Elements Of Successful Emerging Tech Companies

Value Catalysts

There are plenty of big waves…

keep paddling fast

Presentation to Cal Poly GSB528

September 2, 2008
Christopher J. Rust
rust@usvp.com

© 2005 USVP. All Rights Reserved 1

 Agenda Value Catalysts

 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

 Investment History As Context Value Catalysts

Investments - 1998 to Present

 Abrizio – switch fabric ICs > PMCS  Nexsi – network security > JNPR
 Avanex – optical modules > AVNX  Afara – next gen server > SUN
 Santur – tunable lasers
 Telera – Call center software > ALA
 Memx – optical switch > OOB
 Syndesis – IP OSS SW > Hamant  Commerce5 – ecommerce sw > DRIV
 Santera – voice switch > Tekelec  LVL7 – networking software > BRCM
 Mellanox – Infiniband ICs > MLNX  Dilithium – transcoding gateway
 Mahi – Metro core switch > Meriton  Stratalight – 40Gbps optical
 SwitchOn – Processor > PMCS  Veriwave – WLAN equipment
 Turin – Metro transport switch  Akros – Networking ICs
 Zannel – Mobile social networking
 VxTel – VoIP ICs > Intel
 Clustrix – Internet Infrastructure
 Springbank – Caching system > CFLO  Dune – Networking ICs
 Onetta – optical amplifiers > BKHM

25 investments; 2 IPOs, 10 acqs > 1x, 3 acq <=1x 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 Value Catalysts

 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
 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

 Typical VC Ecosystem Value Catalysts

Unfiltered Entrepreneurs, Unstructured Plans

Existing Entre- Early Late Stage University Individual Limited

Portfolio preneurs Stage VCs Investors Professors Investors Partners Targeted
Recruitment
Partner Personal Industry Funding Investment Corporate
Recruiters E-mail Transom For Internal
Contacts Contacts Pundits Agents Bankers Partners Ideas

Referred Entrepreneurs, Plans Unreferred Entrepreneurs, Plans

VC Firm Due Dilligence Process

(market, team, technology, location sort)

New investment

Retained Commission Outsourced Interim Commercial Tool Outsourced

Bank Lease Foundry
Recruiters Recruiters Accountants Management Real Estate Vendors Mfging

Corporate Personal Outside

HR Marketing
Partners Contacts Director(s)

© 2005 USVP. All Rights Reserved 7

 Typical VC Due Diligence Process Value Catalysts

Pass. Quick screen Pass Pass

Only proceed if
there is a GP
Initial sponsor
Contact Second Mtg
First Filter 1:1 Meeting
1-2 GPs

Pass Begin Due

Pass Diligence
Distribute Detailed
Initial Diligence
Package
Deliver
GP All Hands Final Package &
Presentation 90-Day Plan
3rd Mtg
Onsite Visit
Pass. Material changes Begin Pass
Negotiations

Negotiate Deal &

Close Pre-close Review Term Sheet
$$$
© 2005 USVP. All Rights Reserved 8
 VC Due Diligence Checklist Value Catalysts

Business Plan
Investor Presentation “Pitching” skills can mask flaws

Team Resumes Major Component Of Success

Equation, but HCA Often
Founder References Highly Subjective/Superficial

Market Research Emerging sector > incomplete data

Customer Testimonials Can be “pre-wired” by entrepreneur

Competitive Assessment Based on incomplete data

Operational Review Not much to assess at seed stage

Technology Assessment Often relies on 3rd party SME

Financials Review
Case Specific Research
© 2005 USVP. All Rights Reserved 9
 Investment Criteria – A VC Survey Value Catalysts

1-relevant, 2-m oderately 3- 4-very 5-mos t

0-n/a unim portant important important im portant im portant
Investment Criteria
Market 0 0 0 1 27 22
Team 0 0 0 0 23 27
Product or technology 0 0 0 12 33 5
Corporate strategy 0 0 6 30 13 1
Operating plan / financial model 0 0 13 25 10 2
Deal 0 0 3 18 29 0
Co-investors / syndicate 0 1 13 13 23 0

