March 20061

At SVB Financial Group, understanding the industries we serve is fundamental. Like you, we track, study and analyze the activity in our markets and, as your partner, we want to share our findings. This report chronicles recent venture capital activity and includes commentary from our vantage point in the industry regarding what it all means. We seek out and consolidate the most compelling data, pointing to the trends in the technology and life science industries. We invite your opinions and encourage ongoing dialogue regarding the opportunities ahead of us.

buyout’s record fundraising raises many questions

U.S. Venture-Backed IPOs Deals & Dollars

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

Fundraising by Venture and LBO/MezzanineFunds, 2001-2005

Fun

ds R

aise

d ($

mm

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Source: Thomson Financial Venture Economics/National Venture Capital Association

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Venture Capital UpdateWritten by: Aaron Gershenberg, Managing Partner, SVB Capital and Mike Clovis, Associate, SVB CapitalMarch 2006

Will the record amounts of capital raised by buyout funds impact the venture industry?Buyout funds have had a record year in fundraising, pulling in a staggering $86.2 billion from LPs in 2005. The successful fundraising environment has allowed a number of firms to raise “mega-funds” like the $12.5 billion fund raised by Blackstone, the $10 billion fund raised by Leon Black of Apollo, and the $10 billion fund raised by Carlyle, to name a few. Some experts have questioned whether recent fundraising levels may exceed existing opportunities in buyout’s traditional industry segments. Therefore, a push into technology, an area buyout investors have historically shied away

from, may be a new focus for the buyout industry. A recent example of this is the $11.2 billion leveraged buyout of SunGard Data Systems by a consortium of buyout funds including Silver Lake, Bain, Blackstone, Goldman Sachs, KKR and TPG.

This quarter, we explore whether the significant amount of capital raised will force buyout firms to compete with venture investors for investments. We also examine whether the record amount of capital raised by buyout funds will make them more acquisitive of venture-backed companies, providing additional liquidity to venture investors.

Venture Capital Update

March 20062

Based on our analysis and conversations with senior partners at both buyout and venture firms, we believe it is highly unlikely that buyout firms will compete with venture firms or be a significant source of ad-ditional liquidity for venture investors. This is due to fundamental differences in investment models as well as scalability. At the same time, we observe a few specialized firms with strategies that bridge the two industries, employing approaches from buyout and venture. Whether this becomes a broad phenomenon will be determined in the years to come based on the financial results they achieve.

While buyout and venture firms play the same game, they employ very different business models.

From the outside, buyout and venture funds look very similar: they share the same limited partners, le-gal structure and economic incentives. However, the way they conduct their business is very different.

Buyout and venture investors focus on companies at different points in their life cycles using different investment approaches. Take Silver Lake Partners and Kleiner Perkins Caufield and Byers, for exam-ple. Buyout firms such as Silver Lake structure their investments through purchases of mature cash-flow-positive companies via complex acquisitions that require thousands of hours of consultants’, lawyers’, accountants’, bankers’ and partners’ time, typically costing millions of dollars. “We may spend $5 million determining whether we have a deal and $50 million to close one,” commented David Roux, a founding partner at Silver Lake Partners. In order to be suc-cessful, buyout firms must have a clear understanding of the economics of a business and know how to drive operational efficiencies.

Conversely, venture capitalists like Kleiner Perkins create companies around great technologies and new business models. They must make decisions based on the concept of a potential company, often with little or no existing market confirmation. While some ven-ture investments have been made over a cup of coffee with a business plan sketched on a napkin, years of

Regional Focus All Industries - 4Q05

Post Money Valuation Report ($M) - 4Q05

Source: VentureOne and Ernst & Young

Source: VentureOne

Most Active Investors - 4Q05

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

Venture Capital Update

March 20063

successful operations and investing experience are at the heart of the venture capitalist’s craft. Venture capitalists form companies, often from scratch, creating legal and operating structures, recruiting manage-ment teams and boards, planning for multiple rounds of equity and debt financing, and ultimately guiding a company to exit.

Venture capital firms invest in start-up companies whose success is far less certain than the well-estab-lished, stable companies buyout investors pursue. Because of this different risk profile, venture capital and buyout investors have markedly different return objectives. Buyout investors are looking for signifi-cant Internal Rate of Return (IRR), where venture investors are looking for significant multiples on the capital they have invested. Venture firms target multi-ples in excess of 3 to 5 times invested capital whereas buyout firms typically strive to generate 30 percent IRRs, which can be achieved by returning capital ear-ly to investors (dividend recapitalizations and spin-offs) even with multiples of less than 2 times invested capital. The buyout business is a fielding game with the most successful firms having very few losses. With 3-5x multiples considered wins, buyout inves-tors cannot afford to write-off many investments. The venture business is a slugging game with 10 to 100 times multiple return potential. Venture firms need home runs to make up for the 30 percent and greater losses they typically take in their portfolios.

Buyout and venture investors also generate returns in different ways. Venture returns are generated by building startup companies with tremendous growth potential into profitable enterprises. Venture inves-tors plan for multiple rounds of financing, balanc-ing returns through step-ups in valuation with dilu-tion from additional capital and investors. Venture capitalists must focus primarily on rapid growth and endure negative cash flows, high volatility and signifi-cant uncertainty. This uncertainty requires venture backers to forgo the use of significant financial lever-age to enhance returns and support the development of their companies.

