Classic presentation by Bill Janeway on alternative means to finance technology companies

1. Alternative Models of the Venture Investing Process v3
Alternative Models of
the Venture Investing
Process
Bill Janeway
Vice Chairman
Warburg Pincus

2. 2
Alternative Models of the Venture Investing Process v3
“IT Doesn’t Matter”
Nicholas Carr
Harvard Business Review
May 2003
 Technological infrastructure has been commoditized
 No competitive advantage from investing in IT
 Spend less and cut costs
 “Focus on vulnerabilities, not opportunities”

3. 3
Alternative Models of the Venture Investing Process v3
The Fifth Wave
Carlota Perez
Technological Revolutions and Financial Capital
 The Bubble of 1999-2000 marked the MID-POINT of the “Fifth Wave”
of transformational technology
 Like railroads and electrification: two phases
 From infrastructure to applications
 From experiment to existence proofs
 From speculation to common sense
 The promise of technological revolutions is transformational
 Speculative Bubbles are endogenous

4. 4
Alternative Models of the Venture Investing Process v3
The “Killer Apps” of the Fifth Wave
 The Bubble financed experiments in:
 Customer self-service
 Straight-through processing
 Real-time intelligent transactions
 The vehicles for the Fifth Wave’s productivity revolution
 The sources of major market discontinuities in IT infrastructure and
applications
 Two decades to mature/two decades to deploy

5. 5
Alternative Models of the Venture Investing Process v3
The Status of The Technology
 Standardization is in process (and costs are falling)
 BUT:
 Complexity rises with convergence
 Computing vs. communications paradigms
 Integration costs more than development
 Syntax versus semantics
 Required: Higher levels of abstraction
 Required: Technological innovation
 Required: New ventures to bring innovation to market

6. 6
Alternative Models of the Venture Investing Process v3
PRODUCT MARKET MANAGEMENT
LIQUIDITY FOR
FOUNDERS
TECHNOLOGY
Round-by-Round
MANAGEMENT CHANNEL PRODUCT
CREATE SELF-
SUSTAINING
BUSINESS
MARKET
DISCONTINUITY
Fully Funded
Two Models of Venture Investing

7. 7
Alternative Models of the Venture Investing Process v3
Round-by-Round VC Model: 1
 Focused on product innovation
 Start with intersection of: Well-defined market
New technology
 Specify an innovative product (faster, cheaper, better)
 Add management as needed
 Achieve liquidity ASAP: IPO or sale

8. 8
Alternative Models of the Venture Investing Process v3
Round-by-Round VC Model: 2
 Fund in multiple rounds/multiple investors per round
 Each round validates (or NOT) continuing investment
 New investors leverage returns for earlier ones (and for entrepreneur)
 Value at each round = f (operational progress,
Capital Market environment)

9. 9
Alternative Models of the Venture Investing Process v3
Round-by-Round VC Model: 3
 Key attributes
 Goal = Deliver product to market
 Risks = Operational and Capital Market
 Time horizon
 12 months per round
 ~3/4 years to liquidity event
 Key exposure: Capital Market volatility

10. 10
Alternative Models of the Venture Investing Process v3
Capital Market Volatility
 The round-by-round VC model evolved to manage operational risk
 But every new venture is also exposed to Capital Market risk
 Ability to respond to Capital Market risk
 Potentially compromised by multiple VCs
 With diverse cost bases, availability of capital
 What the Bubble gave…hath been taken away

11. 11
Alternative Models of the Venture Investing Process v3
$2.9 $6.6 $5.7 $6.8
$13.3 $16.9
$25.7
$57.5
$83.7
$50.7
$13.3
$3.4
$0
$20
$40
$60
$80
$100
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 YTD03
0
1,000
2,000
3,000
4,000
5,000
NASDAQ Index
Fundraising Barely Noticeable in 2003
Underlying data available in VentureSource
Commitments to Venture Capital Funds
Funds Raised ($ Billions)

12. 12
Alternative Models of the Venture Investing Process v3
$8.5
$10.7
$9.5
$11.2
$12.6
$15.5
$22.0
$26.0
$16.8
$10.5 $10.0
$0
$10
$20
$30
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 1H03
Valuations at Mid-’90s Levels
Underlying data available in VentureSource
Median Premoney Valuations by Year
Median Premoney Valuations ($ Millions)
0
1,000
2,000
3,000
4,000
5,000
NASDAQ Index

13. 13
Alternative Models of the Venture Investing Process v3
$100
$17
$39
$14
$5
$13
$3
$5
$0
$20
$40
$60
$80
$100
2Q00 4Q00 2Q01 4Q01 2Q02 4Q02 2Q03
Valuations Regress Toward Overall Median
Underlying data available in VentureSource
Median Premoney Valuations by Round Class
Later Rounds
Second Round
First Round
Seed
Median Premoney
Valuations ($ Millions)
0
1,000
2,000
3,000
4,000
5,000
NASDAQ Index

