From survival to growth

Global venture capital insights and trends report 2009

Foreword

Nearly all aspects of the global economy are feeling the impacts of the economic downturn. The Venture Capital
(VC) industry, for one, faces a number of difficult challenges: falling demand for portfolio company products and
services; a dearth of exit opportunities through Initial Public Offerings (IPOs) and acquisitions; and the need for
tough decisions about the prospects of some portfolio companies.

But while the challenges are significant, a number of factors suggest that the industry will soon move from the
challenges of survival to opportunities for growth. First, the venture industry is applying many of the lessons
learned in the aftermath of the technology bubble of 2000. VC firms have reacted quickly to assess their portfolios
in light of the downturn and to set aside reserve capital to support companies with the potential to succeed in the
long term. Portfolio companies’ strategies are being adjusted to the new economic realities with cost management,
an intense focus on the customer value proposition and overall operational excellence.

Most important, venture-backed companies are identifying and pursuing the opportunities inherent in a downturn —
“Never waste a good crisis” has become the new industry catchphrase. These opportunities include the ability
to access cheaper resources, attract the best talent more easily and overtake or acquire struggling competitors.
Forging innovation partnerships with large corporations that increasingly view innovation as a primary source of
competitive advantage is another opportunity to be seized. Honing a business model and innovation strategy that
work in a downturn can pay impressive dividends on the upswing.

Indeed, many of today’s market-leading companies were founded or received their first round of venture financing
in recessionary periods — Hewlett-Packard, Apple and Cisco, Starbucks, Intuit, Skype and Shanda, to name just a
few. While it is hard to predict which venture-backed companies will emerge as market leaders this time, it is safe
to say that some will develop and bring to market great new innovations and become the billion-dollar enterprises
of tomorrow.

As you will read in our interviews with leading VC investors around the globe, the work of funding great new
companies continues despite the difficult economy. Investors point to cleantech, cloud computing, Software
as a Service (SaaS), genomics and consumer applications as a few of the areas in which they expect to see
disruptive innovation.

Given the importance of innovation to the world economy, VC funding should not be taken for granted, especially
in some of the most trying economic conditions since the Great Depression. That is why we make a number of
policy recommendations for the support of the VC ecosystem: incentives for innovation and entrepreneurship
in government stimulus packages; cross-border cooperation to improve the flow of talented individuals; and a
multinational task force to develop a plan to increase the number of IPOs by venture-backed companies.

From survival to growth, our seventh annual report on venture capital, examines the state of VC today and provides
insights into such topics as strategies for seizing opportunities in the current downturn, managing working capital
and concerns for technology companies. Throughout the report, leading company executives and VC investors from
around the globe share their own perspectives on the impacts of the downturn and strategies for success. We are
grateful for their contributions.

We hope that you will find this report a source of valuable insight and look forward to working together with you on
the global challenges and opportunities that lie ahead.
Table of contents

• From crisis to opportunity

by Gil Forer, Ernst & Young, and Dr. Martin Haemmig, CeTIM.........................................................2

• Fireside chat on venture capital and growth companies

Interview with Scott Carter, Sequoia Capital, and Paul Deninger, Jefferies ...................................10

• Lessons learned from building a company in turbulent times

Interview with Matthew Szulik, Red Hat .....................................................................................14

• Innovation finds finance despite market turbulence

by John de Yonge, Ernst & Young..............................................................................................18

• Perspective from Europe

Interview with Bruce Golden, Accel Partners ..............................................................................20

• Current topics for technology companies

Ernst & Young Global Technology Center ...................................................................................23

• Perspective from China

Interview with Bo Shao and David Zhang, Matrix Partners ..........................................................26

• Perspective from the United States

Interview with Deepak Kamra, Canaan Partners .........................................................................28

• How to manage cash

by Steve Payne and Al Sardo, Ernst & Young ..............................................................................30

• Perspective from Israel

Interview with Chemi Peres, Pitango Venture Capital..................................................................32

• Perspective from the United States

Interview with Noubar Afeyan, Flagship Ventures .......................................................................34

• Perspective on corporate innovation and collaboration

Interview with Steve Meller, Procter & Gamble ...........................................................................36

• Perspective of a corporate investor

Interview with Nino Marakovic, SAP Ventures ............................................................................38

• Perspective on biotech
Interview with Alex Barkas, Prospect Venture Partners...............................................................40

• Perspective on US cleantech policy

Interview with Timothy Urban, Washington Council, Ernst & Young .............................................42

• Perspective from the United States

Interview with Jeffrey Glass, Bain Capital Ventures ....................................................................46

• Contacts
Ernst & Young Global Venture Capital Advisory Group ................................................................49

1
From survival to growth
Winning through excellence and innovation in a downturn
Gil Forer,
Global Director, Cleantech, IPO and
Venture Capital Initiatives,
Ernst & Young
Dr. Martin Haemmig,
Senior Advisor on Venture Capital,
Stanford University (APARC-SPRIE),
and Adjunct Professor, Globalization of
Venture Capital, CeTIM
Key points
The VC industry has reacted quickly to the
downturn, moving to reassess portfolios
and refocus portfolio company strategies.
Operational excellence in a downturn
means not only cutting costs and
increasing revenues but also seizing
opportunities to gain market share.
Innovation partnerships between
emerging-growth companies and
large corporations become even more
important in a downturn.
VC industry financing for innovation
should not be taken for granted — global
policy initiatives to ensure the health of
the VC ecosystem are needed.
2 From survival to growth
When assessing the current state of the
Venture Capital (VC) ecosystem, an
important distinction needs to be made
between the current financial crisis and the
aftermath of the burst internet bubble of
2000 — the last severe downturn faced by the
VC industry with which it is tempting to draw
parallels to today’s situation.
In 2000, the venture industry was part and
parcel of the bubble and the subsequent
downturn. Fueled by “overexuberant” stock
markets that placed unsustainable valuations
on dot-com and technology companies, VC
grew globally from a US$30 billion industry
to a US$125 billion industry, only to retreat
to a US$25 billion industry as public markets
collapsed — all in the space of just three years.
This collapse was followed by a real industrial
downturn in telecommunications, software,
computers and electronics, hitting even
quality companies with real business models
and real products. Even so, the downturn
was largely confined to the technology sector
while other parts of the economy continued to
perform relatively well.
The current downturn is much more complex
and driven by fundamental issues that are
not related to VC or the technology industry.
A variety of overlapping circumstances
combined to create today’s global financial
crisis. Among them were the collapse
of bubble-like real estate markets, poor
lending practices, a lack of adequate risk
management in the use of derivative financial
instruments, and debt being overleveraged
by both businesses and consumers. Thus,
the venture industry is adapting to a financial
crisis caused by external factors.
Funding trends and challenges
While the financial crisis began to be felt in
2008, overall VC financing declined only
gradually over the course of the year. This
is partly because the VC business has a
long latency: while the economy may be
slowing, there is still a lot of money in the
system from the limited partners that have
committed capital to funds for 7 to 10 years,
regardless of the economy. Another reason
is that cleantech investing remained strong
throughout the year, supporting the overall
investment figures.
But by the first quarter of 2009, the impact
of the downturn on VC investing became
clear, with a substantial drop-off in financing
globally. We can expect significantly few
new VC investments around the globe in the
near term as firms allocate more capital to
reserves for existing portfolio companies
(see Figures 1 and 2).
However, the longer the global downturn
lasts, the more likely it is that VC firms with
relatively young funds will place bets on new
investments. This is because the economy is
likely to have recovered in the five to seven
years it typically takes to build a company to
the point of being ready for an exit. History
has proven that many world-class companies
have been funded in periods of downturn.
Challenge: potential exit backlog
Any company financed during this downturn
will find thousands of other venture-backed
companies ahead of it in the pipeline to exit.
The years between 2002 and 2008 saw a
wave of new financings by VCs around the
world that seems disproportionate to the
capacity of the capital markets to provide an
exit through Initial Public Offerings (IPOs) instrumental in advising the Chinese to set Figure 1. Global VC investment by
or Mergers and Acquisitions (M&As). In up guidance funds, similar to Israel’s Yozma geography 1Q’08–1Q’09
the United States, VC firms provided 6,013 program in the early 1990s, in which the
Total investment (US$b)
companies with an initial round of financing. government invests as a limited partner
$11.8
In Europe, the figure is 3,077 newly financed in local and foreign VC firms along with $11.8
$11.4
$0.14 $0.14 $0.14 $0.25
companies; in Israel, 325 companies. At the other institutional investors. The recently $0.46 $0.23
$0.25
$0.26
$0.22
rates that venture-backed companies have established Russian Venture Company (RVC) $1.02 $1.43
$1.00

conducted IPOs and M&As in the post-bubble is doing the same to attract international $9.0
$1.61
period, it is questionable whether these brand-name VC firms to Russia. It remains $2.22
$1.94 $0.17 $0.29
$0.25

companies financed post-bubble will achieve to be seen whether the money will be used $0.75

the rates of exit seen earlier. for early-stage companies in these two $1.64
$5.9
emerging nations. $0.10
The large population of private venture- $0.08
$0.12
$0.46
backed companies could not only hurt the The United States, on the other hand, has a
$1.21
weaker VC firms and their limited partners network of “angel” groups or individuals. As $7.78
$8.17
$7.77

but could also damage the returns of in every downturn, angel investors are also $5.95

stronger VC firms. This could happen through being hit, and their investment volume has
$3.90
two mechanisms: first, overpricing of hot come down accordingly.
1Q'08 2Q'08 3Q'08 4Q'08 1Q'09
deals by venture firms drives the returns
Venture-backed exits: in search of US Europe China Israel Canada India
down, and second, the overfunding of “me
a way out Source: Dow Jones VentureSource
too” companies creates an overcrowded
Since 2004, M&A transactions have become
segment, making it harder for the good
a solid exit route for American, European and Figure 2. Global VC investment in
companies to get heard.
Israeli companies, while IPOs are the main cleantech by geography 1Q’08–1Q’09
Challenge: dependence on government path to liquidity in China and India. In 2008,
for early-stage financing both M&A and IPO transaction activity fell Total investment (US$m)
$2,437
Europe would have very few start-ups off a cliff in the major investment regions
$45
without government financing. There, almost although IPOs are remaining relatively $15
$140
all start-ups are funded in one way or another strong in China. It appears that the recent
by government-sponsored programs. Many of opening of the second board in China will $415

$1,693
them go on without further, VC funding and lead to increasing domestic IPO activity. It $15
$13
take a path of slower organic growth while a is still too early to tell, however, whether $73
$1,348
$197
smaller number get venture funding in the the local Chinese stock exchanges can gain $23
$21
$1,130
next stage. and maintain the trust of investors, making $25
$88
$17 $222
Shanghai and Shenzhen viable exit platforms $114
China has spent an enormous amount $1,823
for venture-backed companies from China $231
$604
of money on Research and Development
and elsewhere. $1,395
$5
(R&D) at universities and research labs $994
$14 $67

and has learned the lesson that appointed A successful VC model must incorporate IPOs $742
$232

$287
government officials should not run VC of portfolio companies to drive appropriate
1Q'08 2Q'08 3Q'08 4Q'08 1Q'09
firms. The Israeli venture community was risk-adjusted returns. In the mid 1990s,
US Europe China Israel Canada
Source: Dow Jones VentureSource

Global venture capital insights and trends report 2009 3


Global venture firm
operating models
Joint fund: a collaboration between a US
fund and a China-based fund in which the
China team is responsible for the day-to-
day operations and investments and the
US-based team provides expertise and
experience
Strategic limited partners: based on
the approach that the local fund serves
as a deal feeder and provides some local
support to the fund overseas
Independent local fund with global
brand fund: a stand-alone local fund with
homegrown partners and investment
team that share a logo, investment
practices, methodologies, philosophy and
close cooperation with other funds under
a global brand
Team expansion to the emerging
market: fund makes direct hires in the
emerging market, from a junior team
member to a full team on the ground
Corporate partnership model: leveraging
multinational technology firms as limited
partners and in return, providing them
access to the market or new technology
solutions; can be combined with other
operating models, as it represents a
strategic platform and reference for the
VC fund
GP-LP joint operation model: limited
partners leverage their brand name with
top local venture capital or growth capital
firm in an emerging market, providing
fundraising and back-office support for
compensation but gaining deep insights
into the local market structure and
investee companies
4 From survival to growth
30% of venture-backed exits in the US came
through IPOs. During the period from 2004
to 2007, this figure was only 10%, despite
increasing global IPO activity that culminated
in a record year in 2007, both in the number
of transactions and in the amount of capital
raised. It is clear that this decline in venture-
backed IPO activity in the US poses a
significant challenge to the US VC ecosystem.
The reasons for the decline are complex
and include: changes in the regulatory
environment; a higher bar for entry, which
resulted in the lack of an equity market for
small-cap emerging growth companies;
changes in the investment banking industry;
and reduction in analysts’ research coverage.
While the structural barriers to venture-
backed IPOs are real, part of the solution
lies in investing in companies focused on
the right end markets. VC investors should
ask themselves whether their portfolio
company target markets are large enough to
enable a critical mass of companies to grow
and, critically, achieve profitability — a key
requirement for IPOs in many industries.
New platforms enable such opportunities. For
example, the start of the personal computer
era and the creation of the internet led to
“green fields” that could sustain hundreds
of companies, many of which grew rapidly
and became market leaders. Green fields
are based on a technological breakthrough,
the opening up of new user segments or
emerging markets driven by huge domestic
growth with an increase in the purchasing
power of a growing middle-class population.
It is clear that the creation of significant
market opportunities cannot come from
marginal improvement of efficiency or added
features in a mature product market.
Limited partner dilemma
Investors in VC funds are currently faced
with their own challenges because of
their investment allocations to alternative
investments generally, and the private equity
asset class in particular, where buyouts often
account for 80–90% of allocations. We may
expect some serious valuation problems
in limited partners’ investment portfolios
that will result in the reduction of capital
allocation to VC funds. Nevertheless, the
top-performing venture funds with long track
records are not likely to encounter challenges
that will prevent them from raising their next
fund. However, the trickle-down effect on the
rest of the venture industry is inevitable as
fundraising becomes more difficult.
The firms that managed to close their most
recent funds in the last 6–18 months will
likely see the best opportunities in years
to come since valuations have come way
down and entrepreneurs are forced to
build their ventures in a capital-efficient
manner. Although the world’s economies
are either in a recession or a significant
slowdown, entrepreneurs continue to pursue
their dreams. Real value creation through
innovation will be one of the key drivers to
restart growth around the globe.
Swift reaction
Very few VC firms moved quickly to correct
their portfolios and strategies following the
dot-com bust. For example, when the telecom
companies and carriers cut their spending
dramatically, many venture firms kept
pouring money into the start-ups. This time,
however, most VC firms reacted quickly and
have worked with their portfolio companies
not only to address the market changes
through cost cutting but also to better
understand the opportunities that have been
created by the global economic crisis.
But as VC investors work with their portfolios
to adjust to the new market conditions,
limited partners might pressure their
invested venture firms to reconsider their
experiments, such as expansions into
emerging markets or branching into new
sectors that have not yet proven their
business models and do not have their new
specialist teams fully in place.
On the other hand, the innovation pipeline
is robust, and we have witnessed both new
technology-based and business-model
innovation. Emerging growth companies will
also have to accelerate execution of their
Figure 3. Surviving and thriving in turbulent times

Financial/capital: extend cash burn

• Cash/working capital management
• Develop 13-week rolling forecast — know cash position
• Any “going concern” considerations anticipated and addressed
• Cost reductions — improve accounts receivable and inventory age
• Defer capital expenditures
• Sell/leverage assets/Intellectual Property (IP)
• Financing alternatives
• Debt — new funding opportunities/address existing covenant issues
• Additional equity capital — when are valuation inflection points?
• M&A
• Confirm readiness for transaction/investment/IPO or divestiture

Innovation/IP Market/customer
• Evaluate internal R&D programs • Confirm stability/quality of current
• Maintain/accelerate customer relationships
• Partner/joint venture • Reevaluate service/product offer — where
Systemic Reputation
• Divest/defer/kill are customers really spending/what are
risk and brand
• Acquisitions critical key features and benefits of product
• Companies • Do niche or emerging markets offer better
C-suite
• Technologies/IP growth potential?
• Talent • Reassess sales strategy
• Investor strategy/preferences Ability to Cost • Pricing and terms
• Early vs. late operate reduction • Sales/marketing channels, partnerships
• Tax planning for managing IP and alliances
• Monitor competitors — “buy or bury”: seize
opportunities to take market share, M&A,
hire best people and so forth

Operations/supply chain
• Supplier relationships • Cash vs. equity alternatives — consider tax and accounting impact
• Counterparty risk assessment • Availability of government incentives to offset training and so forth
• Negotiate better pricing/terms (COGS and SG&A) • Other cost control/expense reduction
• Supplier reliability/delivery times • Product — bill of materials and Selling, General and Administrative
• Compensation strategy and staffing expenses (SG&A)
• Retain and protect best talent • Lease/premises costs
• Evaluate size of workforce — hiring freeze, reductions, outsource • VC or other coordinated preferred vendor/group buying power and/
• Compensation freeze/rollback/deferral or shared service/resources models
• Move compensation to more “pay for performance” • Communications
• Suppliers, employees, customers, stakeholders/board

