Download - “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,You Can’t Stop the Waves,But You Can Learn to Surf!”But You Can Learn to Surf!”
Larry Kubal – Labrador VenturesMay 31, 2007
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““You Can’t Stop the Waves,You Can’t Stop the Waves,But You Can Learn to Surf!”But You Can Learn to Surf!”
34 minutes, 34 slides to answer two questions:34 minutes, 34 slides to answer two questions:
Part 1: The MarketPart 1: The Market Where are we in the VC wave cycle? Where are we in the VC wave cycle?
Part 2:Part 2: The Investment OpportunitiesThe Investment Opportunities Where are the opportunities today, created Where are the opportunities today, created by cultural & technological waves that are by cultural & technological waves that are transforming our world?transforming our world?
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PWC’s Cascading Technology WavesPWC’s Cascading Technology Waves
Source: PricewaterhouseCoopers
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Gartner’s Hype Cycle of Emerging TechnologiesGartner’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
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Kondratiev Waves – Components of the Kondratiev Waves – Components of the Economic Cycle Wave FormEconomic Cycle Wave Form
P R D E
P: prosperityR: recessionD: depressionE: improvement
1800 1850 1900 1950 2000
Steam Engine Railroads Electrical Engineering Petrochemicals Information Cotton Steel Chemistry Automobiles Technology
Source: Wikipedia, Labrador
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Mathematics of the Kondratiev WaveMathematics of the Kondratiev Wave
Николай Дмитриевич КондратьевNikolai Kondratiev (1892-1938)Nikolai Kondratiev (1892-1938)
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A More Conceptual Approach A More Conceptual Approach
RealismRealism
DisappointmentDisappointment
HypeHype
Waves of change / growthWaves of change / growth
Market Market valuesvalues
TimeTime
Source: Morgan Stanley Dean Witter & Co., Labrador
GrowthGrowth
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Liquidity Cycle in Venture CapitalLiquidity Cycle in Venture Capital
Companyliquidityevents
VC / Angelinvestments
in companies
Companygrowth
LPinvestment
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
AngelAngelShortcutShortcut
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Annual Progress Along the CurveAnnual Progress Along the Curve
Waves of change / growthWaves of change / growth
Market Market valuesvalues
Source: Morgan Stanley Dean Witter & Co., Labrador
RealismRealism
DisappointmentDisappointment
HypeHype
TimeTime
19991999
20002000
20012001
20022002 2003200320042004
GrowthGrowth
20052005
20062006
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Potential Divergence For Different Potential Divergence For Different VC ModelsVC Models
Waves of change / growthWaves of change / growth
Market Market valuesvalues
Source: Morgan Stanley Dean Witter & Co., Labrador
RealismRealism
DisappointmentDisappointment
HypeHype
TimeTime
19991999
20002000
20012001
20022002 2003200320042004
GrowthGrowth
20052005
20062006
??
20072007
““I’ve been telling our investors for three or four I’ve been telling our investors for three or four years, I don’t think this is a good asset class to years, I don’t think this is a good asset class to commit money to right now.”commit money to right now.”
-Paul FerriPaul FerriFounding Partner Matrix Partners (1982)Founding Partner Matrix Partners (1982)
Private Equity Hall of Fame (2003)Private Equity Hall of Fame (2003)quoted in quoted in Private Equity AnalystPrivate Equity Analyst, March 2004, March 2004
““Technology finance has turned rational – so I’m Technology finance has turned rational – so I’m outta here.”outta here.”
-Howard AndersonHoward AndersonWilliam Porter Distinguished LecturerWilliam Porter Distinguished Lecturer
MIT Sloan School of ManagementMIT Sloan School of Management(co-founder Battery Ventures)(co-founder Battery Ventures)
quoted in quoted in Technology ReviewTechnology Review, June 2005, June 2005
““The traditional venture model seems to us to The traditional venture model seems to us to be broken.” be broken.”
-Steve DowSteve DowGeneral Partner, Sevin Rosen FundsGeneral Partner, Sevin Rosen Funds
quoted in the quoted in the New York TimesNew York Times, October 7, 2006, October 7, 2006
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Why Are Smart, Experienced Why Are Smart, Experienced People Saying This? People Saying This?
““There is a pig in the python and the python is constipated.”There is a pig in the python and the python is constipated.”““There is a pig in the python and the python is constipated.”There is a pig in the python and the python is constipated.”
