Review of the Utah 2010 Angel Investor Update – the Power of the Start Zions Bank Founders Room November 4, 2010
Report prepared by Wayne Brown Institute
Sponsors
Utah 2010 Angel Investor Update – the Power of the Start Contents Introduction
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Status of Angel Investing in Utah
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Angel Investor Group Updates:
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Olympus Angels
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Park City Angels
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Salt Lake Life Sciences Angels
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Utah Angels
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WBI Angels
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Addenda – Summaries of Keynote Speeches and Panel Discussions: Keynote –
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Court Coursey, Managing Partner, TomorrowVentures, LLC
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Opening Panel –
The Pitch – Anatomy of a Deal – Matchbin
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Panel 2 –
Government’s Role in Fostering an Angel Environment
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Panel 3 –
The Power and Influence of Super Angels
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Richard Long, Investment Strategy Manager , Contango Capital Advisors
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“Angel Investing – The Challenges and the Rewards,” Ray Freer, Park City Angel Network
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100% Exclusion for Qualified Small Business Stock Jeffrey Davine, Ballard Spahr LLP
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Summary Keynote – Selected Slides – Handout –
“Utah 2010 Angel Investor Update – the Power of the Start,” booklet, containing speaker and panelist bios and photos
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Introduction The “Utah 2010 Angel Investor Update – the Power of the Start” brought together Angel Groups, individual Angel investors and other accredited investors to compare notes, share experience, exchange information, discuss and debate trends, and network. Angel investors – individuals as well as those in Angel Groups – are a potent force in enhancing the health and vitality of the economy. While Angel investment size is smaller than that of venture capital firms, the large number of Angel deals results in approximately the same capital infusion to the national economy: $17.6 billion in 20091. Angels are at the forefront of commercialization. They provide sustenance and guidance to the ideation of entrepreneurs or professors. In the first half of 2010, Angel investment was $8.5 billion, a decrease of 6.5 percent over the first half of 2009. However, the number of ventures receiving Angel funding showed a 3 percent increase over the same period. The combination of reduced total dollars and a slight increase in the number of deals resulted in a decline of 9 percent in deal size, compared to the 2009 report. At the same time, the number of active individual investors was down 11 percent, to 125,100.2 Each of these trends – increased number of Angel deals, reduced deal size, and fewer active investors – can be observed in Utah. However, the number of deals increased by a much higher 67%. Accordingly, even with a reduced total dollar investment, Utah is emerging as the hub of Angel investing in the West. Despite the reduced number of active investors, Angels and Angel Groups play an increasingly important role in the economy of the State of Utah, through aggregation of capital, syndication of capital among Angels, and promoting a more efficient deployment of capital to deserving young companies. Startup and early-stage businesses that have exhausted seed funding from “friends and family” are often dependent upon other investors because they are not yet of sufficient size or profitability to be of interest to typical venture capital firms. Angel investors fill this gap, and at the same time take an active role in guiding and helping an entrepreneur to achieve his or her company’s goals. As a result, Angels and Angel Groups help young businesses to prepare for their next level of financing, improve their viability, and contribute greatly to the local economies in which they operate. In recognition of the continuing importance of Angels and Angel Groups to the Utah economy, the Wayne Brown Institute and its lead sponsor, Zions Bank, organized the Utah 2010 Angel Investor Update. This is the 2nd annual event, following on 2009’s Utah Angel Summit, held on December 8, 2009. The key objectives of this event remain unchanged from the prior year: 1) Educate the Angel Groups on current economic trends as they apply to Angels, and other issues pertinent to improving Angel investing. 2) 1
Jeffrey Sohl, “The Angel Investor Market in 2009: Holding Steady but Changes in Seed and Startup Investments”, Center for Venture Research, March 31, 2010. 2 “Angel Investing Down,” November 4, 2010, Business NH Magazine 3
Document and report the impact of Utah’s Angel Groups. 3) Facilitate networking among the groups and the outstanding speakers and panelists assembled. 4) Promote Angel investing and Angel Groups to the local investment community with an eye to recruiting new members. Angels and Angel Groups from throughout the State of Utah, as well as venture capitalists, private investors and entrepreneurs, were invited to the Utah 2010 Angel Investor Update, held in Salt Lake City at the Zions Bank Founders Room on November 4, 2010. This is a summary report of the proceedings of the event. Keynoting the Summit was Court Coursey, the Managing Partner of TomorrowVentures, LLC, the personal venture arm for Eric Schmidt, Chairman and CEO of Google. Richard Long offered the Summary Keynote. Long is the Investment Strategy Manager for Contango Capital Advisors in San Francisco, an affiliate of Zions Bank. Several panels were organized for the event, and panelists were selected from among the community of local Angels, out-of-state venture capitalists, investors, legislators, regulators, service providers and entrepreneurs. Bios on all speakers and panelists are included in this report.
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Status of Angel Investing in Utah Angel investing in Utah is experiencing some of the same challenges that Angels are faced with in other parts of the United States. The soft economy since 2008 may be one major reason for this, but there are others. Tax policy – both local and national – can signal governments’ support – or lack of support – for the activity of investors. Regulatory action can have a chilling effect on the expansion of individual investment and venture debt initiatives. Kent Thomas, Founder and Managing Member of Advanced CFO Solutions and a member of the Olympus Angels, discussed the pluses and minuses of being an Angel investor in Utah in 2010. He explained that 86 of 134 – or 64 % – of active Angel Group members in Utah have invested at least once during 2010. This represents a decline from 75% in 2009. Number of Investments 5 or more 3 or 4 2 1
Number of Members in 2010 10 10 13 53
Number of Members in 2009 10 19 17 51
The number of active Angels declined from 144 in 2009 to 134 in 2010. Also, the average number of investments from each of those active Angels declined. Further, there were some changes within the Angel Groups, including turnover. So, while active investors in some Groups were up as much as 29%, others were down 25%. Over half of the Angels made only one or two investments in 2010. These trends are reflected in the portfolios, as shown below.
Angel Portfolios Total Companies Invested in: 45 (up from previous average of 27.5) Total Amount Invested in 2010: $6.697 million (up slightly from previous average of $6.234 million) Average Investment Size in 2010: $145,587 (down from previous average of $226,690) Average Number of Investments per Group in 2010: 9.2 (down from previous average of 11) Investment Size: Range = $800 to $1.05 million
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Represented Industries The following industries received Angel funding in Utah in 2010: Internet Web Services Consumer Products Medical Products Apparel
Semiconductor Software Pharma Outdoor Products Biotechnology
Medical Devices Business Services HCIT Seed Fund Media & Entertainment
Drug Discovery Consumer Services BioPharma Food Service/Software Cleantech
Thomas observed that the above list of industries receiving Angel funding has expanded greatly since he founded his company fifteen years ago. At that time, Angels were seen to be investing only in tech, software, life science, and some manufacturing companies. Accordingly, Angel investors continue to play an increasingly important role to a broader range of companies and to the economy as a whole.
Comparative Angel Statistics The following presents and compares Angels’ 45 investments in 35 companies in 2010: Angel Group Investment Activity
2010
Prev. Avg.
Number of Investments in Companies
45
27.5
⇧
Amount Invested
$6,697,000
$6,234,000
⇧
Average # of Investments
9.2
5.5
⇧
Angel Group Investment Size
2010
Prev. Avg.
