An assessment of how the top performing PE managers do it.

1. GETTING BACK TO BASICS
IN VENTURE CAPITAL
ALPHA BETS CONFERENCE
MONTERREY PLAZA HOTEL
MONTERREY, CA
JUNE 12, 2006
LOGAN McK. CHEEK
SENIOR MANAGING DIRECTOR
PITTSFORD VENTURES MANAGEMENT
(585) 223 3523
LOGAN.CHEEK@PITTSFORDVENTURES.COM

2. HOW DO WE GET BACK TO THE
WORLD OF PRE-1998 RETURNS?
SIMPLE ANSWER: WHEN WE GET BACK TO BASICS.
BUT WHAT ARE THE BASICS / KEY SUCCESS
FACTORS -- BOTH BEFORE 1998 AND SINCE?

3. A LITTLE HISTORY ...
PRE 1998 THE BUBBLE POST 2001
20-30% RETURNS MEGA RETURNS NEGATIVE RETURNS
SMALL FUNDS BIG FUNDS SHAKEOUTS
OFFER VALUE ON P&L & MINIMAL IPOS/
HYPE FUMES
BALANCE SHEETS CORPORATE SELLOUTS
SELF REGULATED BY “GOOD EMERGING OVERSIGHT:
“WILD WEST”
FORM” SOX / DHLS

4. IS THE GLASS NOW HALF FULL …

5. … OR STILL EMPTY?

6. WHAT HAPPENED?
WITH LARGE FUNDING INFLOW …
A. MORE OUTSOURCING
B. ADDRESSED SIZE AND COMPLEXITY WITH HEURISTIC RULES
C. THESE UNDERSCORED BY A HANDFUL OF INFLUENTIAL ACADEMIC STUDIES
D. VCS TILTED TOWARD PORTFOLIO APPROACH

7. WE’VE ESPECIALLY BECOME FIXATED
ON TRACK RECORDS …
The New Yorker, May 22, 2006, p. 61

8. SPECIFICALLY:
IS THERE SERIAL PERSISTENCE?
• VERY SLIGHT CORRELATION, BUT DON’T BET THE FARM ON IT.
• CHANCE OF TOP QUARTILE FUND REPEATING EQUAL TO A COIN FLIP

9. SO WHAT HAPPENS TO TOP PERFORMERS
IN THEIR SUCCESSOR FUND?
37% 35% 28%
Remain in Drop to Drop to
top tercile middle tercile bottom tercile

10. WITHOUT A NEW APPROACH, WE’RE BACK
TO A WORLD OF RANDOM WALK …

11. … WITH THE OLD APPROACHES.

12. SOME “BACK TO BASICS”
VC* KEY SUCCESS FACTORS …
1. HOW ARE DEALS VETTED?
2. HOW ARE ENTREPRENEURIAL TEAMS VETTED?
3. SPECIALIZED BY TECHNOLOGIES / SECTORS / GEOGRAPHY?
4. WHAT IS OPERATING STYLE / STRATEGY?
5. IS DEAL FLOW REACTIVE OR PROACTIVELY CREATED?
6. ARE LEAD DEALS IN BACKYARD? OR OUT OF EVERY AIRLINE VIP LOUNGE?
7. WHAT IS FUND SIZE / $ PER PARTNER?
8. WHAT’S DEAL SIZE?
*OR GATEKEEPER, CONSULTANT, FOF MANAGER, OR IM

13. METHODOLOGY …
1. SAMPLED 200+ DEALS OFFERED FOR CO-VENTURING FROM NEARLY 100
PARTNERSHIPS OVER 25 YEARS.
2. ASSESSED AND SLOTTED DEALS BY TERCILES
3. OBTAINED FROM PREQIN AND OTHER PUBLIC SOURCES OVERALL
PARTNERSHIP PERFORMANCE IN WHICH THAT DEAL RESIDED.
4. ASSUMED SAME MANAGEMENT APPROACHES / POLICIES WERE USED ON
ALL DEALS IN THAT PARTNERSHIP
5. GRAPHED THE RESULTS

14. 1. DEAL VETTING
BOTTOM MIDDLE TOP
-29% 9.7% 38.8%
<------------------- Terciles ------------------>
WAS THE DUE DILIGENCE PACKAGE AS PRESENTED TO ME A “LEEMING”, “GUT FEEL”,
“HEURISTIC”, “GO WITH THE FLOW” APPROACH? (BOTTOM TERCILE). OR WAS IT DISCIPLINED,
RIGOROUS, ANALYTICAL, AND DRAWING ON MANY THIRD PARTIES? AND WAS THE PROCESS OF
THE ORIGINATING FIRM SYSTEMATIC? (TOP TERCILE)