Global venture capital insights and trends report 2009 5

To build the next wave of billion-dollar market cap venture-
backed companies, there must be a major new platform
that will enable a large number of companies to introduce
disruptive solutions, either in the form of new technology,
new business models or, ideally, a combination of both.
Ingredients for success in China
Invest in sectors where you have
expertise/experience.
Conduct solid due diligence not only from
a financial and commercial perspective
but also from a people perspective.
Invest at a controlled pace with a
disciplined valuation methodology and the
willingness to walk away.
Focus on a stable team and have ”entirely
local” decision authority.
Senior partners and leaders of a VC
fund should be able to perform realistic
self-criticism, adjustment and continuous
improvements for the firm to stay ahead
and remain competitive.
acquisition and partnership strategies to gain
advantage in an increasingly competitive
world that demands innovation in capital,
partnership models and distribution
channels.
Managing start-ups in the downturn
By now, most entrepreneurs have acted
on their own experience and the advice of
their boards to be more prudent with their
cash, focus on sales and cut costs. In this
downturn, however, entrepreneurs may also
be well advised to invest more in product
development and improvements to be ready
when the market rebounds. From a product
perspective, entrepreneurial teams should
think about what constitute their core
customers and about intelligent ways to
segment and meet those customers’ needs.
6 From survival to growth
Ernst & Young has developed an execution equity players in this space, the new entrants
map for turbulent times to help emerging from the VC side will have to bring new added
growth companies and their investors value or clear differentiation.
formulate an approach not just to cost
The next big bang
cutting and revenue generation but also
What is the next mega breakthrough that
to better understanding how to seize
will create a huge market and enable some
opportunities, gain market share and beat
new market leaders to become global market
the competition. The execution map is
leaders? Will it be cleanech, cloud computing,
organized according to four opportunity
Software as a Service (SaaS) or another up-
areas: financial/capital; innovation/IP; market
and-coming set of innovative and disruptive
and customer; and operations/supply chain
technologies? For many, if not all of us, the
(see Figure 3).
answer is not clear. But it is clear that to
Growth capital funds build the next wave of billion-dollar market
Over the last 24 months, a number of cap venture-backed companies, there must
early-stage VC firms have added a growth be a major new platform that will enable
capital fund or raised a large fund with the a large number of companies to introduce
mandate to invest both in early-stage and disruptive solutions, either in the form of new
in growth capital companies. Some leading technology, new business models or, ideally,
venture firms have been making growth a combination of both.
equity investments for a decade or even
Globalization and investment patterns
longer. These seasoned players realized long
Globalization for portfolio companies and
ago that growth equity is a distinct product
VC investors has become mainstream. In
line, with a different skill set, different
the mid 1990s, Israel was one of the first
mindset and different operational DNA from
places to experience the entrance of foreign
early-stage investing, even if both types of
VC funds. In the last five years, foreign VC
investing are conducted under the same
funds, mainly from the US, have entered
organizational brand name.
the fast-growing emerging markets of China
There are two types of growth equity and India.
investment structures. One uses a
In Russia over the last few years, well-known
separate team, separate fund and separate
corporate investors and VC funds — such as
compensation scheme. The other uses a
Intel Capital, Index Ventures, Benchmark
global fund but separate early-stage and
Capital and Cisco Systems — have made
growth equity teams with crossovers in
important new investments. In 2007, Cisco
various organizational dimensions. Since
announced that it would pursue investment
growth capital requires a different analysis
opportunities not only in Russian emerging
and the business is entirely different, deal
technology companies but also in local
discussions will often be held in separate
teams, as a limited partner. Last year, the
sessions even when the team is mixed. Since
Russian government established RVC to
there are already many seasoned private
provide capital to VC firms to create funds for
investments in Russia, like the Israeli Yozma
model that sparked the development of the
Israeli venture industry in the early 1990s.
RVC is targeting about 10 to 15 foreign funds
from the United States, Europe and Israel.
Bigger brand names, such as Draper Fisher
Jurvetson, have already entered Russia
under this regime.
Vietnam, Brazil, South Africa and other
emerging markets are seeing increasing
VC investments as well, mainly from local
investors, but early-stage investment is still
largely absent.
VC operating models
During the last five years in China, the last
two years in India and the last year in Russia,
foreign VC funds have established various
investment models. Since it has become
clear that implementing just a frequent-
flyer model is not sustainable for the long
term and that the risks will be greater than
potential rewards, the foreign funds, mainly
from Silicon Valley, have chosen the right
models for themselves or a combination of
models that allow them to maximize value
and mitigate risk. All these models are based
on various levels of collaboration between
foreign and local funds, as well as foreign
and local investment teams (see descriptions
on page 4). As we expected, the same
scenario is occurring in India these days, and
the lessons learned from China are being
implemented in India at a faster rate.
Some of the top US-based VC firms entered
China or India rather late. To make up for lost
time, they either acquired an existing local
VC firm or partnered with it first and invested
as a limited partner. The two high-profile
examples of this strategy in 2008 were the
Matrix-WI Harper deal in China and the Accel-
Erasmic deal in India.
Lessons from China
As the VC ecosystem matured in China, it
became clear that not all the models and
relationships/partnerships between foreign
and local teams would be successful. The VC
ecosystem in China has now become more
sophisticated, with more knowledgeable and
experienced investment teams. Although
it is too early to declare the winners in the
Chinese VC market, we have already seen
signs of failure in some funds, and it is
evident that the next five to seven years will
be critical in determining which funds will
emerge as leaders.
Over the last several years, many VC funds in
China implemented an investment strategy of
investing mainly in pre-IPO companies about
12 to 24 months before the IPO. With rising
competition for deals, the growing maturity
of the VC ecosystem and the changing
landscape of global capital markets, these
opportunities are disappearing rapidly — and
along with them, some VC partnerships.
Early-stage deals in China take between three
and five years to mature. With valuations
becoming increasingly rational, it is an ideal
time to consider investments in companies
at this stage.
One of the current investor challenges in
China is that a large number of deals are at
a stalemate as the founders still hope to get
higher valuations while the investors exercise
valuation discipline. Another challenge is that
many of the funds that were the most active
Global venture capital insights and trends report 2009
Market-leading companies
started in economic downturns
1939 — William Hewlett and David Packard
start Hewlett-Packard in a garage in Palo
Alto, California
1975 — Bill Gates and Paul Allen found
Microsoft during the recession of the
mid–1970s
1976 — Steve Jobs and Steve Wozniak
launch Apple Computer
1980 — Mitch Kapoor founds the Lotus
Corporation
1983 — Len Bosack and Sandra Lerner
start Cisco Systems in their living room
investors over the last five years are now
highly focused on portfolio management.
Their portfolio management work is made
even harder because many of the firms
lack industry focus and invested in multiple
industries without having a deep sector
understanding or operating background.
Partnerships with large corporations in
innovation networks
Under pressure from global competition
and challenged by the fast rise of emerging
markets, corporations understand that
to maintain or increase their competitive
advantage, they must reach beyond the
boundaries of their own payrolls to find the
best brains and the smartest ideas wherever
they are in the world. Venture capitalists
too have recognized the dramatic changes
and are moving to where the talent is today:
everywhere on the planet.
7
It has thus become imperative that
corporate innovation today embrace a more
collaborative, flexible and open model with
many innovation partners, including VC
funds and their portfolio companies. Such
a model has already been described as an
“innovation network” by Larry Huston of
the Wharton School of the University of
Pennsylvania. The potential benefits of the
innovation network model include an ability
to combine internal and external sources
of innovative ideas, increased efficiency in
converting innovation into products and
services and better risk management through
partnerships and collaboration. Given their
resource constraints, small companies
naturally look for outside help to address
challenges. Emerging growth companies
are increasingly among the key drivers of
innovation as they now file 35% of all patents.
Large corporations need innovation; small
companies need market access. Innovation
networks provide a structure for them to
work together successfully.
With greater globalization, innovation has
become the new currency of competition.
A robust innovation strategy includes both
internal initiatives and mechanisms to access
external innovation, including collaborations,
partnerships, acquisitions, joint ventures,
licensing and investments in emerging
venture-backed companies. Corporate VC is a
vital component of the innovation strategies
of corporations around the globe. With the
exception of more developed economies,
8 From survival to growth
corporate venturing by emerging market-
based corporations is practically absent.
Since many of these global growth companies
have either grown through manufacturing
or business process outsourcing, they can
only maintain their long-term growth rates by
adding innovation to their lists of priorities.
This forces them to consider their strategic
options, of which insourcing innovation
from start-up companies through a venture
network or corporate VC business unit is
one of the key success factors on the path to
long-term value creation.
In the present world economic crisis, the
need for partnerships between emerging
growth companies and large multinational
corporations has become even more critical
for both sides. External innovation, availability
of capital, access to markets and faster
development and deployment of technology-
based products are some of the key drivers.
Further, the current challenges in certain
sectors, such as cleantech, have created the
need not only for partnerships but also for
partnership innovation. Cleantech is a complex
and growing sector that involves not only
technology-based corporations and emerging
growth companies but also corporations
from all industries and governments. The
economic crisis has created opportunities for
partnership innovation between emerging
growth companies, their investors, large
corporations and governments. The capital
formation challenges in cleantech have also
led to innovation in capital formation and
new players along the financing value chain
of cleantech.
Market-leading companies are started
in downturns
While it is a natural tendency to retrench in
economic downturns, it is worth remembering
the origins of some of today’s largest market-
leading companies in hard times past.
Companies like HP, Microsoft, Apple Computer
and Cisco were launched when economic
conditions were less than ideal. In the article
“Innovation finds finance despite market
turbulence” on page 18, we discuss some of
the market-leading companies that emerged
from the most recent downturn periods,
1991–1993 and 2001–2003.
A down economy can offer advantages to
entrepreneurs — cheaper rent, more available
talent, more flexible suppliers and weakened
competitors. That said, a recession is not
necessarily a better time to start a company;
rather, the evidence suggests that it is as
good a time as any. What matters most is the
innovation and drive of the entrepreneurs.
Call to action
The VC industry today faces serious
challenges around the globe, some common
to mature and emerging markets and
some unique to different levels of market
development. Innovation, both in technology
and business models, as well as the
ecosystem of entrepreneurs and VC funds,
are critical for future growth, job creation,
closing the gap between rich and poor and
enabling the recovery from the current global
economic crisis.
Given the importance of innovation and the
venture ecosystem to the global economy, an
immediate action plan is needed to facilitate
the continuing vibrancy of these economic
drivers. We use this opportunity to ask the
key stakeholders, including governments,
to take the following actions based on the
current state of the local market:
• Make certain that current and future
economic stimulus packages include:
• A focus on fostering innovation
• Incentives for capital formation that
will be invested in innovation and
entrepreneurial initiatives
• Incentives for entrepreneurs
• Incentives for corporations to invest in
R&D centers
• Incentives for technology adoption by
businesses and consumers
• Reduction of red tape
• Cooperate globally on human capital flow
to enrich VC ecosystems and innovation
• Create a global task force to discuss what
needs to be done with capital markets to
facilitate future IPOs of emerging growth
companies, including stock exchanges,
policy-makers, accounting firms,
investment bankers, VC/private equity
firms and institutional investors
Outlook
We would like to thank the following
A substantial reduction in the number of VC
leading venture capitalists for their
firms is inevitable. It is the natural churn of
insightful contributions to this article:
the 1999 and 2000 vintage funds that lost a
fair amount of money, and many managers David Skok, General Partner, Matrix
of these vintages will quietly leave the scene. Partners, Boston
In addition, many limited partners not only
Dick Kramlich, Cofounder and General
got badly burned during the bubble years but
Partner, NEA, Beijing and Menlo Park
have also become better informed and more
professional in the intervening time. Further, Doug Leone, General Partner, Sequoia
their private equity and VC allocations are Capital, Menlo Park
out of balance, due to the dramatic collapse
Dr. Helmut Schuhsler, Managing Partner,
of public markets and real estate, and their
TVM, Munich
long-term asset ratio needs to be adjusted
as a result. With the cheap debt market for Jean Bernard Schmidt, Managing Partner,
private equity gone for some time to come, Sofinnova Partners, Paris
VC is clearly the best alternative asset for
Steve Krausz, General Partner, USVP,
real value creation realizable over time.
Menlo Park
With new innovation platforms such as
cloud computing, cleantech, personal
medicine and security, new market leaders hotbeds will have to face, recognize and act
that go on to achieve billion-dollar exits are quickly in a collaborative way to solve their
likely to appear. It is the new technologies, local challenges.
combined with global applications and the
We will also see the acceleration of
emergence of new untapped markets, that
involvement by corporations in the
can lead to the creation and growth of new
innovation pipeline to source technologies
market leaders.
and solutions or localize them in the regions
We anticipate that the lessons learned where they will be deployed. With the lack of
from China and India will be applied in new robust IPO markets in the immediate future,
emerging markets and that the global flow of M&A transactions will remain the dominant
capital and people will continue to increase. exit route.
Both VC funds and corporations will follow
No crisis should be wasted, and we are
opportunities around the globe. In addition,
confident that entrepreneurs, investors and
both China and India will continue to evolve
innovators will make the most of this one. •
from a VC perspective while the mature VC
Global venture capital insights and trends report 2009 9
Fireside chat on venture capital
and growth companies
Interview with Scott Carter and Paul Deninger

Scott Carter Scott Carter of Sequoia Capital and
Sequoia Capital
Paul Deninger of Jefferies & Company
participated in a fireside chat at Ernst
& Young’s Strategic Growth Forum and
shared their perspectives on the impact of
Paul Deninger the economic downturn on VC and growth
Jefferies & Company companies. Following are highlights of their
discussion.
A partner at Sequoia Capital, Carter focuses
on software and services investments. Prior
to joining Sequoia Capital in 2006, he was
with Summit Partners where he was involved
in private equity investments in the financial
services and technology sectors. Earlier,
he was with JPMorgan and its predecessor
entities and served in various staff positions
in the United States Senate.
Deninger is a vice chairman at Jefferies. He
was previously Chairman and Chief Executive
Officer(CEO) of Broadview, the specialist
technology investment banking firm acquired
by Jefferies in 2003. With more than 20
years of experience working with companies
in the technology and, more recently, the
cleantech markets, Deninger has advised
on more than 125 M&A transactions and
numerous IPOs.
Ernst & Young: Are we in a recession or
a depression? What is your view and what
advice would you give to CEOs of emerging
growth companies?
Paul Deninger: What the last two years
prove is that there is a good and a bad side to
globalization, and that we really are in a global
economy — when the US consumer catches a
cold, then China sneezes and vice versa.
It is clear that the financial crisis is driving
the process of a massive deleveraging
of the global capital markets, and the
use of synthetic investment instruments
exacerbated what was already an extremely
highly leveraged situation. The thing that
had kept the system going was asset quality.
When the asset quality came into question,
everything started to come apart. In its
most simple form, that is what’s happened.
The European-based global megabanks
have double the leverage ratios of the US
banks that are having problems, but their
asset quality is better — they don’t have the
domestic mortgage problem so badly.
Our biggest problem may be a crisis of
confidence. The depth of that crisis will
dictate whether we’re merely in a recession
or we are going to end up in a depression.
When the history of the financial crisis in the
US is written, I believe that the event that
people will point to as the breaking point was
when The Reserve Fund broke the buck. And
it broke the buck when Lehman Brothers
defaulted and US$4 billion worth of bonds
the fund had that they thought to be cash
suddenly wasn’t. Someone at Treasury either
(a) didn’t know that or (b) didn’t think it
mattered. Either way, it was unforgivable
because it was the catalyst for what was
effectively a run on the bank by highly
sophisticated investment professionals. In my
view, that was the tipping point. Since then,
people have had no confidence in the rules
by which the Treasury plays. I can’t tell you
how it’s going to be solved, but solving this
crisis of confidence is the key to whether we
end up in a recession or a depression.