Average Investment Size
$145,587
$226,690
⇩
Maximum Investment Made
$1,050,000
$833,333
⇧
Minimum Investment Made
$800
$1,333
⇩
Summary In spite of their broadened reach, serving an expanding list of industries, Angel investors experienced a difficult year in 2010. The total number of Angel investors in Utah declined 7%. Angels dropped out and new Angels were recruited into the Angel Groups. So Angels invested in 67% more deals, but the average investment declined 36%. As a result, total investment increased only 7%. Due in part to Angel turnover, Angels in Utah participated in more deals, but in smaller investment sizes. Accordingly, Angels’ contribution to the strength and vitality of the economy has certainly been affected.
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Angel Investor Group Updates This section includes the presentations from six Angel Groups in the State of Utah, each of whom participated in the opening panel discussion: Jill Elliss, Dixie Angels Representing Dixie Angel Chair Ron Metcalf, Jill Elliss reflected on a very difficult year. They had a reasonable year when they came together in 2008, but the succeeding two years have been hard for them and for their “mentor” Vegas Valley Angels in Las Vegas, who disbanded last year following the significant downturn in the Las Vegas economy. At the beginning of this year, needing energy and enthusiasm, the Dixie Angels affiliated with Adam Snow and Mike Christensen of Vision Ventures Capital and Consulting to handle management of the group. Todd Dauphinais, Olympus Angels Todd Dauphinais has just recently taken over leadership with Olympus Angels. He characterizes Olympus Angels as an “open” group, in that any qualified investor is welcome. Several Olympus Angels members are also members of other Angel Groups. They are very interested in new members and are accommodating to any members who wish to be involved with multiple groups. They have a broad view, looking at technology, cleantech, and life sciences businesses. Their approach in the past has been much like other Angel Groups – a “passive” approach to dealmaking. He is hoping to facilitate good deal flow, and to help investors and entrepreneurs in Utah have broad exposure to all the Angel Groups. Martin Frey, Utah Angels Utah Angels is the oldest and most active Angel Group in Utah, serving both Utah County and Salt Lake County. It is unique, in that each member Angel has a minimum $5 million net worth, which makes them unaffected by the recent change in the definition of an accredited investor. Utah Angels has 26 active investors, and they have experienced a slowdown this year, as more people are cautious and thinking of reasons “why not to invest” rather than “why to aggressively put money in.” They continue to actively pursue deals, and they have had a number of opportunities to syndicate, but he believes that they need to do a better job of partnering with other Angel Groups. Utah Angels has also been working on its brand, trying to come up with some standardized term sheets that are entrepreneur-friendly and that have been syndicated
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through some Angels in Silicon Valley. This more standardized process is intended to be less polarizing to investors and entrepreneurs. Also, working with Robb Kunz and the Olympus Angels, Utah Angels organized BoomStartup, using a mentor capital model with ten selected entrepreneurs. More than half of these startup companies have achieved funding, thus far. Andrew Laver, Salt Lake Life Sciences Angels Salt Lake Life Science Angels (SLLSA) has been around for 4-5 years. SLLSA focuses exclusively on medical-related deals. Members have medical backgrounds, including clinicians, scientists, and former and current entrepreneurs in the medical field. SLLSA has 18 members, but several have not made an investment this year. The Group invests broadly within the category, whether health care IT, pharma, or medical devices and services. Mike Florance, Park City Angel Network Mike Florance is on the 6-member Executive Committee of the Park City Angel Network (PCAN). PCAN is about three years old, and has 46 members from Summit and Wasatch Counties. Current activity is characterized as “slower� than previous years, due to tighter pocketbooks and the realization that some follow-on investments are now needed in companies that had received funding previously, between 2007 and 2009. Brad Bertoch, WBI Angels WBI Angels is somewhat different than the other Angel Groups, as they are less structured. There are nine members that are made up of people who have worked with the Wayne Brown Institute in the past and who are very interested in the Utah market. They like to co-invest rather than originate deals. This year, total investment was nearly a half million dollars, ranging from $5,000 to $125,000.
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30 Angel Members (not including guests) – (up from 25 in 2009) 11 Angel Members have invested in 2010 – (down from 16 in 2009) 36% actively investing Number of Investments In 2010
Number of Members
5 or more
0
3 or 4
0
2
1
1
10
0
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12-Month Portfolio Summary: Total invested $540,000 # of investments in companies 4 Smallest investment 25,000 Largest investment 270,000 Average investment per company 135,000
OA Investments Scintilla Mangia High West Distillery Domain Surgical
Industry Communications Software Software Consumer Products & Services Medical Devices
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Established 2007, first investment 2008 46 members (not including guests) – (down from 61 in 2009) 34 members invested in 2010 74% actively investing Number of Investments in 2010
Number of Members
5 or more
5
3 or 4
4
2
3
1
22
0
12
12-Month Portfolio Summary: Total invested $ 1,075,000 # of investments in companies 5 Smallest investment 50,000 Largest investment 700,000 Average investment per company 215,000
PCAN Investments Vutara Panoptic Security Wastewater Compliance High West Distillery Saga Games
Industry Biotechnology Software Biotechnology Consumer Products & Services Media & Entertainment
10
23 members have invested in 2010 – up from 21 in 2009 100% actively investing Number of Investments in 2010
Number of Members
5 or more
2
3 or 4
4
2
4
1
13
0
0
12-Month Portfolio Summary: Total invested $ # of investments in companies Smallest investment Largest investment Average investment per company
SLLSA Investments Thermimage MediPro Pharma Larada Domain Surgical Olive Medical
600,000 5 80,000 185,000 120,000
Industry Medical Devices Pharma Medical Devices Medical Devices Medical Devices
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26 Angel Members (not including guests) – (down from 30 in 2009) 10 Angel Members have invested in 2010 – (down from 11 in the prior year) 38% actively investing Number of Investments in 2010
Number of Members
5 or more
3
3 or 4
1
2
2
1
4
0
8
12-Month Portfolio Summary: Total invested $ 4,027,050 # of investments in companies 24 Smallest investment 800 Largest investment 1,050,000 Average investment per company 167,793 UA Investments Allegiance AlwaysAthletes Bazari Boomstartup Capital 2010, LLC Creative Niche Media Domain Surgical iCount iActionable
Innoventures LenderPayments MediProPharma Mercato Partners NextPages Olive Medical Partner Vision Phonex Broadband
Revinetix Vutara Skull Candy SoukFX Symmetry Wireless Sera Prognostics Thermimage Veritract
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WBI Angels 9 Angel Members (not including guests) – (up from 7 in 2009) 8 Angel Members have invested in 2010 – (up from 7 in 2009) 88% actively investing Number of Investments in 2010
Number of Members
5 or more
0
3 or 4
1
2
3
1
4
0
1
12-Month Portfolio Summary: Total invested $455,000 # of investments in companies 8 Smallest investment 5,000 Largest investment 125,000 Average investment per company 35,000 WBI Angels Investments Catheter Connections Domain Surgical Mangia Matchbin MediProPharma Sendside Venture Diagnostics
