“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,
But You Can Learn to Surf!”
34 minutes, 34 slides to answer two questions:
Part 1: The Market
Where are we in the VC wave cycle?
Part 2: The Investment Opportunities
Where are the opportunities today, created by
cultural & technological waves that are
transforming our world?
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PWC’s Cascading Technology Waves
Source: PricewaterhouseCoopers
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Gartner’s Hype Cycle of Emerging Technologies
VISIBILITY
TIME
Technology Peak of
Trough of
Trigger
Inflated
Disillusionment
Expectations
Source: Gartner Group
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Slope of
Plateau of
Enlightenment Productivity
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Kondratiev Waves – Components of the
Economic Cycle Wave Form
Steam Engine
Cotton
Railroads
Steel
Electrical Engineering
Chemistry
Petrochemicals
Automobiles
Information
Technology
P R D E
1800
1850
1900
P:
R:
D:
E:
2000
prosperity
recession
depression
improvement
Source: Wikipedia, Labrador
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1950
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Mathematics of the Kondratiev Wave
Николай Дмитриевич Кондратьев
Nikolai Kondratiev (1892-1938)
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A More Conceptual Approach
Waves of change / growth
Disappointment
Market
values
Growth
Hype
Realism
Time
Source: Morgan Stanley Dean Witter & Co., Labrador
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Liquidity Cycle in Venture Capital
VC / Angel
investments
in companies
 $30B+ 2006
commitments
best in 5 years
LP
investment
in VC
Angel
Shortcut
Company
liquidity
events
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 $7B in Q1’07,
best in 5 years
Company
growth
 Up rounds
exceeded down
rounds for 13th
consecutive
quarter
 Q1’07 IPOs raise
$1.2B – double Q1’06
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Annual Progress Along the Curve
Waves of change / growth
Growth
2006
Disappointment
Market
values
Realism
Hype
2000
1999
2001
2005
2002 2003
2004
Time
Source: Morgan Stanley Dean Witter & Co., Labrador
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Potential Divergence For Different
VC Models
Waves of change / growth
Growth
2007
2006
Disappointment
Market
values
?
Realism
Hype
2000
1999
2001
2005
2002 2003
2004
Time
Source: Morgan Stanley Dean Witter & Co., Labrador
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“I’ve been telling our investors for three or four
years, I don’t think this is a good asset class to
commit money to right now.”
-Paul Ferri
Founding Partner Matrix Partners (1982)
Private Equity Hall of Fame (2003)
quoted in Private Equity Analyst, March 2004
“Technology finance has turned rational – so I’m
outta here.”
-Howard Anderson
William Porter Distinguished Lecturer
MIT Sloan School of Management
(co-founder Battery Ventures)
quoted in Technology Review, June 2005
“The traditional venture model seems to us to
be broken.”
-Steve Dow
General Partner, Sevin Rosen Funds
quoted in the New York Times, October 7, 2006
Why Are Smart, Experienced
People Saying This?
Case for the venture model being broken:
 LOTS OF MONEY: lots of funds funding lots of deals – 10,000 over
the last 4 years
 “Capital overhang” has become a “company overhang”
 VENTURE FRATRICIDE: excessive competition funded within
market segments
 EXIT MARKETS CONSTRAINED: getting liquidity at good return
multiples is tough
 EXTENDED HOLDING TIMES: from initial investment to a
liquidity event – M&A and IPO are at historic highs ( > 5 years)
“There is a pig in the python and the python is constipated.”
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"It's a great time for investing in early-stage
companies that will mature in three to five years."
-Larry Kubal
Managing Partner, Labrador Ventures
quoted in the Los Angeles Times, July 13, 2003
So who is right?
What accounts for the
divergence of opinions?
Most Important:
What does the future hold?
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Fund Size: A Defining Difference
OPTIMISTIC
PESSIMISTIC
$500
$450
$400
$350
$300
Fund Size
($ Millions)
$250
$200
$150
$100
$50
$0
Labrador
Ventures
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Matrix
Partners
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Battery
Ventures
Sevin
Rosen
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Case Study to Support the Broken Model
Thesis…
$400M fund
Target 20% IRR (3x return over 6 years)
20 company investment portfolio
Must create $1.2 billion of exit value
If 20% of a company owned at liquidation, then portfolio needs to
create $6 billion of value
If ALL are winners (aggressive) = $300 million per company
If 50% winners = $600 million per company
CHALLENGE: In today’s environment, assumptions > $150
million average for winners is very optimistic
Thanks to Josh Kopelman, MD First Round Capital for the example.
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What Does This Mean For the Early Stage
Investor Today?
The venture business is experiencing a sea change …
and the earliest stage VC or angel investor is well-positioned.
