Internet Infrastructure

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STATE OF THE VENTURE CAPITAL MARKET
Bret Maxwell MK Capital May, 2003
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Agenda

• My background
• Current environment and future expectations
• Lessons learned from the Bubble Era and the
  implications for entrepreneurial businesses going
  forward
• Success factors for entrepreneurial companies
• Current investment terms
• Current topics of interest

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Bret Maxwell

• Managing general partner of MK Capital and the
  managing member of the general partner in the
  last three Productivity Funds, totaling 200
  million in committed capital
• Decision-making partner in six other fully
  invested funds, representing over 300 million in
  committed capital
• Nearly 20 years of venture investment experience.
  Supervised over 200 private investments. Led
  over 40 investments including a number of
  successful IPOs and trade sale/MA exits
• Areas of expertise include outsourced business
  services, telecom and internet infrastructure,
  and energy and power infrastructure
• Graduate of Northwestern University and The
  Kellogg Graduate School of Business
• Previously Chairman of the Illinois Venture
  Capital Association

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MK Capital

• MK Capital, LP is a venture capital fund making
  investments in companies whose solutions
  substantially enhance business efficiency or
  effectiveness.
• Formed in 2001, MK Capital is a spin-out of
  Chicago-based investment bank, First Analysis
  Corporation.
• MK Capital team is the core group of investment
  professionals that managed the last 3
  Productivity Funds (TPF II-IV) each of which has
  generated above average returns.
• Aggregate venture capital experience gt40 years
  across all economic cycles. The managing general
  partners have worked together for 9 years.

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Key Takeaways

• The current environment is a return to
  normalcy. Bubble habits and metrics distort
  perspectives and encourage poor decision making.
  Data from the last 5 years is a poor predictor of
  the next 10 years
• The Internet is the greatest deflationary
  phenomenon of the past 100 years as well as the
  greatest accelerator of economic decision making
  since the introduction of the television
• Deployment of technology is not correlated with
  capital market performance or psychology
• Many successful venture backed companies will be
  started/restarted in the current environment as
  long as they have the 4Ms (Market, Model,
  Momentum and Management)
• The venture capital sector is undergoing the most
  significant secular change in its history and is
  only about 40 of the way through the process.
  When the cleansing is completed, 75 of the
  personnel in the business will have left the
  profession

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Key Takeaways

• The focus has changed from exits to building
  companies
• The true opportunity cost of making bad
  investments is now better understood
• Venture Capitalists need to expect a 5-7 year
  investment cycle, not 24 months
• Venture Capital is an apprenticeship business and
  does not scale well when compared to other asset
  classes

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Venture Capital Fundraising
( in Billions)
Source Venture Economics
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Venture Capital Financings

• The venture capital market is undergoing dramatic
  correction. 40 of traditional venture
  capitalists will exit the business in next 3-5
  years
• Marginal sources of capital have retreated or
  exited the business (Angels, Public Money
  Managers, Corporate Investors, etc.)
• 2002 financings down nearly 50 vs. 2001
• Over the last 24 months, the majority of time and
  capital has been devoted to existing portfolio
  companies
• MA market continues to be spotty as sellers
  greatly outnumber buyers

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Investments
( in Billions)
Nationwide
Midwest
Source PWC Moneytree
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However, Now is the Time to Invest

• Historically, the most favorable time to invest
  in new ventures is at the end of an economic
  downturn
• Valuation expectations are more rational
• Management talent is plentiful, more seasoned and
  most importantly more humble.
• Wasteful spending practices have been largely
  eliminated
• Value to be had in focusing on underserved
  markets, both in terms of geography and deal size

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Lessons from the Bubble and Implications for
Entrepreneurs and Venture Capitalists

• Customers are the best predictor of long term
  value. Make sure that your customers are 100
  successful
• Markets (financial and product) move with
  staggering speed. Firms and managements must be
  sensitive to market feedback and flexible to
  alter strategies in days, not months
• David can beat GoliathMicrosoft is not
  dominating on-line services, wireless services or
  hand held computing
• The world continues to look to the US for
  commercial technology leadership

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What Venture Investors Look For in an Opportunity

• Focus on the basics (Market, Model, Momentum,
  Management)
• Capital efficiency is critical as valuation and
  future capital needs matter.
• Profitability and a successful business model
  must be established prior to an exit
• Existence of revenue with poor or negative gross
  margins does not demonstrate viability.
• Bias towards deals with broader, deeper financing
  syndicates.
• Management teams that Get It!

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Management Team Criteria

• In my nearly 20 years of investing,
• I have found successful management teams meet the
  following criteria
• Know ingredients of a sustainable business
• Understand market need, differentiated solutions,
  market approach
• Thorough understanding of pricing strategy and
  cost structure
• Validation of the business
• Look to marketplace for feedback
• Solid customers references and revenue potential
• Business management approach
• Controlled growth plan
• Sensible long-term financing strategy and
  valuation expectations

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Entrepreneurial Company Success Factors

• Adjust quickly to market feedback
• Contingency plans for lost customers, problematic
  product, slow development, ineffective channels
  or partners
• Modular growth strategy, minimizing fixed cost
  base
• Wise use of financing proceeds
• Superb market intelligence
• Develop products that meet customer demand just
  in time
• Position as market leader before competitors
  catch up
• Superior hiring practices
• Skills and talent at all levels
• Leaders who delegate

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Key Points for Angel Investors to Consider with
Venture Capitalists

• Cash flow, cash flow, cash flow
• A strong, compelling sales and marketing plan is
  often more important than superior technology
• Venture capitalists and active angel investors
  need to appreciate the value each brings to the
  party

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Contacting a Venture Capitalist

• Focus on VCs with expertise in your market
• Get a personal introduction
• Provide a concise executive summary
• Dont just focus on the product, also focus on
  the business
• Address market size, sales/marketing strategy,
  distribution channels, and customer value
  proposition
• Market correction is a return to normalcy
• Many market-leading companies were started in
  difficult times, such as Cisco
• Good companies with well thought-out business
  plans and solid teams are still getting funded.
• In a given year, most quality venture capital
  firms look at thousands of opportunities,
  carefully consider 100-200 and make 5-10 new
  investments