Elements Of Successful Emerging Tech Companies Value Catalysts

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Elements Of Successful Emerging Tech Companies Value Catalysts There are plenty of big waves… keep paddling fast Presentation to Cal Poly GSB 528 September 2, 2008 Christopher J. Rust rust@usvp. com © 2005 USVP. All Rights Reserved 1

Agenda § Introduction § Understanding Venture Capital • Deal Flow, Diligence Process, Flaws w Diligence, etc. § § VC Investment Criteria Elements Of Successful Startups “Hot Areas” Group Discussion © 2005 USVP. All Rights Reserved 2 Value Catalysts

Investment History As Context Investments - 1998 to Present § Abrizio – switch fabric ICs > PMCS § Avanex – optical modules > AVNX § Telera – Call center software > ALA § Syndesis – IP OSS SW > Hamant § Santera – voice switch > Tekelec § Mellanox – Infiniband ICs > MLNX § Mahi – Metro core switch > Meriton § Switch. On – Processor > PMCS § Turin – Metro transport switch § Vx. Tel – Vo. IP ICs > Intel § Springbank – Caching system > CFLO § Onetta – optical amplifiers > BKHM § § § § Value Catalysts Nexsi – network security > JNPR Afara – next gen server > SUN Santur – tunable lasers Memx – optical switch > OOB Commerce 5 – ecommerce sw > DRIV LVL 7 – networking software > BRCM Dilithium – transcoding gateway Stratalight – 40 Gbps optical Veriwave – WLAN equipment Akros – Networking ICs Zannel – Mobile social networking Clustrix – Internet Infrastructure Dune – Networking ICs 25 investments; 2 IPOs, 10 acqs > 1 x, 3 acq <=1 x or TBD, 2 OOB, 8 active © 2005 USVP. All Rights Reserved 3

USVP’s Philosophy § § Value Catalysts Hyper-Growth Emerging Markets Real Businesses High Gross and Net Margins Back Leading Company In Sector • Mkt cap of leader often more than others combined § § Obtain Significant Ownership Drive for Leading Market Share Help with Recruiting, Sales/BD, Follow-On $, Exit Patient Long Term Investor © 2005 USVP. All Rights Reserved 4

USVP’s Philosophy § Small Elite Teams Intent On Changing The World • Massive Passion • Super Aggressive • No Bozos - Lemons Ripen Early § Frugality Reigns Supreme • • • Low Rent District Plywood Tables Fly Coach Dilution Is The Common Enemy Eye-Popping Progress On Series A To Earn Big Step-Up Company-Wide Focus on Equity, Not Current Income § Stand On Shoulders Of Giants Via Smart Partnering § Patience, Perseverance To Build A True Franchise © 2005 USVP. All Rights Reserved 5 Value Catalysts

VC Investment Criteria Value Catalysts § VCs Rewarded For Finding & Funding Growth Engines § VCs Want To Invest In • Markets with hyper-growth potential • Companies that can create and dominate a new market • Disrupting a large established market also interesting but harder • Driven entrepreneurs that can build strong teams • The best CEOs are often first time CEOs • Viable business models. GM is a proxy for value of tech § VCs (Usually) Avoid • • Customers that won’t buy from small private companies Low gross margin businesses Long development cycles, compounded tech risks Unloved sectors with low exit multiples © 2005 USVP. All Rights Reserved 6

VC Due Diligence Checklist Value Catalysts “Pitching” skills can mask flaws Major Component Of Success Equation, but HCA Often Highly Subjective/Superficial Emerging sector > incomplete data Can be “pre-wired” by entrepreneur Based on incomplete data Not much to assess at seed stage Often relies on 3 rd party SME © 2005 USVP. All Rights Reserved 9

Investment Criteria – A VC Survey Value Catalysts Market and Team clearly dominated when evaluating a new investment Product or Technology was also very important, as that is the tool to address the market opportunity © 2005 USVP. All Rights Reserved 10

Causes of Failure In VC-Funded Companies Value Catalysts § “Team did not execute” cited by VCs as the top reason companies fail § Picking good markets is job one, but… § Building great teams as a tangible asset is just as important § Acquirors always ask “Is this a team I want working for me? ” © 2005 USVP. All Rights Reserved 11

VCs Like Entrepreneurs With Value Catalysts • A track record of success, but… • The best entrepreneurs often have no prior successes • The best entrepreneurs are often young, single, workaholic geeks • Work experience in a (winning) small company • If you go to a startup early on, pick one w a great CEO and VCs • Expertise in the target market • High motivation level, positive attitude, and personal integrity • Mental toughness and emotional stability for sustained arduous effort • Resilient and adaptable to change, hardship, and uncertainty • Strong “off the list” references sourced without input from the entrepreneur © 2005 USVP. All Rights Reserved 12

Life In A Venture-Backed Startup Value Catalysts Success Is (Usually) Determined By Revenue Growth and Profits Usually requires extreme focus on being the best at one thing © 2005 USVP. All Rights Reserved 13

Steps In Successful Startup Value Catalysts § Total Commitment for Long Haul. 1% Inspiration + 99% Perspiration § Define a Compelling Product or Service for a High Growth Market § Create Critical Mass • Best people first. Hiring well = single greatest point of leverage § Focus on Execution • Build tools to track against a plan, development processes • Stretch Goals for Talented Team w Common Vision= Inspired Effort • V = S 3; Victory = Speed * Stealth * Sweat • F = R * V 2; Force = Resources * (Velocity)2 § Expand in Control (sort of) § Make Every Penny Count. Raising Capital is Expensive At All Levels § If Your Market Does Not Materialize, Quickly Adapt To Succeed/Survive § NEVER Doubt That You Will Be Successful and Trust Your Team…No Matter How Bad Things Get © 2005 USVP. All Rights Reserved 14

