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Is Everything Going to be OK?
The new reality,
and its implications for private equity
Bruce Rothney
Managing Director
October 30, 2001
RBC Capital Markets
Extensive Corporate Relationships
Pro-AMS Trust
Focused and Credible Research
80 analysts covering over 800 companies
30 analysts covering technology and communications
Ranked #1 Overall by Canadian Fund Managers
- Reuters Survey 2000
Ranked #1 for ideas and #3 for quality by US investors
- 2000 Greenwich Associates Survey
Top M&A Advisor
“RBC DS, the best domestic M&A
house in Canada” - Euromoney 2000
Results in 2000:
• advised in 14 of the 20 largest
transactions involving Canadian targets
• eighth ranked advisor in North American
Technology and Communications M&A
One of North America’s leading growth investment banks
RBC Capital Markets
Combined North American Retail Sales Force:
Investment Advisors:
3,772
Total Assets Under Management:
US$168 Billion
Largest Canadian Retail Distribution
Network
Retail Assets
Under Management
(C$ Billions)
Comparison of Canadian Investment Dealers
Number of
Retail Brokers
$120
1,800
$100
1,500
$80
1,200
$60
900
$40
600
$20
300
$0
0
RBC DS
BMO Nesbitt
Burns
Merrill Lynch
Canada
AUM
CIBC World
Markets
Scotia Capital
TD Securities
Brokers
Expanding North American Retail Distribution Capabilities
RBC Capital Markets
KBI Banking
RBVI
RBC Cap Partners
RBC Capital Markets
EPPG
Provide
seed capital
Start-up
Provide
venture
capital &
merchant
banking
Growth
Place
equity
securities
with
institutional
investors
Expansion
Manage
entrance
into public
equity
markets
IPO
Provide
comprehensive
follow-on
support
Issue
follow-on
equity & debt
securities
Mergers &
Acquisitions
sell-side/
buy-side
Research
& Trading
Addl. Public
Financings
Advisory
RBC Financial Group - Life cycle approach to financing
The Bubble has Burst - Then and Now
Then

Real economy captivated by technology





Limited (or negative) growth in IT spending


Public/private take-out “Bubble”
Virtually unlimited new VC capital formation


Moving from bricks to clicks
Tremendous IPO & M&A returns


Now
Exit opportunities are limited


Billion dollar funds
New VC’s entering the game

Corporate investment arms established
Crossover funds played the quick flip

Thousands of VC funded technology and
communications companies


Collapse of unrealistic growth expectations
Only experienced VC’s can raise capital


Telecom spending at support levels
Some funds completely written off
Some VC’s are in survival mode
Corporate investment arms are reducing or
eliminating their investment activity
Crossover funds are focused on public
market opportunities, if anything at all
Investment levels have returned to prebubble levels
What a difference a year makes
Then
Dogbert Venture Capital
The Latin word for
“close your eyes and open your mouth”
is prospectus
Now
Nortel Picnic
The picnic’s over
The New Reality
U.S. Investment Returns (as of June 30, 2001)
Fund Type
3 Mths
Early/Seed
Balanced
Later Stage
Buyouts
Mezzanine
All Private Equity
6 Mths
1 Year
3 Year
5 Year
10 Year
20 Year
(3.3%)
(2.6%)
(2.7%)
2.2%
0.0%
(14.3%)
(13.6%)
(11.3%)
(1.7%)
2.6%
(20.6%)
(16.1%)
(16.3%)
(7.2%)
20.8%
81.4%
46.3%
28.3%
6.1%
11.0%
55.1%
35.5%
24.6%
11.9%
11.3%
34.5%
24.7%
25.4%
14.4%
12.2%
22.4%
16.6%
17.4%
16.5%
11.6%
0.4%
(6.0%)
(11.3%)
20.1%
21.7%
20.2%
17.8%
Source: Venture Economics & National Venture Capital Association
Industry
Communications
Computer Related
Internet Specific
Biotech/Pharmaceuticals
Medical/Health
3 Mths
(7.0%)
(0.6%)
(8.2%)
3.3%
3.7%
1 Year
(38.3%)
(12.1%)
(27.7%)
12.4%
(6.3%)
3 Year
69.7%
7.3%
35.7%
60.6%
12.9%
5 Year
43.4%
0.6%
33.8%
42.5%
12.6%
Source: Venture Economics & National Venture Capital Association
* Based on returns from venture capital funds with 60% and above concentration in a particular industry
Returns are down significantly
The New Reality
U.S. Exit Summary of VC-Backed Companies (as of June 30, 2001)
# of Exits
500
486
391
400
295
274
300
$92.1
$100.0
533
160
200
100
Value of Exits (US$ B)
600
$80.0
$55.9
$60.0
$40.0
$20.3
$12.7
$13.0
$10.7
$20.0
$0.0
0
1996
1997
1998
M&A
1999
IPO
2000
YTD 2001
1996
1997
1998
M&A
1999
2000
YTD 2001
IPO*
Source: Thomson Financial/Venture Economics & National Venture Capital Association
* Value of IPO based on shares offered
M&A is currently the only available exit
The New Reality
U.S. VC Fund Raising
$180.0
Funds Raised (US$ B)
$150.0
$120.0
$90.0
$60.0
$30.0
$0.0
1990
1991
1992
1993
1994
Venture Capital
1995
1996
1997
1998
1999
2000 2001*
Buyout/Mezzanine
Source: Thomson Financial/Venture Economics & National Venture Capital Assoc.
* 2001 figures have been annualized based on six months figures to June 30, 2001
Experienced VC’s continue to raise capital
The New Reality
Canadian Investments (as of June 30, 2001)
$7
1600
1400
$6
1200
1000
$4
800
$3
600
# of Companies
Investment (C$ B)
$5
$2
400
$1
200
$0
0
1998
1999
2000
Capital Invested
H1 2000
H1 2001
Companies Funded
Source: Macdonald & Associates Limited
Canadian investing ahead of 2000 pace, for now
The New Reality
U.S. Investments by Quarter (as of June 30, 2001)
$35
2000
1800
$30
1600
1200
$20
1000
$15
800
# of Companies
1400
600
$10
400
$5
200
Capital Invested
Q2 2001
Q1 2001
Q4 2000
Q3 2000
Q2 2000
Q1 2000
Q4 1999
Q3 1999
Q2 1999
Q1 1999
Q4 1998
Q3 1998
0
Q2 1998
$0
Q1 1998
Investment (US$ B)
$25
Companies Funded
Source: National Venture Capital Association
The U.S. reverts to early 1999 levels
What Does this Mean for Great Private Companies
Difficult times often produce opportunities