Industry Medical Devices Medical Devices Information Technology Information Technology Drug Discovery Information Technology Information Technology
Addenda Summaries of Keynote Speeches and Panel Discussions, Selected slides from “Angel Investing – The Challenges and the Rewards,” Ray Freer, Park City Angel Network, “100% Exclusion for Qualified Small Business Stock,” Summary by Jeffrey Davine, Ballard Spahr LLP
and Utah 2010 Angel Investor Update program booklet, with speaker and panelist bios and photos
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Court Coursey, Managing Partner, TomorrowVentures, LLC Keynote speaker Court Coursey was selected as the keynote speaker at the second annual Utah 2010 Angel Investor Update. He is the Managing Partner of TomorrowVentures, LLC, which is the personal venture arm for Eric Schmidt, Chairman and CEO of Google. Accordingly, Mr. Coursey was invited to share his unique perspective on the role of a so-called Super Angel and the important role investors – and especially Super Angels – play in strengthening the economy. He began his address by sharing a statistic that demonstrates the importance of investors to the strength and vitality of the economy. According to Coursey, it takes the government $1.2 million in investment to create one full-time job, while in the private sector it only takes, on average, $300,000 in investment to do the same. In contrast, in the last 20 months, TomorrowVentures has been able to create one full time job for every investment of $75,000. So whether as an Angel or a Venture Capitalist, investment in business is great for job creation. Background Mr. Coursey describes himself as a serial entrepreneur, starting his first business at the young age of 14, brokering tee shirts to church basketball teams in Atlanta. At 15, his second business was planning and executing childrens’ birthday parties. By the time he graduated high school, he was already making about $50,000 a year. At age 19, while at the University of Colorado, he started a business of buying and selling private airplanes. After college, he ran the gubernatorial campaign for his mentor, raising $6.5 million in six months. He has had a number of successes and failures along the way, but he truly believes the failures were “the best learning experiences.” In 2000-2001, he and a business partner became the business managers of Michael Jackson’s business, overseeing everything in Michael’s life, including agents, managers, and attorneys. However, he chose to leave the entertainer “babysitting” business for other opportunities. He sold his subsequent “buy here/pay here” used car business to a hedge fund in 2007, just prior to the downturn. TomorrowVentures Coursey met Google CEO Eric Schmidt at about that time. Following a number of conversations, Schmidt invited Coursey to set up a new entity that would serve as his direct investment vehicle. TomorrowVentures was created in late 2008, and all of his entrepreneurial experiences have now “come full circle” as he is now “on this side of the table.” TomorrowVentures is very entrepreneur-friendly and takes an entrepreneurial approach to venture capital. While most VCs focus on a specific region, Coursey has no geographic boundaries. Rather, he looks for the best deals, the best management, and the 15
best co-investors, because he truly likes helping other entrepreneurs to be successful and to realize their dreams. Accordingly, in over 20 months, TomorrowVentures has grown into a very mature organization, including 29 portfolio companies in 19 different cities and three countries. These companies employ over 400 full-time employees, and this employment is expected to grow to over 500 by the end of 2010. These portfolio companies have raised over $115 million in outside capital, some of which has come from TomorrowVentures’ network of over 150 co-investors. While TomorrowVentures is a venture capital firm, it is more of a “hybrid” investment firm. It has an incubator that launched this past summer (making investments ranging rom $10,000 to $100,000), early-stage investments (making investments ranging from $100,000 to $3 million), later-stage deals (such as serving as co-lead in the D round for Prosper), and special financial opportunities (which includes everything from opportunistic private equity investments to factoring government receivables to distressed assets. TomorrowVentures invests globally, from a modest $10,000 to as much as $10 million. Themes that have emerged in the firm’s portfolio are specialty finance, media and gaming, and consumer Internet technology, but Coursey describes TomorrowVentures as “opportunistic” and “willing to look at anything.” They focus on companies where they can add value, and companies that are “swinging for the fences, but are real companies, too.” Of great interest is when companies can get cash flow positive. They also look for companies that are “doing positive stuff” in the world. Mentorship According to Coursey, mentorship is often overlooked but is critical in the life cycle of an investment. He observed on a recent State Department tour that mentorship is sorely lacking in other parts of the world, and even in parts of the U.S. It is a big focus in the Bay Area and some other areas in the United States. He suggested that it is may be easy to write a check, and not as easy to give your time, but an investor’s time is significant in making an investment successful. Accordingly, one of the most valuable characteristics of the opportunities they consider is an active Angel who has helped to establish a company and get good systems and processes in place. 70-20-10 Rule Coursey spoke about Eric Schmidt’s “70-20-10” rule – 70 percent of an executive’s time should be spent on his or her core business function, 20 percent devoted to something that is “somewhat related,” leaving 10 percent on something completely unrelated. The 10 percent actually generates some “very cool” business ideas and concepts. For example, Coursey has spent his 10 percent on philanthropy -- developing some very innovative and disruptive charitable opportunities, where he can add not only money, but also intellectual resources, as well.
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Last year, they invested in Citizen Affect, creating “social venture capitalists” to assist small projects throughout the world by bringing other high net worth individuals together “in smaller chunks” to not only fund things like a daycare facility in India but to also help them build out their technology. This year, they are focused on Jumo, a social network geared toward people for philanthropic purposes (founded by Chris Hughes, one of the cofounders of Facebook). People In addition to the big ideas and capital, it all still comes down to people: those whom TomorrowVentures is backing, what they are about, and where they’re going. Coursey gets to work with great entrepreneurs, great co-investors, great partners, and “an especially brilliant capital partner.” And besides generating good returns, he is satisfied that they are doing things that make a difference in the world. Invested businesses help peoples’ lives and give a higher quality of life, which helps with job and wealth creation, and this helps in improving the economic environment. Partnering with Others TomorrowVentures enjoys building on its network of co-partners. They like to work with any group that is doing things that are smart, as this helps in the diligence process. When Coursey works with members of an Angel Group, and sees a deal that has had good Angel investor involvement by someone he knows, it helps the deal. Partnerships are very important at all levels, including banking relationships/venture debt, universities, and venture groups in the U.S. and around the world. TomorrowVentures has a good relationship with Google Ventures, although they do not have any coinvestment to date.