10 From survival to growth

That said, I’m relatively optimistic it’s only
a recession. A lot of the fundamentals in
the global economy remain positive. The
biggest issues are the cost of squeezing this
leverage out of the system and the crisis
of confidence. One reason for optimism is
that those hedge funds that don’t go out
of business will be sitting on 40% to 70%
cash — there is no way those funds can stay
in that position forever. And even if they
go out of business and give the money
back to somebody, the cash still has to go
somewhere. A diversification strategy that is
50% cash in a mattress and 50% cash in a can
in the backyard is not a long-term investment
strategy. It’s logical in a three-, six- or nine-
month period like we are seeing now, but not
long term. At some point, someone is going
to wake up and see that Google is trading at
9 or 10 times forward EBITDA* and that’s a
buy, or that MGM Mirage bonds are nearly
investment grade — yielding 18% to maturity.
That’s an equity return with senior debt. And
at some point, people are going to start to
buy into those securities. When they do, I
think we’ll be on the way to healing.
Scott Carter: We often feel that our growth
companies serve as leading indicators for
the direction of the economy. Why is that?
Because a small consumer products business
in China or a private technology company
in the US will tend to have orders cut before
a company like Cisco or before you see a
decline in sales at Wal-Mart or Target. This
is something we have been witnessing
across our portfolio for awhile. Across India,
China and the US, almost every one of our
companies is experiencing a slowdown on
some level.
There seem to be a few common themes
emerging. Companies that are burning
through, or are low on, cash had better
tighten their belts now. What inevitably
happens in situations like this is that you
take mini-steps along the way and then six
months down the road, you realize you aren’t
even close to where you need to be. It puts
the company on a downward spiral that’s
* EBITDA = Earnings Before Income Taxes, Depreciation and Amortization
very hard to correct. When a company is out marketplace. This is a company that has the
of money, no one wants to invest — at least opportunity to really wreak havoc on some of
not under reasonable terms — and there its competitors.
aren’t a lot of other capital resources that are
Ernst & Young: Cleantech has been
available to small businesses. So a big part
massively capital intensive in some aspects —
of the message is to belt-tighten now and do
energy generation being one of them. Can
it in a more extreme manner than you would
you talk a little bit about those companies
for a “normal” slow economic period.
that were built in the expectation of some
There are companies in our portfolio that are normalcy in the capital markets?
actually doing quite well in this environment.
Paul Deninger: I’m very nervous about
They may not hit their forecast, but the
cleantech because the capital intensity is so
competitive landscape has suddenly become
significant. Investors in environments like this
more attractive than it had been in previous
get more risk averse. So we’ve suddenly got a
months. For those companies, the time
huge pipeline of private placement prospects —
is perfect to increase business in a new
companies that need to raise US$50 or
geography, to recruit people or develop in
US$100 million and don’t think they can do it
other ways. Realistically, it’s a minority of
on their own. But we’re being very selective
companies that are going to be able to execute
about which ones we take on because this is
a growth strategy in this kind of economic
not the kind of environment where significant
environment. But those that can, need to do it.
technological risk is something that investors
They’re going to find themselves significantly
want to undertake. They still seem to be
ahead of the competition when the economic
interested in taking on risks in scaling
environment improves.
operations or expansion, but fundamental
Paul Deninger: If you can avoid interfacing technological risk is a different matter.
with the capital markets between now and
Having said that, a lot of customers of
the end of 2009, then you should. The
cleantech companies that have gone green
lowest-cost capital is the capital you already
have saved money — turning off a light switch
have. Said another way, your lowest-cost
automatically saves money. So the low-
capital is the cost you haven’t cut. That’s
hanging fruit and most exciting opportunities
the attitude I think you need to bring at the
in the near term are on the demand side
moment because there are so many things
rather than the generation side — managing
we do not know.
the cost of energy and by happenstance,
Ernst & Young: What are the characteristics being green, rather than managing the
of those companies that do represent growth carbon footprint directly. People don’t
opportunities? appreciate the incredible inefficiencies
in existing energy infrastructure because
Scott Carter: There are some markets where
until now, energy has been so cheap. So we
there’s a company or two that is clearly a cut
think there’s going to be enormous interest
above the others. For example, one of our
and enthusiasm for energy efficiency, next
portfolio companies — Green Dot — has the
generation lighting, etc.
largest prepaid credit card network in the
country. In the US, Green Dot’s distribution As a consuming society, we are used to
network is enormous. They have anyone energy being cheap. And cheap energy is
you could possibly want if you were in the the foundation of all economic development
prepaid credit card business. There are a around the world. So we have to find carbon
whole lot of other competitors who may have reduction solutions that are cheap.
a handful of relationships, but they don’t
There are massive opportunities around
possess nearly the scale or reputation in the
Global venture capital insights and trends report 2009 11
energy utilization and energy management
that are, in this economic environment,
the low-hanging fruit since they are less
capital intensive.
Scott Carter: There’s going to be a massive
amount of money lost in cleantech over the
next few years although Obama’s presidency
will probably give it new life for awhile.
But that doesn’t mean we’re not fans of
cleantech and alternative energy. We’ve
been actively investing for three years, but
we have one golden rule, which is investing
where low capital expenditures are required.
That means a big part of the market is a
lot less appealing to Sequoia Capital. We
view innovation in cleantech as we do in
other technology sectors. If you have great
entrepreneurs who are incredibly frugal,
who really focus on delivering a product
that solves an immediate need, and you
apply those principles to cleantech, then
you’re going to make money. You may not
make money every time, and it’s going to be
challenging, but it’s a formula that fits well
with our overall investing strategy. Other
people are perfectly comfortable investing
heavily in a biofuels facility in the Midwest.
They may make money, but it has not been
our approach in cleantech.
Ernst & Young: What are your thoughts
on the Obama administration’s impact on
cleantech?
Scott Carter: I think there will be meaningful
changes in healthcare, environmental
regulations, the relationship between
companies and unions and tax policy. I don’t
think there’s enough money in the system
to make all of those things happen. But I do
have some concerns about the impact on
small and growth businesses. In the US, we
are on the verge of embracing a number of
policies that we abandoned long ago because
we recognized how detrimental they were to
business development. How do you prepare
for the changes? I don’t think anyone knows
the answer because they don’t know exactly
what’s coming. I am very concerned, though,
that we will become less competitive.
Paul Deninger: On cleantech, I’m nervous
about too much investment from government
going down another corn ethanol-type hole.
That was a disaster from day one. Anybody
who knows anything about energy knows
ethanol is a weak fuel. You can’t get as
much power out of a gallon of ethanol as
you can out of a gallon of diesel or a gallon
of gasoline, never mind the cost. So I really
worry about government’s deciding what is
the “right solution.” But there are things that
government could do that would be fantastic.
For example, mandating that a significant
percentage of the federal fleet be electric,
hybrid or plug-in hybrid or mandating that
the federal government only buy vehicles
with a certain mile-per-gallon target.
Here’s another example: the biggest property
holders in the country are our governments —
federal, state and local. Let’s do something
there on the building-energy-efficiency front.
One of the things that made the tech industry
in the US the leader in the world over the
past 20 years was that we had the largest
homogeneous market for those products
in the world. So the companies that were
founded here got better and faster customer
feedback. They got to scale faster and so on.
We could do that in cleantech if the federal
and state governments get out in front as
consumers of these technologies in order to
drive better products at lower costs. That’s the
most important thing I think they could do.
Ernst & Young: When do you think the IPO
market will open up, and how can we best
make it happen?
Paul Deninger: Rather than telling you when,
let me tell you the signals that will tell you
that it’s going to open up. The first signal is
a return to price stabilization — rational price
stabilization — on certain investments. The
T-bill went negative in yield in September ‘08
for the first time since 1940. I was at an event
with the Boston Fed chief and somebody
asked the question: “Are you worried that
people aren’t going to buy US Treasuries
because they’re worried about the US
economy?” He laughed and said, “Our biggest
problem is people all over the world only
want to buy US Treasuries.” So when that
changes — yield goes back to around 4% —
that’ll be a good sign. When Google is trading
at a reasonable multiple or when the Mirage
debt that I talked about earlier is trading at a
10% or 12% yield to maturity rather than 18%,
that’ll be a good sign.
What is the IPO market? The IPO market is a
primary-issuance equity market. In order for
the primary-issuance market to be effective,
first the secondary market has to be fixed.
And right now, the secondary market — which
includes the three types of instruments
I’ve just talked about — is all messed up. So
once those instruments start seeing price
correction, that’s your first sign.
The second thing that needs to happen is a
couple of big IPOs. No one is going to choose
a US$100 million revenue, US$400 million
market cap technology company to be the
first onto the market. So something big —
such as a spin-out or a big foreign company —
is going to need to hit the market. That’ll give
people some confidence.
The third sign is established issuers coming
back into the marketplace to issue follow-
on stock — specifically issuers other than
financial institutions who are doing it now
because they are desperate to reduce their
leverage ratio from 25 to 1 down to 12 to 1.
When those three things happen, you can
then look to an IPO market as being a
possibility.
Scott Carter: The only thing I would add is I
think it’s going to take a while for institutional
capital to return to the table. The hedge
funds, endowments and pension plans
that fund them are all upside down. I think
when they start to figure out exactly where
they are in terms of redemptions and their
overall portfolio, then there will be a lot more
stability and interest in having new capital

12 From survival to growth


pumped into the system. Hopefully, that
leads to an IPO market of sorts. It’s just very
difficult to predict when that would happen.
Paul Deninger: Part of the dislocation in the
IPO market over the last several years has
been the consolidation in the institutional
investor and investment banking industries.
And what’s happening now is even more
consolidation. So what made it harder for
small companies to go public is going to be
worse, not better, because the bar for what
makes a deal important to a Goldman Sachs
or to a Fidelity is going to be set even higher.
So there needs to be an emergence of a
new set of banks to make a smaller-cap IPO
market work.
Ernst & Young: Do you anticipate confidence
in the M&A market returning earlier than in
the IPO market?
Paul Deninger: The M&A market for growth
and venture-backed companies is flat. In fact,
it’s actually down, and it’s been going down
for a couple of years. What’s made people
feel good about the M&A market is that over
the last four or five years, the number of
larger deals has approximately quadrupled.
But if you looked at the deals between, let’s
say US$20 million and US$100 million for
VC-backed companies, those deals are down
in number and down substantially over the
last three or four years. That is because we
are in the eighth straight year of a decline
in the number of public companies in all
markets, never mind technology. The reason
for that is the lack of IPOs.
“We're focusing aggressively on cleantech because we
think that is one of the growth areas. But we need stability
in the stock market. … The problem is not a lack of growth
opportunities; the problem is stability.”
In today’s M&A market, the best companies markets in recent months have been an equal
will get good value, but everybody else opportunity destroyer — literally. No category
will have trouble. Because there are fewer of investment has been positive.
buyers, you can maybe sell the best company
Paul Deninger: We’re focusing aggressively
in its space and you can maybe sell the
on cleantech because we think that is one
second-best company in the space, but while
of the growth areas. But we need stability in
10 years ago, you could sell six companies
the stock market. I don’t care whether the
in a space, that is no longer the case. The
stock market stabilizes at 10,000, 9,000,
M&A market is really difficult right now. In
8,000 or 7,000; I just want it to stabilize. The
regard to cleantech, there really isn’t much of
problem is not a lack of growth opportunities;
an M&A marketplace in cleantech right now
the problem is stability — even at a level that
because very few companies have the kind of
is low, any stability is better than the current
revenue that makes them attractive or have
volatility. People need to be able to make
proven themselves to be the solution that
decisions knowing that they won’t appear
big oil or whoever else wants to buy into. We
stupid tomorrow — the sovereign wealth
have a few things going on, but they are in
funds, for example, invested US$75 billion in
energy efficiency and smart grid.
investment banks in Q2’08 and not a nickel
Ernst & Young: A few economists predict in Q3’08. Not a nickel. Why? Because in Q3,
growth, noting that there is cash sitting on those Q2 investments looked stupid. No one
the sidelines, the cost of energy is going wants to look stupid. When the bullets stop
down and that the subprime problem areas flying, people will come out of the bunkers.
cannot, by themselves, kill the US economy. There are no points for courage in facing
Given that backdrop, where do you think the a machine gun. I think that’s where we are
growth will be? right now. •
Scott Carter: I agree with you. But let me
revert back to what I said in answer to the very
first question, which is confidence. Specific
geographical areas of real estate can’t bring
down the US economy. But the worry is that
there’s always going to be another problem
around the corner, and then another one
behind that and another one behind that —
that’s what causes people to turn inward
and not focus on growth. Growth requires a
mind-set that is a search for opportunity and
a belief in a better future than today. The
Global venture capital insights and trends report 2009 13
Lessons learned from building a
company in turbulent times
Interview with Matthew Szulik
Matthew Szulik Matthew Szulik joined Red Hat in 1998 as
Chairman
President and CEO and was immediately
Red Hat
faced with the challenge of turning Linux
technology into a profitable business
when no one believed a company could
make money on free software. Stock in the
company soared to more than US$300 per
share at the height of the dot-com boom,
only to fall back to less than US$3 per share
after the crash.
Szulik found a new direction for the company
by talking to customers who were tired of
paying for software licenses and maintenance
and then waiting for upgrades, only to receive
imperfect software. Szulik bet the company
on a strategy to compete in the enterprise
computing market by offering businesses an
alternative to other operating systems.
Red Hat is now the only profitable public
open-source software company and has
revolutionized the software market. Red
Hat has become one of the world’s most
recognized technology brands, with 3,000
people in 60 offices worldwide and annual
sales of US$523 million in 2007.
In November 2008, Szulik was recognized
as the Ernst and Young Entrepreneur Of The
Year® for the USA.
Ernst & Young: Red Hat is a venture-backed
company that went public at the height of
the dot-com boom. How did you deal with the
subsequent decline in the stock market and
the economic downturn?
Matthew Szulik: At that time, we had three
important issues to present to the public.
First we had to prove you could build a
business around the free distribution of your
14 From survival to growth
technology. That was without precedent and
naturally raised eyebrows. Next we had to
show that we could create and sustain an
economic model that would lend itself to
becoming a proven and sustainable publicly
traded company. Then we had to work out
how to compete with a monopoly — people
forget that there was a very large competitor
out in Seattle that did not want us to succeed
or survive.
In many ways, it’s no different from what I
think successful companies that emerge from
the terrible economic crunch we’re facing
now will need to do. That means working
24/7 on the very basics — making sure
that they have an absolutely crystal-clear
understanding of their markets and who their
customers are. They will need to have a very
clear relationship with, and understanding
of, the forecasting of demand and the
management of their cash and burn rate.
They must also be ruthless in the operational
execution of their company. That ultimately
will allow them to build sustainable customer
relationships and to manage the cash
consumption of their overall businesses.
Red Hat was a magazine business in 1998.
That’s very hard for people to get their heads
around today because now it’s the world’s
leading supplier of open-source software
to companies. Organizations like the New
York Stock Exchange, Swiss Telecom and
DreamWorks are now highly dependent on
our technology and their relationship with
Red Hat — people never dreamed that was
possible back in 1998.

