Venture Capital Opportunities in Information Technology Bob Stearns Managing Director Sternhill Partners Houston Technology Center Technology Showcase September 30, 2004

2 Agenda Facts about Sternhill The VC Industry Today Opportunities in IT Advice to the Prospective Entrepreneur

3 Facts about Sternhill Fund size: $105M Date closed: March 15, 2000 Stage focus: Seed, early-stage Geographic focus:Texas, Southwest, West Coast Industry focus: Computing Communications Storage Infrastructure Software Enterprise Software

4 GPs: Bob Stearns, Marc Geller, Ned Hill LPs:75% Individuals 25% Institutions Advisors: Rod Canion Co-founder, Compaq Ted EnloeFormer director, Compaq Jim Liang Managing director, Morgan Stanley Paul Murphy, Jr. CEO, Southwest Bank of Texas Ed OlkkolaPartner, Austin Ventures Partners and Advisors

5 Sternhill Investments: Computer Systems Computer Applications & Software Network Infrastructure

6 What We Look For: People ► Domain expertise ► Strong leadership ► Entrepreneurial skills Market ► Large and/or growing market ► Nature and extent of competition Technology / Product/Service ► Solve expensive customer problem ► “Hard to do” solution / unique service offering Business Model ► Reasonable revenue model ► Profitable ► Scalable Exit Potential ► IPO candidate ► Reasonable acquisition candidate The Deal ► Good valuation/sufficient ownership ► Sufficient return multiple ► Capital efficiency ► Right stage SHP Value- add ► Fits our domain expertise ► Leverages our network

7 The Sternhill Difference: Technical savvy Operational experience Entrepreneurial track record Network of contacts, relationships Location in underserved tech hotspot Hands-on managerial style “Sternhill Partners is, arguably, the most important VC firm headquartered in Houston” -Upside Magazine

Venture Capital Today

9 After 3 Years of Decline, Venture Capital Has Begun to Rebound VC investments rose 22% to $5.8B in Q2 ’04 from $4.7B last year. Investments have increased steadily since Q4 ’02, when they bottomed out at $4.2B. Fundraising is also picking up. 82 funds raised $5.8B in 1H ’04, as compared to 1H ’03, when 76 funds raised $3B. Venture Capital Investments ($B) Source: VentureEconomics (7/27 & 8/3/04)

10 VCs Are Starting to Invest Again in Early-stage Companies After the market collapsed in 2000, VCs preferred to reinvest in their existing portfolio (expansion stage) rather than fund new companies (seed stage). However, that has begun to change. Seed and early-stage deals made up 36.8% of all companies funded in Q2 ’04 – a level not seen since Expansion Seed/Early- stage Later-stage Percent of VC Financings by Stage Source: VentureEconomics, 7/27/04.

11 And the IPO Market Is Staging a Comeback… 29 venture-backed firms raised more than $2B in Q2 ’04, the greatest number since Q3 ’00. There were 79 additional companies in registration as of 7/04. However, 38% of ’04 IPOs have priced their below expectations. Number of IPOs Total Offering Amount ($M) Recent Venture-backed IPOs Total Offering Amount Number of IPOs Source: VentureEconomics (July 2004), Wall Street Journal, 9/8/04.

12 Though Signs Bode Well, Venture Capitalists Remain Conservative… in Managing Their Existing Portfolios… Rightsizing their funds Focusing on sustaining their winners Keeping extra cash to support winners through the slowdown Ensuring portfolio companies raise enough money to allow plenty of operating runway Removing poor management when necessary Closing or selling their losers in Making New Investments… Limiting, or postponing, new investments Putting extra effort into due diligence. Making sure to choose the: Right management team Right market Right product Right price

Technology Opportunities

14 Our Investment Focus Computing Bladed Architectures Optical Processing Sensors-on-silicon Nano-electronics Communications Wireless Equipment (e.g., Wi-Fi, WiMAX, UWB) Voice over IP Optical Advanced Signal Processing Services Storage Optical Storage Storage Virtualization Infrastructure Software Datacenter Automation Virtualization – applications, processing, operating systems Enterprise Software Data Visualization Business Process Management Data Security Systems/Resource Management Linux-based applications Other Security, biometrics, encryption Haptics Power sub-systems, batteries, fuel cells Informatics Past our investment window Still in research stage: Fits investment profile today

15 Opportunities Data (creation, usage, communication) is exploding exponentially Data (creation, usage, communication) is exploding exponentially Demand for connectivity is increasing Demand for connectivity is increasing Data security is of fundamental importance Data security is of fundamental importance Customers need efficient and cost-effective ways of dealing with the increasing load of bits being created, manipulated, stored, secured, and communicated. Data and voice are converging Data and voice are converging Wired is going wireless; wireless is going wired Wired is going wireless; wireless is going wired Convergence of industries: Consumer electronics and computers Convergence of industries: Consumer electronics and computers Customers need help dealing with the complexities created by industries and technologies in transition. Companies must continually innovate (in both its technology and its business model) in order to derive margins in an increasingly competitive market. Hardware/systems are constantly moving toward commoditization Hardware/systems are constantly moving toward commoditization Markets are becoming increasingly global Markets are becoming increasingly global Pressure on IT budgets is intense and increasing Pressure on IT budgets is intense and increasing Trends Opportunities

Advice to the Potential Entrepreneur

17 On Getting Venture Capital: Identify your competitive differentiation (e.g., IP, management). Know how much money you will need and why you need it. Know how much money your competitors are getting, and what range of valuations you can expect. Know the VC’s strengths and weaknesses, and what return the VC requires. Know the tricks of the trade (participation, anti- dilution, liquidation preferences, etc.) and be prepared to negotiate.

18 And on Using Venture Capital: Venture money is the most expensive capital you will ever have. Spend a dollar of venture money like it were ten dollars. Take the cash that is offered to you! Even if the valuation is not what you want, take the cash. Remember: intermediate valuations are not as important as the final valuation placed on your company at the time of acquisition or IPO. When spending venture capital, remember to keep a tight rein on burn. Match burn to revenue. And beware of big company marketing. Vendors will eat your lunch!

19 “Yes, in this immense confusion one thing alone is clear. We are waiting for good dough [Godot] to come.” Samuel Beckett, 1952 [italicized words, ours]