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Angel Panels Excerpts and summaries of comments (refer to bios of each participant in the program booklet)
“The Pitch – Anatomy of an Angel Deal -- Matchbin” The Wayne Brown Institute selected a company that has recently been through the fundraising process and with which numerous Angel investors and Angel groups have been involved and committed. Matchbin is an alumnus of the Wayne Brown Institute’s Investors Choice Venture Capital Conference. Matchbin President/CEO Reed Brown has made his pitch for funding numerous times in the past. However, this time, he was asked to merely demonstrate the process, update the audience on what Matchbin has achieved, and discuss the contributions of numerous Angel and other investors to his young company’s success. Matchbin has gone from Angel funding to Venture funding with a recent up round, which is an achievement in itself during the challenging economic era of 2010. Joining Reed Brown on the panel were Hal Widlansky, Olympus Angels, Julian Castelli, Park City Angels, and Gavin Christensen, Kickstart Seed Fund. The panel moderator was Brad Bertoch, WBI Angels. (All of the groups represented by these panelists were investors in Matchbin.) Reed Brown, President/CEO Matchbin Matchbin helps traditional media companies transform into the new media by selling them a technology platform, creating and hosting their website, and training their editorial staff to be able to publish their local content on both their website and through mobile solutions. Then, Matchbin makes its money when they train these media companies’ sales representatives how to sell the Matchbin portfolio of online advertising solutions to local businesses. Matchbin takes a revenue share of all the advertising that is generated, and their research firm has estimated this as a $32 Billion opportunity. This is a highly leveraged channel model, with each of Matchbin’s media partners acting as channel partners. Matchbin has a sales team, but they are primarily there to train sales representatives of the media partners. Accordingly, there are now “thousands” of sales reps throughout the country who do not report to Matchbin, but who are selling Matchbin’s solutions to all their small business clients. “On average we have a sales leverage of 7.5 to 1, or for every dollar we spend on sales we get $7.50
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back.” This has created very rapid growth. Olympus Angels’ investment in August, 2008, was based on “a belief and a faith,” and this has been rewarded with tremendous growth in the two years since. Mr. Brown hopes – and tells his team – that they will continue to grow 10 to 15 percent, month-over-month. Matchbin’s business model calls for a technology fee, averaging $5,000 for each media partner per year, but the real revenue potential is in all Matchbin’s share of advertising dollars – whether for the small business websites, banner ads, SEM, pay-per-click campaigns, or their just-launched iPhone applications. Matchbin’s investment history, since its founding in December 2003, included the first $2 million from friends and family. After Reed Brown joined in September, 2005, the company went through a period of restructuring. Through early 2008, Reed had raised $2.1 million from some friends and from his own resources – which he called the “Reed Angel Group.” In March, 2008, he presented for the first time at WBI’s The Deal Forum. During the next twelve months, he raised $2 million in a Series A, led by Olympus Angels and Park City Angels. In July of this year, Matchbin closed a Series B round, $5.3 million equity, with Greycroft Partners, vSpring, Level Equity, and some of the Series A investors. In addition, Silicon Valley Bank provided $2 million debt financing – $1 million term loan and $1 million line of credit. Hal Widlansky, Olympus Angels, and Former Matchbin Board Member Hal was very skeptical at first, because of his prior experience, but Matchbin’s story was compelling. This was the first serious due diligence effort for Olympus, involving a number of people who looked into the technology and the advertising model and all other facets of the business. Julian Castelli, Park City Angel Network (PCAN) and Former Matchbin Chairman of the Board Julian was very interested in Matchbin’s model both because of his media experience and because of Hal Widlansky’s “passion” for the deal. He also observed that network economics are expensive, but the Matchbin model offered the opportunity to build a network in a “protected, very local area,” where local media were going to pay to build it, and that they would provide the content and the salesforce and the end customers. PCAN did a lot of due diligence, after which they put together a sizable amount of money to get Matchbin to the next level. Gavin Christensen, Kickstart, and Former Matchbin Board Member Gavin was not involved until about six months after PCAN, but had heard of Matchbin through vSpring. Initially, he loved the business model but was concerned about a few things: Matchbin was still a Nevada corporation, the management team was thin, and the valuation was “pricey” for where the company was at the time. But other investors were starting to commit, so given the risks, “there were a lot of smart people around the table that could figure things out.” In retrospect, the experience and abilities of all of these investors have helped Matchbin to achieve what it has.
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Comments from the panel: The Board Brown: “There is always going to be some interesting tension with the Board on operational things. But what I found with the Board I had was great connections . . .” Perhaps the most important part of who was on the Board is the people they know. Each round of investment and involvement by investors laid the foundation for the next steps, and often introduced Mr. Brown to even more sophisticated investors. “We had to go back to the well multiple times, and Hal and Julian did some influencing.” Christensen: Matchbin had a “fantastic Board,” but one of the challenges was that there were – and still are – a lot of “talkers” on the Board. Due Diligence Widlansky: In the “spectrum of deals,” there are deals that are “clean deals” and Matchbin was not one. They needed to clean up the cap table, cram down the original $2 million in capital and get a single class of stock, and these “were not really simple conversations. But fortunately, we had a sophisticated manager in Reed, who understood where the company needed to get, to be venture fundable.” Cleaning up these issues was a multi-step process, not only to make Matchbin right for the Angel investors, but also to be better prepared for the next round with venture investors. Castelli: “The cash flow is when the tensions came up . . . when you think you’re funded for a year or two and then have to go back to the well.” They got through some “tense times” because the group had Angel networks behind them, and they had networks they could call in, like Kickstart and other VCs. Growing pains were addressed by hiring Advanced CFO Solutions and someone with a good finance background. Widlansky: “There is a reason we didn’t write the check in May. We wrote the check in August. There are problems that are solvable, and there are problems that are systemic and not solvable.” They spent a lot of time looking at this, and it became clear to him that the problems they identified were solvable – “some more painful than others.” The CEO Christensen: Reed Brown was “coachable,” and he “stood up” personally, writing a lot of checks. Castelli: He is an energetic leader, but “it makes a big, big, big difference if the CEO is writing a check, too.” There is something special when someone sacrifices not only their time, but their money as well. It demonstrates their commitment. Widlansky: “It was great that Reed stepped up, because we knew he was the right guy. If it was a guy who did not have the kind of experience like Reed, it could have turned out much worse.” Advice to other Angel investors Widlansky: “Be careful when you volunteer to serve on the Board . . . It takes a lot of time.” Be sure to understand the business, and be prepared to spend a lot of time.
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Castelli: The Board has transitioned three times, so this is a process that requires significant involvement by Angels and other investors. At each stage, you need to do the things that are necessary to get to the next stage. Christensen: With that many Board transitions, it’s really surprising that there have not been lawsuits and other problems, because it seems that everyone continues to be involved . . . “and that’s commendable.” Brown: “You’ve got to have faith in starting a company. . . because there are many ups and downs.” Through this process, he has really found out the importance of the team to make it happen. Transition of the Board Castelli: As Chairman at the time, “it was the Golden Rule – He who has the gold rules.” When someone is asked to put the next term sheet in and have next-level control of financing, they are going to have a seat on the Board, which is appropriate. For Matchbin, both recent investors Greycroft Partners and vSpring have had principals added to the Board, and two others have rolled off the official Board. Accordingly, Matchbin now has a broader number in an advisory capacity. Brown: Everybody who was on the board earlier is staying on as an observer, staying around to help the team. Christensen: Angels need to stay engaged and keep up to date on what is happening at the company. Follow the deal closely, and keep some “dry powder” so cash-hungry entrepreneurs will stay close.