The vital thing for entrepreneurs is being
very careful in the selection of their venture
partners. We were incredibly fortunate to
have two outstanding investors and directors
in Bill Kaiser of Greylock Partners and
Kevin Harvey of Benchmark Capital. They
brought incredible knowledge of how to
build companies, in contrast to how to make
a short-term buck and flip the company.
We were never obsessed with valuations,
which is something I see in a lot of early-
stage companies. There was a willingness to
potentially compromise short-term valuation,
to select board-level partners that could help
the management team and build a great and
sustainable organization.
Ernst & Young: You made a strategy shift
that paid off hugely. What were the success
factors in executing this shift?
Matthew Szulik: The critical success factors
were great partnerships between the board
members and the senior management of
the company. We never felt that board
members were being onerous or difficult to
the management or that there had to be a
liquidity event so they could get their money
back. We had the support of our board and
investors every step of the way, and they had
confidence in our abilities to eventually find
a solution. I think we were very fortunate to
have partners and management that were
willing to sacrifice and take a big gamble on
Red Hat.
Think about it. We were stepping into an
enterprise computing market that had
been dominated by the likes of Oracle,
IBM, Hewlett-Packard and Microsoft and
sitting down with the Chief Information
“Throughout that process, the management and investors
continued to believe in the vision, despite the enormous risk,
that some day we could become a great enterprise supplier.”
Officer(CIO) saying that our technology
is developed by millions of developers that
don’t work for our company and it’s free —
“Just trust me; it will work!”
Throughout that process, the management
and investors continued to believe in
the vision, despite the enormous risk,
that some day we could become a great
enterprise supplier.
That was vitally important. When I speak to
CEOs and entrepreneurs, there often isn’t the
level of collaboration that we had. You need
that to sustain companies over the long term
and produce great enterprises.
Some of the big names in the tech sector
have become very aggressive in buying up
great young companies at a fraction of their
value. I find that very unfortunate for the
entrepreneurs because there are probably
great opportunities for them if they can
sustain themselves longer term. But for
whatever reason, they’re liquidating now and
selling out at pennies on the dollar. I think we
were very fortunate.
Ernst & Young: Based on your experience,
what is the role of the CEO, especially in
turbulent times?
Matthew Szulik: Tremendous accountability
must be placed on the CEO. I can remember
numerous board meetings where we had
difficult discussions with our board about
moving the company out of Raleigh, North
Carolina, because it would never get the
market visibility, and out to Palo Alto,
California, to “jump-start” it. Even during the
fundraising process I can remember sitting
in front of the partners at a prominent VC
Global venture capital insights and trends report 2009
firm and having them ask me what part
of northern California we were based in. I
told them it was Raleigh, North Carolina,
and they teased me about NASCAR and
about barbeque.
So the CEO must have a compelling vision
and be willing to bet and risk everything to
pursue that vision. No one came to Red Hat
because they dreamed of making big profits.
Nobody had ever done this before; there was
no status for open source in the computer
market at that time. But we believed that we
were on the verge of something great. For
me personally, I was unwilling to move our
business — one of our core commitments was
to continue to take enormous risks and to
build this business in Raleigh, North Carolina.
At one point, shares were worth more than
US$300; Red Hat was losing US$70 million
a quarter and had a market cap of
US$18 billion. Very shortly, the stock was
US$3, and I went from being the smartest guy
in America to the dumbest guy in America in
less than 12 months. It was no different from
most early-stage companies in that we were
continuing to work hard to find solutions, but
it took time to get all of the basics of business
in place. That had to happen before we could
hit our stride. We did do that, but there were
some very lonely times.
But you also need a team of great leaders.
Over the last 10 years in my industry, the
market has been very generous in financially
rewarding many entrepreneurs, which has
had the effect of removing them from the
marketplace. I don't know what the refresh
rate is of people that have the depth of
experience, the know-how and drive to build
15
“You will find that in periods of deep economic pain
and recession, it usually has been a fantastic time for
entrepreneurship.“
great companies and make the sacrifices
that come with that. It can be a 24/7 job,
and there’s great temptation to heed the
siren song of taking an early exit that may
not be at the optimal price but that will
allow somebody to get off the treadmill.
I worry that choosing to cash out too soon
is reducing the overall talent pool in the
marketplace.
Ernst & Young: How did you build a team of
great leaders at Red Hat?
Matthew Szulik: First and foremost, there
has to be an internal culture of risk tolerance.
That acts as a great magnet for people with
the kinds of intellectual talent and drive that
we want. People want to work for a company
that is willing to continue to take bold risks,
even in the face of enormous failure, to
achieve large results.
I believe that the role of the CEO is to
create a culture that never gets content
and continues to search for new value
creation. That’s especially true for a young,
small company. It’s easy to lose that focus
when the company is being successful and
throwing off the kinds of cash that Red Hat
ultimately was — in the last fiscal year, the
company generated over US$240 million in
free cash flow. After we started to see the
economic model kick in, it certainly would
have been easy to sit back and be content
with this progress. But we continued taking
16
large risks in investing in areas such as the
One Laptop Per Child initiative and building
our own internal apps store similar to what
Apple has done with the iPhone store.
Ernst & Young: What were the key lessons
— operational or strategic — learned from
building a company in the last downturn?
How are they applied at Red Hat today?
Matthew Szulik: You have to have a great
appetite and desire for your vision — I think
vision motivates a workforce. Whether it’s
10 people or 3,000, vision really starts
with the CEO of the company. When you
look historically over the last 100 years at
the great sustainable companies like IBM,
Johnson & Johnson and General Electric,
at every step of the way, they seemed to
produce a leadership model that created a
compelling vision. Their people got up in the
morning determined to do something great.
You are going to experience failure in that
process, and that failure can be lonely
and dark. Even though Red Hat went from
US$300 a share to US$3, I don't believe that
our people ever lost sight of our vision to
improve society through our actions, to really
want to do great and compelling work. It was
leadership’s job to create that culture, to
say, “Yes, this is a dark time but our vision is
intact, our customers are responding and we
will navigate through this issue.”
The great leaders in my business over the
From survival to growth
last 25 years — Michael Dell, Andy Grove and
Larry Ellison — are able to create that culture
and that vision. That is something that we
worked very hard to do at Red Hat.
Ernst & Young: We are in the early days
of this downturn, but do you have any
perspectives on whether it is similar to or
different from the one that we experienced
from 2001 to 2003?
Matthew Szulik: The situation then was
very much tech-specific, and people believed
the solution was far more obvious than is
the case today. The solution to the current
problems is not entirely clear to most people
in business globally. No one can really provide
a clear and concise answer as to when “the
recovery” will take place.
This issue about availability of cash and
credit is really making it very difficult across
all sectors. The recession is very broad and
very deep. I think that those characteristics
are what make it much more distinct than
2001–2003.
Having said that, in 2008 there was
US$18 billion invested globally in
entrepreneurial and venture-backed
companies. So there is money being spent,
there is venture capital being invested and
there are quality leadership teams out
there with compelling ideas that are getting
funded. When you look historically over the
last 125 years in North America, you will find
that in periods of deep economic pain and
recession, it usually has been a fantastic time
for entrepreneurship and for companies to
search out funding. You’ll find the next Red
Hat in periods like today.
I can remember how difficult it was in 2000
to try to recruit a chief financial officer,
due to the large amounts of money that
were being thrown around by early-stage
companies trying to rush out the gate and
get public. Today’s environment means that
there’s going to be some top-notch talent
finding itself without employment. There
will be people who realize they have one last
shot at building something from the start. At
the moment, there is an availability of talent
which, coupled with a good idea, could make
this a prime time to find funding.
Ernst & Young: If you had to give an
entrepreneur some advice on trying to grow
a business in today’s economic environment,
what would it be?
Matthew Szulik: The best CEOs that I meet
are great listeners. They realize that they
don’t have all the answers. They put ego in
their back pocket and they seek out subject
matter experts that complement their
skills. They look for sources of input to build
wonderful, scalable business opportunities.
The ones that I see fail are typically ego-
driven — they don’t really reach out and
build a collaborative network of honest and
authentic advisors. They don’t get the benefit
of collective areas of wisdom.
Let me give you a great case in point.
Red Hat was very fortunate to recruit a
gentleman by the name of Dr. Steve Albrecht,
Associate Dean of the Marriott School of
Management at Brigham Young University.
Steve is incredibly well known in the field of
public accounting and was transformative
to our business at a critical time. Although
it was very difficult to recruit him to come
from Utah to Raleigh, North Carolina, to sit
on a board of a very immature company,
we did it because we realized that we were
moving from pro forma to General Accepted
Accounting Principles (GAAP)-based
accounting and that the right approach to
Sarbanes-Oxley was going to become critical.
We knew that Steve would not only be a great
head of our audit committee but also a great
leader.
A young CEO or a CEO thinking about
building a great company needs to seek
out and be authentic in these types of
relationships — not just to solve a tactical
problem but to really establish the
collaborations that will ultimately solve the
many problems and challenges CEOs face
today when building a great company. •
Global venture capital insights and trends report 2009 17
Innovation finds finance
despite market turbulence
Despite challenging global economic conditions, venture
investors and entrepreneurs with an eye on the future
can take encouragement from the record of current
market leaders financed during previous downturns
John de Yonge
Global Research Director,
Venture Capital and Cleantech
Ernst & Young
18
In such challenging market conditions, you’d
be forgiven for thinking that now is the time
for survival, not growth. But historical data
show that innovation will continue to find
capital despite economic challenges, and that
many VC-backed companies initially funded
during downturns have gone on to become
enduring market leaders.
In the United States alone, there are 22
companies in business today that were
first funded by venture capitalists during
the recession years of 1990–92 and
remain independent entities with market
capitalizations of more than US$400 million.
Of these, half enjoy market capitalization
of more than US$1 billion. These billion-
dollar market cap companies include
consumer brands such as Starbucks, Intuit
and PetSmart among their ranks, as well as
companies such as Microchip Technology,
Onyx Pharmaceuticals and Nuance
Communications. All have ultimately created
significant shareholder value.
Nor were the early 1990s unique for
producing recession-beating companies.
The 2000–2003 slowdown also produced
current market leaders, not just in the USA
but also in Europe, China and Israel. These
“downturn babies” have market capitalizations
measured in the billions or hundreds of
millions of dollars. They are dominated by
biopharmaceuticals in Europe; center on
traditional, regional VC industries such as
technology, consumer goods and industrial
technologies in China; and are clustered
around medical devices in the Israeli market.
Some of these downturn-financed companies
have rewarded investors with M&A and IPO
From survival to growth
exit transactions in excess of US$1 billion.
Skype Technologies in the UK (initially
funded in 2002), which revolutionized voice
over internet to home users, was acquired by
eBay for US$2.5 billion. US-based Masimo
(initially funded in 1991) pioneered life-
saving medical devices and went on to an
IPO with a billion-dollar valuation. Likewise,
Semiconductor Manufacturing International
and Spreadtrum Communications (both
initially funded in 2001) were trailblazers
for the Chinese high-tech economy with IPOs
that hit the billion-dollar valuation mark.
The common ground shared by these
companies is that they were quick to gain
market share by harnessing trends that were
lasting and fundamental to progress in their
markets. Some were at the forefront of deep
technological or biotechnological advances.
Others recognized substantial new consumer
market opportunities. And feedback
from current investors suggests that the
billion-dollar exits of tomorrow are likely
to be positioned around such megatrends,
with a focus on communication and the
environment.
Digital media, social networking and digital
security (in particular, protecting personal
data online) have been flagged as having
strong investment potential. Cleantech and
biotechnology companies are also likely to
prove fertile ground. In particular, the green
elements of stimulus packages in the US,
Europe and Asia may lay the groundwork for
future growth through incentives and rebate
programs that promote investment in clean
technologies, renewable energy and other
energy infrastructure.
Of course, the success stories of the past
don’t prove that it is better for entrepreneurs
to be financed during a downturn or that
companies financed during downturns are
more successful than others. What they do
show, however, is that even during difficult
times, genuinely beneficial innovation will
continue to get financed.
Understandably, difficult market conditions
necessitate a longer exit strategy. Analysis
shows that the median time from initial
financing to IPO exit reached eight years in
2008. The same time measure for M&As was
only slightly less — seven years.
This increase means that business
fundamentals such as cash preservation,
sharpening the customer proposition may be distressed and concentrating on
and clear communications with potential survival, not growth.
investors are crucial to survival. At the
Difficult market conditions provide
same time, companies must not be so
opportunities for investors to find great
focused on “just getting by” that they are
companies early and to be the first to benefit
unable to pursue strategic, capital-efficient
when the upturn arrives. And entrepreneurs
opportunities as they arise.
can take heart that VCs are still investing. As
Challenging market conditions naturally long as you have a great idea, a great team
create some difficulties for these companies, and realistic expectations of valuations, the
and growth is unlikely to be simple or easy. money is still out there. •
But downturns do have positive market
attributes for those positioned to take
advantage of them. Physical assets and
other inputs cost less and are more capital
efficient. Talent is also cheaper and more
readily available. In addition, competition

Selected companies that received initial VC funding in downturn years

Current
Initial VC Total VC raised Current market
Company Country Industry revenue
financing year (in US$) cap* (in US$)
(in US$)
Starbucks US Consumer services 1990 $30m $8.3b $10.4b

Intuit US Software 1990 $18m $7.8b $3.1b

PetSmart US Retail 1990 $17m $2.9b $5.1b

Microchip Technology US Semiconductors 1991 $14m $4.1b $1.0b

Onyx Pharmaceuticals US Biopharmaceuticals 1992 $41m $1.4b $194m

Nuance Communications US Software 1992 $33m $3.5b $868m

Masimo US Medical devices 1992 $85m $1.6b $307m

Semiconductor
Manufacturing
China Semiconductors 2001 $3.1b $871m $1.4b
International Corporation
(SMIC)
Riverbed Technology US Software 2002 $57m $1.0b $333m

Communications Acquired by eBay for $2.5b

Skype Technologies UK 2002 $20m
software in 2005

Shanda Interactive
China Software 2003 $10m $3.3b $338m
Entertainment

Acquired by Novartis for

Speedel Switzerland Biopharmaceuticals 2003 $81m
$880m (CHF 907m) in 2008

*Market capitalization data as of 20 April 2009

Global venture capital insights and trends report 2009 19

Perspective from Europe
Interview with Bruce Golden, Accel Partners, UK
Bruce Golden joined Accel Partners in
1997 and primarily focuses on investments
in enterprise software and internet
companies, with a particular interest in
data management, analytic software, next-
generation SaaS and open-source software
companies.
Bruce Golden
Accel Partners
20
Ernst & Young: The VC industry is again
facing a difficult exit environment only a
short while after venture-backed IPOs and
M&A activity had recovered from the dot-com
bust. How are VCs in your area (Europe/
Israel) altering their investment strategies
in response to this newly challenging exit
environment? Comment on both early-stage
and late-stage VCs.
Bruce Golden: When looking at the current
exit environment, two questions need to be
taken into account: how long will there be
limited IPO activity, and how long will the
M&A market be depressed? They are relevant
because multiples of private companies are
constrained largely by what is happening in
the public markets.
Assuming that the exit environment,
whether speaking about IPOs or M&As, will
be weak for the next one to two years, or
possibly longer, we are focusing on making
investments where real value can be created
over this challenging period of time.
We think this is an interesting time to make
very early-stage investments, especially
those that are capital efficient, as these
companies can make enormous progress
and achieve significant valuation upside if
they are decisive in delivering a strong new
From survival to growth
product with a clear, compelling insertion
point in the market. The current situation
is a good crucible to build the DNA of great
businesses because it forces a clear focus
and discipline on market problems. Large
established companies are typically very
inward looking, and in times like these, they
are not primarily focused on new innovations.
So investing in very early-stage companies is
quite attractive in the current environment
and provides an opportunity to emerge in two
or three years with exciting, disruptive, new
approaches to large markets.
We are also selectively looking at mature,
growth capital opportunities in markets that
offer potential for new companies to achieve
category leadership.
Ernst & Young: What lessons did the VC
industry learn from the experience of the
last downturn that can be applied to today's
situation?
Bruce Golden: In terms of lessons learned,
the first is that new capital is incredibly
expensive in this kind of environment and for
some companies, unattainable. Therefore,
cash must be preserved and utilized
efficiently at all costs. Over the last one to
two years, we have been particularly focused
on ensuring that our companies are well

capitalized and have cash on their balance
sheets for the next 18–24 months. This
comes from really understanding their cash
positions and cash needs, which is critical.
The second lesson is that the strength of the
syndicates supporting companies can be the
difference between survival and collapse:
we have always focused on the strength
and predictability of our syndicate partners.
Specifically, we like working with like-minded,
proactive investors who work collaboratively
to anticipate issues and preemptively address
them. This means finding people with a
willingness to focus on facts and metrics
to support whether a company is making
progress or not.
The third lesson highlights the importance
of encouraging management teams to
communicate frequently and in sufficient
detail. This curtails the possibility of being
taken by surprise and then being forced to
deal reactively with major issues in a crisis.
Ernst & Young: What advice are you giving
to your portfolio companies? Does the
current situation offer them opportunities as
well as challenges?
Bruce Golden: The first piece of advice is to
watch cash. Companies have to make sure
“The bottom line is that portfolio companies have to make sure
that their value proposition is irresistible.”
they are well funded and doing everything
possible to reduce cash requirements
prudently and appropriately in order to get
through the next two to three years. To
control their own destinies, the most crucial
issue is to make sure they have access to the
cash needed to survive this period.
Beyond that, we advise our companies to
hone their sales processes carefully. For
example, having a clean insertion point for
products and ensuring that there is quick
time-to-value for customers, who should
therefore have a measurable Return on
Investment (ROI), is a crucial success
factor. In the current environment, people
are buying things that drop in quickly,
don’t require a lot of expensive Information
Technology (IT) resources and offer fast
time-to-value for customers. We work closely
with our companies to ensure their value and
sales propositions are tight and focused with
carefully selected sales targets.
Some portfolio companies, such as those
heavily concentrated in financial services,
may need to diversify their sales efforts.
In an environment where banks are
cutting costs dramatically, it is difficult for
unproven early companies to break into the
market. The willingness of banks to try new
Global venture capital insights and trends report 2009
technologies in the current climate is very
limited. Companies that are horizontal must
be prepared to penetrate new markets and
focus on where businesses feel the urgency
to adopt their products. The bottom line is
that portfolio companies have to make sure
that their value proposition is irresistible. At
the end of the day, this is all about building
killer products.
It’s also important to ensure strong reference
ability through positive public relations,
word of mouth or other communication
channels. Increasingly in our business, there
is high-impact potential from causing a buzz
around companies that create a lot of value
or have developed interesting innovations,
such as disruptive new approaches to market
problems. Ensuring that there is a positive
awareness of a company’s performance
is crucial.
This is also a time when, generally speaking,
businesses should favor optimizing
profitability and free cash flow vs. maximizing
growth and investing in new geographies
which could require significant incremental
operating expenses.
In summary, although capital is very
expensive right now, young companies
21
“This is actually a period of great opportunity for new companies.
Talented, ambitious and tenacious entrepreneurs can create
extraordinary companies in this kind of difficult environment.”
with a really crisp value proposition, a
clear insertion and quick time-to-value for
customers can do very well.
If we look at the operating performance of
many of our enterprise software companies
in the last 12 months, for the most part, it’s
been very strong, in many cases generating
growth of 50–100+% year over year.
Their performance is a reflection of their
innovative approaches to difficult problems.
The most successful companies tend to offer
a modestly priced product, have a faster ROI
and require less IT hand-holding relative to
incumbents.
Ernst & Young: Many great venture-backed
companies were founded during down
economic periods. What segments today are
most likely to generate new market leaders?
Can you specify?
Bruce Golden: The venture community is
very focused on cleantech, which certainly
offers promise, although the term is still quite
fuzzy and acts as an umbrella for a range
of market segments. It will take a long time
for VCs to get clarity on the various venture
opportunities in each market area.
Cloud computing and SaaS, or specifically,
the concept of delivering software on
demand to any device from “the cloud,” are
certainly areas of interest to many of us who
invest in enterprise software. The underlying
technology concepts, such as virtualization,
offer the opportunity to radically transform
the economics and technological complexity
22
of business software. That said, there are
enormous technical and business issues that
have to be solved, and VCs have to try to
focus on bets with the potential to yield big
stand-alone companies.
As we continue to digitize virtually all
content, turning all this data into useful,
liquid information continues to be an
interesting topic. We are likely to see new
opportunities in market data services,
analytics and infrastructure for real-time
information processing and management.
Also, given that the way most organizations
store information is very purpose-built
around individual proprietary applications,
there is an opportunity to democratize
information to enable more people within
organizations broader information access
through new-generation user interfaces.
New devices also create opportunities for
new types of information delivery as well
as broader audiences, especially when
business software is designed to be more like
consumer software in terms of ease of use
and limited IT dependencies.
Ernst & Young: What are the key challenges
for the VC industry in your area and the likely
industry response?
Bruce Golden: Europe and Israel are much
smaller venture markets than the US,
especially Silicon Valley. Over the next few
years, we will see a contraction of VC in
these geographies, just as we will in the US.
The asset class will be smaller, there will
From survival to growth
be fewer practitioners and there will be a
number of smaller firms unable to raise new
funds. As a result, there will be less capital
available for start-ups, and increasingly, the
global firms capable of helping businesses
originating in Europe and Israel will have
an advantage. Entrepreneurs should seek
venture firms that can deliver value globally
and have both expertise in their specific
market area and deep connections with
relevant ecosystem partners.
Most of our companies have to compete
globally if they are going to achieve
meaningful scale. In Europe, there are few
opportunities to build national champions
that can achieve very significant market caps.
Best practices show that companies need
to try to be global as early in their lives as
possible. Because the world is flat and people
become aware of innovative solutions quickly,
there can be copycat approaches and new
competitive thrusts that require successful
start-ups to stake their claims in the key
market very early in the life of the business.
This is actually a period of great opportunity
for new companies. Talented, ambitious
and tenacious entrepreneurs can create
extraordinary companies in this kind of
difficult environment because it’s the right
crucible to force everyone in the company to
focus on the issues that matter and to create
value for customers and their business. •
 Current topics for technology companies
Ernst & Young’s Global Technology Center
(GTC) reflects our sustained, worldwide
commitment to the technology industry. The
Center connects clients, service professionals
and account teams from our member firms
around the globe. It facilitates collaboration
and knowledge sharing and helps us provide
consistent, seamless, high-quality service to
our technology clients worldwide.
The GTC brings together the resources of
Ernst & Young’s global network of firms to
address crucial issues facing technology
executives and their boards. These include
issues related to assurance, risk, tax
and transactions, as well as finance and
operations.
The Center also helps our professionals draw
on Ernst & Young’s proven methodologies,
Carpe diem: risk-rating change yields
opportunity for technology companies
Standard & Poor’s (S&P) ear-ier this
year became the first of the 10 Nationally
Recognized Statistical Rating Organizations
(NRSROs)in the United States to
announce the assessment of Enterprise
Risk Management (ERM) in nonfinancial
companies as part of its process for
determining credit ratings. S&P is expected
to report its ERM assessment findings as
early as the second quarter of 2009. Other
credit-rating agencies, such as Moody’s, are
following S&P’s lead.
This change is important for technology
companies. Research has shown that
transparent risk management and internal
control are critical factors for many internal
and external stakeholders (the board, audit
committee, shareholders and suppliers).
The result is that credit-rating agencies have
made clear their intent to discuss ERM in
their rating reports. Technology companies
should seize this rating assessment
change as an opportunity to clarify their
risk management activities and deliver
comprehensive and consistent messaging
about those activities.
tools, learning systems, quality assurance Rick Fezell
Global Technology Leader
and continuous improvement processes.
Ernst & Young
These global resources allow our people
to focus their collective industry and
business knowledge on their clients’ unique
challenges — anywhere in the world.
The GTC connects our people to focus on
today’s issues and anticipate tomorrow’s. “It is our belief that technology
Companies connect to our latest thinking innovation will continue to
on a broad spectrum of challenges, from
industry-wide issues to specific technical, drive solutions to the most
business, regulatory and compliance challenging issues of our times.“
concerns. Following are three examples of
recent GTC thought leadership publications
focused on current topics in the technology
industry today. Visit www.ey.com/technology
to find out more about the Global Technology
Center.
In Carpe diem: risk-rating change yields Issue 2: February 2009
opportunity for technology companies, we Top of mind
address the issue of ERM as an opportunity Issues facing
technology companies
for technology companies to clarify their
risk management activities and deliver
comprehensive and consistent messaging
Carpe diem: risk-rating
about those activities. change yields opportunity
for technology companies
Key points
Situation
Opportunities associated with the credit- Standard & Poor’s (S&P) earlier this year became the first one of the
10 nationally recognized statistical rating organizations (NRSROs) in the
United States to announce the assessment of enterprise risk management
rating change include: (ERM) in non-financial companies as part ofi ts process for determining credit
ratings. S&P is expected to report its ERM assessment findings as early as the
second quarter of 2009. Other credit-rating agencies, such as Moody’s, are
following S&P’s lead.
• Increased transparency into a company’s This change is important for technology companies. Research has shown that
transparent risk management and internal control are critical factors for many
internal and external stakeholders (the board, audit committee, shareholders
and suppliers). The result is that credit-rating agencies have made clear their intent
risk management and internal controls to discuss ERM in their ratings reports. Technology companies should seize this
rating assessment change as an opportunity to clarify their risk management
activities and deliver comprehensive and consistent messaging about those activities.
• Opportunity to influence shareholders with
a strong and consistent risk management
message
• Strategic performance improvements
• Use of ERM as a strategic growth tool
Global venture capital insights and trends report 2009 23
Technology industry global financial
management and reporting survey:
insights into leading practices of
technology companies
In response to the need for financial
management benchmarking data,
Ernst & Young surveyed senior technology
industry finance executives about the following
topics: the organizational structure of finance;
management of the financial “close process”;
revenue recognition accounting policies; and
International Financial Reporting Standards
(IFRS) adoption. Participant responses were
summarized in aggregate and packaged in a
quick-read reference report. Here is a sampling
of the first survey’s findings.
Key points*
• Among the identified functions performed
at shared service centers were the
following:
• Accounts payable was cited by 79% of
the survey participants.
• Statutory financial reporting was cited by
64% of the survey participants.
• Revenue recognition contract review was
cited by 47% of the survey participants.
24
• Almost a third (31% of the survey
participants) recorded 10 or fewer
corporate journal entries as part of their
consolidation process.
• The methods used to establish fair value
were as follows:
• Almost a third (31% of the survey
participants) used Vendor-Specific
Objective Evidence (VSOE).
• More than a quarter (27%) of the
survey participants used the “residual
method,” under Statement of Position
(SOP) 98-9.
• The top three accounting issues cited as
having the biggest potential impact on a
company during its IFRS adoption process
were as follows:
• Revenue recognition was cited by 74% of
the survey participants.
• Taxes were cited by 45% of the survey
participants.
• Research and development costs were
cited by 29% of the survey participants.
*Multiple responses allowed for questions
From survival to growth
Revenue recognition in technology • The general revenue recognition principles Issue 2: December 2008

