CONFIDENTIAL

Perspective on the Enterprise Software Industry and New Venture Success

Will Price

September 6th, 2005

Page 2

Executive Summary

•Context and Assumptions

•The investing environment has fundamentally shifted, but also created great opportunities for savvy early stage investors

•Significant trends are creating great opportunities for new companies

•Scale-free profitability demands new business models and optimized business practices

Page 3

IT Venture Capital: Secular Not Cyclical Shift, Early Stage May Be Bastion of Extraordinary Returns

• Surplus capital in the industry appears to be a secular rather than a cyclical shift

• Ratio of IT VC $ Invested YTD to IT VC $ Raised YTD

– .50

• If no new funds raised, current pace of investing suggests overhang will be put to work in 11.9 quarters

– $32.7bn/$2.747bn

• Where is the IT capital going

– Apparently not in early stage– 2000 Early Stage $/Total $

• 34%– 2003 Early Stage $/Total $

• 20%– 2004 Early Stage $/Total $

• 20%– 1H2005 Early Stage $/Total $

• 16%

• Early stage investing bastion of pricing discipline and IRR given barriers to entry

– Later stage deals largely won on share price alone– Barriers: deal flow, syndication, optimized investment

decisions, post-deal value add

IT VC

$-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

IT InvestmentsYTD

IT Funds RaisedYTD

Current IT VCOverhang For

NewInvestments

Total Current ITVC Overhang

Source: Venture One

Page 4

When It Goes Right, What Does It Cost to Build a Great Software Company?

Median Capital Raised: $10.1mMedian 1st-4th Year Revenue Ramp: $.1 $.8 $6.9 $21.6mMedian Years to Exit: 4Market Comps: Massive varianceLesson: •Pricing discipline is critical as multiples at exit are impossible to forecast and may not be consistent with market multiples at time of funding•With market pricing impossible to forecast, capital efficiency is critical•Software model supports the creation of great companies on <$20m of capital

Page 5

Gains from Information Technology M&A Suggest Capital Efficiency is Critical

$31

$55 $55

$136$140

$115

$60

$42

$26$29

$9

$23$25

$38$35

$30

$7$10 $11

$8 $8 $10 $12$15

$18$13

$16$22

$18 $18 $18$24

$21

$35

$14

$45

$29

$68

$33

$45

$27

$31

$101

$39

$13

$20

$35

$11$8$10$9

$27

$5$9

$22

$14$14

$12

$0

$20

$40

$60

$80

$100

$120

$140

$160

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q

Median Amount Paid Median Equity Raised Prior to M&A

(US$ in millions)

1998 1999 2000 2001 2002 2003 2004 '05

Implications: Stage and Capital Efficiency MatterInvest early and avoid >$15-20m in a given deal

Page 6

If I Were to Start Tomorrow…

•Goal– Comprehensive, quality deal flow

•Comprehensive, quality deal flow– Function of (top down appreciation of key trends + bottoms up coverage of superset of possible

opportunities)

•Key Trends– Function of (secular economic, technical, market, competitive drivers)– Buyer power, regulation, consolidation, operating leverage concerns, off shoring, on demand, open

source, virtualization, increased specialization of enterprise applications

•Bottoms up coverage– Function of (law/service firms, M&A targets, university/corporate research, incumbents, IT

community, start-up network, industry literature/blogs, conferences)

•Good deal identification– Function of (filter that isolates signal from noise)

•Filter– Technical Innovation– Business models that support scale-free profitability– Tailwind– Leverage of ecosystem-based competition– Strategy to align vendor and customer interests

Page 7

Enterprise Software Trends and Emerging Needs

Usage Model and Category

New Characteristics and Trends

Analysis Real-time DSS (in-memory, frequent ETL)

Query across DB, XML/XQuery, text, web, and voice

Data mining/greater need for machine learning to deal with data

deluge (Intel’s RMS)

Industry DBs and scoring algorithms

Collaboration Dynamic data gathering from DBs, Web services

AJAX and RSS

Rendering large content using XSLT

BPEL/BPML and composite applications

Security to address concerns re: trust and privacy

Federated ID to allow SSO

Voice interaction

Entitlements

eBiz/Web OLTP Increased data volume, processing

Scale out – apps deployed over sets of independent, networked

resources

Frequent DB syncs concurrent with OLTP – data integrity

App/DB level security

Messaging/XML acceleration

Technical Computing 64 bit computing – 2x memory per clock cycle

Grids/clusters/dynamic provisioning

Increased data volume/ XML

Virtualization/Resource Pooling

Data Center Ops Autonomic management/server virtualization

Decoupling of logical and physical

Logic driven ILM

Page 8

Example Areas of Implementation

Next Gen Infra•Virtualization and resource

pooling (Scalent)