Elements of A Fundable Plan Value Catalysts Business - Clear. Succinct. Easy to Understand Market - Hyper Growth (> 50% CAGR) Team - Best-in-Field, History of Success Product or Service - Unique. Fresh Idea. Hard IP Financials - >$100 M revenues in 4 years, Cisco GMs Risk Factors - Entrenched Competition = BAD, 1 st Mover in New Category = GOOD § Deal - Small Check for Big Ownership and Pool § § § © 2005 USVP. All Rights Reserved 16

A Model for Partnering Value Catalysts Strategic partner Alliance partner tactical Teaming & cooperation VALUE Value shipper, exclusive supplier Preferred Supplier Commodity Supplier MATURITY © 2005 USVP. All Rights Reserved 19 COMPLEXITY

Addressing “Corporate Viability” Value Catalysts § Vi’ a. bil’ i. ty n. Capable Of Living And Developing • Corporate viability not determined by balance sheet, fundraising skills, or our product/technology leadership, but by winning business and establishing commercial success § Factors That Influence Perceived Viability • • • Customer list – A reference network sell is infinitely easier Customer satisfaction and responsiveness do matter… a lot Clear technology leadership is table stakes Caliber and commitment level of all shareholders Critical mass to support the product § Sales Team’s Ability To Close Repeat Business Is Key • Build customer base, make sure they keep buying © 2005 USVP. All Rights Reserved 22

Recipe for Winning Acquisitions § § § Value Catalysts Minimum Overlap in Products Complementary Skills, Assets, Customer Base Common Vision and Culture Near-Term Wins -> Validates the Decision Long-Term Wins -> Retains Key Talent Clear definition of which culture and product(s) survives Respect on Both Sides of Deal Geographic Proximity is often a plus Wealth Creation Potential for All Stakeholders Well thought out common retention plan Well thought out integration plan © 2005 USVP. All Rights Reserved 23

The Deal Value Catalysts § If Seeking Funding • • • Amount needed Valuation looking for - justify with comparables Use of proceeds - be as specific as possible Support requirements beyond money Be careful of the detailed Ts & Cs. Ratchet clauses, participating preferred liquidation preferences, drag-along rights to force acquisitions, many other terms can gut the upside for common § If Seeking Employment • • Opportunity to build valuable, marketable skills Match to lifestyle preferences Comp package: salary and benefits, equity participation Runway, staying power of investor base, mgmt team, vision… © 2005 USVP. All Rights Reserved 24

Recruiting Value Catalysts § MAKE WORLD-CLASS RECRUITING A HIGEST PRIORITY • Map out a recruiting plan with goals and metrics and stick to it • Screening/qualifying candidates takes time. Spend the time • Use right resources to get to qualified candidates at all levels § Attracting top executives & individual contributors to startups • Was always hard • Will always be hard • Hire for intellect + drive + culture fit over specific skills § Compensation negotiations § Staying close between start date and signed offer § Post interview assessment © 2005 USVP. All Rights Reserved 25

A Personal Decision-Making Filter § § § § Value Catalysts Do You Believe In The Founders & Mgmt Team? Does Anyone Need The Product or Service? Is There A Quantifiable Competitive Advantage? Is There a Realistic Business Model? Can The Opportunity Attract Talent and Capital? Will You Develop Marketable Skills? Can You Have Fun In the Process? If Yes, Go For It! © 2005 USVP. All Rights Reserved 26

Comparing VC vs. Organic Model § Self-Funded/Angel Funded • Set modest, achievable goals • Focus on one customer • Incrementally raise $ • Incrementally build skills • Relatively low risk • Live within means § (Tier One) VC Funded • • • Set AGGRESSIVE goals Change markets Focus on Market Share Raise big $ Give up big ownership Suffer big liquidation pref overhang Buy experience to move fast High risk. Big programs Cut losses early “Lemons ripen early” Select Investors With Common Goals Perhaps More Important Than Picking Co-Founders (Are Stuck With Investors) © 2005 USVP. All Rights Reserved 27 Value Catalysts

Comparing OUS Tech Hubs Value Catalysts China Israel India Market Huge, Fractured Not meaningful. Tiny Huge, Fractured Skilled Workforce Growing Small, but elite 1. 4 m in IT w 450 k in top 3 BPOs. ~45 m pay taxes Innovation Growing High Growing Multinational presence High, growing Highest, growing High, growing Government Single party Democracy, ethnic politics Literacy, English skills 90%, English mandated in schools since 2000 100%, high <= 60%, English high among educated classes Infrastructure spend/year $140+B. Efficient via central planning Not meaningful. Size of Bay Area <$40 B. Inefficient use of money spent. Corruption © 2005 USVP. All Rights Reserved 28

Some Hot Topics Value Catalysts § The Broadband Mobile Internet § The Rich Media Internet (HD video-capable) § The Energy Efficient Data Center • Infrastructure-As-A-Service, Cloud Computing, Virtualization § Next Generation Search (GOOG’s results less useful w time) § Software-As-A-Service § All Things “Cleantech” – The Current Bubble • • • Energy generation (clean coal, solar, wind, wave, nuclear, fuel cells) Energy storage & transport (batteries, hydro+wind, smart grid) Energy conservation (building automation, smart meters) Clean water (desalination, purification, reclamation) Green construction (low embodied energy materials, green cement) § Medical devices and bio-pharma © 2005 USVP. All Rights Reserved 29