1. THE VENTURE FINANCE ECOSYSTEM Michael Danaher Wilson Sonsini Goodrich & Rosati

2. 2632179 2 1. Venture Funding Activity 2. Demand Side Dynamics 3. Supply Side Dynamics 4. Dealing with Deflation 5. Other Trends and Fashions

3. 2632179 3 1. Venture Funding Activity

4. 2632179 4 The View From on High: Investment Rises Slightly in 2Q’03 Amount Invested ($B) Number of Deals Underlying data available in VentureSource Source: VentureOne/Ernst & Young

5. 2632179 5 The View From the Ground  Consumer confidence in the venture industry moved strongly up in the Spring  Multiple term sheets – what a concept!  Some instances of valuation giddiness  Overall activity is sharply up  First round deals are up

6. 2632179 6 2. Demand Side Dynamics

7. 2632179 7 Confidence is Up The Market has awakened Nasdaq Composite Index

8. 2632179 8 Confidence is Up The economy has awakened Source: Bloomberg & Zachs Investment Research * Estimated Earnings

9. 2632179 9 Confidence is Up  The world is adjusting to life after 9/11  The Iraq war ended quickly

10. 2632179 10 Venture Fund Dynamics: The Clean-up is Mostly Done  In 2001 & 2002 VCs were preoccupied with the care of their existing portfolio  Now that most of the the triage is complete, VCs can focus on investing again

11. 2632179 11 Funds Raised ($B) Commitments to Venture Capital Funds Underlying data available in VentureSource Source: VentureOne/Ernst & Young Venture Fund Dynamics

12. 2632179 12 Number of Deals Source: VentureOne/Ernst & Young Underlying data available in VentureSource Venture Fund Inflow and Outflow Funds Raised ($B) Amount Invested ($B)

13. 2632179 13 Source: VentureOne/Ernst & Young Underlying data available in VentureSource Venture Fund Inflows and the Nasdaq Funds Raised ($B)

14. 2632179 14 Negative Dynamics  A number of “fair weather funds” are drying up  Many top funds have downsized  Corporate investors are mostly gone

15. 2632179 15 Corporate Investment is Mostly Gone Amount Invested ($M) Underlying data available in VentureSource Source: VentureOne/Ernst & Young (except Intel and Cisco)

16. 2632179 16 First Round Financings Data extrapolated from VentureSource Source: VentureOne/Ernst & Young

17. 2632179 17 Negative Dynamics The Ex-Smoker Syndrome: the Reformed VC Excessively risk averse Excessively slow Excessively LP conscious

18. 2632179 18 3. Supply Side Dynamics

19. 2632179 19 “The older but wiser girl is the girl for me.” -- The Music Man

20. 2632179 20 The Entrepreneurs  More realistic about valuations  More patient about building a company, and building a career  More down-to-earth  More plentiful  More hard core technology plans  More thrifty

21. 2632179 21 4. Dealing With Deflation

22. 2632179 22 The Old Days of the New Economy  The market rewarded First to market Scale (e.g. engineer head count) Revenue prospects  Earnings didn’t matter The rational response: go fast, spend big, never mind the losses

23. 2632179 23 Earnings Really Didn’t Matter YearOfferings Percent profitable in IPO year 19994749% 2000669% 20011331% The WSGR IPO Universe* (Company and Underwriter Side) * An unofficial compilation

24. 2632179 24 Exit Valuations Are Now Earnings Driven  IPO’s Require Profits  Acquirers want accretive acquisitions No big premiums for “time to market”

25. 2632179 25 The Venture Industry Responds: Valuations Remain Down Median Amount Invested ($M) Underlying data available in VentureSource Source: VentureOne/Ernst & Young

26. 2632179 26 The Venture Industry Responds: Deal Size Remains Down Median Amount Invested ($M) Underlying data available in VentureSource Source: VentureOne/Ernst & Young

27. 2632179 27 The Entrepreneurs Respond: Run Silent, Run Cheap  Smaller budget business plans  Lower headcount, smaller salaries, cheaper facilities, leased equipment, smaller marketing budgets…  Focus, do less, outsource  Aim right—sell, design, build  Overseas Design Centers

28. 2632179 28 The Entrepreneurs Respond: Run Silent, Run Cheap  Some great businesses are being built on $200k to $300k per month

29. 2632179 29 5) Other Trends and Fashions

30. 2632179 30 Proceed With Caution  Show me the customers  Almost every deal is syndicated  More first round deals are traunched

31. 2632179 31 Other Deal Terms  Often smaller shares for founders (especially outside Silicon Valley)  Investors prefer plain vanilla deals when possible No cumulative dividends, weighted average anti- dilution Liquidation preferences: usually 1x participating preferred, often without caps Redemption rights (but why bother?)

32. 2632179 32 Market Dislocations  Fewer dislocations (un-served sectors) than years past Most will consider first round, second round and mezzanine Seed rounds are still a problem – the angel market is still decimated

33. 2632179 33 Market Dislocations  Out of fashion Optics Telecom services  In fashion Network security, homeland security (government sales!), wireless, consumer electronics, biotech