companies: the convergence of of IFRS and US GAAP are more alike than Conversations
two standards different. IFRS in the technology industry

As the adoption of IFRS becomes more

• Emerging Issues Task Force (EITF) Issue
likely in the United States, many technology
No. 08-1, “Revenue Arrangements with
companies are beginning to think about what
Multiple Deliverables” (Issue 08-1), may
their initial financial statements will look Revenue recognition in technology
more closely align IFRS and US GAAP companies: the convergence
like when they convert from US GAAP to of two standards
accounting for certain multiple-element
IFRS. Chief among these concerns for such
arrangements. • The general revenue recognition principles of IFRS and US GAAP are
more alike than different; differences are due primarily to differing levels

companies is how their revenue recognition of specificity.

• Current IFRS and US GAAP revenue recognition standards soon may be

replaced by a converged standard — the result of the FASB’s and IASB’s

policies may change upon conversion. • IFRS is less restrictive than US GAAP in joint revenue recognition project.

• EITF Issue No. 08-1, “Revenue Arrangements with Multiple Deliverables”

(Issue 08-1) may more closely align IFRS and US GAAP accounting for

relation to demonstrating evidence of an certain multiple-element arrangements.

In the most recent edition of Ernst & Young’s

• IFRS is less restrictive than US GAAP in relation to demonstrating
evidence of an arrangement with a customer.

arrangement with a customer. • Under both IFRS and US GAAP, revenue recognition arrangements are
accounted for based on substance and not form when evaluating whether

Conversations: IFRS in the technology multiple contracts represent a single arrangement.

• Elements of an arrangement may be more likely to be accounted for

separately under IFRS than US GAAP.

industry, we take a look at a number of • Under both IFRS and US GAAP, revenue • Absent any change in their business relationships, it is likely that
companies that use the sell-through method of revenue recognition for
transactions with resellers under US GAAP will use a similar method

revenue recognition issues that are of recognition arrangements are accounted when reporting under IFRS.

particular interest for technology companies, for based on substance, rather than
and provide an overview of how US GAAP form, when evaluating whether multiple
and IFRS are comparable for those issues contracts represent a single arrangement.
as well as where they diverge. The article
• Elements of an arrangement may be more
also provides a perspective from the Boards’
likely to be accounted for separately under
(International Accounting Standards Board
IFRS than under US GAAP.
[IASB] and Financial Accounting Standards
Board [FASB]) joint revenue recognition • Absent any change in their business
project. relationships, it is likely that companies
that use the sell-through method of
For each topic, we summarize the guidance
revenue recognition for transactions with
of both US GAAP and IFRS and provide
resellers under US GAAP will use a similar
commentary on the implications of IFRS
method when reporting under IFRS.
adoption for US technology companies.
This publication also discusses our
current understanding of the Boards’
revenue recognition project and how
distinct revenue recognition issues (e.g.,
establishing evidence of an arrangement;
evaluating separate contracts as a single
arrangement; accounting for multiple-
element arrangements; and accounting
for arrangements with resellers) may be
affected by a converged standard.

Key points

Global venture capital insights and trends report 2009 25

Perspective from China
Interview with Bo Shao and David Zhang
Bo Shao joined Matrix Partners as a general
partner in 2007, with a particular focus on
Matrix’s China strategy and investments.
He is currently based in Hong Kong, and in
addition to his venture responsibilities, he
is also a cofounder and the Chairman of
Novamed Pharmaceuticals and a cofounder
of BabyTree in China.
Bo Shao
Matrix Partners
David Zhang is a founding managing
partner for Matrix Partners China
and oversees all operations in China.
Previously, he was the Managing Director
and head of the Beijing office for WI Harper,
where he oversaw all investments, portfolio
management and operations in both life
sciences and IT in China.
David Zhang
Matrix Partners
26
Ernst & Young: How are VCs in China altering
their investment strategies in response to the
challenging exit environment?
Bo Shao: The current downturn is going to
be very different in nature from the dot-com
bust. That was relatively concentrated in
the technology sector. It spread out a little
bit but was more or less concentrated in
that one sector and then ended because the
fundamental demand for various other kinds
of products was still strong. It was the result
of a wacky valuation of a particular sector.
The downturn that we are currently facing
is very widespread, and there is an almost
unprecedented combination of a fall-off in both
consumer and business confidence around
the world — it’s the first synchronized global
recession in our lifetimes. The impact of the
current downturn is going to be much deeper
and longer than most people think, even today.
The second point is that if you look at the
VC and growth-stage investments in China,
activity is not limited to the technology sector.
It’s fairly widespread, ranging from chicken
farms to technology, to media, to regular
consumer services and even education. It’s a
very wide spectrum, which means that if it had
been another dot-com crash, it would actually
have been okay because China presents many
different kinds of opportunities. But because
this downturn is quite widespread, almost
every sector that a typical private equity
investor looks at in China will be impacted in a
similar fashion.
The third thing is the picture in terms of early
stage versus late stage. For a while, late-stage
investments were almost too easy — the market
was hot. You picked a company that was one
From survival to growth
year or half-year before an IPO and boom. It
was pretty easy for a while to double or triple
your money by investing in late stage. That
opportunity has more or less disappeared, and
it’s now going to be very difficult to get out in
the next two or three years.
In early-stage investment, things are a bit
different, as typically the time frame is three
to five years. I would say for early-stage
investment, today’s environment overall
presents more of an opportunity than a
problem because valuations are becoming
more and more rational. I don’t think they
have fully reflected the public market multiple
decrease yet, but they certainly have been
coming down in the past few months. Those
who are disciplined and have the guts to
continue to invest will be rewarded three to
five years down the road. For early-stage
investment it is, in fact, not a bad time at all.
David Zhang: I just have a couple of comments
to add. First, a lot of people nowadays are
taking a wait-and-see attitude. Many of them
have stopped investing altogether. Not a lot
of new deals are getting done; not a lot of
new term sheets are being issued. That’s
across the board — in early, in growth and in
late stage. However, as compared with the
last bubble, what’s different is that there are
more firms now with available capital and a
stable team. So the competition is still there.
For a good company in this environment — a
leader in a subsector — a premium valuation
is still possible. Many VCs are still interested in
companies like these, so competition over a hot
deal will still occur, albeit a lot more selectively.
We are also experiencing something of a
stalemate with lots of companies. This is
because the founder is still holding out hope
for a higher valuation. Expectations are
coming down, but not as fast as the capital
markets. In our own case, we currently have
three to five very good companies — sector
leaders — where we have quite a large
valuation disparity. Because of that, we may
end up doing only one deal, or none, because
I believe we must have valuation discipline.
Ernst & Young: You said that a lot of funds
are in wait-and-see mode right now. Can you
estimate when this mode will change and
we will see the pace of investments picking
up again?
David Zhang: It’s very hard to say. The period
from last October until now is unlike anything
anyone has really experienced in the past 15
or 20 years — certainly in my professional
career. As long as the market continues to
be so volatile, the adjustment period is still at
least six months out. During this period of time,
it’s probably safe to say that many of the VC
firms will still take a wait-and-see attitude and
are most likely to pull the trigger for growth-
stage investments in clear market leaders in
well-known sectors — more traditional types
of investments. There will be no early-stage
investments. I see that continuing for at least
six months or longer. There is a funding gap at
the moment in China.
The funding gap would not exist if companies
had clear leadership and a reasonable
expectation of valuation. The money and
companies are out there — the problem is
the investors are more hesitant and require
larger margins of safety, and entrepreneurs
are holding on to the old days of valuations.
Where the founder’s valuation expectation has
been adjusted downwards to reflect the market
sentiment, the gap doesn’t actually exist.
Ernst & Young: What advice are you giving
to your companies in terms of current
opportunities or the challenges they have
now that they can turn into opportunities?
David Zhang: We are really lucky to be in
China doing investment, and from a portfolio
CEO’s perspective, it’s a great place to be
starting a business today. The financial crisis
has been quite fierce, but at the same time,
China is ready to take off. We believe this is a
unique period for all of us involved in creating
and investing in companies. Across the
board, there are opportunities in healthcare,
internet, wireless and consumer services. The
downturn gives you more breathing room
and probably less competition, less noise and
a better mind-set. Portfolio CEOs need to
seize this opportunity.
I think there is some truth to the proposition
that great companies tend to be formed
during the most difficult times.
Bo Shao: Before the crisis, I had been
saying that China had no shortage of capital;
it had a shortage of good people. We’ve
got 1.3 billion people, but there’s still a
tremendous shortage of good entrepreneurs.
Today, there is still a shortage of good people,
but now there is also a bit of a shortage of
capital because everybody is in fear and wants
to hold on to their money.
David Zhang: Regarding what segments
today are most likely to generate new
market leaders, we are looking at a lot more
opportunities in early stage, which is where
we see the greatest opportunities. We also see
more opportunities in internet, in healthcare
and consumer services.
One sector I myself am very negative on is
media. You will see a heightened shake-up of
many media companies in the next six months
to a year because of the wild success of Focus
Media. That kind of added fuel to the fire and
powered a lot of wasteful investment in the
media space. Many of the top-tier VC firms
have invested in many media companies. You
will hear a lot more blow-ups in six months’ to
a year’s time.
Ernst & Young: We have seen five or six
models of foreign VCs going to China. Are we
starting to see the emergence of successful
ones that will last much longer than some of
the models that will result in separation?
Bo Shao: I want to emphasize particularly the
issue of the team. The VC industry in China is
Global venture capital insights and trends report 2009
a very young industry. As we have all rushed
to China, there have been a lot of hastily
arranged marriages to get a fund set up. Not
enough attention has been paid to the culture
of each firm. These marriages will probably fail
because, basically, the partners haven’t dated
long enough before getting married — and a
partnership is like a marriage.
That’s a big challenge facing the industry today
as a lot of firms start with a fairly low common
ground in culture and personal relationships,
and that gets aggravated as the market turns
down. Inevitably, there will be a portfolio
problem and issues with the time expected
before exit. If a marriage starts with poor
foundations and then gets shaken by money
problems, there are always going to be issues.
As for success — what is the definition of
success? Is making money in the short term
a definition of success? Is making money
after 10 years the definition of success? Is it
building a brand or knowledge?
Depending how you define success, different
models will be different. For example, if
you say you ultimately want to build a team
in China that can last for 10 or 20 years,
then obviously, it is not going to work if
all the decisions get made in the United
States. Those decisions have to be very local
because decisions are best made on the
ground. Good people will not go to work for a
fund where decisions are not made locally.
If people can successfully invest and build
good companies and raise successful
funds, I would say one criterion here is local
decision-making. This is for several reasons.
One is that entrepreneurs — particularly,
good entrepreneurs who are in demand —
don’t want to have to explain themselves
at midnight to general partners who live in
another country and who do not understand
their business. Second, local decision-making
is the best way to attract the investment team
you need. The best people are not going to
work where they are not deeply involved in
the decision-making process. •
27
Perspective from the United States
Interview with Deepak Kamra
After an 11-year career growing technology
start-ups into successful global leaders,
Kamra joined Canaan in 1991 and now
focuses on investments in digital media and
software. He led Canaan’s early investment in
DoubleClick, the internet’s first and leading
online advertising solution; Match.com, the
most popular dating site worldwide; and
BharatMatrimony, the world’s number-one
online matrimony site.
Deepak Kamra
Canaan Partners
28
Ernst & Young: How are you responding to
the financial crisis?
Deepak Kamra: It’s a tough time, and we’re
trying to set a tone of partnership and
coaching with our companies. But there
definitely is a sense of triage, and having
lived through 2000–2003, you understand
that acting quickly is important.
I think that in 2001 and 2002, people just
thought the market would come back and
didn't worry about it. They remained in a
bubble mentality for a long time. People who
went through that have learned that even if
the market comes back, things change.
You need to pick which companies are going
to make it and cut out the ones that aren’t —
quickly helping people find jobs if possible.
Then make sure the ones that are going to
make it, but need cash, are funded for the
next 12 to 18 months.
A while ago, we started telling our companies
to figure out how they’re going to get
through the next 12 to 18 months and make
sure the cash is in place for that, whether
that means going out to raise money or
pursuing alternative means.
Ernst & Young: What is your view of the
current challenges in the exit environment?
Deepak Kamra: A key challenge will be the
IPO market because there’s a structural and
From survival to growth
not a cyclical issue. We have never got back
to the kind of IPO activity we had before the
bubble. For about seven years before the
bubble, we had around 150 IPOs a year, and
in the seven years after the bubble, we’ve
had more like 50. There’s definitely been a
change, and you can’t blame Sarbanes-Oxley
for everything. Certainly, in the investment
banking world, you had to try to get Goldman
Sachs or Morgan Stanley on the cover of
your prospectus. I think that mentality’s
going to have to change, and we’re going
to need to go back to some of the smaller
investment banks.
There are lots of small banks. I hope they
survive, because there haven’t been a lot
of M&A or IPO fees lately. The big guys like
Goldman and Morgan aren’t going to be able
to be as aggressive as before. I think it’s also
a time when the venture community just has
to say, “We need to support these smaller
banks because if we get smaller banks, we
don’t have to wait for a really large IPO like
Goldman and Morgan Stanley can do.”
A lot of hedge fund buyers have gone away.
So we may see a move back to the more
traditional kind of investment banking
industry. That would be a great thing. There
are also other structural changes, namely
that research analysts are paid for by trading,
not traditional banking. If you’ve got small
companies, they may not generate enough
 “We are encouraging our companies to go and do
partnerships, and partnerships are still happening without
cash changing hands.”