LOTS OF MONEYLOTS OF MONEY: lots of funds funding lots of deals – 10,000 over : lots of funds funding lots of deals – 10,000 over the last 4 yearsthe last 4 years
““Capital overhang” has become a “company overhang”Capital overhang” has become a “company overhang”
VENTURE FRATRICIDEVENTURE FRATRICIDE: excessive competition funded within : excessive competition funded within market segmentsmarket segments
EXIT MARKETS CONSTRAINEDEXIT MARKETS CONSTRAINED: getting liquidity at good return : getting liquidity at good return multiples is toughmultiples is tough
EXTENDED HOLDING TIMESEXTENDED HOLDING TIMES: from initial investment to a : from initial investment to a liquidity event – M&A and IPO are at historic highs ( > 5 years)liquidity event – M&A and IPO are at historic highs ( > 5 years)
Case for the venture model being broken:Case for the venture model being broken:
"It's a great time for investing in early-stage "It's a great time for investing in early-stage companies that will mature in three to five companies that will mature in three to five years."years."
-Larry KubalLarry KubalManaging Partner, Labrador VenturesManaging Partner, Labrador Ventures
quoted in the quoted in the Los Angeles TimesLos Angeles Times, July 13, 2003, July 13, 2003
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So who is right?So who is right?
What accounts for the What accounts for the divergence of opinions?divergence of opinions?
Most Important:What does the future hold?
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Fund Size: A Defining DifferenceFund Size: A Defining Difference
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
$500
LabradorVentures
MatrixPartners
Battery Ventures
Sevin Rosen
Fund Size ($ Millions)
OPTIMISTIC PESSIMISTIC
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Case Study to Support the Broken Model Case Study to Support the Broken Model Thesis…Thesis…$400M fund$400M fund
Target 20% IRR (3x return over 6 years)Target 20% IRR (3x return over 6 years)20 company investment portfolio20 company investment portfolio
CHALLENGE:CHALLENGE: In today’s environment, assumptions > $150 In today’s environment, assumptions > $150 million average for winners is very optimisticmillion average for winners is very optimistic
If ALL are winners (aggressive) = $300 million per companyIf ALL are winners (aggressive) = $300 million per company
If 50% winners = $600 million per companyIf 50% winners = $600 million per company
If 20% of a company owned at liquidation, then portfolio needs to If 20% of a company owned at liquidation, then portfolio needs to create $6 billion of valuecreate $6 billion of value
Must create $1.2 billion of exit valueMust create $1.2 billion of exit value
Thanks to Josh Kopelman, MD First Round Capital for the example.
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• Small “fund” sizeSmall “fund” size
• Low $ / partnerLow $ / partner
• Earliest stage focus – small investment, very early at low valuationsEarliest stage focus – small investment, very early at low valuations
• Experienced, consistent, disciplined investment team & strategyExperienced, consistent, disciplined investment team & strategy
• Capital efficiency a core valueCapital efficiency a core value
• Manage company growth and cash to fundable milestonesManage company growth and cash to fundable milestones
• Well-networked with larger VCs that are potential follow-on fundersWell-networked with larger VCs that are potential follow-on funders
What Does This Mean For the Early Stage What Does This Mean For the Early Stage Investor Today?Investor Today?
The venture business is experiencing a sea change …The venture business is experiencing a sea change … and the earliest stage VC or angel investor is well-positioned. and the earliest stage VC or angel investor is well-positioned.
Key Positioning FactorsKey Positioning Factors
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IRRIRR(%)(%)
IRR increases with experienceIRR increases with experience
Fund #Fund #
Supported by Data: Experience & Small Supported by Data: Experience & Small Size are Success IndicatorsSize are Success Indicators
IRRIRR(%)(%)
IRR increases with more IRR increases with more partners & fewer dollarspartners & fewer dollars
Source: Lerner & Schoer 2005
# Partners# Partnersper $100Mper $100M
1 2 3 4 5 6 7 8 9 10 11
25
20
15
10
5
00 0.2 0.4 0.6
25
20
15
10
5
0
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Early / Seed VC Returning to Historic Early / Seed VC Returning to Historic Pre-eminencePre-eminence
Early / seed VCEarly / seed VC
Later stage VCLater stage VC
NASDAQNASDAQ
S & P 500S & P 500
9.99.9
25.225.2
4.84.8
10.810.8
6.56.5
9.49.4
6.36.3
8.28.2
36.436.4
9.09.0
6.46.4
6.76.7
(3.0)(3.0)
3.73.7
4.34.3
4.34.3
20.520.5
14.014.0
10.110.1
9.29.2
20 years20 years 10 years10 years 5 years5 years 3 years3 years 1 year1 year
Returns to investors as of 12/31/2006Returns to investors as of 12/31/2006
Source: Thompson Financial, NVCA
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Valuation Inflation Has Not Impacted Valuation Inflation Has Not Impacted the Early Stagethe Early Stage
15.414.2
12.8
17.7 17.5
26.2
19.4
10.18.8 9.5 8.7
7.3
95 96 97 98 99 00 01 02 03 04 05 06
$ M
illi
on
s
Source: PriceWaterHouseCoopers, NVCA
Pre-money valuations – early stage companiesPre-money valuations – early stage companies
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Early / Seed VC Driven by Recognized Early / Seed VC Driven by Recognized Value CreationValue Creation
Series A to Series BSeries A to Series B
Series B to Series CSeries B to Series C
Series C to Series DSeries C to Series D
120%120%
60%60%
34%34%
Financing roundFinancing round Average % price increaseAverage % price increase
Source: Fenwick & West’s Q1 ’07 San Francisco Bay Area Venture Capital Survey
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Summary of the Health of the VC MarketSummary of the Health of the VC Market
For whom is the traditional venture model especially challenging today?For whom is the traditional venture model especially challenging today?• $400+ million funds that focus on capital intensive businesses or Series B and later $400+ million funds that focus on capital intensive businesses or Series B and later
For whom is the model still intact and vital?For whom is the model still intact and vital?• Smaller funds that invest earlier and do not depend on exceptional exit Smaller funds that invest earlier and do not depend on exceptional exit
markets markets
How long will exit challenges persist?How long will exit challenges persist?• We believe the state of the exit markets is an anomaly and will self We believe the state of the exit markets is an anomaly and will self
correct in the normal cyclicality of our business correct in the normal cyclicality of our business
Part 2: Investment OpportunitiesPart 2: Investment Opportunities
Where are the investment Where are the investment opportunities today, created by opportunities today, created by
cultural & technological waves that cultural & technological waves that are transforming our world?are transforming our world?