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Panel 2 – “Government’s Role in Fostering an Angel Environment” Richard Nelson, President and CEO of the Utah Technology Council, moderated a panel on the subject of the government’s role in incenting Angel investment. Exploring this topic were panelists Ray Freer, member of the Park City Angel Network, Debra Beresini, CEO of invencor, inc., Senator Wayne Niederhauser, Majority Whip, Utah State Senate, Spencer P. Eccles, Governor’s Office of Economic Development, and Jeffrey Davine, Partner at Ballard Spahr LLP. Mr. Nelson expressed that although the tech industry has partnered with others to achieve their legislative goals, “we now use advocacy in moving issues forward,” and suggested that “if you are in business, you are in public policy.” People in the Angel industry should partner with others to get things done for the State by building trusted relationships with 104 legislators and working with them on other significant pieces of legislation. Ray Freer, Park City Angel Network Ray Freer spoke about the challenges and rewards of Angel investing in Utah. The illiquid and speculative nature of this type of investing, coupled with the long exit horizon, clearly pose the most significant challenges. These acknowledged risks require expectations of high returns. Freer referred to data from the Angel Capital Education Foundation, explaining that returns improved – even doubled -- with industry experience. This is a significant role that is often filled for a young company when an Angel investor joins the board of directors. (Refer to the addendum for selected slides from Ray Freer’s presentation, “Angel Investing – The Challenges and the Rewards”)
Due diligence is perhaps the greatest predictor of a favorable return on Angel investment. Also, higher involvement by the Angel investor – meeting with the entrepreneur one or two times per month – can nearly triple the return, from 1.3 times to 3.7 times the investment. And while Mr. Freer suggests that follow-on investment is not generally advisable, it is sometimes necessary to protect and keep a venture alive, and preserve the possibility of a favorable exit. Mr. Freer also extolled the virtues of Kickstart, which is a seed fund with multiple investments in its portfolio. Consequently, the investments benefit from venture professionals’ substantial due diligence. The “portfolio effect” from a larger number of Kickstart deals reduces from 52% to 39% the expectation of investments achieving less than 1X return. Accordingly, the chances of coming out ahead are much improved. He explained the portfolio effect this way: that the median expected return is 50% higher when the portfolio is increased from 5 to 10 companies, and the median expected return is 100% higher when the portfolio is increased to 20 companies. Typical returns for Angel Groups are symptomatic of the risks involved. Of an average ten investments, five can be expected to be “strikeouts” (using a baseball metaphor) of 22
less than a 1X return. Perhaps three or four will be “hits” of 1X to 10X returns. And only one or two will be “home runs” of greater than 10X returns. In fact, only 7% of all investments account for 75% of returns. Taken together, Angel investments are getting a 2.6X return, with an average 5-year exit, and an internal rate of return of 27%. This compares with S&P returns averaging 14.9%, Nasdaq averaging 13.2%, and hedge funds of 18.7%, among others (see slide). There were 50,000 Angel investors in 2009 who invested nearly $18 billion in startup or seed funding, while 500 venture funds only invested $300 million in seed funding and state funds only provided $500 million. However, Angel investments in these early stage companies declined by 22% in 2009, an “unfortunate” trend in getting needed funding for young businesses, and this trend was continuing in 2010. Trends over the last 3 ½ years show that the number and dollar amount of Angel deals has declined, as has the number of IPOs and acquisitions, all while bankruptcies as a percent of exits has risen sharply, to as much as 40%. In conclusion, Mr. Freer suggested that the State of Utah needs to sustain businesses, because the State’s economy loses long-term benefits when companies relocate. Utah is only 47th in the U.S. in growing and keeping businesses. Angel investment is one of the key ingredients in this process, but Angels are less risk tolerant. Angels and Angel Groups need better underwriting, screening, and deal flow. Mr. Freer suggested the need to better educate entrepreneurs regarding Angel funding needs. Further, he suggested greater Angel participation on state economic advisory boards and he also offered that there is a need to create an angel deals clearinghouse to monitor policy impact. Most important, he recommended that government provide financial incentives to encourage Angel investment. Debra Beresini, CEO, invencor, inc. / International Venture Fund Debra Beresini has had personal experience investing in a number of other states that offer a variety of incentives for Angels – “some very good, some ugly.” She was complimentary of the Angel Group presentations that were made during an earlier panel discussion, saying that there is a “solid foundation” in the Angel community in Utah that she does not see in other states, and this is a “key piece” in growing entrepreneurs and driving job growth. Ms. Beresini explained while in some areas, government incentives for Angel investment are not necessary, these incentives can be very important to achieve strong economic objectives. It is noteworthy that entrepreneurship drives business innovation, business innovation drives job creation, and job creation is very important to our economies. Of 50 states, 21 have some type of tax credit program, varying in size from 10% in New Jersey to 100% in Hawaii. They are applied in different ways, with annual limitations and imposing other requirements on the participating companies.
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This is good news / bad news for Angel investors, depending on who is asked. A tax credit, structured properly, can create jobs and add great value. If not structured properly, tax credits can create problems and division within the investor community. Hawaii, for example, has a population of 1 million people, and 343 companies were started on tax credit money. But only 55 of these companies had any kind of patent or proprietary product or service. Further, only 10 of these realistically had the potential of becoming big businesses. Certain “tax credit funds” were created, and these did not have the venture investors’ same rules or the same goals for the investment. As a result, a number of companies failed, and the venture investors were hurt by the existence of tax credits that were not structured properly. It is important that tax credits, to be effective, must have goals that are aligned with the goals of other players – companies, Angels, follow-on investors, etc. By definition, tax credits can eliminate significant risk, but doing so is not necessarily in the best interest of investors or entrepreneurs. The desire should be to have all parties on the same pathway – all sharing the risk – so that all head for the same light at the end of the tunnel, or strive for the same goal. Another risk of tax credits is creating, in some entrepreneurs’ eyes, an expected cash flow at the end of every year that becomes a personal cash flow budget. And finally, the existence of tax credits often removes the benefit derived from the mentoring of a sophisticated investor. Companies that rely solely on tax credits and not on the experience of Angels or other investors are those that have “no chance for growth.” Ms. Beresini suggested that there are other tools available to encourage Angel investing. Regional websites and networks such as Angelsoft facilitate deal flow. And venture debt is often a possibility. But in all cases, building partnerships with all constituents in the deal becomes ever more important, as Mr. Coursey said in his remarks. Her prescription for success with tax credits: Alignment of goals among all parties, involve all stakeholders in putting a program together, manage expectations (because the “bad ones are going to hit first”), don’t eliminate significant risk, and “talk the same language” so all parties can build businesses and create jobs together. Senator Wayne Niederhauser, Utah State Senate Senator Niederhauser first wanted to review what Utah does, in comparison to other states. In 2008, the State enacted a tax credit where individuals’ capital gains that are invested in small business can be taken as a tax credit in certain circumstances (Utah Code, Sec. 59-10-1022). The Senator suggested that this would be a valuable tool for a small startup company to have this kind of tax treatment for investors. Also, in its last session, the legislature passed a “single-sales factor” for certain companies. Without giving details, he suggested that this single-sales factor provides a significant tax