•Grid interconnects (Pathscale)•Application performance mgt (SEBL

issues)•Event

archiving (KX Systems)

Storage•ILM logic to move data

between tiers (Neopath)

•Backup and recovery (SysDM)

Security•Fine-grain

entitlements (Citibank fiasco)•Federated SSO

(PingID)•Virtual patch (Blue Lane)

•Secure email (Voltage)

Analytics•Event

processing (Coral8)•Natural language

processing (Attensity)•Scoring (Vindicia)

•RSS Syndication

(Feedburner)•XML OLAP (Skytide)

Page 9

Applications Also Possible Bastion of Value Capture

• Applications

– “Computer science” required to build applications increasingly subsumed into readily available components

• J2EE and .Net – Business logic and domain specific solutions may be a bastion of value and margin – Suggests application layer will compete more on product management than engineering

• Applications Criteria

– Deep domain/business knowledge– World class product management– Robust enterprise and data integration strategy– Leverage of OSS and 3rd Party Infrastructure Stack– Leverage of low cost R&D human resources

• Examples

– Demandtec– ACL

Page 10

9

Source FactSet

Notes1. Companies with >$5Bn revenue run-rate include Microsoft, Oracle and SAP2. Companies with $1Bn - $5Bn revenue include Computer Associates, PeopleSoft, Intuit, Veritas, Symantec, Siebel, Compuware, Adobe, Novell, BEA and VeriSign3. Companies with $500MM - $1Bn revenue run-rate include McAfee, Sybase, Parametric, Hyperion and Mercury4. Companies with $300MM - $500MM revenue run-rate include Kronos, i2, Macromedia, Dendrite, FileNet, Lawson, Progress, Quest, TIBCO and Aspen5. $75MM - $300MM category includes a representative set of 50 software companies with annual revenue of $75MM - $300MM

– Scale is increasingly necessary to achieve competitive operating leverage in the software industry• More efficient sales &

marketing and R&D per dollar of revenue

– Sub-$75m revenue companies average <10% operating margins and SG&A represents > 40% of revenue.

33%

16%

27%

12%

7%

11%

18%

15%

18%19%

16%

45%

48%

39%

43%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

$75MM - $300MM $300MM - $500MM $500MM - $1Bn $1Bn - $5Bn >$5Bn

LTM Operating Margin LTM R&D Spend LTM SG&A Spend

LTM Revenue:

% of LTM Revenue

LTM Operating Margin (12 Months Ago)

% of Revenue

2%

8%

12%

16%

32%

Scale Matters for Sustained Profitability

Source: Morgan Stanley

Page 11

Scale Free Profitability Requires New Approaches and KPIs

• Start-up companies must innovate their business models and strategies in order to reach attractive profitability metrics independent of scale

• R&D– R&D expense as a percentage of revenue can be dramatically reduced via ecosystem pooling of resources

and labor arbitrage• Track cost per R&D head, Rev/component and cost/component

• Marketing– Marketing must become more KPI driven and quantitative with CEO’s demanding detailed activity-based

cost analysis of marketing programs. Internet savvy marketing • Track cost per lead, cost per close

• Sales– Cost of direct sales is crippling and the variability of reps (see Mark Leslie’s Sales Life Cycle Analysis) makes

direct selling very challenging– MySQL’s “try before you buy approach”– Distribution channels (ex. VMWare)

• Track sales as % of revenue, sales resource op margin contribution

• Operations and Delivery

– A hosted/ratable revenue model should be considered early on

• Customer benefits: lower risk and cost, faster go live and payback, lower upgrade costs, broader access to complex functionality

• Vendor benefits: higher adoption rates, lower development and support costs, recurring revenue

– Track GM

• Vendor’s delivery, pricing, and product strategies must not be orthogonal to IT buyer’s interests and counter to the dominant trends in the industry

Page 12

Executive Summary

The investing environment has fundamentally shifted, but also created great opportunities for savvy early stage investors

Significant trends are creating great opportunities for new companies

Scale-free profitability demands new business models and optimized business practices