15. BUT THE ON-LINE SEARCH IS ONLY THE BEGINNING OF
A THOROUGH DUE DILIGENCE / VETTING PROCESS.

16. 2. ENTREPRENEURIAL TEAM VETTING
BOTTOM MIDDLE TOP
-44.1% 10.1% 46.4%
<--------------TERCILES ------------>
WAS THE DUE DILIGENCE PACKAGE AS PRESENTED ON MANAGEMENT TEAM
“THEY HAVE PRIOR CORPORATE P&L” “I’M FUNDING THIS BECAUSE THEY
CALLED ME PERSISTENTLY” “THEY WERE SUCCESSFUL IN A PREVIOUS DEAL
WITH ME” “I KNOW THE ENTREPRENEUR WELL FROM BEING MY (PICK ONE)
GOLF BUDDY, COLLEGE ROOMMATE, ETC. (BOTTOM TERCILE).
OR WAS IT DISCIPLINED, RIGOROUS, ANALYTICAL, AND DRAWING ON MANY
THIRD PARTIES ? H ONESTLY ASSESSED MANAGEMENT AND TECHNICAL
CREDENTIALS IN THIS MARKET WITH THIS PRODUCT AT THIS TIME? PEER
APPRAISALS? MULTIPLE INTERVIEWS? BACKGROUND CHECKS? PROFILING?
PSYCHOLOGISTS? KROLL? (TOP TERCILE)

17. 3. GP SPECIALIST CREDENTIALS
BOTTOM MIDDLE TOP
-20.1% 8.0% 38.7%
<--------------TERCILES ------------>
IS THE ORIGINATING GP RELYING ENTIRELY ON INPUTS FROM A SOLE THIRD PARTY? (BOTTOM
TERCILE). OR WAS IT DISCIPLINED, RIGOROUS, ANALYTICAL, AND DRAWING ON MANY THIRD
SOURCES? OR ON HIS OWN KNOWLEDGE? (TOP TERCILE)

19. 4. OPERATING STYLE
BOTTOM MIDDLE TOP
-28.3% 3.8% 26.9%
<--------------TERCILES ------------>
WAS THE FUND SIZE LARGE, AND PASSIVELY MANAGED? (BOTTOM TERCILE) WAS THE FUND
SMALL WITH BOARD INVOLVEMENT AND HANDS ON APPROACH, EVEN UNDERTAKING C-
LEVEL RESPONSIBILITY? (TOP TERCILE)

20. 5. DEAL ACCESS / DEAL DEVELOPMENT / DEAL FLOW
BOTTOM MIDDLE TOP
-18.1% 5.3% 31.1%
<--------------TERCILES ------------>
DOES THIS FIRM REACT TO DEALS PRESENTED (OVER-THE-TRANSOM SUBMISSIONS, WEB SITE
SUBMISSIONS, VC CONFERENCES, VENTURE FAIRS (“GONG SHOWS”), POKING AROUND THE
LOCAL UNIVERSITY / RESEARCH LAB? (BOTTOM TERCILE)
OR ARE THEY PROACTIVE? ON THE FEW OVER THE TRANSOM DEALS THEY RARELY DO, DO THEY
SUBSTANTIALLY ALTER THE STRATEGY AND MANAGEMENT TEAM? DO THEY CREATE THE DEAL AND FIND
THE TEAM? DO THEY DISCOVER A MARKET NEED / NICHE THEN GO TO THE LOCAL UNIVERSITY / LAB /
ENTREPRENEUR / GEEK AND SAY “CAN YOU BUILD THIS / SOLVE THIS?”

21. 6. LOCALE
Text
BOTTOM MIDDLE TOP
-12.1% 2.4% 25.4%
<--------------TERCILES ------------>
THIS IS THE GLOBAL VS. BACKYARD DILEMMA. BEING INVOLVED IN YOUR DEALS -- OR AT LEAST THE DEALS YOU LEAD -- MEANS NOT
WASTING TRAVEL TIME. THAT HAPPENED ONCE BEFORE TO VCS IN THE EARLY 80S. AND IT OFTEN HAPPENS WITH MEGAFUNDS. <1000
MILES BOTTOM TERCILE; >300 MILES TOP TERCILE
BUT WHAT IS TRUE HERE FOR VCS DOES NOT APPLY TO LPS: EVIDENCE SUGGESTS THAT LPS WHO THINK OUTSIDE OF THE BOX AND
MOVE THEIR CAPITAL INTO OTHER REGIONS AND NEW PROMISING SPECIALTIES -- GOING OUTSIDE THEIR BACKYARD -- PERFORM BETTER.

