Noubar Afeyan, PhD.Senior Managing Director, Flagship Ventures

Senior Lecturer, MIT Sloan School

MIT Enterprise ForumJune 2003

What are private equity investors looking for?

Need for Change in Venture Capital

• Tradition of venture capitalists helping build great companies replaced by momentum investing

• Conflict between focus on short-term apparent value (1-2 yrs.) vs. long-term sustainable shareholder value (5+ yrs.)

• Potential conflict between LP and GP interests when fee replaces carry as motivation

• Large legacy portfolios impact capacity for and attitude toward new investments

• Tradition of teamwork and true partnership in decision-making replaced by individual practitioners (superstar syndrome)

Easy to be pessimistic… much harder to create returns!

So how do we make money in today’s environment?

• Building great companies with sustainable advantage transcends macro environment

• Focus on essential technologies, not just enabling technologies

• Identify emerging themes before others, and build companies that are early leaders with barriers to entry

• Efficient capital deployment – employ sources of leverage

• Engage firm’s network to assist in early customer traction

Think Macro … Act Micro!

Introduction to Flagship Ventures• Entrepreneurship and venture capital firm• Managing $405M in funds raised during 2000 and two

earlier funds ($150M)• Interdisciplinary team of 24 professionals with

entrepreneurial, growth management and investment experience

• Investing 4 forms of capital: Intellectual, Experiential, Relationship, Financial

• Balance across Life Science and Information / Communications Technology (ICT) sectors

• Venture creation strategy• Proprietary sector themes drive deal generation

Entrepreneurial Challenges

Why Are Start-ups So Hard?

• a strong entrepreneur to lead the effort

• a good business concept• a good (typically new) technology

to implement concept• sufficient capital (typically

$30MM+ to get to IPO stage)• a good management team for:

• R&D• Marketing• Sales• Financial• Engineering• Manufacturing• Etc.

• test of technology• test of market acceptance• test of management/

organizational recruiting• proof of ability to operate

profitably• proof of ability to respond to

competitive threats• proof of ability to sustain

profitability for long term (many quarters)

• proof of ability to develop

•Because so many things can go wrong

•Consider the minimum needs for success:

Finding a Profit Zone

Technicallypossible

Desirable tolarge or growing

market

Can beproduced/deliveredat a profit

Can beprotected

Challenges to starting

• How can you know you will raise money to move forward?

• Is your venture and team investable?• Opportunity• Experience• Competition• Path to further funding or liquidity

• Design for “investability” vs. profitability, growth and sustainability• Should you build towards a great company or one that can

raise money in the beginning?

The Dilemma

• The more revolutionary, unconventional or “out there” your idea;

• The harder it is to point to:• tangible market potential• path to sustainable profitable growth • appropriate team composition

• The less the business can be guided by comparables;• BUT, the easier it is to differentiate, prevent competitive

threats, excite extraordinary team members to join, envision the potential to build another Microsoft, excite investors

• And vice versa

Elements of Success

• Sustainable competitive advantage• Large growing market• Perfect execution• Persistence/Patience• Luck

Venture Capital Opportunities

What are VCs looking for ideally?

• Companies with significant market opportunity ($1B+) and rapid revenue growth prospects

• Management teams with appropriate experience and track record

• 35-50% ROI and 5-10x multiple on invested capital• Multiple liquidity options within a reasonable timeframe• Proper fit with firm objectives

• Deal size• Industry focus• Deal type

• Also, subjective goals• Opportunity to make a difference• Chance to be associated with transformer/emerging leader

What VCs are looking for in a new venture?

• Is there a problem worth solving?• How many customers? At what price?

• Why now?• Why you?• Can you, with partners/channel, deliver a “whole

product solution?”• Can you create, or do you have, an unfair advantage?• Is there a pricing/channel mix that makes sense?• Can the weaknesses be fixed in a timely fashion

• Introduction to the right team members, including a CEO

How VC’s assess the entrepreneurial team

• Integrity• World-class understanding of the problem to be solved• Intellectual rigor/objectivity• The self confidence to accept coaching, without losing

sense of direction• Bias towards action• Orientation towards customers, rather than technology• Ability to recognize, and hire to, weaknesses• Ability to attract world-class talent• Leadership

Views on the Current Environment

• Challenging time to grow revenues• New capabilities less valuable than cost savings• Maturing IT industry coincides with economic slowdown• Increasing cost, time and uncertainty of drug development

compounded by pharma ills • “Essential Technologies” vs “Enabling Technologies”• Profitability and market leadership require sustainable competitive

advantage• No easy exit options• Back to “test tube to tank car in 7 years”

Do Entrepreneurs and VC’s mix?

Entrepreneurship and Venture Investment

• Entrepreneurs: Paranoid Optimists

Entrepreneurship and Venture Capital

• Entrepreneurs: Paranoid Optimists• Venture Capitalists: Skeptical Optimists

Entrepreneurship and Venture Capital

• Entrepreneurs: Paranoid Optimists• Venture Capitalists: Skeptical Optimists

• Early stage venture capital needs to combine both:

Paranoid Skeptics?

Entrepreneurship and Venture Capital

• Entrepreneurs: Paranoid Optimists• Venture Capitalists: Skeptical Optimists

• Early stage venture capital needs to combine both:

Paranoid Skeptics?Cautious optimists!