FountainBlue

The December 15 Connections event was on The Year in Perspective, The Good, The Bad, The Huhs? and our panelists and facilitator were:

• Ysabel Duron, "KRON 4 Weekend Morning News"
• Martin Kan, Silicon Valley Bank
• Jay Phillips, Senior VP, Cornish & Carey
• Keith Virnoche, Virnoche-Frigon Group at Merrill Lynch

Below are notes from the session.

Thoughts about Silicon Valley

• It's been a tough year for the low income. The middle income is also feeling the pinched, the upper income are becoming more strategic about how they spend their money.
• The economy is slowing down for some
• Our political leaders received a strong message encouraging change, as their perspectives are straying from that of their constituency.
• There's an undercurrent of unease. It's difficult to trust our leaders.
• On a positive note, values-driven business leaders are making strides to change our views on leaders, particularly in Silicon Valley where hope springs eternal. These business leaders striving to make money, have fun, and do good.

Thoughts about Real Estate Trends

• Due to increased corporate earnings, venture financings, and other factors, the real estate market is very strong, at all-time high prcies in some cases. We haven't seen such numbers since 1999-2000.
• Sales activity extremely strong, residential conversion subsides. Total vacancy rates continue to fall
• The rapid commercial expansion of companies like Google (and indirect residential expansion for employees) are directly affecting housing prices much more quickly and with much greater impact than anticipated
• Green energy companies are starting to impact the real estate market
• M&A activities are more strongly impacting the real estate market than anticipated

Thoughts about Venture Financing Trends (statistics from PriceWaterhouseCoopers Q3 2006 Shaking the MoneyTree Report)

• Steady Pace in Number of Deals: 2004: 3,024; 2005: 3,092; 2006: 2,533 (thru Q3)
• Increase in Total Dollars Invested: 2004: $22.1 billion; 2005: $22.7 billion; 2006: $19.2 billion
• Silicon Valley Continues to be the Leading Region for US Investments: 250 Deal in Q3 2006; 87 Deal in Q3 2006 for the New England Region.
• Software and Biotechnology Continue to Attract Strong Investor Interest
• Software -  Number of Deals and Total Dollars in Q3: 2005: 205 $1.14 billion; 2006: 186 $1.10 billion
• Biotechnology - Number of Deals and Total Dollars in Q3: 2005: 101 $1.03 billion; 2006: 95 $1.14 billion

More thoughts on venture financing:

• VCs are raising their expectations/standards/requirements for funding
• Natives from India (software companies) and China (hardware companies) are returning to their countries
• Migration of European companies from UK, France, Finland establishing headquarters in Silicon Valley
• China is interested in moving from hardware manufacturing into design and India is looking at moving from software test to design

Thoughts about Investment Trends

• The economy is stronger than many people think - double-digit earnings growth ends after 15 quarters in a row
• Investments in 500 S&P may be a good opportunity now

What can we as leaders do?

• Foster innovation in your companies and partners as innovation offers countries and companies a competitive advantage
• Build a collective social conscience while meeting and exceeding business/revenue objectives
• Get involved - in your company, in your family, in your community!
• Support our local educational system

The November 17 Connections Event was on the Topic of Corporate Governance: What It Means for the Average Exec

Corporate Governance is at the center of all investors' minds as decision-makers for companies of all sizes are charged with mitigating the risk of high-profile business failures, such as Enron and WorldCom. In order to reinforce investment confidence and protect investors by improving the accuracy and reliability of corporate disclosure, executives today are adopting Sarbanes-Oxley compliance standards, proactively managing board communications, and, in general, building corporate infrastructure and processes to automate reporting and accounting practices.

• Mark Leahy, Partner, Fenwick & West
• Leinani Nakamura, Partner, Mohler Nixon
• Tom Sa, Executive Vice President and Chief Administrative Officer, Bridge Bank

Below is a Summary of Notes and Advice for your reference, drawn on the wisdom of our facilitators and each of you as participants.

With the recent corporate scandals, there is a public outcry against the behavior of coporate executives

There was a similar outcry against the behavior of the banking industry in the 80s, and federal mandates helped to reform that industry. The Sarbanes-Oxley corporate governance requirements might do the same for corporate America, and may be worth the administrative and financial burden for complying with these requirements.