revenue to pay the analysts. But you still Still, even those guys need to adjust their nice sector, mainly because people don’t
need analyst coverage somehow. product strategies to the time. For example, want to pay 20% for their credit cards or they
we have a company called ON24 that does can’t, and this is a more reasonable way to
Ernst & Young: Are you seeing companies
webcasts. They also have a new product borrow and lend because you take the banks
securing strategic money, whether equity
called Virtual Trade Shows, and that has just out of the middle.
investments or through partnerships?
taken off because no one wants to travel
We are still excited about things like digital
Deepak Kamra: It’s still strictly financial. The to trade shows anymore. They did that in
media and search. Search is still a big growth
strategic guys have been totally frozen as far anticipation of tougher times. That’s just one
market, we have companies that are doing
as we can see, both in terms of acquisitions example of how to adjust your strategy.
semantic search that are doing well. Biotech
at any meaningful level and financing. We
We have another company called Blurb that is another area — the next generation of
are encouraging our companies to go and
allows you to design and print your own antibiotics and cancer treatment drugs. In
do partnerships, and partnerships are still
book online. They raised money even though cleantech, we try to stay away from the deals
happening without cash changing hands. For
they were cash flow positive. And they were that take exceptional amounts of capital and
example, Original Equipment Manufacturer
singled out by some media who said they look for storage efficiency, smart energy
(OEM) deals or ventures, or getting a larger
shouldn’t boast about it because they said, usage in buildings and in grids, more software
company to sell your product because those
“Hey, we raised cash even though we don’t as opposed to building huge plants. You have
larger companies are the ones that may want
need it.” Well, I think you should boast about to identify the niches that will continue to
to buy you in 12 to 18 months.
that in this market; if you can raise money, grow, even within a general downturn. •
There are companies that are more mature, you should.
that are cash flow positive or close to it.
Ernst & Young: We know many great
And it’s a nice position to be in. And the
venture-backed companies were founded
companies that managed to raise money last
during tough economic periods and are all
year before the market shut down are sitting
looking for the future market leaders of
quite pretty.
today. What is your perspective on that?
Cash is going to have a lot of value over the
Deepak Kamra: You need to look for things
next coming year. If the exit and/or financing
that’ll do well in tougher economic times. A
droughts last longer than 12 to 18 months,
year ago, we invested in a company called
then we’ve got to do a reset on this. But at
Lending Club, peer-to-peer lending, where
least those with cash flow positive are in a
people lend and borrow money from each
good space.
other online. That’s turned out to be a very

Global venture capital insights and trends report 2009 29

How to manage cash
by Steve Payne and Al Sardo

Steve Payne In good times, VC investors and portfolio Despite these efforts, companies continue to
Americas Leader of Working
company executives focus on revenue growth leave significant dollars locked up in working
Capital Advisory Services
Ernst & Young
and the drive toward profitability, often capital. Many companies deploy the usual
leaving balance sheets on the back burner. and classic tactics — many of these methods
Now that the global economy is slowing, revolve around quarter-end — to reduce
senior executives need to make sure their working capital but still reach a performance
Al Sardo
businesses know how to conserve cash. plateau. For sustainable improvements, the
US Leader of Working Capital
Advisory Services
objective should be to liberate cash each day
Accurate cash flow forecasting is a vital
Ernst & Young so that it can be redeployed and not to focus
component of any cash management
on cash flow at the end of the quarter.
practice. It requires input not just from the
finance team but also from operational areas What steps can venture capitalists and their
of the businesses. This input should answer portfolio companies take to accomplish
the question, “Who really controls where this goal? Companies should focus on
my cash is going and how it is coming in?” their balance sheets, specifically their
Focusing on cash flows in this way should inventories, payables and receivables, and
produce a clearer picture of a portfolio procurement processes to uncover additional
company’s sources and uses of funds. It also opportunities, and ask such tough questions
will help managers make more informed as:
decisions about how to improve cash flows.
• Do our metrics and variable reward
Even in the best of times, cash from working program emphasize the importance of cash
capital is the preferred source of liquidity. or focus on sales and EBITDA?
But in a global downturn — when credit,
• Is our inventory at the stock-keeping
market capitalization, growth and profits
unit level imbalanced, leading to excess
have all slowed dramatically — preserving
inventory in some products and shortages
cash through disciplined working capital
in others, thereby exposing us to product
management is becoming essential.
obsolescence?
Companies often meet their quarterly cash
• Do we have good insight into our
goals by driving inventories down to an
customers’ evolving needs for our
unhealthy level that endangers customer
products/services or are we reactively
service quality, postponing receipts from
responding to their purchase orders?
suppliers until the first day of the new
quarter, delaying supplier payments and
bombarding customers with payment notices
to collect aged receivables.

30 From survival to growth


• Are we buying the same supplies from
too many different sources? Would it be
more cost effective to consolidate our
spending with fewer suppliers, negotiate
better terms and take advantage of volume
discounts?
• Have we examined supplier payment terms
as well as payment triggers and schedules?
• Have we segmented our customer base to
understand better where we need to focus
collections efforts based on relationships
and customer payment behavior?
To take advantage of working capital best
practices, VC firms can leverage the best
practices in one portfolio company and apply
them across all. By sharing knowledge and
processes, everyone benefits.
Start by taking a closer look at their
collections process. Smart companies
make certain bills go out accurately and
on time, giving customers no easy excuse
for slow payment. They also work hard to
understand their customer base and tailor
collection strategies to the payment behavior
demonstrated by individual customers.
Improvement can also be achieved by
scrutinizing payables. A surprising number
of otherwise sophisticated firms are chronic
early payers. In the current environment,
when your own customers are likely to
pay more slowly, negotiate more favorable
terms when possible and do not pay until
the due date. Supplier segmentation allows
companies to “move out” payments for
commodity suppliers whose products can be
Sometimes companies can focus on cash simply by looking
ahead. Smart executives will pay more attention to cash flow
forecasting.
sourced cost-effectively from one or more
alternative vendors with little risk that the
supply will be interrupted.
Many companies have made inventory
management harder by sourcing parts and
products from lower-cost suppliers in Asia.
The distance and supply chain risk involved
may compromise oversight and control.
Inventory is the buffer between supply
and demand, and low-cost sourcing means
companies need to thicken that buffer.
Ideally, firms will try to improve forecasting
over the extended future. They will also
look for opportunities to build flexibility into
product configuration so its final appearance
can be changed easily and cost-effectively to
meet customer demand.
Sometimes companies can focus on cash
simply by looking ahead. Smart executives
will pay more attention to cash flow
forecasting. In addition, they’ll look at
customers, suppliers and creditors to see
who else might be at risk and then develop
contingency plans.
Finally, it can be helpful to make certain that
incentives are aligned with prudent cash flow
management. When business is profitable, other
issues take priority, leaving cash and inventory
management to become less disciplined over
time. Companies can remedy this situation by
immediately creating cash-focused performance
measures and applying them from the top of the
organization to the bottom.
VC firms should take additional steps. For
example, venture capitalists can encourage
companies to strengthen corporate
Global venture capital insights and trends report 2009
governance through more frequent
monitoring of internal controls relating
to cash.
Also, where applicable, venture capitalists
and their portfolio company executives
should review credit facilities and covenants
and step up communications with key credit
providers. Companies may also want to focus
efforts on improving bank account structure
and banking relationships. Redesigning
the bank account structure may increase
visibility and provide better access to cash.
Reevaluating bank services and fees can also
lead to significant cost savings. Companies
could renegotiate with their lenders to
achieve favorable and standard bank fees.
Where it is beneficial and practicable, VC
firms may consider collectively negotiating
better rates for their portfolio companies.
In summary, it’s important to make all
possible efforts to make certain that working
capital management is a topic of attention
for all VC-backed boards and management
teams. •
Visit www.ey.com for further reading on
capital management strategies from
Ernst & Young:
“Unlocking cash: where are the
opportunities,” PE Insights, Vol. 1, No. 1,
18 March 2009
“Transaction insight — Liquidity and
working capital management: cash is king,”
InterChange, Vol. 22, November 2008
31
Perspective from Israel
Interview with Chemi Peres
Chemi Peres is a managing general partner
and cofounder of the Pitango Venture
Capital partnership. In 1992, he founded
the Mofet Israel Technology Fund, an Israeli
VC fund publicly traded on the Tel Aviv
Stock Exchange, which he managed until
1996, when he cofounded Pitango.
Nechemia (Chemi) J. Peres
Pitango Venture Capital
32
Ernst & Young: The VC industry is again
facing a difficult exit environment only a
short while after venture-backed IPOs and
M&A activity had recovered from the dot-
com bust. How are venture capitalists in
Israel altering their investment strategies in
response to the return of this challenging
environment?
Chemi Peres: The number of companies
seeking additional financing rounds, across
all stages, is increasing by the day. With
the IPO market at a standstill, a long line
of good companies that could have been
IPO candidates is forming, creating a huge
bottleneck and leaving these companies with
just a few options.
The first option is to explore exit opportunities
via acquisitions. The hunger for innovation
will grow, the interest of strategic players in
acquiring companies will continue to grow
and they can take advantage of the current
situation to buy companies at relatively
low valuations.
The second is to achieve profitability as
quickly as possible — sometimes by sacrificing
growth and becoming more financially
efficient. Getting to a positive cash flow will
enable a stand-alone business, sparing the
need for additional equity or debt financing.
Ultimately, the company can continue
its growth toward a later stage, when an
IPO opportunity emerges or an attractive
proposal is on the table.
Companies that are not able to reach
this stage fast enough will be forced to
complete mergers between themselves in
order to achieve a critical mass. Combining
From survival to growth
businesses will yield a sizeable company that
can continue to grow to a later stage where
options become viable again.
These basic options are true across
geographical boundaries, Israel included.
Ernst & Young: What lessons did the VC
industry learn from the experience of the
last downturn that can be applied to today's
situation?
Chemi Peres: The main lesson learned is
that certain of the VC-backed companies did
not have a long-term sustainable model for
reaching profitability and positive cash flow
without having to rely on external sources of
capital.
Additionally, the time to exit might be very
long. Therefore, companies must make
sure they are equipped for a marathon run,
focusing on management, capital efficiency,
revenue generation and realistic assumptions
while planning ahead.
The current crisis is a continuation of
the previous crisis. The VC sector in both
cases was forced to adopt the point of view
according to which businesses need to be
built for the long term rather than the short
term. These times demand a paradigm shift:
focus on building companies to last, rather
than building companies to exit.
Ernst & Young: What advice are you giving
to your portfolio companies? Does the
current situation offer opportunities as well
as challenges to your portfolio companies?
Chemi Peres: Times of crisis are also times
for new opportunities. Obviously, we advise

our portfolio companies to try and preserve
resources and raise capital that they need
now in order to extend the runway as much
as possible. We advise them to examine
their plans, assumptions, opportunities
and potential threats and risks. We ask
them to brainstorm and not to take anything
for granted — business models should be
challenged, and the same applies to
current strategies.
Having said that, it is imperative not to lose
the risk-taking opportunities: it is important
not to become stagnant or too conservative
and to seize opportunities that exist. Those
who are alert enough to act will find that
they can use market opportunities and gain
breakthroughs.
I also suggest that companies reevaluate
their market, competition, financing plans
and management teams, making sure that
the entire team is adjusting to the new
situation and everyone is on the same page.
No company should underestimate the
value of conducting face-to-face strategy
discussions and meetings, which are now
more important than ever before.
Ernst & Young: Many great venture-backed
companies were founded during down
economic periods. What segments today are
most likely to generate new market leaders
(e.g., cleantech, cloud computing, software
as a service)? Can you specify?
Chemi Peres: The pace of change of
industries is fast, making room for new ideas
and new ventures in the coming years. We
see new convergences between traditional
information, technology and communications
“It is important not to become stagnant or too conservative
and to seize opportunities that exist.”
sectors and new emerging industries. The
current technologies will accelerate the
growth of tomorrow’s ventures.
We are witnessing the emergence of
innovative solutions in the fields of
renewable and alternative energy sources,
water desalination, purification, storage
and conduction. We also see a new era
in biotechnologies and life sciences
developments, safety and homeland security,
new education methods and platforms,
nanotechnology and green technologies
that are revolutionizing the use of our
natural resources. We will also continue to
see innovation in the more traditional areas
such as IT, communication, internet, media,
software and so on.
Ernst & Young: What are the key challenges
for the VC industry in Israel and the likely
industry response?
Chemi Peres: Some of the key challenges are
preserving leadership and competitiveness
in a technological world that is shifting gears
in an accelerated way. We need to rethink
the old discipline’s food chain, beginning
with school education through research
institutions and universities, national
encouragement and investment in R&D and
promotion of entrepreneurship, innovation
and financial resources. We need to create
a supportive and enabling regulatory
environment and make Israel not only
an innovation lab, but also a beta site for
implementation and consumption of
new technologies.
Global venture capital insights and trends report 2009
Ernst & Young: Pitango is one of the few
Israeli funds that invested in a Chinese
company — why, and is it a part of your
strategy? What are the lessons learned by
the Israeli VC industry?
Chemi Peres: The China-Israel relationship
is very unique, having much in common
and complementing Israeli technological
development with the creation of new
technology in China.
We recently invested in a later-stage Chinese
solar energy company. We were very
impressed by their abilities and their pace
of development. Leadership in many energy
fields will expand across the globe, with China
being a major player in the development of
silicon manufacturing.
Pitango invests primarily in Israeli companies;
however, from time to time, it invests in
global ventures with local partners. Aside
from financial backing, we invested time and
resources to learn the Chinese and Asia-
Pacific area as it is strategically important
to our portfolio companies as well as to us.
We think the Chinese economy will become
more integrated with the global economy,
for better or for worse; China is a prominent
market opportunity and also a place that
will produce leading companies. The same
can be applied to India, Russia and other
areas around the world. Venture capital and
innovation are becoming more and more
globally integrated. •
33
Perspective from the United States
Interview with Noubar Afeyan
Noubar Afeyan is managing partner
and CEO of Flagship Ventures, a firm he
cofounded in 2000. He is also a senior
lecturer at the Massachusetts Institute
of Technology in both the Sloan School of
Management and the Biological Engineering
Department. A technologist, entrepreneur
and venture capitalist, Afeyan has
cofounded and helped build 20 successful
life science and technology ventures during
the past two decades.
Noubar Afeyan
Flagship Ventures
34
Ernst & Young: What is your assessment of
the current state of Venture Capital?
Noubar Afeyan: At the moment, everyone is
being very careful with their words. People
are saying we are in a crisis and avoiding any
mention of a depression. I would say that
crisis is probably not the right word because
it implies the ability to manage the situation
and reasonable steps to take. Crisis almost
assumes that you have a mental model of
what the world looks like after the crisis. And
usually, after the crisis, you return to what
the world looked like before the crisis. The
overriding thinking throughout is that you’ve
got to survive the crisis, then afterward,
you can get back to how things were. For
instance, the internet bubble bursting was
viewed as a crisis.
I think that, at the moment, we don’t have a
crisis — we’ve got chaos. Managing in chaos is
a very different concept. In fact, I don’t know
what it even means to be an expert on how
to manage in chaos. So it’s extremely difficult
to tell you how to survive or how to be better
positioned for the recovery. At the moment,
we’re going to keep doing the same thing for
as long as we think things might return to the
way they were — more or less. But we don’t
know if things will return. No one does.
From survival to growth
We have a situation that is unlike any I have
seen in my professional career. It’s not clear
what might happen, where we might end up
or how long it might take.
Ernst & Young: What advice are you giving
to your portfolio company management
teams?
Noubar Afeyan: We’re in an environment
where I think it’s all going to be about how
to get nonequity or nondilutive capital. Our
advice to our companies is, where possible,
to favor strategies that don’t require them to
raise much capital.
Right now, we don’t see signs of a step
change in portfolio companies. If anything, I
would argue that this environment is initially
advantageous for start-ups because start-
ups, by their nature, tend to be disruptive to
the status quo. In the current environment,
the status quo has been shattered for
everyone, both newcomers and incumbents.
As a result, incumbents now have few of
the natural defenses to mount against little
companies as they did pre-chaos.
Another observation that we make with our
management teams is that they are usually
impatient. They are often racing, but it’s not
clear against whom they are racing. It’s very