Key Positioning Factors
• Small “fund” size
• Low $ / partner
• Earliest stage focus – small investment, very early at low valuations
• Experienced, consistent, disciplined investment team & strategy
• Capital efficiency a core value
• Manage company growth and cash to fundable milestones
• Well-networked with larger VCs that are potential follow-on funders
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Supported by Data: Experience & Small
Size are Success Indicators
IRR increases with more
partners & fewer dollars
IRR increases with experience
IRR
(%)
IRR
(%)
25
20
25
20
15
15
10
10
5
5
0
0
1
2
3
4
5
6
7
8
9
10
11
0
Fund #
0.4
0.6
# Partners
per $100M
Source: Lerner & Schoer 2005
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Early / Seed VC Returning to Historic
Pre-eminence
Returns to investors as of 12/31/2006
20 years
10 years
5 years
3 years
Early / seed VC
20.5
36.4
(3.0)
6.5
9.9
Later stage VC
14.0
9.0
3.7
9.4
25.2
NASDAQ
10.1
6.4
4.3
6.3
4.8
S & P 500
9.2
6.7
4.3
8.2
10.8
Source: Thompson Financial, NVCA
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1 year
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Valuation Inflation Has Not Impacted
the Early Stage
Pre-money valuations – early stage companies
26.2
$ Millions
19.4
17.7 17.5
15.4
14.2
12.8
10.1
8.8
9.5
8.7
7.3
95 96 97 98 99 00 01 02 03 04 05 06
Source: PriceWaterHouseCoopers, NVCA
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Early / Seed VC Driven by Recognized
Value Creation
Financing round
Average % price increase
Series A to Series B
120%
Series B to Series C
60%
Series C to Series D
34%
Source: Fenwick & West’s Q1 ’07 San Francisco Bay Area Venture Capital Survey
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Summary of the Health of the VC Market
For whom is the traditional venture model especially
challenging today?
• $400+ million funds that focus on capital intensive businesses or
Series B and later
For whom is the model still intact and vital?
• Smaller funds that invest earlier and do not depend on exceptional
exit markets
How long will exit challenges persist?
• We believe the state of the exit markets is an anomaly and will self
correct in the normal cyclicality of our business
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Part 2: Investment Opportunities
Where are the investment
opportunities today, created by
cultural & technological waves that
are transforming our world?
Four Waves Are Changing Our Lives and Creating
Investment Opportunities
 Globalization
 Digitization
 Millennialization
 Geo-political destabilization
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Globalization: Increasing Interdependence Among
Nations
Outsourcing originally driven by lower manual labor costs has
transitioned to knowledge workers
•
Nearly 100% of Citibank’s IT programming requirements are outsourced to India
50% of US Treasury debt obligations are held by foreign entities
China accounts for 20% of the world population. Its people have transitioned into
21st century consumers representing the largest single market in the world
•
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Morgan Stanley forecasts China as the #1 consumer of TMT (technology, media and
telecommunications) products and services in 2010
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Digitization: Content Creation, Distribution and
Consumption Are Increasingly Frictionless
News, movies, music and communication transition to digital: newspapers,
DVDs, CDs and phone calls become bits in the ether
As old media transitions to new digital media, advertising dollars follow
Beyond consumers, digitization encompasses enterprise business information,
legal documents and medical records
Behavioral, psycho-social waves of change are underway -- as ease to create,
distribute and consume digital content grows.
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Millennialization: Millennials Rather Than Boomers
Now Define the Online Consumer Experience
Millennials (born 1982-2000) -- the internet generation immersed in digital
technology and content
“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.”
–Duncan Davidson
Multi-tasking, multi-cultural – in charge of their online experience – “long
tailers.” Demand personalized, customized, self-expressive, creative, engaged,
communicative, anytime/anywhere, connected web experiences.
Global: 75 million US, 200 million China
From Facebook to YouTube, the Millennials are defining the evolution of the
consumer online experience that the rest of us adapt to.
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Geo-Political Destabilization: Power Shift From
Massive Military to Small Groups
High instability in the Middle East:
Afghanistan, Iran, Iraq, Israel, Lebanon,
Syria
Higher energy costs
Attention & dollars to
Higher energy costs
• Solar
• Fuel cells
• Batteries
Growing sensitivity to terrorism
Demand for security
• Surveillance
• Identification
• Tracking
• Detection
Funds have been created to address “Homeland Security.” In the
last year KPCB has launched initiatives in both Greentech and
Pandemic / BioDefense.
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Technology Platform/Infrastructure Waves
Also Define Areas of Investment Opportunity
Global data subscribers - cellular
Subscribers
(M)
Growth of WiFi hotspots
# of hot
spots
clients
(M)
1800
1400
80
50
1000
30
650
15
5
300
2005
40
2006E
2007E
2008E
2009E
2001
2002
2003
2004
2005
2006E
Global broadband subscribers
Subscribers
(M)
209
148
97
57
30
2001
Source: Morgan Stanley research estimates
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2003
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2004
2005E
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Examples of Investments Riding the Intersections
of Cultural and Platform Waves
Customized streaming internet radio connecting
listeners with the music they love – anytime, anywhere.
Cultural – Digitization, Millennialization
Platform – Cellular, WiFi
Allows users to indulge, discover and personalize their
passion for video entertainment – online or on TV.
Cultural – Digitization, Millennialization
Platform – Broadband, Cellular, WiFi
Mobile photo and video messaging -- transforming the
camera phone into a tool for mobile video and photo
communication.
Cultural – Digitization, Millennialization
Platform – Cellular
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Four Takeaway Thoughts
1.
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
and improving.
2.
The venture capital industry itself is in transition. For some funds, the model is
structurally challenged – at least temporarily. Despite their best efforts,
returns for their investors will be sub-standard.
3.
Experienced investors at the earliest stage, investing relatively small amounts
at low valuations, are well-positioned in the current environment.
4.
Fundamental cultural and technology transitions are underway. These waves
of change are transforming our world. Startups that ride the intersections of
multiple waves represent extraordinary investment opportunities.
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“You Can’t Stop the Waves,
But You Can Learn to Surf!”
Larry Kubal
May 31, 2007
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VENTURES