Boards are more involved as the duty of loyalty and the duty of care (to meet frequently, to understand the issues) is enforced through SOX.

With more involvement and participation and ownership from leadership, the 'tone at the top' may be better, with higher integrity, better accountability, better communications, better transparency, etc.,

The requirement for independent auditors and an audit committee helped ensure better run companies with better internal controls, cleaner partnerships with independent auditors, more proactive ownership of issues, earlier notifications of problems, earlier preparation

The code of conduct for CEOs, CFOs, Directors and Staff has helped ensure clear guidelines for behavior and encouraged consequences for breaches in conduct

The disclosure requirements encourage transparency of communication, proactive management, etc.,

The certification requirements encourages planning, process, validation, etc.,

Companies are encouraged to take some early steps to prepare for 404 Compliance, prior to the start of the documentation and testing process, even before they become public.

However, there are tremendous time, money and loss-of-opportunity costs for complying to these standards above

As a result there are fewer finance professionals, particulary at the senior level, just at a time when we need them more

As a result, fewer companies are deciding to go public, and more are going through M&A exits

As a result, CEOs in smaller public companies are opting to merge with another company rather than accepting the legal, fudiciary and other requirements demanded for senior executives.

As a result, companies may choose _not_ to go public due to the additional SOX requirements.

Below is a Summary of Notes and Advice on Outsourcing Challenges and Solutions, provided by the facilitators and the audience in general at our event on October 20, 2006.

Comments from facilitator Dave Gardner, Founder and Principal of Gardner & Associates Consulting, DGardner@Gardnerandassoc.com:

At the edges, outsourcing relates to the ever present dilemma of "make or buy"—should a company do something itself or find another company to do it for them. For years and years, American companies have outsourced. Why? It simply didn’t make sense to "do everything yourself" or "vertically integrate" as it was once described. What’s changed during the past generation? Today, we not only outsource tangible goods but also intangible items such as information technology management, software development, product development, etc.

At one point in our economy, we talked about a company having "core competencies"—those things perceived as their value-add in the market place—those elements that you could never remove without ruining a company’s value proposition.

Today, we are finding that we can establish outsourcing "core competencies" heretofore considered unthinkable.

• Entrepreneurs no longer have to hire a staff of engineers to commercialize their innovations.
• Companies that design products do not have to manufacture them
• We have fabless semiconductor companies
• We no longer simply have to outsource the manufacturing of key components and sub-assemblies—we can go to turn-key outsource manufacturers who can drop ship complex capital goods directly to customers
• Need a software application but don’t want to spend a fortune? Outsource it!

The U.S. competes in the global economy for both market share and capital. Investors want to know what a company is going to do with their capital to create a return-on-investment.

If a start-up company commits to outsourcing from the outset:

• This strategy reduces the risk to investors and improves ROI
• Makes a company more agile
• Allows company to focus on those things it does best and avoid the things it doesn’t want to do
• The company doesn’t expend nearly as much capital on plant, equipment, inventory, people, employee benefits—the outsource company does that
• Conversely, many companies are looking to migrate to an outsourcing as a way to reduce costs and improve their capital utilization. Outsourcing can be employed by start-ups as well as established companies. We’ve assembled a panel of experts who’ve "been there/done that" to give us insights about how to successfully outsource manufacturing, information technology, software development, product development and what you need to do to have legal agreements in place that protect you, your company and your intellectual property.

Manufacturing/Supply Chain, Comments from Dave Gardner with reflections from Lila Dormishian, Director of Global Supply Chain Management, Lam Research

This past month, a study produced by the National Institute of Manufacturers stated that U.S. manufacturers now suffer a 31.7% cost disadvantage—the equivalent of $6 per hour worked—over other countries including Canada, Mexico, Japan, China, Germany, U.K, South Korea, Taiwan and France.

The overall calculation takes into account corporate tax rates, employee benefits, tort costs, natural gas prices, and spending on pollution abatement.