Part 2: Investment OpportunitiesPart 2: Investment Opportunities
Where are the investment Where are the investment opportunities today, created by opportunities today, created by
cultural & technological waves that cultural & technological waves that are transforming our world?are transforming our world?
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Four Waves Are Changing Our Lives and Creating Four Waves Are Changing Our Lives and Creating Investment OpportunitiesInvestment Opportunities
GlobalizationGlobalization
DigitizationDigitization
MillennializationMillennialization
Geo-political destabilizationGeo-political destabilization
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Globalization:Globalization: Increasing Interdependence Among Increasing Interdependence Among NationsNations
Outsourcing originally driven by lower manual labor costs has Outsourcing originally driven by lower manual labor costs has transitioned to knowledge workers transitioned to knowledge workers
• Nearly 100% of Citibank’s IT programming requirements are outsourced to IndiaNearly 100% of Citibank’s IT programming requirements are outsourced to India
50% of US Treasury debt obligations are held by foreign entities50% of US Treasury debt obligations are held by foreign entities
China accounts for 20% of the world population. Its people have transitioned into China accounts for 20% of the world population. Its people have transitioned into 2121stst century consumers representing the largest single market in the world century consumers representing the largest single market in the world
• Morgan Stanley forecasts China as the #1 consumer of TMT (technology, media and Morgan Stanley forecasts China as the #1 consumer of TMT (technology, media and
telecommunications) products and services in 2010telecommunications) products and services in 2010
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Digitization:Digitization: Content Creation, Distribution and Content Creation, Distribution and Consumption Are Increasingly FrictionlessConsumption Are Increasingly Frictionless
News, movies, music and communication transition to digital: newspapers, News, movies, music and communication transition to digital: newspapers, DVDs, CDs and phone calls become bits in the etherDVDs, CDs and phone calls become bits in the ether
As old media transitions to new digital media, advertising dollars followAs old media transitions to new digital media, advertising dollars follow
Beyond consumers, digitization encompasses enterprise business information, Beyond consumers, digitization encompasses enterprise business information, legal documents and medical recordslegal documents and medical records
Behavioral, psycho-social waves of change are underway -- as ease to create, Behavioral, psycho-social waves of change are underway -- as ease to create, distribute and consume digital content grows.distribute and consume digital content grows.Behavioral, psycho-social waves of change are underway -- as ease to create, Behavioral, psycho-social waves of change are underway -- as ease to create, distribute and consume digital content grows.distribute and consume digital content grows.
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Millennialization:Millennialization: Millennials Rather Than Boomers Millennials Rather Than Boomers Now Define the Online Consumer ExperienceNow Define the Online Consumer Experience
Millennials (born 1982-2000) -- the internet generation immersed in digital Millennials (born 1982-2000) -- the internet generation immersed in digital technology and contenttechnology and content
“ “The first generation to have a home PC, a cell phone while still in school, a 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.” Nintendo, and an iPod for Xmas. The Internet is their medium.” –Duncan Davidson–Duncan Davidson
Multi-tasking, multi-cultural – in charge of their online experience – “long Multi-tasking, multi-cultural – in charge of their online experience – “long tailers.” Demand personalized, customized, self-expressive, creative, engaged, tailers.” Demand personalized, customized, self-expressive, creative, engaged, communicative, anytime/anywhere, connected web experiences.communicative, anytime/anywhere, connected web experiences.