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

1-relevant, 2- 3-very 4-most

Post-Mortem Learnings from Failed Investments 0-n/a uncommon common common common
Management team and/or founders do not execute 0 2 10 18 20
Poor recruiting by the founders 0 12 21 17 0
Poor executive recruiting by the VCs 0 10 24 13 3
Missed top-line sales objectives 1 2 13 26 8
Missed bottom-line profitability objectives 3 10 25 10 2
Schedule slips on development 0 7 20 21 2
Technical differentiation anticipated at start does not materialize 0 13 20 14 3
Missed market window by being too early 0 9 20 17 4
Missed market window by being too late 0 16 16 14 4
Target market did not materialize 0 5 18 11 15
Crushed on price by competitor 1 24 18 5 0
Crushed on features by competitor 3 23 21 1 1
Crushed on distribution and/or sales by competitor 1 19 19 8 2
Incompetent Board of Directors 0 23 16 10 1
Failure to secure outside investors for follow-on financing 0 10 23 16 0
Collapse of existing investor support / syndicate 1 14 27 6 1
Government or regulatory bottlenecks 4 41 4 0 0
Other noteworthy causes of new venture failures 6 Total responses (see text)

 “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 = S3; Victory = Speed * Stealth * Sweat
• F = R * V2; 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

 Clarity Of Purpose Value Catalysts

Source: Don Valentine

© 2005 USVP. All Rights Reserved 15
 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 - >$100M revenues in 4 years, Cisco GMs
 Risk Factors - Entrenched Competition = BAD, 1st
Mover in New Category = GOOD
 Deal - Small Check for Big Ownership and Pool

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 Product Focus Value Catalysts
Important To Do One Thing Better Than Everyone Else

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 Disciplined Partnership Value Catalysts

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 A Model for Partnering Value Catalysts

Strategic
partner
Alliance
partner
tactical
Teaming &
cooperation
VALUE COMPLEXITY
Value shipper,
exclusive supplier
Preferred
Supplier
Commodity
Supplier

MATURITY

© 2005 USVP. All Rights Reserved 19

 A Culture of Success Value Catalysts

Dare To Be Different Team DNA

Responsiveness Fight Hard But Fairly

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 Comments On Financials Value Catalysts

Profit = Independence Frugality = Survival

It Takes A Long Time

To Build A Franchise

© 2005 USVP. All Rights Reserved 21

 Addressing “Corporate Viability” Value Catalysts

 Vi’ a.bil’ i.ty n. Capable Of Living And Developing

• Corporate viability not determined by balance sheet, fund-
raising 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 Value Catalysts

 Self-Funded/Angel Funded  (Tier One) VC Funded

• Set modest, achievable goals • Set AGGRESSIVE goals
• Change markets
• Focus on one customer • Focus on Market Share
• Incrementally raise $ • Raise big $
• Give up big ownership
• Incrementally build skills • Suffer big liquidation pref overhang
• Relatively low risk • Buy experience to move fast
• Live within means • 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

 Comparing OUS Tech Hubs Value Catalysts

China Israel India

Market Huge, Fractured Not meaningful. Tiny Huge, Fractured

Skilled Growing Small, but elite 1.4m in IT w 450k in top 3

Workforce BPOs. ~45m pay taxes

Innovation Growing High Growing

Multinational High, growing Highest, growing High, growing
presence
Government Single party Democracy Democracy, ethnic politics

Corruption

Literacy, 90%, English 100%, high <= 60%, English high among
English skills mandated in educated classes
schools since 2000
Infrastructure $140+B. Efficient Not meaningful. Size <$40B. Inefficient use of
spend/year via central planning of Bay Area money spent.

© 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
 One Key Take-Away… Value Catalysts

Adapt & Succeed

© 2005 USVP. All Rights Reserved 30

 Value Catalysts

Thoughts?

Group
Discussion

© 2005 USVP. All Rights Reserved 31