U.S. VC-Backed Liquidity Events by Industry 2003-2005

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

U.S. VC-Backed M&A Activity

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

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Commitments to U.S. Venture Capital Funds

Source: Thomson Financial Venture Economics

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U.S. IPOs vs. M&As

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

Venture Capital Update

March 20064

In contrast, buyout investors acquire companies with stable and predictable cash flows where returns are achieved through the use of financial leverage, growth and operational efficiencies. Buyout investors rarely expect to infuse additional capital into their portfolio companies post acquisition. This investment model is suited to larger, more mature companies. As buyout fund sizes grow, Roux of Silver Lake Partners, states, “with more money you are able to go after bigger targets. Public companies that would have thought themselves immune to acquisition suddenly aren’t anymore.” The buyout industry can scale as long as debt markets scale with it.

Most venture investors we spoke to are not averse to selling portfolio companies to buyout firms. Dixon Doll, founder of Doll Capital Management, claims, “It’s just like selling a company to Cisco; we’ll look at the deal based on the economics and if the buy-out offer is fair, we’ll consider it.” However, given the differences between buyout and venture investors’ investment models and the scalability of the buyout industry, it is unlikely that buyout firms will become significant acquirers of venture-backed companies providing additional liquidity to venture investors. A more realistic prospect is that the portfolio companies of buyout funds will become more acquisitive. It is reasonable to assume that SunGuard Data Systems’ buyout investors will encourage the company to be-come more acquisitive of cutting edge technologies to help it grow.

While buyout is unlikely to compete with venture, a hybridstrategy is emerging.There are a few specialized firms that bridge thebuyout and venture industries, employing strategies from both worlds. In transactions often referred to as “venture buyouts,” firms such as Oak Investment Partners, NEA and Garnett & Helfrich Capital seek to purchase underutilized technology assets and unlock their growth potential. Describing this investment approach, David Helfrich, co-founder

U.S. Deal Flow by Round Class

U.S. Cumulative Uninvested

Cumulative Fund Type Performance as of 09/30/05Calculation Type: IRR

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

Source: Thomson Financial Venture Economics

Source: Thomson Financial Venture Economics / National Venture Capital Association

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Venture Capital Update

March 2006

Cumulative Vintage Year Performance as of 09/30/05Venture Capital Funds (only) Calculation Type : IRR

Source: Thomson Financial Venture Economics / National Venture Capital Association

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U.S. Venture Capital Investing Activity by Quarter

U.S. Venture Capital Investing Activity by Year

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

Source: VentureOne and Ernst & Young Quarterly Venture Capital Report

and managing director of Garnett & Helfrich Capital, says, “the transaction itself is buyout but, post trans-action, it becomes very venture-focused and growth- oriented.” Whether this hybrid strategy becomes a broad phenomenon will be determined in the years to come based on financial results achieved.

in closing. While it is challenging to generalize about the private equity industry given that no two buyout and venture firms are the same, it is important to evaluate how market developments will influence future returns. Given the dynamic and rapidly chang-ing nature of the venture capital and buyout indus-tries, we can safely predict that the landscape will be quite different a year from now. We believe it is highly unlikely that buyout firms will compete with venture firms or be a significant source of additional liquidity for venture investors. Essentially, the venture capital industry must continue to rely on strategic M&A and IPO markets to achieve liquidity, making it critical that venture investors maintain valuation discipline, and support the revision of Sarbanes-Oxley compli-ance requirements for small- and micro-cap public companies. Please let us know if you agree or disagree with our conclusions and why.

We’d like to thank Senior Partners from Bessemer Ventures, Charles River Ventures, Doll Capital Man-agement, Garnett & Helfrich Capital, Kleiner Perkins Caufield & Byers, Matrix Partners, Oak Investment Partners, Sequoia Partners, Silver Lake Partners, Sut-ter Hill Ventures and Technology Crossover Ventures for contributing their invaluable insights to this arti-cle. We also thank Natalie Braun of SVB Capital for her assistance.

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Venture Capital Update

March 2006

Fenwick & West’s 4Q05 Venture Capital BarometerTM

Source: Fenwick & West LLP Average per share % increase or decrease from previous round of 100 SF Bay Area tech companies receiving VC investment in 4Q05Complete report available at http://www.fenwick.com/vctrends.htm

Price Change

Source: Fenwick & West LLP

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This update is for informational purposes only and is not a solicitation or recommendation that any particular investor should invest in any particular industry, security, or fund.

SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value.

iso newsletter

SVB Asset Management, SVB Silicon Valley Bank’s registered investment advisor affiliate, publishes a weekly newsletter offering timely economic news about the technology and life science markets, and the private equity and venture capital industries. The Investment Strategy Outlook (ISO) newsletter offers readers unique insight and analysis. http://www.svb.com/services/iso.asp *

* Equity financings include cash investments by professional venture capital firms, corporations, other private equity firms, and individuals into companies that have received at least one round of venture funding

Source: VentureOne/Ernst & Young

The direction of price changes for 115 SF Bay Area companiesreceiving financing in 4Q05, compared to their previous round.

Equity Financings* for U.S. Venture-Backed Companies by Industry Group

Venture Capital Update