Advice and Comments from Lila:

Be strategic about your outsourcing decisions:

• Consider your core competencies and bring those competencies in-house. Don't outsource them. Does outsourcing help you focus on your core competency?
• Consider materials sourcing for your short term and long-term needs. Where is the best place and who is and will be the best providers
• Leveraged model for volume purchase, sourcing, and manufacturing capability
• Efficiency of operations if DF is used
• Does it improve your ability to sell in the region (PRC local content mandate)?
• Does it bring you closer to customer base

Consider the Risks

• Communication
• IP infringement Risk
• Adequate top level management skills
• Engineering change management
• Systems/Tools
• Quality control
• Capacity management control
• Social and Political factors

Consider long-term and short-term costs for your outsourcing decisions.

• Cost reduction for high volume manufacturing
• Cost reduction if localized material is used
• Lead time and inventory increase (based on FOB terms)
• Transportation costs and delays
• Weigh in the infrastructure setup and maintenance for any outsourcing relationship and ensure that the value outweighs the costs in time and money and resources.

Information Technology Comments from Dave Gardner with reflections from Usha Sekar, CEO of CriaTech,

Is outsourcing IT overseas past its prime? According to a new survey, some think it is. Consider this:

• Two years ago, 84 percent of the respondents to a Global IT Outsourcing Study sponsored by a Chicago-based consulting firm said they planned to increase their level of offshore outsourcing.
• In October 2006, that figure fell to 64 percent.
• Meanwhile, 47 percent of respondents said they "abnormally" ended at least one outsourcing deal in the past 12 months—up from 21 percent in 2004.
• There are several reasons why the bloom is coming off the outsourcing rose-- the largest factor is cost. The claim is, "New tools are making it easier to manage and measure projects in-house, so many firms are realizing that it's actually less expensive to bring certain IT functions back."
• Meanwhile, companies have learned that getting outsourcers to deliver to specifications requires far more oversight and management than they bargained for. And then, of course, there's the security issue. All these factors, the study claims, make outsourcing IT overseas "grossly inefficient."

Usha's Thoughts and Advice:

Companies in general are more comfortable with outsourcing in general and outsourcing to countries like India for example.

• There has been a history of success working with outsourcing companies.
• In addition, there is a trend for Indian entrepreneurs and executives to return to their native India and providing development and support services there. These outsourced services are attractive to corporate executives in Silicon Valley for example because the former-Silicon Valley entrepreneurs and executives in those companies better understand the corporate and cultural expectations for Silicon Valley technology companies.

Be strategic about your outsourcing investment

• Similar remarks to Lila's comments about long-term and short-term needs for the company.
• Identify the best of breed for your outsourcing needs.
• Accept that there might be a drop-off in service in the second and third year of an outsourcing relationship and plan around that/anticipate it.
• Understand what needs to be outsourced, why it needs to be outsourced. What needs to be done in-house - e.g. a company's core competencies and why it needs to remain in house. Then plan accordingly.

Legal Advice around Outsourcing: Stephen Gillespie, Partner, Intellectual Property Group at Fenwick & West, Sgillespie@fenwick.com

Stephen's Thoughts and Advice:

• Provide detailed and specific descriptions, deliverables, milestones and consequences prior to an engagement.
• Manage the relationship based on those agreements
• Consider consequences for cost overruns. Be specific about budgets and caps.
• Be clear on IP ownership agreements prior to project engagement
• Everyone involved should have an NDA signed and a release form
• Be clear about who should have access to your data

Product Development/Software Development Comments from Dave Gardner with reflections from Yogen Upadhye, Omnivant, yogen@omnivant.com

Yogen's Comments and Advice:

• For IT services or Business Processes in general, the industry has learned about many hidden costs in terms of continuous oversight of the process and the controls needed to enforce agreed SLAs. Therefore, after factoring the company's own compliance and oversight costs and costs of onsite vendor resources needed for success, savings are significantly less than what was/is touted by vendors. Again, the savings depend on the type of engagement model actually being used and the skills and location mixes involved.
• Consider the business and technical risks when making outsourcing decisions, such as Loss of IP. Unless proper controls are put in place and thoroughly tested first, losing customers due to perceived lack of quality of service or product is a very real possibility. Litigation and consequences of a less than ideal break in relationship with an outsourcing partner if such a break is desired. Other risks include information security, unclear communications due to cultural and other differences, etc., Even if business continuity plans are in place, managers should check whether the plans are sustainable, scalable and easy to implement.
• When managing technology risks, consider the architecture, design, quality and maintainability of final product. Understand the software development process and its limitations and opportunities and gauge the expertise level and process maturity of the vendor's team.
• Formal communication and formal documentation are critical factors to success. Over-communicate to begin with and then pull back as both parties learn what's the optimal level. Be prepared for initial setbacks. It will get better over time.
• Have well defined and agreed SLAs and Acceptance Criteria at different points throughout the delivery process - not just the final point. Have controls to monitor them and remediation process defined.
• Don't put all eggs in one basket and have a good plan to pull back gracefully with minimal impact on your operations.

For more information, visit http://www.FountainBlue.biz.

• Define success
• Venture Funding?
• Delivery of product?
• Merger/Acquisition Event?
• Great Team?
• Grasp and communicate the market opportunity and trends
• VCs can work with technology challenges and even leadership challenges, market challenges are much more difficult to address
• Get support
• IP and corporate attorney from established, well-respected firm like Fenwick & West has many advantages
• Protect what you have, build the fences;
• When working in partnerships, attorneys can help develop an understanding of who owns which IP
• Attorneys from established firms are better positioned to negotiate with VCs as they have more leverage
• Finance professional
• Business Development professional
• Management professional
• Don't have a one-man team
• Management Team should be able to speak candidly, manage conflict, build consensus
• Corporate Board
• Scientific Board (not just the big names)
• Technical advice and cross-checking
• Represent product to professional environment, users, evangelists
• Regulatory pathway
• Put investor's minds at rest
• Company qualities
• Must have a balance of vision, passion, discipline and risk management
• Senior management must be able to balance the business people (rewarded for teamwork, collective problem-solving, seeing beyond the data) and the scientists (rewarded for facts, being #1)
• Senior management must have the ability to manage the tremendous cash-burn of R&D activities while sustaining the enterprise and growing

Trends in Funding:

• Pharmaceutical companies are funding earlier stage companies
• Consequently, VCs are looking for funding opportunities before pharma companies fund them
• As a result, entrepreneurs may have more latitude in the negotiations, both in seeking funding earlier in development and also negotiating governance agreements through the funding process.
• Mergers and acquisitions are a more common exit path.

• Mike Jones, Managing Director of Onyx Associates mikejones@onyxassociates.com;
• Ken Gonzalez, VP Corporate Development, McAfee;
• Andrew Luh, Partner, Mergers & Acquisitions Group, Fenwick & West;
• Dave Petroni, Advisor to Valchemy Inc., former VP Corporate Development, PeopleSoft, and
• Frank Young, Private Equity Investor and CEO, PS Print.

Below is a summary of advice provided by the facilitator and panelists.

Words of Advice on Successful Mergers and Acquisitions

• It's about the people
• Be self-aware
• Have ethics and integrity
• Maintain Relationships
• Negotiate with transparency - put your cards out on the table/lead with your chin
• It's a small Silicon Valley, word gets around if you don't act with integrity
• Strategic M&A activities are more likely to succeed
• Make sure the People, Technology, IP, Culture etc., of the company being bought fits into current and/or future business direction for the combined organization
• Maintain a strategic perspective about the value of the M&A activity throughout the course of the evaluation
• Have a financially strong core business and keep working on building the business through the M&A activity because sellers with Viable business model and financial health are better prospects for buyers
• Customers, vendors, management team is distributed among many parties, not concentrated in a few people and relationships
• Selling companies are evaluated on pre-selected criteria
• Be thorough with the due diligence
• Both sellers and buyers should have options if the M&A activity doesn't go through
• IP issues should be especially thorough reviewed with competent counsel
• Sellers should assemble a team of advisors including investment banker/intermediary, attorney, and accountant to help guide them through the complicated sales process
• Deals can be fun and Integration can be a lot of work
• Culture Matters