14. 14
Alternative Models of the Venture Investing Process v3
0
1,000
2,000
3,000
4,000
5,000
NASDAQ Index
$7.6
$3.5
$6.7
$1.5
$0.5 $0.3 $0.2
$0.8
$0.4
$0.9
$0.0 $0.4
$0.0 $0.2 $0.4
6
2
0
6
1
9
4
8
4
5
5
18
71
43
70
$0
$2
$4
$6
$8
$10
1Q00 2Q00 3Q00 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03
0
15
30
45
60
75
IPO Liquidity Has Been Rare, now Recovering
Underlying data available in VentureSource
“Normal” means ventures can go public that don’t need to
Amount Raised ($B) Venture-Backed IPOs

15. 15
Alternative Models of the Venture Investing Process v3
4.0 4.1
3.5
3.2
2.8 2.8
3.1
4.5
3.6
5.7
0
2
4
6
1994 1995 1996 1997 1998 1999 2000 2001 2002 YTD03
Underlying data available in VentureSource
Time from Initial Equity Funding to IPO
IPO Companies Older
0
1,000
2,000
3,000
4,000
5,000
NASDAQ Index
Years

16. 16
Alternative Models of the Venture Investing Process v3
0
1,000
2,000
3,000
4,000
5,000
NASDAQ Index
$4.7 $6.3 $4.6 $5.2 $5.5 $6.9 $10.2 $9.5
$13.9 $14.0
$18.7
$23
$19
$26
$100
$55
$31
$34
$40
$25
$22
$20
$0
$20
$40
$60
$80
$100
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 YTD03
$0.00
$20.00
$40.00
$60.00
$80.00
$100.00
Underlying data available in VentureSource
Median Amount Paid in M&As vs. Median Invested in Private Rounds Prior to M&A
Less Gains in Current M&As
Median Invested in Private Rounds Median Amount Paid

17. 17
Alternative Models of the Venture Investing Process v3
PRODUCT MARKET MANAGEMENT
LIQUIDITY FOR
FOUNDERS
TECHNOLOGY
Round-by-Round
MANAGEMENT CHANNEL PRODUCT
CREATE SELF-
SUSTAINING
BUSINESS
MARKET
DISCONTINUITY
Fully Funded
Two Models of Venture Investing

18. 18
Alternative Models of the Venture Investing Process v3
“Fully Funded” Alternative: 1
 Focused on market discontinuity
 Partner with proven management team
 Define business strategy:
 “Buy what you can/build what you must”
 Estimate capital needed to cash flow break-even
 Negotiate price and availability up-front

19. 19
Alternative Models of the Venture Investing Process v3
“Fully Funded” Alternative: 2
 Evolved to address Capital Market risk
 If markets move favorably, can always take advantage of them
 If markets move unfavorably, keep building the business
 Management of operational risk = Continuing responsibility of
financial and operating team
 Operating team wholly focused on building the business

20. 20
Alternative Models of the Venture Investing Process v3
“Fully Funded” Alternative: 3
 Key attributes
 Goal = Positive cash flow from sustainable competitive position
 Risks = Operational only (Capital Market risk insured)
 Time horizon
 4-7 years
 Liquidity event = “Nice” NOT “need” to have
 Added benefit: this model was totally irrelevant during the Bubble!

21. 21
Alternative Models of the Venture Investing Process v3
Where are we now?
 The existence proofs are evident: Amazon, Dell, eBay
 The innovators have proven their case
 “Main Street” has no choice but to follow
 But transformational technology only becomes universal when it
becomes transparent
 Transparency requires higher levels of abstraction

22. 22
Alternative Models of the Venture Investing Process v3
Levels of Abstraction
 How to drive a car
 “Turn steering wheel 10 degrees to left”
 “Take Uncle Bob to the airport”
 From railroads to railway express
 From electrification to the assembly line
 From distributed computing to resource virtualization and web
services

23. 23
Alternative Models of the Venture Investing Process v3
Abstracting the Infrastructure
 Fundamental paradigm change:
 From bus-based to router-based processing: IP everywhere
 From remote calls to messaging: XML everywhere
 From the “smart” SMP system to the dumb crowd: numberless nodes
 New architectures are needed:
 To manage heterogeneous, distributed resources
 To make them work as an application platform
 New architectures are the context for new point products
 Delivering new architectures requires building sustainable businesses

24. 24
Alternative Models of the Venture Investing Process v3
Abstracting the Application
 Fundamental paradigm change
 Composite applications: Functionality = Service
 Value from business process understanding
 Ease of customization
 Ease of incremental extension
 Payment for value delivered over time
 New business model means new investment model
 New product = $15 million-25 million
 Sustainable business = $75 million-100 million

25. 25
Alternative Models of the Venture Investing Process v3
Conclusion
 The “fully funded” alternative is relevant again
 (f) The post-Bubble capital market environment
 AND paradigm change at the infrastructure and application levels
 But only for a sub-set of strategic ventures
 The entrepreneurs are self-selected
 Build a business versus
 Deliver a product
 When the capital markets are “normal”, IPOs are available to the
businesses that don’t need them
 Strategic ventures require long-term capital