1972/73 - Intel

1985/86 - Microsoft, AOL, Apple

1990/91 - Oracle, Cisco
Criteria for success

Cash, patient investors, great fundraising capability
 Far easier to find “pile-on” money than lead investors

Partnerships / alliances

Management

Real markets / lead customers

Self evident value proposition
 lower capital cost, reduce operating expenses, increase efficiency………
Reduced investor returns means competing for less capital
What Does this Mean for Great Private Companies
Industries going “no-bid”

Anything “dot com”

Photonics

Travel related
Industry Opportunities

Energy and power technology

Life sciences

Other leading edge technologies, like quantum computing and nanotechnology
What was hot, is now not
What Does this Mean for Great Private Companies
Terms of Investment
1999/2000
2001
Purchasers
Mostly new investors
Requires significant support from existing investors
Valuation
Multiple of revenue / engineers
Cashflow based (down-rounds and performance ratchets are
commonplace)
Offering Size
Often larger than originally planned for, with no identified use
of proceeds for the additional amount
Shrinking in absolute terms, but increasing in percentage
terms as valuations fall
Lead conditional on hitting minimum to meet plan
Liquidation Preference
Last money in, first money out
Double or triple dips (or more)
Liquidation Event
At value less than purchase price
Any event
Anti-Dilution Clause
Weighted average
Full ratchet
Protective Provisions
On senior and par security issuances
On debt, asset sales, capex and operational decisions
Board Representation
Membership
Control
Option Dilution
On existing options
On options to be issued
Investor Returns
As converted to common
Guaranteed return to IPO (2-3x)
Purchase Rights
First offer
First refusal (trump right)
President's List
No mention
Right to direct pro-rata share
The investor is clearly in the driver’s seat
Implications for Angels
Definition for success

Same goals, different scale
 Returns in line with historic levels

Emphasis on acquisitions
 Private to private deals and roll-ups

Exiting an investment in years (rather than months)
How should Angels and VCs behave?

Take their time - cash is KING

Handcrafting companies - less capital, more time

Low entry valuations

Conservative milestone phased funding structures

4 to 7 years to liquidity

Less deals started, more time to effect each one
Everyone can’t be Barry Bonds
Implications for Angels
Many VC’s are fully invested with no liquidity in sight

U.S. finds who gorged on dot coms are suffering

Canadian funds who filled up on photonics have limited options

Angels can play a more prominent role in building/funding promising management teams
VC Firms are being very conservative with respect to investing in new names

Focused on existing portfolio - protecting their best companies

Increased emphasis on due diligence

With public markets all but shut down, a strong desire to “keep powder dry” with existing cash
VC’s are facing the same challenges as their portfolio companies

Difficulty attracting new investment

Performance is not meeting previous expectations

Weaker players are disappearing
The venture capital landscape is changing
In Conclusion...
The biggest risk we all face,
is not being willing to continue taking risks
Angels are more important than ever