Slide1: “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!”: “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?


PWC’s Cascading Technology Waves: PWC’s Cascading Technology Waves Source: PricewaterhouseCoopers


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


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


Mathematics of the Kondratiev Wave: Mathematics of the Kondratiev Wave Николай Дмитриевич Кондратьев Nikolai Kondratiev (1892-1938)


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


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


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


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


Slide11: “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 Ferri Founding Partner Matrix Partners (1982) Private Equity Hall of Fame (2003) quoted in Private Equity Analyst, March 2004


Slide12: “Technology finance has turned rational – so I’m outta here.” Howard Anderson William Porter Distinguished Lecturer MIT Sloan School of Management (co-founder Battery Ventures) quoted in Technology Review, June 2005


Slide13: “The traditional venture model seems to us to be broken.” Steve Dow General Partner, Sevin Rosen Funds quoted in the New York Times, October 7, 2006


Why Are Smart, Experienced People Saying This? : Why Are Smart, Experienced People Saying This? “There is a pig in the python and the python is constipated.” 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) Case for the venture model being broken:


Slide15: "It's a great time for investing in early-stage companies that will mature in three to five years." Larry Kubal Managing Partner, Labrador Ventures quoted in the Los Angeles Times, July 13, 2003


Slide16: So who is right? What accounts for the divergence of opinions? Most Important: What does the future hold?


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


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


What Does This Mean For the Early Stage Investor Today?: 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 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


Supported by Data: Experience & Small Size are Success Indicators: Supported by Data: Experience & Small Size are Success Indicators IRR (%) IRR increases with more partners & fewer dollars Source: Lerner & Schoer 2005 # Partners per $100M 0 0.2 0.4 0.6 25 20 15 10 5 0


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


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


Early / Seed VC Driven by Recognized Value Creation: 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


Summary of the Health of the VC Market: 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


Slide25: Part 2: Investment Opportunities Where are the investment opportunities today, created by cultural & technological waves that are transforming our world?


Four Waves Are Changing Our Lives and Creating Investment Opportunities: Four Waves Are Changing Our Lives and Creating Investment Opportunities Globalization Digitization Millennialization Geo-political destabilization


Globalization: Increasing Interdependence Among Nations: 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


Digitization: Content Creation, Distribution and Consumption Are Increasingly Frictionless: 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.


Millennialization: Millennials Rather Than Boomers Now Define the Online Consumer Experience: 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.


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


Technology Platform/Infrastructure Waves Also Define Areas of Investment Opportunity: Technology Platform/Infrastructure Waves Also Define Areas of Investment Opportunity Source: Morgan Stanley research estimates


Examples of Investments Riding the Intersections of Cultural and Platform Waves: 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


Four Takeaway Thoughts: 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.


“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 May 31, 2007