clear that everything they previously planned
simply won’t be done in the next two years —
if only because the other companies will also
be having a hard time raising money. We
want to avoid racing ourselves into oblivion —
using up all our capital thinking there’s a race
and then finding out there wasn’t one in the
first place.
What do you control as a management
team? You control your firm, the decisions
to forge partnerships, the team that you
have and the things you choose to focus on.
You have to ask yourself as a management
team: “Where are the appropriate set-points
of each of these things in view of a chaotic
environment?” You must identify what the
right set-points are and how frequently you
should go back and look at them. One good
analogy is being sick. How often do you
measure your temperature? If you measure it
too often, you feel sicker and sicker, so there
is such a thing as measuring it too often
and making yourself feel psychologically like
you’re losing the battle.
Since survival will precede success, think of
cash burn rate as a more immediate-term
focus versus a very long-term focus. Those
are the things most good management teams
“We want to avoid racing ourselves into oblivion — using up all
our capital thinking there’s a race and then finding out there
wasn’t one in the first place.”
are doing, and I think that’s what boards But we hear from limited partners that,
should encourage them to do. objectively, there’s often no merit in making
a new commitment to many of these funds.
On a practical level, people shouldn’t lose
Performance against benchmarks is a
track of goals and objectives. A lot of boards
more reliable basis for decisions. But after
and venture capitalists go to their teams
a decade of poor performance across the
and tell them to cut their burn. Management
venture industry, beating low benchmarks
comes back with a set of cuts aimed at
will likely not be sufficient. Venture firms will
cutting burn rapidly but fails to revisit the
need to stand out based on many factors and
goals committed to last year, to restate what
not rest on their laurels.
targets it will and won’t be possible to hit.
I expect to see changes to the relationship
If the team can’t tell you what objectives it’s
between limited partners and general
not going to meet because it cut the burn,
partners because this is just such a traumatic
then it didn’t really do it or it has too much
period. We’re all going to have to earn our
slack. Any time I tell a team that what is
living. As an entrepreneurial firm with only
needed is to burn less money, I immediately
three funds under management, we have to
insist on also seeing the things it is simply not
rely on our current performance rather than
doing or will not be able to continue doing.
solely our brand and performance during
Ernst & Young: Are there different the ‘90s or ‘80s. I expect that in the current
expectations of VC funds now than there environment, funds will need to re-earn their
were before the financial crisis? brand every single day. •
Noubar Afeyan: The limited partner
community has historically invested based,
in part, on reputation. The same inclination
that prompted people to invest in a bunch
of hedge funds that have recently been in
the press, also caused “safe” investments
into venture funds with long track records.
Global venture capital insights and trends report 2009 35
Perspective on corporate innovation and
collaboration
Interview with Steve Meller
Steve Meller is on the leading edge for
the global open innovation programs at
Procter & Gamble. In this role, he serves
as Chief Innovation Catalyst and leads
the global technology innovators and
entrepreneurs “community of experts,” the
North American and Latin American open
innovation hubs and several key business
and technology platforms across the
company, including Venture Capital (VC)/
Small and Medium-sized company (SME)
strategies and the global bioscience and
industrial biotechnology platforms.
Steve Meller
Procter & Gamble
36
Ernst & Young: What is your perspective
on big corporates’ need to interact with VC
funds and portfolio companies?
Steve Meller: SMEs are the largest-growing
source of innovation globally today. VC
organizations and private equity are a
very important route to gain access to
those companies.
In particular, many venture capitalists are
investing in “higher-tech” SMEs — those that
have some very fundamental information
related to health IT or sustainability, for
example.
Being able to develop relationships with a
wide variety of VC organizations around
the world is an important plank for us in
finding access to the right types of
portfolio companies.
To do that, we’ve become much clearer with
the outside world on what our needs are and
where we’re really looking to play. Many of
the areas that a consumer products company
would look into don’t overlap very well with
the large buckets the VC industry typically
invests in.
We need to help the venture community
better understand those types of platforms
that are of high interest to us — such
as nonpetroleum alternative energies,
nonpetroleum alternative materials,
From survival to growth
devices, diagnostics, nonpharmaceutical,
health, beauty and wellness areas, enabling
technologies.
All of those areas have significant impacts in
some, or in some cases many, of our business
areas. By educating the venture community
about what we’re looking for, we can gain
access to their portfolio companies.
Also, companies that may come across their
desks, that they may choose not to invest
in, could be of interest to us. Developing
relationships that allow that sort of
information flow is important to us — we want
a two-way street dynamic that allows those
VCs and the portfolio companies to better
tailor what they’re doing.
Companies sometimes come along that have
a technology that is of interest, despite it
not being directly related to our business.
For example, with biofuels. We do not
work in fuels. But we are heavily involved
in the purchase, and use of, materials in
which ethanol and diesel are involved as
intermediary molecules. That means we’re
interested in these biofuels companies for a
different reason than that originally intended —
but we can still add value.
We want to be the partner of choice for the
VC community. We want people to think
of us both because of the integrity of our

collaboration and the way we choose to do
business. Even if a VC isn’t directly interested
in a company it becomes aware of, we want it
to think of us and pass the company across if
it thinks we might be interested.
Ernst & Young: What are some of the plans
and programs that you have in development
at P&G to access the VC community and
create those effective partnerships?
Steve Meller: We have a variety of things in
place already today, both organizationally
and connectivity-wise. We have a very robust
external business development organization
of 40–50 people who are experts at
connecting with outside companies, as well
as building relationships within our company.
We’ve been building that network for around
a decade. That’s an avenue for us to get
the message out. The same thing is true in
the R&D organization as we continue this
connect-and-develop approach that’s been
successful for us.
There is also a similar group or network of
people — about 30 to 40 or so — in different
parts of the world whose full-time job it is
to be out there creating and maintaining
relationships with all aspects of the part of
the world they’re operating in.
One of the things we’re doing at the moment
is really spending time shaping what our
“Last calendar year, there were about 3,700 specific
opportunities that came in through the portal, and we have
some very specific ways we go about assessing and evaluating
them in a systematic way within the company.”
message track is, asking “How do we want to
interact with venture capitalists and SMEs?“
We’re developing forums and open days to
allow us to interact with the communities
we’re looking to work with, along with some
really good web portals that bring people into
our world and allow them to see what
we’re about.
As each year has gone on, we’ve had
significant success. Last calendar year, there
were about 3,700 specific opportunities
that came in through the portal, and
we have some very specific ways we go
about assessing and evaluating them in a
systematic way within the company.
Ernst & Young: On the other side, how are
you making technology developed inside P&G
available to the venture and private equity
communities?
Steve Meller: We have a large portfolio of
patents in the company — roughly 36,000
of them. We certainly don’t use all of those
in terms of their technology and product
development.
For example, we spent some time developing
an alternative renewable material approach
for resins that we called Nodax. We took it to
the point of a proof concept of what it would
do and how it would do it. But we're not a
resin manufacturer.
Global venture capital insights and trends report 2009
So we looked for a partner, and it was sold
to Meridian — a Georgia-based, privately
held company — and Meridian has actually
been developing that technology further for
themselves. It may be something that we
would then ultimately license back as
a fully developed technology in our
product portfolio.
A second example is a recently announced
partnership with ConAgra. We struck a
deal where we shared a whole host of our
packaging, product and material portfolio
with them primarily in the food technology
area. ConAgra can now leverage all of those
individual technologies, packaging knowledge
and expertise within the company, to be able
to further develop their portfolio products.
And again, as we have less of a focus today
in food technology than we have had in the
past, it makes perfect sense to partner up
and leverage what we already have and know
with leading companies out there.
We'll be a part of the continuing development
of those types of relationships — of sharing
things with that community. As we share a
need, we can also be sharing examples of
how we work and the types of opportunities
that we as a company could work at
collaboratively with the venture community. •
37
Perspective of a corporate investor
Interview with Nino Marakovic
Nino Marakovic is the senior vice
president of SAP Ventures, the corporate
venture investing entity of SAP AG. He is
responsible for the worldwide strategy and
overall performance of the venture funds.
Marakovic has a strong track record of
technology venture investing since 1999.
Prior to joining SAP Ventures, he was a
partner with meVC Draper Fisher Jurvetson
and IVF Ventures in Palo Alto.
Nino Marakovic
SAP Ventures
38
Ernst & Young: What are the key challenges
for the VC industry today?
Nino Marakovic: One challenge is this idea of
momentum investing. For example, we might
invest in a feature that’s going to generate
around US$10 million in revenues, which
you can count on selling to some product
or platform company that will absorb that
feature. But the feature by itself could never
really be profitable because you can’t really
build a sustainable business around it. In a
hot market, it’s rational for companies to
pay a significant multiple for it because they
can sell it as part of their platform. But in
times like this, when you have to get your
product cash flow positive quickly to have
a sustainable business model, investing in
these momentum features is just not viable
any more. So I think you’ve got to go back
to basics and really invest in businesses
that have an opportunity to become big,
sustainable, stand-alone companies. And
that’s a skill set and discipline that we haven’t
really seen for a long time.
The need to make the hard calls early is one
of the key lessons I have learned from the
last recession. I had to deal with a portfolio of
30 to 40 companies that had been backed at
the height of the bubble. It’s irrational to keep
doing the same thing and expect a different
outcome, especially in a worse environment.
I think making dramatic changes cutting
From survival to growth
the losers shows your support for the firms
you stick with. It is just the prudent portfolio
approach right now.
Ernst & Young: Do you think that we are
seeing corporates on the sidelines just
because of a belief the valuation is still going
down or is it that there is no rush due to lack
of competition?
Nino Marakovic: It’s both. There is no
urgency. Companies are just running out of
cash. They are going to be cheaper.
I work closely with the M&A team here, so I
get a much closer perspective than most to
one of the key buyer’s mind frames. While
it sounds great that all these companies are
available for half-price, and the corporates
are just there on the left and right willing
to buy companies, the reality is much more
nuanced, and the corporates are not dumb.
They are not going to pay much money for
just a technology without revenue. They
know they are not competing with many
other people right now. They know that
companies are running out of cash and
available for very little.
And there is also the corporate side of the
equation. Don’t forget that half of these
companies’ market caps got cut in half.
They are all cutting budget; they are all
concerned. Internal dollars have gotten much
more expensive, and everything is getting
reevaluated three times from Sunday,
so it’s gotten harder for companies to get
deals approved.
Ernst & Young: How do you view the current
challenges in the exit environment?
Nino Marakovic: The exit environment
question is obviously one of the key issues.
There are two aspects to the story. There is
a temporary exit environment issue — the
fact that we are obviously in a recession
and there is a dramatic downturn in public
market valuations, which affects exit
expectations, both on the M&A and IPO side.
But I expect that to be temporary — around
two years or so. I am more concerned about
the permanent structural changes in the
exit environment affecting the venture
market. There is the general issue of what’s
happening with the investment banking
industry and the whole support system
around raising capital and underwriting
IPOs, providing research so that institutional
investors can actually buy some of these
companies.
Ernst & Young: How do you think the
industry will change, or should change, so
that when we work through the current
problems, there is still a working banking
infrastructure?
Nino Marakovic: First, there’s going to be
a hole for a couple of years in the analyst
coverage, in investment bankers interested multiple exit, you’ve basically got to become
and willing to visit start-ups and do business a big company.
with them, and in terms of interest from
The last implication is that VC is just
institutional investors in buying into any
incredibly expensive right now. If you look at
kind of new market issue below a certain
what the demand and return expectations
threshold in revenue and significance. Over
are for some of these bonds — relatively safe
time, I suspect that the large players will be
bonds — then look at the required return to
somewhat marginalized and a new set will
invest in something with the risk premium of
evolve, much like it did 20 to 30 years ago.
VC, it’s just incredibly expensive right now.
Big banks never used to pay attention to
small start-ups. It’s going to be the new set What does all that mean? It means you have
of small boutique players that are going to to get invested at much lower valuations. You
build up the capability to support the small absolutely have to invest in more capital-
businesses. But it will take time. efficient models. The idea of relying on
others to give your company more money
The other thing is just as bad, if not worse.
just to keep growing profitably is just not
The buyer universe has just shrunk. A whole
appropriate any more. It means generally
set of buyers who could pay US$100–
pursuing a more conservative growth path,
$US300 million for a start-up company has
meaning getting cash flow positives from
gone. That’s the other structural issue that
existing money and growing profitably,
I think is going to take a little bit longer.
rather than relying on outside capital.
And in conjunction with that, there’s got
Fundamentally, it’s going to be much more
to be a healthy IPO market to entice the
important to be frugal and not necessarily
strategic buyers to actually pay more for
be as fast to market. That’s okay in this
these companies. Because if an IPO is not an
environment because if your competitor is
alternative, there is a limited set of buyers,
not strong financially, it won’t be in the
and they can afford to wait and pay less.
race either. •
Another key challenge is tied to liquidity:
you can pretty much count on liquidity
requirements going up. In terms of size
required to exit to meet somebody’s
threshold, and for you to put money and get
a decent multiple return on a low-revenue
Global venture capital insights and trends report 2009 39
Perspective on biotech
Interview with Alex Barkas
Alex Barkas is a managing director of
Prospect Venture Partners. Prior to
cofounding Prospect Venture Partners, he
was a partner at Kleiner Perkins Caufield
& Byers from 1991 to 1997, focusing on
healthcare-product company investments.
Previously, Barkas was a founder and CEO
of BioBridge Associates, a healthcare
industry consulting firm.
Alex Barkas, PhD
Prospect Venture Partners
40
Ernst & Young: How do you view the current
difficult exit environment?
Alex Barkas: In biotech specifically — and
it’s also true in medtech — we are actually
continuing to see a robust environment in
terms of M&As and the opportunities for
both deal-making and exits. Historically, most
biotech companies went public initially, and
maybe some time later were involved in M&A
activities. The direct path to M&As for private
companies, as well as for public companies,
is a relatively new phenomenon in biotech.
And it’s one we find to be a very significant
positive for both the biotech industry and for
the wider venture industry.
This is a reflection of the fact that the big
companies have recognized that gaining
access to a highly productive biotech R&D
engine is actually very much in their interests
relative to the inefficiencies they’ve seen in
their own internal R&D organizations.
Ernst & Young: A lot of great venture-backed
companies have been founded in downturns.
Where do you see the potential for great
future companies to be funded initially at the
present time?
Alex Barkas: I don’t know whether I could cite
you the statistics on when great companies
were started, but it’s very rare that you know
they are great when you start them.
From survival to growth
It sometimes seems as if companies emerge
from obscurity and all of a sudden, they
get very interesting to people. You need to
ask what companies are going to be game-
changing. You will discover that they are out
there and were started a few years ago. We
try to have some of those in our portfolio.
Some of that is luck; some of it, we hope, is
related to the processes that we have in place
to try to identify them.
At the same time, there are opportunities
to deploy capital right now that are
extraordinary because there are an awful
lot of companies that need to finance, and
valuations are likely to be very attractive for
the near term and maybe longer. We think
there are really good opportunities to identify
companies, some of which may be the real
thought leaders and industry leaders of the
future and some of which will just be great
investments. We are definitely screening to
find both kinds of companies.
In terms of where there is going to be real
excitement and enthusiasm going forward,
from an investor standpoint, later-stage assets
are quite interesting to people. But later-stage
is an interesting concept because people
tend to think that must mean they are close
to profitable or they are about to get their
product approved. I think what it really means
is they are about to get to a value inflection
point where people will be more likely to
recognize the value in those companies.