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advantage to, for example, companies with employees and payrolls in Utah that sell outside of Utah. So to incentivize small business in Utah, he suggests the following: 1. Make it easy to do business here, 2. Create policies that are broadly-defined, and don’t just incentivize small segments of the economy, and 3. Continue to build on our State’s already-great reputation, and more aggressively “get the word out.” Spencer P. Eccles, Governor’s Office of Economic Development Mr. Eccles reflected on the role of government – and specifically his role at GOED. He recognizes that government doesn’t create jobs . . . people create jobs. However, he wants to create an environment for business that is unfettered, and easier to do business. In fact, Utah is one of the easiest places to do business. So he asks himself, “what should we be doing?” and “is it a subsidy or an incentive?” Also, “is it a carrot or a stick?” GOED just published the Governor’s Economic Plan which can be found on their website: www.business.utah.gov. The Governor seeks to lead the nation as the best performing economy, “which we’re doing, and we’re also number one coming out of the downturn” . . . and be recognized as a “premier global business destination.” In a recent rural business trip, Mr. Eccles related that 80 to 90 percent of the small businesses he met with have some business activity internationally, involving some import/export activity. Utah is the only state in the U.S. that had a positive export rate. Every other state was down, while Utah was up. “We’re small, but we’re pretty good at what we do.” The Governor’s Economic Plan has four basic objectives: 1. Strengthening and growing existing Utah businesses, both rural and urban, 2. Increase innovation, entrepreneurship, and investment, 3. Increase national and international business, and 4. Prioritize education to develop the workforce in the future. There is a plan and metrics for each of these objectives. Regarding taxation, Utah’s flat tax is very favorable to business. So in summary, Utah has many strengths and few weaknesses. There are great opportunities to “create Utah solutions to Utah problems.” The things that are being done by USTAR and the TCO offices are helping to create these Utah solutions. It will take some time, but hopefully, these can be accelerated. Jeff Davine, Partner, Ballard Spahr LLP Mr. Davine described a new tax incentive that has a limited life, not available after the end of 2010. (Refer to Mr. Davine’s handout, which is included as an addendum to this report.) This new tax incentive is only effective for investments made between September 27th and December 31st, and provides a 100% exclusion of gain on sales of qualified small business stock. This only applies to C corporation stock, and it must be 25
held for at least five years. Requirements are complex, so it was suggested that investors should consult their tax advisors. (Editor’s Note: This tax incentive was extended by Congress to December 31, 2011.) Responding to questions, the panel discussed whether there is a need for an Angel tax credit. Senator Niederhauser suggested that there ought to be a “State Angel Investing Policy” discussion before tax credits are decided upon. Ms. Beresini re-stated that all stakeholders should be included in that discussion, to avoid some of the problems she identified in other states. Mr. Eccles responded that the State has done a great deal to ensure that there is great dialogue occurring among stakeholders in Utah right now. Regarding a tax credit, he said “we do need it.” He doesn’t yet have a firm conclusion about how it might be structured, but discussions are being held right now to make that determination. Brad Bertoch shared with the audience a conversation he had with one of his board members, concluding that Angels don’t go into deals to have them fail. Rather, they go into deals to have them succeed. So government shouldn’t protect Angels on the downside, but should instead encourage and protect their upside, through such positive things as capital gains exemptions, grants, or something else to provide support to Angel investment, all of which can help companies to grow. Another member of the audience highlighted misperceptions of living in Utah that make it difficult to recruit talent from other states. Alan Hall commented that he is working on a bold new viral video effort, intended to complement the State’s other branding efforts, showing prominent people in Utah, from all walks of life. Mr. Eccles suggested that “once we get people here, they love it.” Adjustment to alcohol laws helped. The continuing perception of Utah as “remote” is being addressed by new advertising that promotes metropolitan images. “It’s a start, but we need to do more.”
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Panel 3 – “The Power and Influence of Super Angels” Linda Wells, Executive Director, Center for Entrepreneurial Studies at the Stanford Graduate School of Business, moderated a panel on the subject of what Silicon Valley refers to as Super Angels, or those Angel investors who invest independently of any Angel Group – and who often invest larger amounts. Exploring this topic were panelists Ed Esber of the Halo Fund, independent venture capitalist Mike Levinthal, and Alan Hall, Island Park Angel investor and the founder and chairman of MarketStar Corporation. Ms. Wells observed that Super Angels in the Silicon Valley have really changed the way Stanford works with students, because it is “certainly a very fast way of getting funding.” Many alumni are expressing a preference to approach a Super Angel rather than an Angel Group. Alan Hall, Island Park Mr. Hall has six venture investments and about 60 Angel investments. For these Angel deals, he serves as the “lead investor,” and invites other Angels to invest along with him. He has a team of six people who help in all aspects of helping a company grow. Each of these six people has a stake in the exit. Ed Esber, The Angels’ Forum The Angels’ Forum was founded in 1997, and represents about 25 former entrepreneurs, all of whom made enough money to semi-retire early. They meet every Thursday to see two new companies and review one or two of the investments that they have made. Before an investor gets to be in their group, he or she must meet specific criteria, such as the amount they can invest each year. Ultimately, as the Angels’ Forum members make individual commitments to invest, the group aggregates the amount and makes one investment, as an LLC, so the company doesn’t have to deal with too many shareholders. Mr. Esber also has a Halo Fund, which is about $8 million of “other people’s money.” The Halo Fund invests in about a third of what the Angels’ Forum does. It can invest in something other than what the Angels’ Forum does, but the entire team is comprised of Angels. They primarily invest in three areas: Saas Web 2.0, medical devices, and consumer retail. Mike Levinthal, independent venture capitalist Mr. Levinthal was a partner in the Mayfield Fund in Silicon Valley for more than 20 years. When he moved to Utah over six years ago, he started doing things on his own. He doesn’t consider himself as a Super Angel, but likes to invest where he is “actively involved” -- usually in projects where he meets people or when something looks like it will be fun or if it looks like an exceptional opportunity to work with entrepreneurs. He has invested in 18 companies, mostly where he has been “actively involved.” Many of these companies are “below the radar screen” in Utah. Acting independently, he works 27
with about nine companies today, compared to an average of six companies when he was at Mayfield. But he can do this because he no longer has to deal with partner meetings and administrative duties of the Fund. Panel discussion and response to questions: Ms. Wells observed that Alan Hall and Ed Esber have staff to help do a lot of the needed work, but asked Mr. Levinthal how he accomplishes all he needs to do. He responded that when he is the only investor in, “it’s a lot of work.” He does work some long days, but finds balance in the lifestyle in Utah. He did one CEO review while the two of them took a hike in the mountains. “And once a company gets to a sufficient size and they start to bring in some quality institutional investors, it eliminates a lot of the heavy lifting.” Speaking of Utah, Mr. Levinthal said “It’s a fabulous place . . . and much better than my friends in Silicon Valley recognize.” He enjoys bringing some of his friends from Silicon Valley to see what is going on and to participate. He believes this represents a great opportunity for the venture firms here to work with some of the better firms throughout the country. Responding to where the deal flow is coming from in Utah, Mr. Hall said that he has endowed 28 or more students at Weber State University to interview and bring potential deals forward. Typically, Mr. Hall invests in only about 1 percent of these. However, students have told him that this activity may be the singular most beneficial part of their academic experience. And in the process, he’s developing some skills among the next generation of investors. Ms. Wells inquired about the differences in the structure of Angel Groups in the Bay Area and the Angel Groups in Utah. Ed Esber responded that the person who founded the Angels’ Forum, Carol Sands, has a staff that does much of the due diligence. One of the reasons why Mr. Esber went from being an individual investor to being affiliated with an Angel Group is “I get the benefit of people with expertise.” In their group of 25 investors, there is always someone who has HR experience, or sales experience, or operations experience. And whether they invest in a deal or not, if he calls on them, they’ll help. The Halo Fund has a team of about five Angels who are the management team, and they also do due diligence. Although Carol Sands is the only legal decisionmaker, one of these five will often be the sponsor for a deal. Mr. Levinthal commented on one of the challenges that he has experienced in syndicating a deal in Utah: wonderful distractions. He offered that Utah is a great place to live. However, the Utah lifestyle, including the occasional “great powder day,” gets some investors to look at Angel investing as a type of “men’s club” – a lot of fun rather than an important job. They don’t add value, and he tries to weed them out, because he said he doesn’t need the money . . . rather, he needs help.