Global: 75 million US, 200 million ChinaGlobal: 75 million US, 200 million China
From Facebook to YouTube, the Millennials are defining the evolution of From Facebook to YouTube, the Millennials are defining the evolution of the consumer online experience that the rest of us adapt to.the consumer online experience that the rest of us adapt to.
From Facebook to YouTube, the Millennials are defining the evolution of From Facebook to YouTube, the Millennials are defining the evolution of the consumer online experience that the rest of us adapt to.the consumer online experience that the rest of us adapt to.
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Geo-Political Destabilization: Geo-Political Destabilization: Power Shift From Power Shift From Massive Massive MilitaryMilitary to Small Groups to Small Groups
High instability in the Middle East: High instability in the Middle East: Afghanistan, Iran, Iraq, Israel, Lebanon, Afghanistan, Iran, Iraq, Israel, Lebanon, Syria Syria
Higher energy costsHigher energy costs
Growing sensitivity to terrorismGrowing sensitivity to terrorism
Funds have been created to address “Homeland Security.” In the Funds have been created to address “Homeland Security.” In the last year KPCB has launched initiatives in both Greentech and last year KPCB has launched initiatives in both Greentech and Pandemic / BioDefense.Pandemic / BioDefense.
Funds have been created to address “Homeland Security.” In the Funds have been created to address “Homeland Security.” In the last year KPCB has launched initiatives in both Greentech and last year KPCB has launched initiatives in both Greentech and Pandemic / BioDefense.Pandemic / BioDefense.
Higher energy costsHigher energy costs
Attention & dollars toAttention & dollars to• SolarSolar• Fuel cellsFuel cells• BatteriesBatteries
Demand for securityDemand for security• Surveillance Surveillance • IdentificationIdentification• TrackingTracking• DetectionDetection
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515
3040
50
80
2001 2002 2003 2004 2005 2006E
Growth of WiFi hotspotsGrowth of WiFi hotspots# of hot # of hot
spotsspotsclients clients
(M)(M)
300
650
1000
1400
1800
2005 2006E 2007E 2008E 2009E
Global data subscribers - cellularGlobal data subscribers - cellularSubscribersSubscribers
(M)(M)
30
57
97
148
209
2001 2002 2003 2004 2005E
Global broadband subscribersGlobal broadband subscribersSubscribersSubscribers
(M)(M)
Technology Platform/Infrastructure Waves Technology Platform/Infrastructure Waves Also Define Areas of Investment OpportunityAlso Define Areas of Investment Opportunity
Source: Morgan Stanley research estimates
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Examples of Investments Riding the Intersections Examples of Investments Riding the Intersections of Cultural and Platform Wavesof Cultural and Platform Waves
Customized streaming internet radio connecting Customized streaming internet radio connecting listeners with the music they love – anytime, anywhere.listeners with the music they love – anytime, anywhere.
CulturalCultural – Digitization, Millennialization – Digitization, Millennialization PlatformPlatform – Cellular, WiFi – Cellular, WiFi
Allows users to indulge, discover and personalize their Allows users to indulge, discover and personalize their passion for video entertainment – online or on TV.passion for video entertainment – online or on TV.
CulturalCultural – Digitization, Millennialization – Digitization, Millennialization PlatformPlatform – Broadband, Cellular, WiFi – Broadband, Cellular, WiFi
Mobile photo and video messaging -- transforming the Mobile photo and video messaging -- transforming the camera phone into a tool for mobile video and photo camera phone into a tool for mobile video and photo communication.communication.
CulturalCultural – Digitization, Millennialization – Digitization, Millennialization PlatformPlatform – Cellular – Cellular
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Four Takeaway ThoughtsFour Takeaway Thoughts
1.1. The venture business is cyclical. We are currently in the growth phase of the 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 wave with the four elements of the venture liquidity cycle generally in balance and improving.and improving.
2.2. The venture capital industry itself is in transition. For some funds, the model The venture capital industry itself is in transition. For some funds, the model is structurally challenged – at least temporarily. Despite their best efforts, is structurally challenged – at least temporarily. Despite their best efforts, returns for their investors will be sub-standard.returns for their investors will be sub-standard.
3.3. Experienced investors at the earliest stage, investing relatively small amounts Experienced investors at the earliest stage, investing relatively small amounts at low valuations, are well-positioned in the current environment. at low valuations, are well-positioned in the current environment.
4.4. Fundamental cultural and technology transitions are underway. These waves Fundamental cultural and technology transitions are underway. These waves of change are transforming our world. Startups that ride the intersections of of change are transforming our world. Startups that ride the intersections of multiple waves represent extraordinary investment opportunities.multiple waves represent extraordinary investment opportunities.
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““You Can’t Stop the Waves,You Can’t Stop the Waves,But You Can Learn to Surf!”But You Can Learn to Surf!”
Larry KubalLarry KubalMay 31, 2007May 31, 2007