THE VENTURE FINANCE ECOSYSTEM

Michael Danaher

Wilson Sonsini Goodrich & Rosati

October 2004

2

1. So Goes Nasdaq...

2. The New Economies Continue

3. What’s with Valuations?

4. What’s with IPO’s?

5. The LP Glut

6. The Coming Crisis

3

1. So Goes Nasdaq...

4

The Venture Ecosystem Food Chain

Nasdaq

LPs

Portfolio Companies

OPEX CAPX

GPs

5

So Goes Nasdaq... FUND INFLOWS

Source: “Venture Capital Industry Overview,” VentureOne, October 2004

Fu

nd

s R

aise

d (

$B)

$7.1$8.7$12.9

$49.3

$81.2

$55.5

$25.7

$15.9$12.1

$7.3$5.7$6.7

$0

$20

$40

$60

$80

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1H04

$14.2*

Source: Bloomberg, Nasdaq 1992-2004

* Annual projection

6

So Goes Nasdaq... FUND OUTFLOWSA

mo

un

t In

vest

ed (

$B)

Nu

mb

er of D

eals

$20.8*

2002*

$10.4

$18.4$21.6

$36.1

$94.5

$49.4

$17.9$13.1

$9.2$6.4$4.4$3.6

1001

20242307

3221

6262

4563

25432211

1912

13151075959

$0

$25

$50

$75

$100

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1H04

0

1,000

2,000

3,000

4,000

5,000

6,000

Amount Invested ($B) Number of Deals

Source: “Venture Capital Industry Overview,” VentureOne, October 2004

* Annual projection

Source: Bloomberg, Nasdaq 1992-2004

7

So Goes Nasdaq... LIQUIDITY EVENTS

$43.41

$98.56

$22.08

$11.03 $13.03$18.09

$3.25$10.11

$26.80

$12.81 $14.87

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 YTD04*

YTD04 = 1Q04 – 3Q04

661

329

354399

424

554

233

306

413352

321

Ag

greg

ate # of M

&A

/IPO

Ag

gre

gat

e V

alu

e ($

B)

Source: “Venture Capital Industry Overview,” VentureOne, October 2004

* YTD04: 1Q04-3Q04

Source: Bloomberg, Nasdaq 1992-2004

8

2. The New Economies Continue

9

New Economies ContinueRun Silent, Run Cheap

Continued frugality in the portfolio companies

Continued productivity gains - more with less

Outsourcing to India and China became a torrent

• WSGR setting up 1 Indian sub a week

10

Me

dia

n A

mo

un

t In

ve

ste

d (

$M

)

$10.0$10.0

$14.4

$8.0

$9.0

$5.1 $5.0

$1.0$1.5

$0

$2

$4

$6

$8

$10

$12

$14

2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04

Later Round Second Round First Round Seed Round

Deal Size Remains Constant

Source: “Venture Capital Industry Overview,” VentureOne, October 2004

11

3. What’s with Valuations?

12

Median Pre-money Valuation by YearM

edia

n P

re-m

on

ey V

alu

atio

n (

$M)

$13.6

$10.0$10.5

$16.0

$25.5

$21.5

$15.5

$12.9$11.1

$9.3$10.0$8.2

$0

$5

$10

$15

$20

$25

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 1H04

Source: “Venture Capital Industry Overview,” VentureOne, October 2004

13

Median Pre-money Valuations by RoundM

ed

ian

Pr e

-mon

ey V

alu

ati

on

($

M)

$0

$10

$20

$30

$40

$50

2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04

Later Rounds Second Round First Round Seed Round

$25

$45

$15

$18

$5

$8

$3$3

Source: “Venture Capital Industry Overview,” VentureOne, October 2004

14

The View From the Ground

More deal competition, more bidding wars

More up-rounds

More eyebrow-raising rounds

15

WSGR Venture Financing

* Top 5 avaerage, top 2 values

Quarter

Average Value of Top 10 Deals

(by Pre-Money Valuation)($m)

Top 3 Deals (by Pre-Money Valuation)

($m)

Q303 $42 $77; $66; $47

Q403 $46 $90; $65; $60

Q104 $63 $115; $112; $60

Q204 $46 $82; $72; $60

Q304 $59 $125; $125; $100

10/4/2004* $44 $100; $70

16

4. What’s with IPO’s?

17

Number of IPO’s

*YTD04: 1Q04-3Q04

Am

ou

nt

Rai

sed

($B

)V

entu

re-Backed

IPO

s

$1.6 $1.4

$3.8

$1.8

$19.2$19.5

$3.7$4.6

$8.7

$5.0

$2.8

48

222022

202

250

68

120

216

144

115

$0

$5

$10

$15

$20

$25

$30

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 YTD04*

0

50

100

150

200

250

Amount Raised ($B) Venture-Backed IPOs

Source: “Venture Capital Industry Overview,” VentureOne, October 2004

18

IPO’s vs. M&A

0% 20% 40% 60% 80% 100%

1995

1996

1997

1998

1999

2000

2001

2002

2003

YTD04*

IPOs M&As

*YTD04: 1Q04-3Q04

Source: “Venture Capital Industry Overview,” VentureOne, October 2004

19

Why the Decline?

Public market profitability requirements

Perceived volatility vs. M&A security

Sarbanes burden

Decreased research coverage

20

Earnings Matter More

YearPercent profitable

in IPO year

1999 49%

2000 9%

2001 31%

2002 30%

2003 100%

2004 60%

The WSGR IPO Universe

21

5. The LP Glut

22

The LP Glut

Portfolio companies are staying frugal

GP’s are staying frugal—fund sizes remain down

But

LP’s

• Increasing fund investments in proportion to public market

• Increasing percentage allocation to VC asset class

= Global Warming in the Venture Ecosystem?

23

The LP Glut

“Why Venture Funds Don’t Want Your Cash”

-N.Y. Times

“Too Much Money Chasing Too Few Good Funds”

-Venture Capital Journal

24

The LP Glut

The Fishing Fleet Example

Fleet profitability

Gill nets and trollers

New fishing grounds

25

New Fishing Grounds

China and India

Domestic

Energy/Clean tech

26

6. Crisis in the Making?

27

Crisis in the Making?

Global technology competition is increasing rapidly

• Funding

• Talent

• Activity

Historically, the U.S. competes by attracting the best and brightest from around the world

28

Crisis in the Making?

The Department of Homeland Sabotage

Foreign applications to graduate school down one-third!

Visa process discouraging visits by foreign students and businessmen

Work visa limitations reducing high tech talent