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Alan Hall said his approach is to take the lead in investment, and then take the deal to other Angel investors in Utah. In previous years, he has tried to encourage formation of other Angel groups in the State, but finds that many of them are still suffering from economic challenges and cannot make any investment. Also, some are still passive, and he is not looking for passive investors. Mr. Esber said it’s not the money . . . it’s the investor’s commitment that makes a deal happen. A lot of the Angels in his group are semi-retired, and Angel investing has become their full-time occupation. Each Angel gets involved to a different degree on each deal. But given the choice of heading up to the ski slopes or helping entrepreneurs, Mr. Esber would personally rather help the next generation of entrepreneurs. “That’s the juice that makes my juices flow.” According to him, the passive investor lawyer or doctor who writes a check is not what they want. Angels need to put in their time. Apparently, there remains a gap between what venture capitalists can put to work and what Angels can put to work. And among some venture capitalists, there is still a lack of respect for Angels. Responding to a question regarding his move to Utah, Mr. Esber said he is moving for a host of reasons, but notably because activity in Utah is high. There are a lot of things going on – activity is high -- companies are being funded -- and he’s getting “plugged in” to the investor community. Another reason is the lifestyle choice. He’s been commuting about one week each month from the Bay Area to Utah, and he now plans to do the reverse . . . live in Utah and commute one week each month to the Silicon Valley. “It’s hard to get totally unplugged there, and there is some cross-fertilization of deals.” Mr. Levinthal discussed the gap that exists between the level of Angel investment and that of Venture funding, and suggested that this gap represents a great opportunity. He believes the shortage of funds at the level just below venture money can severely inhibit the growth of companies. Utah needs more venture funding. Esber added that his fund and Silicon Valley venture funds rarely invest outside of the areas in which they are located. Asked what the difference is between the type of deals Super Angels fund and the type of deals VC’s fund, Mr. Hall responded that Angel deals are usually under $1 million. As a Super Angel, he looks at some small deals, but the difference between what he does and what Angel Groups do might be simply in the number of deals . . . Super Angels do many more deals. Mr. Esber recommended that in addition to new company formation, Utah should also give some focus to helping existing companies be successful. If an entrepreneur is starting a company in Utah, he or she should get together with other entrepreneurs and discuss common problems and challenges. There is great potential synergy and problemsolving that is possible.
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Richard Long, Inestment Strategy Manager, Contango Capital Advisors Summary keynote speaker Mr. Long opened his remarks by explaining that Contango Capital Advisors is majorityowned by Zions Bank, so he works closely with Zions, its affiliates, and its clients. Summarizing the earlier presentations by Angel Groups and panelists, Mr. Long observed that Angel groups need to embark on more collaboration with one another. This could lead to increased diversification in the investments that are being made, which would improve the level of risk inherent in Angel Group portfolios (i.e., “getting the winners along with the losers”). He also reflected on the reported slowdown in the pace of Angel investment, which is consistent with what Contango is seeing with its clients. Finally, as a Californian, he is hearing from everyone at this conference that “Utah is apparently where everyone should be moving.” Regarding the economy, he described a “Tragedy in Two Acts”: Act 1, over the past 15 years, was a period of speculative boom, characterized by debt. Looking forward, Act 2 will find some winners, those who are in growing economies and are responsible with debt, and losers, those who are over-committed and are burdened with debt – for a very long time (perhaps 5 to 10 years). Mr. Long indicated that extraordinary actions reflected in the charts below saved the U.S. financial system in 2008, through a convergence of three separate things during the crisis and in the period of time since: (1) Federal Reserve Bank Credit: the injection of liquidity into the market by buying securities (starting with mortgage-backed securities), as reflected in this graph: Federal Reserve Bank Credit 2276
2276
$ Billions
1836
1836 Total Reserve Bank Credit
1481
1481
1194
1194
963
963 2008
2009
2010
30
(2) Increased Securities Lent to Dealers, designed to free up the collateral markets: Securities Lent to Dealers 277
277
$ Billions
March 2008 - January 2010
96
96
33
33
11
11
4
4 2008
2009
2010
(3) Flattened Treasury Real Yield Curve, where real yields, adjusted for inflation, are currently only 1.4% for 30 years. (Mr. Long said, “It’s not a rate that we’re encouraging our clients to take!”) Treasury Real Yield Curve 1.60
%
1.60
1.20
20-YR
30-YR
0.80
1.20
0.80
0.40
10-YR
0.00
7-YR
Real Yield Curve ( ) 9/24/2010 ( ) 10/08/2010 ( ) 10/22/2010
0.40
0.00
5-YR -0.40
-0.40
Contango Predictions
Mortgage defaults will continue (although there will be some pockets of growth)
Fannie Mae and Freddie Mac will continue to need taxpayer money (which could amount to another $200 billion
Mr. Long describes Contango as being “negative” on commercial real estate defaults. He shared the following chart of Commercial Mortgage Maturities that indicates growing negative equity through 2012, and only slightly improving over 2013 and 2014. Banks and insurance companies that hold large blocks of commercial real estate mortgages will be the hardest hit. (Note: Responding to a question from the audience, Mr. Long explained that “a trillion isn’t what it 31
used to be,” and the better, stronger companies will get their commercial real estate portfolios refinanced. The problem will be with the weaker companies whose outlook is not positive. When asked if their default could push the country into another liquidity crisis, he opined “if it all happened together.”)
There remains a junk debt rollover problem. Higher quality companies have already refinanced, but this may be a problem later, perhaps in 2014.
Sovereign debt in Europe remains an issue. Riots and protests in Europe evidence that austerity measures are not solving the problem – especially in Italy, Portugal and Spain. Accordingly, Mr. Long advises those investing in a bank or a mutual fund that has a larger yield to be wary of what they may be carrying in their portfolios.
Not all economies will be equal. Those countries that are frugal and industrious, such as China and India, will experience growth of 5 to 10 percent over the next couple of years. This is down from previous periods, but still attractive in comparison to others. This will help to drive the global economy. Countries that provide natural resources, such as Canada and Australia, will be beneficiaries of the growth of the emerging markets. And developed countries, such as the United States, will offer products that will be in demand by consumers in the emerging markets. As a result, this growth in emerging markets will benefit the U.S. Contango projects longer-term GDP growth from 1 to 3 percent. Summary of a Volatile and Unbalanced Economy Prospects for governments in a volatile and unbalanced economy are mixed, and relate differently to those that are classified as “frugal” versus those nations that are “indebted”: Frugal Indebted
Inflationary pressure Government stimulus works “too well” Excessive private and government savings -> need to export to grow Capital inflows, current account surpluses -> (suppressed) currency appreciation
Wage stagnation Stimulus has little further effect Excessive government and private debt -> unwilling and unable to consume, invest and import Capital outflows, current account deficits -> currency depreciation
Recognizing the volatility and uncertainty in the near term, Contango recommends that individual clients keep two buckets – one positioned for the next 3 years to meet cash and liquidity requirements and other needs they might have during that time. Risk can be taken with those funds that are in the longer-term bucket. So, these funds can be used to invest in equities, domestic and international, with overweight toward emerging markets, and short-term, high quality fixed incomes (no credit bets or long-term durations). Some
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alternative investments include hedge funds and private equity (as much as 5 to 10 % of client portfolios). Outlook for Venture Professionals Performance in the venture space is varied and inconsistent, and information is hard to get. Performance expectations are still negatively impacted by recollections of the dotcom bubble. Venture performance in the last 5-6 years has been “decent,” but tax uncertainties and regulatory concerns (Dodd-Frank and Basel III) remain. However, on the whole, Contango is still optimistic, due to significant cash levels ($1 Trillion) on corporate balance sheets, right-sized asset class, more realistic valuations, co-investment, and actions by state governments and the Fed.
