“you can’t stop the waves, but you can learn to surf!” larry kubal – labrador ventures may...

““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

CONFIDENTIALCONFIDENTIAL 22

LABRADORVENTURESLABRADORVENTURES


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?



PWC’s Cascading Technology WavesPWC’s Cascading Technology Waves

Source: PricewaterhouseCoopers



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



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



Mathematics of the Kondratiev WaveMathematics of the Kondratiev Wave

Николай Дмитриевич КондратьевNikolai Kondratiev (1892-1938)Nikolai Kondratiev (1892-1938)



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



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



Annual Progress Along the CurveAnnual Progress Along the Curve




RealismRealism


HypeHype

TimeTime

19991999

20002000

20012001

20022002 2003200320042004

GrowthGrowth

20052005

20062006



Potential Divergence For Different Potential Divergence For Different VC ModelsVC Models




RealismRealism


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



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



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?



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



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.



• 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



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



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



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



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



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?



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



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



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.



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.



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



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



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



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.




Larry KubalLarry KubalMay 31, 2007May 31, 2007

“you can’t stop the waves, but you can learn to surf!” larry kubal – labrador ventures may...

Documents

labrador slide

labrador growth slide

pricewaterhousecoopers

years angelshortcut

vc wave cycle

cultural technological

morgan stanley dean

technology finance