONFIDENTIAL

  22. Valuation Inflation Has Not Impacted the Early Stage Pre-money valuations – early stage companies Source: PriceWaterHouseCoopers, NVCA CONFIDENTIAL

  23. Financing round • Average % price increase Early / Seed VC Driven by Recognized Value Creation • Series A to Series B • Series B to Series C • Series C to Series D • 120% • 60% • 34% Source: Fenwick & West’s Q1 ’07 San Francisco Bay Area Venture Capital Survey CONFIDENTIAL

  24. Summary of the Health of the VC Market • For whom is the traditional venture model especially challenging today? • $400+ million funds that focus on capital intensive businesses or Series B and later • For whom is the model still intact and vital? • Smaller funds that invest earlier and do not depend on exceptional exit markets • How long will exit challenges persist? • We believe the state of the exit markets is an anomaly and will self correct in the normal cyclicality of our business CONFIDENTIAL

  25. Part 2: Investment Opportunities Where are the investment opportunities today, created by cultural & technological waves that are transforming our world?

  26. Four Waves Are Changing Our Lives and Creating Investment Opportunities • Globalization • Digitization • Millennialization • Geo-political destabilization CONFIDENTIAL

  27. Globalization: Increasing Interdependence Among Nations • Outsourcing originally driven by lower manual labor costs has transitioned to knowledge workers • Nearly 100% of Citibank’s IT programming requirements are outsourced to India • 50% of US Treasury debt obligations are held by foreign entities • China accounts for 20% of the world population. Its people have transitioned into 21st century consumers representing the largest single market in the world • Morgan Stanley forecasts China as the #1 consumer of TMT (technology, media and telecommunications) products and services in 2010 CONFIDENTIAL

  28. Digitization: Content Creation, Distribution and Consumption Are Increasingly Frictionless • News, movies, music and communication transition to digital: newspapers, DVDs, CDs and phone calls become bits in the ether • As old media transitions to new digital media, advertising dollars follow • Beyond consumers, digitization encompasses enterprise business information, legal documents and medical records Behavioral, psycho-social waves of change are underway -- as ease to create, distribute and consume digital content grows. CONFIDENTIAL

  29. Millennialization: Millennials Rather Than Boomers Now Define the Online Consumer Experience • Millennials (born 1982-2000) -- the internet generation immersed in digital technology and content • “The first generation to have a home PC, a cell phone while still in school, a Nintendo, and an iPod for Xmas. The Internet is their medium.” –Duncan Davidson • Multi-tasking, multi-cultural – in charge of their online experience – “long tailers.” Demand personalized, customized, self-expressive, creative, engaged, communicative, anytime/anywhere, connected web experiences. • Global: 75 million US, 200 million China From Facebook to YouTube, the Millennials are defining the evolution of the consumer online experience that the rest of us adapt to. CONFIDENTIAL

  30. Geo-Political Destabilization: Power Shift From Massive Military to Small Groups Higher energy costs • High instability in the Middle East: Afghanistan, Iran, Iraq, Israel, Lebanon, Syria • Higher energy costs • Growing sensitivity to terrorism Attention & dollars to • Solar • Fuel cells • Batteries Demand for security • Surveillance • Identification • Tracking • Detection Funds have been created to address “Homeland Security.” In the last year KPCB has launched initiatives in both Greentech and Pandemic / BioDefense. CONFIDENTIAL

  31. Global data subscribers - cellular Growth of WiFi hotspots # of hot spots clients (M) Subscribers (M) Global broadband subscribers Subscribers (M) Technology Platform/Infrastructure Waves Also Define Areas of Investment Opportunity Source: Morgan Stanley research estimates CONFIDENTIAL

  32. Examples of Investments Riding the Intersections of Cultural and Platform Waves • Customized streaming internet radio connecting listeners with the music they love – anytime, anywhere. • Cultural– Digitization, Millennialization Platform – Cellular, WiFi • Allows users to indulge, discover and personalize their passion for video entertainment – online or on TV. • Cultural– Digitization, Millennialization Platform – Broadband, Cellular, WiFi • Mobile photo and video messaging -- transforming the camera phone into a tool for mobile video and photo communication. • Cultural– Digitization, Millennialization Platform – Cellular CONFIDENTIAL

  33. Four Takeaway Thoughts • The venture business is cyclical. We are currently in the growth phase of the wave with the four elements of the venture liquidity cycle generally in balance and improving. 2. The venture capital industry itself is in transition. For some funds, the model is structurally challenged – at least temporarily. Despite their best efforts, returns for their investors will be sub-standard. 3.Experienced investors at the earliest stage, investing relatively small amounts at low valuations, are well-positioned in the current environment. 4.Fundamental cultural and technology transitions are underway. These waves of change are transforming our world. Startups that ride the intersections of multiple waves represent extraordinary investment opportunities. CONFIDENTIAL

  34. “You Can’t Stop the Waves,But You Can Learn to Surf!” Larry Kubal May 31, 2007 CONFIDENTIAL

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