(Note: Mr. Long provided for distribution by the Wayne Brown Institute several graphs that depict the trends in venture performance, valuations, capital inflow, and right-sizing. These are presented below and on succeeding pages.)
The Cambridge Venture Index Has Outperformed Other Indices – But Not By Much 180 160 140 120 100 80 60 40 20 -
S&P 500
S&P MidCap
Russell 2000
Apr-10
Dec-09
Aug-09
Apr-09
Dec-08
Apr-08
Cambridge Venture Index
Aug-08
Dec-07
Apr-07
Aug-07
Dec-06
Aug-06
Apr-06
Dec-05
Aug-05
Apr-05
Dec-04
Apr-04
Aug-04
Dec-03
- Cambridge Venture Index - S&P 500 / S&P MidCap - Russell 2000
Source: Bloomberg
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Venture Is Right-Sizing to Levels Not Seen Since 1994
120 100
700 600 500 400 300 200 100 0
VC Capital Raised
80
# of Funds
60 40 20
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
0
Valuations & Capital Inflow at All Stages Are Near Historical Lows $70
$ Invested (Billions)
$60 $50 $40 $30 $20 $10 $0 1995 96
97
98
99
00
01
02
03
04
05
06
07
08
09
Early Expansion
34
Right-Sizing Drives Venture Returns 20
1.4
18
Top Quartile TVPI
VC Capital Deployed as % US GDP 1
14
12 0.8 10 0.6 8
6
0.4
4
Capital Deployed as % of GDP
1.2
Top Quarter TVPI 16
0.2 2
Outcome Unknown* 0
0
2009e
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
Vintage Year *Funds with vintage years after 2003 are considered too early to evaluate performance. TVPI = Total Value to Paid-In (ratio of distributed and undistributed portfolio value to original invested capital. Source: Cross Creek Capital, Thomson Reuters, and NVCA
35
Selected slides from Ray Freer’s presentation, “Angel Investing – The Challenges and the Rewards”
36
Deal Sources -Public
Deal Sources – Private
37
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(Editor’s Note: Subsequent to this conference, this tax incentive was extended by Congress to December 31, 2011.) 100% EXCLUSION FOR QUALIFIED SMALL BUSINESS STOCK Jeffrey Davine Ballard Spahr, LLP 2010 INTRODUCTION Qualified small business stock Internal Revenue Code (“Code”) Section 1202 allows a partial or 100% exclusion of capital gain on sale (or other disposition) of “qualified small business stock” Applies only to a C corporation Must meet the definition of “small business stock” Must be acquired at its original issue Must be held for more than 5 years Active business requirement Limits on gain Exclusions previously available Generally, 50% For stock acquired after September 27, 2010 and before January 1, 2011, the exclusion is 100% 100% Exclusion – how good is it? Corporations are still taxable Top corporate bracket – 35% Exclusion eliminates one tax of the corporate double tax system
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PER-ISSUER LIMITS – The amount of gain excluded cannot exceed, over all tax years, for any corporation, the greater of $10,000,000 ($5,000,000 in the case of married individuals filing separately) 10 times the aggregate bases of all qualified business stock issued by the corporation and disposed of by the taxpayer during the year (without regard to any “addition to basis”) QUALIFIED SMALL BUSINESS STOCK DEFINED C corporation must be a “qualified small business” Must be a C corporation (not an S corporation, partnership or sole proprietorship) Gross asset test Aggregate gross assets cannot exceed $50 million at all times before issuance of stock and immediately after the issuance Gross assets consist of cash and property taken at basis, but the basis of contributed property for this purpose is deemed to be its fair market value on the date of contribution Corporations members of the same parent-subsidiary group are aggregated and treated as one corporation (using a more than 50% ownership test) The corporation must submits reports to the IRS and shareholders to verify this test Stock must be acquired by the taxpayer at “original issue” (directly or through an underwriter) Stock must be issued for cash property services
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Redemptions can disqualify stock issuances Stock is disqualified if during 2 years before or 2 years after the purchase, the corporation redeemed stock from the taxpayer or a related party Stock is also disqualified if during 1 year before or 1 year after the purchase, the corporation makes one or more purchases with an aggregate value exceeding 5% of the total value of all of the stock at the beginning of the 2 year period Certain redemptions through related corporations (under Code Section 304(a) are treated as redemptions) Gain on stock exchanged for property counts only to the extent of the excess of the qualified small business stock disposition proceeds in excess of the value (not the basis) of the property transferred to the corporation – similar rule applies to contributions to capital of appreciated property Subsequent contributions to capital increase stock basis and reduce excludable gain and for this purpose the value of the contributed property is used The corporation must meet an “active business” test during substantially all of the taxpayer’s holding period for the stock and must be an eligible corporation At least 80% by value of the assets must be used in the “active conduct” of one or more qualified businesses Assets used in the following activities are deemed used in the “active” conduct of a trade or business (and whether the corporation has income is irrelevant) Start-up activities described in Code Section 195(c)(1)(A) Activities involving payment of research and experimentation costs under Code Section 174 Activities used for in-house research described in Code Section 41(b)(4) Working capital is considered used in the active conduct of a qualified trade or business if – it is reasonably required to meet the working capital needs of a qualified trade or business, or
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it consists of assets held for investment reasonably expected to be used within 2 years to finance research and experimentation of working capital needs of a qualified trade or business. After the corporation has been in existence for 2 years, not more than 50% of its assets can qualify for the working capital rules. A corporation is an “eligible corporation” if it is any corporation other than a DISC corporation with an election under Code Section 936 RIC, REIT or REMIC cooperative The corporation must operate a qualified trade or business, which is any business other than one engaged in health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or business where the principal asset is the reputation or skill of one or more employees banking, insurance, financing, leasing, investing or similar businesses farming extractive industries (oil and gas, e.g.) described in Code Section 613 or 613A operation of hotel, motel, restaurant or similar business Additional rules and provisions Multiple corporations. If a corporation owns more than 50% of the combined voting power of all classes of stock or more than 50% of the total value of all classes of stock – then stock and debt of the subsidiary is disregarded and the parent is deemed to own its ratable share of the subsidiary’s assets and activities. For any period where more than 10% of the value of a corporation’s assets are stock or securities (other than more than 50% subsidiaries), it shall be treated as failing the qualified business test and shall not be considered an “eligible corporation.” 42
Exchanges, conversions and transfers Conversion of stock (e.g., preferred to common) in a corporation that is qualified small business stock do not disqualify its character as such and the holding period includes the holding period of converted stock Transferees step into the shoes of transferors on transfers of qualified small business stock if transferred: by gift at death from a partnership to a partner Transfer of qualified small business stock to a corporation in a taxdeferred incorporation transaction preserves the character of the stock, but only to the extent of value on the date of transfer Pass-through entities Defined as partnerships, S corporations, regulated investment companies and common trust funds Gain from qualified small business stock held through a passthrough entity that is disposed of may qualify if it was held by the pass-through entity for 5 years and the taxpayer held the interest pass-through entity continuously since the date it acquired the stock increases by the taxpayer of its interest in the pass-through entity (after the date it acquired the qualified small business stock) are not taken into account If the taxpayer has an offsetting short position, that disqualifies the stock from the benefits of the provision unless the stock was held for more than 5 years before the short position was taken, and the taxpayer elects to recognize gain as if the stock were then sold
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