22. A COROLLARY TO LOCALE: GO WHERE THERE ARE TECHNOLOGY AND ENTREPRENEURS,
AND A SCARCITY OF INVESTMENT CAPITAL. US DATA SUGGESTS
THE SOUTHWEST, COLORADO, AND UPSTATE NY ARE GROSSLY UNDER SERVED ...
VC $ INVESTED VC $ INVESTED / VC $ INVESTED /
($ MILLIONS) R&D PERSONNEL PATENT ISSUED OR AVAILABLE
TOP QUARTILE REGIONS SOUTH CENTRAL STATES SOUTHWESTERN STATES SOUTHWESTERN STATES
BY KEY POTENTIALS ($73) ($1,515) ($456,811)
UPSTATE NY COLORADO SAN DIEGO METRO
($122) ($3,263) ($474,060)
SOUTHWESTERN STATES SOUTH CENTRAL STATES UPSTATE NY
($275) ($3,517) ($562,711)
SACRAMENTO / NORTHERN
NORTH CENTRAL STATES PHILADELPHIA METRO
CALIFORNIA
($353) ($653,080)
($6,670)
BOTTOM QUARTILE REGIONS TEXAS NY METRO LA / ORANGE COUNTY
BY KEY POTENTIALS ($1,131) ($33,454) ($1,024,900)
SOUTHEASTERN STATES NEW ENGLAND NEW ENGLAND
($1,211) ($52,130) ($1,324,172)
NEW ENGLAND SILICON VALLEY SACRAMENTO / N CALIFORNIA
($2,963) ($58,282) ($1,155,172)
SILICON VALLEY SOUTHEASTERN STATES SILICON VALLEY
($6,705) ($62,929) ($1,487,026)
PRIVATE EQUITY MEANS CAPITALIZING ON MARKET INEFFICIENCIES. WE WORK IN A WORLD OF NEGOTIATED TRANSACTIONS, NOT MARKET
TRANSACTIONS.
THE DATA ON THIS SLIDE HELPS MINIMIZE BEING TRAPPED WHERE “TOO MUCH MONEY IS CHASING TOO FEW DEALS.” TRICK IS TO INVEST INTO AREAS
WHERE THERE IS A DEARTH OF CAPITAL, WEALTH OF OPPORTUNITY, AND WEALTH OF ENTREPRENEURIAL SKILLS.

23. 7. FUND SIZE / $ PER PARTNER
BOTTOM MIDDLE TOP
-22.1% 5.8% 26.4%
<------------------------TERCILES ------------------------>
IS THE FUND’S TOTAL SIZE GREATER THAN $600 MILLION? IS THE CAPITAL RESPONSIBILITY PER PARTNER
GREATER THAN $200 MILLION IN TOTAL? (BOTTOM TERCILE) IS IT LESS THAN $400 MILLION / $25
MILLION? (TOP TERCILE).
THESE METRICS HAVE TO BE ADJUSTED UPWARD FOR INFLATION, AS SOME DATA GOES BACK SEVERAL
YEARS. ANGEL AND SEED FUNDS EXCEPTED, FUNDS IN THE $300 - $600 MILLION RANGE WITH
MANAGEMENT INTENSIVE STYLE AND $75 TO $100 MILLION PER GP FULL TIME EQUIVALENT MANAGER
SEEM TO OPTIMIZE IRRS.

24. 8. DEAL SIZE
Bottom Middle Top
-12.1% 18.3% 32.9%
<-----------------------Terciles ------------------->
IS THE SIZE OF EACH TRANCHE INVESTED BY THE PARTNERSHIP GREATER THAN $10 MILLION?
(BOTTOM TERCILE) IS IT LESS THAN $3 MILLION? (TOP TERCILE).
SOME CONFIRMATION, AGAIN FROM VIN KHOSLA:
A. 197.7X AGGREGATE RETURNS ON DEALS OF LESS THAT $1 MILLION INVESTED
B. 4.5X AGGREGATE RETURNS ON DEALS IF MORE THAN $1 MILLION INVESTED

25. BUT WE STILL NEED RISK TAKERS, WITHOUT THE NAPSTERS,
AND FACE NEW LEGAL MANDATES …
EVEN IF YOU DO EVERYTHING “RIGHT”, YOU STILL HAVE TO DO THE RIGHT THINGS LEGALLY. THIS IS MORE SO IN THE POST 9/11
WORLD. YOUR VC PARTNERSHIP MAY NOT HAVE TO CONFORM TO SOX, BUT ITS PORTFOLIO COMPANIES WILL EVENTUALLY
HAVE TO DO SO IF THEY ARE IPOED OR SOLD TO A LARGER ENTITY.
INDEED, VETTING OF LPS BY GPS IS NOW REQUIRED BY HOMELAND SECURITY, EVEN IN THE ABSENCE OF DEFINITIVE
TREASURY DEPARTMENT GUIDELINES. SO ASK YOUR GPS WHAT THEY ARE DOING IN THIS ARENA. AFTER ALL, DO YOU WANT TO
BE IN A PRIVATE EQUITY PARTNERSHIP WHERE ONE OF YOUR FELLOW LPS IS USING THE PARTNERSHIP AS A DRUG OR TERRORIST
OR MAFIA MONEY LAUNDROMAT?

27. THE TAKEAWAY / FOOD FOR THOUGHT
FOR INSTITUTIONAL FUND MANAGERS ...
1. HOW DO YOU SCREEN PROPOSED VC LP OFFERINGS?
2. HOW DOES YOUR GATEKEEPER / CONSULTANT / FOF / IM SCREEN PROPOSED OFFERINGS?
3. HOW DO YOUR VC GPS SCREEN DEALS / OPERATE?
GREATER REWARDS / SUPERIOR RETURNS DEVOLVE FROM A MORE
INTENSIVE, HANDS-ON PORTFOLIO MANAGEMENT STYLE -- AT
THE INVESTOR, GATEKEEPER, AND VC LEVELS.

29. I’D WELCOME FURTHER DISCUSSIONS AT THE NINETEENTH HOLE -- OR DINNER.