That can happen at varying points along
the way. We think, for example, that there
is going to be real excitement in the whole
area of genetics and genomics again. You
may remember that in the 2000 time
frame, there was huge interest in the human
genome. For the first time, we sequenced a
human genome, and that was very exciting
to people. Since then, there have been a
dozen or so additional genomes sequenced,
and we are now going to move into a period
when, over the next five years, there may be
a million genomes sequenced. Obviously, the
companies that are involved in doing that,
at all levels, are going to push forward the
frontiers of our understanding of the genetic
basis of disease enormously.
There are going to be multiple winners
in that space: the people who are providing
the technology for sequencing, the people
who are interpreting the results and the
people who are applying that to a new
generation of interventions and therapies.
So we think that is an important area in
medicine going forward.
There is an interesting set of private
companies right now that is coming
up on the radar screens of the bigger
companies. Medtronic has announced a
couple of acquisitions of development-stage
companies. Why were they interesting?
They were interesting because they were
converting an open surgical procedure into a
“As consolidation occurs and as people in the large
companies recognize they can’t even afford the pipelines
they have, they are going to be divesting things that will
represent really interesting opportunities when combined
with the right teams.”
minimally invasive procedure. And we have from the standpoint of balancing the asset
companies in our portfolio that we think classes they are going to have to work
are going to do that for important areas in through. I expect that’s going to get worked
spine and in cardiovascular. There is a better through this year. What kind of environment
understanding of where optimum points we encounter after that remains to be seen.
of intervention are likely to be and what
There are going to be very attractive
things may work in the future. There are a
opportunities to deploy fresh capital in the
lot of creative engineers out there who are
venture business because valuations are
designing next-generation devices to take
going to be particularly attractive going
advantage of that.
forward. There are some very experienced
As consolidation occurs and as people in the teams of people out there who are quite well
large companies recognize they can’t even equipped to deploy that capital efficiently
afford the pipelines they have, they are going with the likelihood of good returns. I do think
to be divesting things that will represent it’s often at this point in a cycle when the best
really interesting opportunities when returns can be generated. •
combined with the right teams. Creative
kinds of spinouts and restructurings of
various kinds, we think, are also going to be
an interesting area for investment.
Big pharma is actually focusing its efforts
toward some areas and away from others.
There will be opportunities to take advantage
of that, and partnership with the big
companies will be possible.
Ernst & Young: From a VC industry
standpoint, what are the biggest
challenges now?
Alex Barkas: There are both short-term and
long-term answers. I think in the short term,
limited partners are still trying to calibrate, to
understand what they have in their portfolios.
They are under various kinds of pressure
Global venture capital insights and trends report 2009 41
Perspective on US cleantech policy
Interview with Timothy Urban
Timothy Urban leads the Washington
Council Ernst & Young energy practice
and has represented a variety of clients
on energy issues, including tax credits
for electricity from renewable resources,
investment incentives for purchases of solar
energy property, production tax credits
for biodiesel and proposed incentives for
investment and production associated with
cellulosic biomass ethanol. He has played a
key role in developing renewable energy tax
policy and working with Congress and the
administration to enact energy legislation.
Timothy Urban
Washington Council
Ernst & Young
42
Ernst & Young: What is your assessment of
the American Reinvestment and Recovery
Act (ARRA) in terms of its impact on
innovative cleantech companies?
Timothy Urban: The ARRA has the potential
to be game-changing for some cleantech
industries. There are certain groups of
companies and industries that really came
out with significant benefits in this bill.
However, there are many other important
issues that were put off until future
legislation.
First of all, the enactment of H.R. 1 should be
seen as merely the first prong of what I think
may be two years of a steady consideration
of various legislative vehicles. In terms of
cleantech, this bill focused largely on green
electricity. It does delve into the many
pressing federal policy issues related to
biofuels or sustainable bio-based materials.
So I think that there is much yet to come.
This is merely the first instalment.
The ARRA contains a couple of noteworthy
changes to the US Internal Revenue Code.
It contains a provision called the Credit for
Investment in Advanced Energy Property.
This provides a 30% investment tax credit for
advanced energy manufacturing property.
These would be assets that a manufacturer
would purchase when building a new plant,
for example, to make solar cells, wind turbine
blades or impellers for use in a hydroelectric
facility. It’s a very significant piece of
From survival to growth
legislation because it’s a manufacturer’s
credit for purchasing assets used in
manufacturing.
If you think about the way our current
tax incentives for renewable energy are
structured, we usually provide either
production credits for the generation of
the energy or investment incentives for the
purchase of assets. The Credit for Investment
in Advanced Energy Property is different
because this is investment in the upstream
assets that manufacture the property, the
various large pieces of equipment that
are then used by the firms who build the
renewable energy facility.
This provision is important because cleantech
and renewable energy are among our
significant potential areas for business
growth nationally, even in the current
recession. And what we are finding is that
a lot of the individual pieces of equipment
that are required to build a renewable energy
facility are being built overseas. Anything
that we can do to maintain our domestic
cleantech equipment manufacturers or
attract manufacturers to establish facilities
in the United States is obviously a priority for
our lawmakers and something that should be
encouraged.
To obtain the credits, taxpayers will have
to file an application with the Treasury
Department, and the proposal has to fit
within the various criteria named in the

statute. There is only just over US$2 billion
worth of credit available to be allocated, so
not every applicant will get the credits, and
there is a process by which the Department
of Energy and the Department of Treasury
will filter the applications and try to identify
the ones that provide the most public benefit.
Ernst & Young: What about the more
traditional tax equity provisions?
Timothy Urban: The ARRA also reflects
the Obama administration’s work with the
Congress to try to rescue the renewable
electricity developers from the almost-
complete doldrums the industry had
encountered during the last quarter of 2008
due to the lack of tax equity financing.
Renewable energy developers found
themselves in very difficult times because
all of their development plans relied upon
the appetite of large investment banks and
other entities for their tax credits — many
of these institutions were now distressed
or worse due to the financial crisis. The
development of wind facilities, large utility-
sized solar facilities and other major projects
almost ground to a halt. There were still
some entities interested in pursuing these
transactions, but the terms in which they
were willing to engage to get the credits
were actually much less beneficial to the
developers.
“When there are these relatively short-duration provisions,
the technologies that lend themselves to being erected in
a hurry within a year or two tend to soak up all the
tax incentives.”
As a result, the administration, the House
and the Senate were besieged by renewable
energy trade associations and their member
companies who were making the point that
the collapse of the tax-equity monetization
process had essentially defeated the intent
of the very significant extensions of the
renewable energy credits approved by the
last Congress.
Early in the year there was a long and
protracted discussion between the new
administration, the House, and the Senate
energy and tax committees. In the end,
the conference report they agreed to was
actually very thoughtfully conceived, and
it stands to have a pretty dramatic effect
in terms of rescuing renewable electricity
development here in the United States.
What they did first was to allow taxpayers
who were developing renewables facilities
to elect to take either the Section 45 credits
that they would be generally eligible for or
a Section 48 investment credit. This is very
significant. In so doing, they created tax
parity for the various technologies that are
listed in Section 45(d) — wind, closed-loop
biomass, open-loop biomass, geothermal
energy and incremental hydropower, etc.
Under the Section 45 rules, there are
two tiers of credit rates that have been
the subject of carping from some of the
recipients of the lower level of tax credit.
Global venture capital insights and trends report 2009
This 30% investment tax credit across-
the-board election for all of the eligible
technologies under Section 45(d) put
everyone on the same playing field.
Then the second step of the two-step
process was to create a process that allowed
renewables projects to go forward even in the
absence of a partner willing to monetize their
tax credits. This is the provision that provides
for Treasury grants in lieu of tax credits.
This is a significant departure from current
law and a very dramatic response to the
economic downturn. Without it, there would
have potentially been many credits generated
and no market for them. But this provision
essentially says that if you are eligible and
submit an application to the US Treasury, the
government will send you a check when the
facility is placed in service. This provides a
lot of certainty to the developers and likely
enhances their credibility to “green light”
projects and obtain financing.
Now the next important provision constitutes
a very inspired bit of drafting and something
the administration and the Congress should
be very proud of. They had to grapple with
some way to create technology neutrality,
i.e., find a way to ensure that the provisions
treated the various different technologies
fairly. In its earliest conception, this
refundable credit was envisioned to run for
only two years as a stimulus measure — any
43
 “The take-home point is that this combination of provisions
for renewable electricity developers was far beyond the
normal run-of-the-mill legislative process and that Congress
had to break long-standing tax legislation taboos.”
eligible facility that was placed in service
before 1 January 2011 could receive
a check. There is a problem with this
structure though, because renewable energy
technologies are not monolithic. Their facts
and development timelines are very different.
And as we have seen repeatedly over the
years in the development of federal policy
aimed at renewables, when there are these
relatively short-duration provisions, the
technologies that lend themselves to being
erected in a hurry within a year or two tend
to soak up all the tax incentives. On the other
hand, some of the other technologies — which
may also provide dramatic public benefits
and could constitute significant potential
contributors to our overall energy mix —
miss out. It is very difficult to permit and
build a biomass plant, a geothermal plant
or a concentrated solar facility in two years,
for example.
What the Congress achieved with the Obama
administration in this bill was the creation
of a two-part eligibility period. First of all,
if you place a facility in service in 2009 or
2010, whether it’s biomass, wind, solar, etc.,
you are set. But if you cannot meet these
deadlines and if you begin construction in
that period, you then have a period beyond
44
the end of the window within which to place
the facility in service and still be eligible. So,
for example, if you start a concentrated solar
facility before the end of 2010, you have
until the end of the expiration of Section 48
for solar, which is the end of 2016.
The take-home point is that this combination
of provisions for renewable electricity
developers was far beyond the normal
run-of-the-mill legislative process and that
Congress had to break long-standing tax
legislation taboos. The whole idea of tax
credit refundability is something that most
members find objectionable. Generally,
the idea of providing a grant in lieu of a tax
credit to an entity where there are no taxes
paid is something of which they usually are
tremendously wary. So the fact that they
were willing to go to such extreme lengths to
make this process work again for renewable
electricity producers is, to me, one of the big
stories of this year.
Ernst & Young: There is a tremendous
amount of optimism in the community
about these developments — how soon
are companies going to be able to take
advantage of them? How soon are they are
going to get rebates, checks or be able to
apply for these credits?
From survival to growth
Timothy Urban: Regarding the renewable
electricity credit, there is going to be a
certain amount of lag time, not because the
system isn’t working but because it takes a
while to take a renewable facility that’s on the
drawing board and place it in service.
Now, clearly, there are going to be some
people that are going to qualify under these
programs who are just going to be, frankly,
lucky — they started planning and permitting
some years ago and just happened to fall
within the window.
But the projects that this bill was aimed
at are at least a year or two out. But it
is important that there is a tremendous
amount of green employment and economic
activity that goes into these facilities long
before they are placed in service. There
are contracts that have to be let with
component manufacturers, whether it’s
turbine or windmill blades or solar cells.
There is a tremendous amount of economic
activity that we are hoping will play its part
in reinvigorating our economy. The theory is
that as we vigorously try to ramp up these
green, cleantech manufacturing jobs, to
some degree, these high-wage jobs may be
able to replace jobs that are going overseas
and jobs in sectors in which the US may no
longer be as competitive. It’s very important
that green manufacturing, green facility
development, the green economy in general,
pick up the slack from these other industry
areas that we may never get back.
Ernst & Young: Cap-and-trade is currently
on the legislative agenda. What are the
dynamics of the policy debate related to
putting a price on carbon, whether through
cap-and-trade or a carbon tax?
Timothy Urban: While different groups have
very different objectives, the majority of
business people just want some clarification
around the issue — they want to know what
this is going to cost.
The challenge that is usually thrown at
the carbon tax option is that our scientific
knowledge of greenhouse gases and
greenhouse gas reduction is terribly limited
right now. It is hard to believe that any gifted
group of scientists, academics and lawmakers
could somehow come up in advance with a
magical carbon tax rate number that would
then generate a certain desired empirical
reduction in the gas. Thus, the main critique
of the carbon tax proposal is that we may
very well set a carbon tax, only to discover in
the end that the realized reductions resulting
in the tax are insufficient to achieve the States participation in multinational
environmental goals. summits, the initial signals from the Obama
administration indicate that they want to
The sponsors of the cap-and-trade approach
have a very active international role. It’s not
point to the fact that a cap-and-trade regime
clear whether Congress will approve a climate
can be better structured to achieve a specific
change this year, or whether our new and
environmental benefit. You enact a system
more aggressive participation in upcoming
that will automatically continue to adjust the
international climate change summits could
cap until you obtain the desired reductions
end up catalysing our legislative process. •
in greenhouse gases. And so this option may
be more appealing to the environmental
advocacy groups, because their objective
may be to reach some targeted goal.
The counter-argument from some in
the business community is that that an
unchecked cap-and-trade program could
inadvertently create unforeseen and
damaging economic impacts. One of the
things that I consistently hear from domestic
manufacturers is that, if we unilaterally
impose a strict cap-and-trade program on
American manufacturing while leaving other
similar operations sited in other countries
relatively untouched, we may possibly drive a
lot of our manufacturing capacity offshore.
The one important dynamic I will point to is
that while the Republican administrations
were very cautious on greenhouse gas
measures, especially with regard to United
Global venture capital insights and trends report 2009 45
Perspective from the United States
Interview with Jeffrey Glass
As a managing director at Bain Capital
Ventures, Jeffrey Glass focuses on
wireless, digital media and consumer
marketing technologies. Prior to joining
Bain Capital, Jeff was president and CEO
of m-Qube, a Bain Capital Ventures
portfolio company recently acquired by
VeriSign. In 2006, Jeff was voted
Ernst & Young Entrepreneur Of The Year®
in New England and named to the Boston
Business Journal’s “40 under 40” list.
Jeffrey Glass
Bain Capital Ventures
46
Ernst & Young: How do you view the current
difficulties in the exit environment?
Jeffrey Glass: I think it is important for folks
to distinguish between the different impacts
of the poor exit climate and the overall
slowing economy on venture capital.
With respect to the slowdown in M&As and
the shutdown of the IPO window, the lack of
a supportive exit environment certainly has a
negative impact on venture, but not a lethal
one for well-capitalized, strong companies.
It slows down the time to exit, which has a
negative impact on Internal Rates of Return
(IRRs). But that alone does not negate the
fact that even today, amid all the chaos in the
world, there are transformative companies
being started right now that in several years
will create tremendous equity value.
The companies that should be exiting today
were created four to eight years ago. At that
time, no one could have known that when
they were mature and ready to go public or
to be acquired, we would be in the middle
of a really tough time right now. Similarly,
markets were hot the last few years, and
there are a lot of companies that had great
exits during those years that benefited from
market conditions you couldn’t have forecast
five years or seven years earlier.
From survival to growth
I really believe that venture capitalists can’t
be in the business of forecasting the capital
markets but need to stay in the business of
identifying great entrepreneurs and emerging
markets and providing patient capital and
sensible advice to bring those two together.
The companies that should be exiting right
now have built good business models, they’ve
got strong intellectual property and they will
use this market to get stronger. While it may
or may not have a negative impact on their
IRRs, depending on how long things stretch
till they see liquidity, they will ultimately in a
binary sense still be successful.
For early-stage companies, it becomes more
important than ever to be well capitalized
and not to depend upon being purchased in
a pre-profitability state — this is always good
advice. But as sales cycles get stretched out
and revenue plans get delayed, it has a cash
impact, and most venture-backed companies,
at least at the early stage, are not profitable.
So it’s all about cash. You have to be more
prudent than ever because that cash is either
more difficult to come by or more expensive.
There is a tendency to think that everybody
needs to cut their burn and hunker down. For
some companies, that’s true. But for others,
the downturn is clearly an opportunity to
gain ground on their competitors. For a

small early-stage company, a handful of new
customers can be all the difference between
a bad year and a great year, an unprofitable
business and a profitable one. I think the
seasoned venture capitalists are working
even harder right now to figure out which of
their companies should get more aggressive
and which ones should take costs out.
Ernst & Young: What advice are you giving
to your portfolio companies?
Jeffrey Glass: Build a company-specific
strategy, not a generic strategy based on
everything you read in the newspaper. For
some companies, the right strategy is to get
more aggressive — take more money, even
at a higher dilution, because you can really
accrue value. Others haven’t figured out their
business model and might be a little bit ahead
of themselves with respect to spending.
That’s generally a bad thing to do, regardless
of the economy, but the cost of being wrong
right now is even greater because the cost of
capital is higher. Those companies really do
need to hunker down.
Investments should be thought about with
respect to the value creation expected versus
the cost of capital. In some ways, it’s a very
simple formula, but more attention is being
paid to it now because of the bad market
“Venture capitalists are working even harder right now
to figure out which of their companies should get more
aggressive and which ones should take costs out.”
conditions and difficulty in raising funds. You The interesting opportunities are related
need a higher hurdle rate with respect to how to the characteristics of the businesses,
much value creation you will get from that irrespective of industry. To the extent you
incremental fund raising. are selling a product based on ROI and/
or cost savings as opposed to a new way
In difficult times, all business decisions get
for somebody to spend more money, you
harder to make. Everybody becomes more
certainly have an easier pitch. We see it
cautious and thresholds are higher. The same
in digital. We see it in healthcare where
is true for venture-backed companies. The
companies are building solutions to help
threshold is higher on whether we should hire
healthcare providers bring cost down. We
that incremental couple of engineers to build
see opportunities for companies that are
out that new product idea. We think it will be
building solutions to threats in both physical
big, but who knows? The cost of capital has
and digital security. We even see it in
risen so we want to make sure that our cash
infrastructure software where real ROI has
lasts just a little bit longer. That is true for all.
never been more valued by enterprises.
An area that I always focused on as an
I feel a little reticent to say this, but I feel
entrepreneur and now push my portfolio
very fortunate and optimistic to be a venture
companies on is to make sure they are at
capitalist investing right now. I certainly
the top of their game from an execution
prefer to be investing in these current market
standpoint and are really able to succinctly
conditions than at the top of the market.
and precisely prove why their product or
We are not always perfect, but we try to be
service has ROI/economic benefit. Companies
grounded in good times and bad times. •
or consumers aren’t willing to take many
fliers in the current economy.
Ernst & Young: Many great venture-backed
companies were founded during down
economic periods. What segments today are
most likely to generate new market leaders?
Jeffrey Glass: I don’t think the right way to
think about it is on a sector or industry basis.
Global venture capital insights and trends report 2009 47
48 From survival to growth
 Contacts
Ernst & Young Global Venture Capital Advisory Group
Global Gil Forer London +44 207 980 0170 gil.forer@ey.com
John de Yonge New York +1 201 872 1632 john.de_yonge@ey.com

Americas Bryan Pearce Americas +1 617 585 0499 bryan.pearce@ey.com

Rebecca Fitzgerald Northeast +1 617 585 1924 rebecca.fitzgerald@ey.com
Rene Salas Mid-Atlantic +1 703 747 0732 rene.salas@ey.com
Michael Schoenfeld Southern California +1 213 977 3611 michael.schoenfeld@ey.com
Jeff Grabow Silicon Valley +1 408 947 5607 jeffrey.grabow@ey.com
Rex Holmes Texas +1 713 750 1265 rex.holmes@ey.com
David Boomer Canada +1 613 598 4354 david.j.boomer@ca.ey.com

China Robert Partridge PRC/Hong Kong +852 2846 9973 robert.partridge@hk.ey.com

Ringo Choi PRC/Hong Kong +86 755 2502 8298 ringo.choi@cn.ey.com

Europe Julie Teigland EMEIA/Germany +49 621 4208 11510 julie.teigland@de.ey.com

Petri Ojala Finland +358 9 1727 7613 petri.ojala@fi.ey.com
Philippe Grand France +33 4 7817 5732 philippe.grand@fr.ey.com
Matt Keson-Lee Switzerland +41 5 8286 3336 matthew.kesonlee@ch.ey.com

India Sanjay Chakrabarti India +91 22 4035 6650 sanjay.chakrabarti@in.ey.com

Israel Oren Bar-on Tel Aviv +972 3 568 7102 oren.bar-on@il.ey.com

Global venture capital insights and trends report 2009 49

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