Wanted: An Interesting Annual Meeting.

It’s that time of year again…annual meeting season….when GPs of all sizes and shapes try to entertain and inform LPs of all sizes and shapes at nice hotels of similar sizes and shapes. In general, these affairs contain more style than content, and in the end disappoint both their audience and their hosts.

So, how can we improve? It is incumbent upon GPs to show creativity in the structure and organization of the meetings. This is not an invitation for dancing bears to appear. We had enough bear sightings in 2000-2002. Rather it is a requirement to offer content that extends beyond the confines of portfolio make-up and performance to address the “why” as much as the “what.”

For example, one of the things our LPs appreciate and so we are providing at our Annual Meeting on June 2-3 in Seattle, is broad perspective on major industry and sector trends. This gives them a framework with which to evaluate not just our firm, but all their GP relationships. Of course, as smart as we like to think we are, there are clearly individuals in these sectors who are far more steeped in their respective spaces. That means the way to gain meaningful insight is to have credible outside folks willing to take the time to share their knowledge. In our case, we have:

• Stuart Cohen, the President of the Open Source Development Lab (OSDL), talking about the impact of the Linux/Open Source movement worldwide
• Dr. Leroy Hood, the head of the Institute for Systems Biology (ISB), talking about the move from traditional wet chemistry to a systems approach to medicine
• Keith Larson, Intel Capital, talking about how the world's largest venture investor views the industry today

So, what can LPs do to contribute? Besides showing up and making the GPs feel their planning efforts were not in vain, be an active participant. If you have recently come from another annual meeting where those GPs offered broad perspectives that do not line up directly with ours (or our guest speakers) don’t be bashful. The best meetings have a little spark to them. Not sparks between investor and manager, but sparks among different points of view on what the future holds. As GPs, we’d like nothing better than to have a few intellectual free-for-alls break out.

Now that would be interesting!

In looking for technology opportunities that have strong roots in the Pacific Northwest, the Linux/Open Source space stands out as a unique differentiator for our region. As part of OVP’s leadership role in the new Oregon Open Source Cluster project, we recently summarized Oregon’s impressive assets in this market segment:

• Open Source Development Labs (OSDL) – The OSDL is accelerating the worldwide growth & adoption of Linux in the Enterprise and is supported by a global consortium of established Linux/Open Source leaders. Linus Torvalds, the Creator of Linux, lives here and is leading new Linux development efforts at OSDL
• IBM Linux Technology Center – IBM’s headquarters for Linux testing & development.
• Intel – Linux is a key investment area for Intel. They run their Linux strategies from Oregon
• Oregon State University Open Source Lab (OSU OSL) – This is the largest university-based applied Open Source research & commercialization lab. They host, distribute &/or mirror >20 Open Source projects, including Mozilla’s popular Web browser, Firefox. OSU OSL also hosts large, multi-state community source projects, e.g., a multi-state transportation application for 13 states, including the Oregon Deptartment of Transportation
• Portland State University (PSU) – Linux & Open Source are rapidly permeating PSU’s Computer Science Department’s curriculum
• Open Technology Business Center – The only center for incubating Open Source start-ups.

In addition to working closely together, these centers have built alliances with the majority of the key players worldwide. Our Open Source Cluster team has established close ties with:

• 12 of the top 15 not-for-profit Open Source organizations
• 9 of the top 10 established Open Source firms
• 5 of the top 10 Open Source start-ups

Did you hear about the guy who died from dilution?

One of the toughest issues we deal with in early stage investing is overcoming the founding team’s fear of dilution. That fear is perfectly natural, normal, and completely misguided.

It turns out most of the pushing and shoving on this issue, particularly at the Series A stage, gets lost in reality as the company grows and requires additional rounds of capital. Let’s consider the following case, and the surrounding reality:

The case: Most substantial venture capital firms require 20%-30% of a company to make their economics work. Most also invest in syndicates of at least two firms. So, no matter what other valuation and discussions go on, after the Series A, the VCs will own 40%-60% of the company. Of course, the business plan usually says this is all the money that will ever be needed. But reality says that is nonsense. The overwhelming majority of firms need two or more likely three rounds to reach cash flow positive.

So, if the VCs pony up the money for round 2, regardless of the progress made, one should expect that financing will consume half the previous one, or about 20%-30% of the company. Round 3, again even with nice progress will require 10%-20%. So, do the math. At the low end: 40% + 20% +10% = 70% of the company to the investors. The management team owns 30% in the best case. At the other extreme, the investors own more than 100% (60+30+20), which is clearly not possible.

That brings in the reality of a reasonable floor. We tell all young management teams that the good news is we may be greedy, but we are not stupid. If they don’t have enough incentive to put in the 100 hour weeks, we don’t get paid. In our judgment, that floor is around 20% of the company. If financing events take them below that, we dilute ourselves to refresh management’s incentive.

So, in the end, all the fuss and bother about valuation and dilution is about a maximum possible spread between a 20% floor and a 30% ceiling on management ownership at the end of the day.

This is why we say, over and over again, “No company ever died from dilution. The ONLY thing companies die from is lack of cash. Optimize for cash – not dilution.” Sometimes the entrepreneurs hear us, sometimes they do not.

The ones that don’t find other sources of capital.

Time for a deal in Canada, eh? Yes, after many years of searching we finally found the first project to get our full support. It is GenoLogics in Victoria, BC. The firm is a software company serving the market for laboratory information management solutions in the proteomics space. With the explosion of data in the world of systems biology, the need to integrate and manage that data becomes paramount, just as it has in other industries as they have automated. The company has already landed some marquis customers and is well on its way to a successful start.

OVP led the $5M Series A investment in GenoLogics, with Vancouver, BC venture firms Yaletown and GrowthWorks also participating. Chad Waite serves on the GenoLogics board for OVP, backed up by Rick LeFaivre.