Software Industry
Mega-Trends:
"The 3 Cs"

By Scott Irwin, General Partner

El Dorado Ventures recently closed its seventh early-stage venture capital fund, raising another $200 million to invest in approximately 20 new technology start-ups. In keeping with our long-time strategy of building a diverse portfolio, we expect to invest roughly 30 percent of the fund in software companies.

In this newsletter, I take a look at three major trends shaping the software industry: consolidation, commoditization, complexity. All three revolve around the most important industry trend of all: a shift in the balance of power to the customer.

Consolidation

The power shift has led customers to choose to simplify their lives by concentrating their IT spending on a handful of strategic vendors such as Oracle, PeopleSoft, SAP, IBM and Microsoft. This has caused many of the remaining software companies to either make quick strategic acquisitions to broaden their product portfolios or find a bigger wagon to hitch themselves to. The Symantec/Veritas deal, in our opinion, is a prime example, as is Oracle's recently announced acquisition of Retek and the deals involving Oracle/Peoplesoft/JD Edwards, Hyperion/Brio, Microsoft/Great Plains and IBM/Ascential.

Where's the investment opportunity for El Dorado Ventures? While the established players are consolidating, we're looking for clever young software companies with a laser-like focus on making customers successful, which we believe results in a high return on investment. In our portfolio, a good example is Nextance, which provides a critical solution not addressed by the larger players, helping Fortune 1000 companies manage future cash flows tied to contracts.

Commoditization

Customers have more choices than ever before, and one of the more compelling options for customers is open source, in which the software license is free to the customer, who only pays for support and maintenance.

The open source movement may be a boon to customers but it is not an interesting investment theme for EDV. We feel that most of the companies pursuing open source business models are not technology innovators. Instead, they seek to replicate existing products or functionality.

We're still investing with the commoditization trend, however - in a contrarian sense. We're seeking to invest in software companies developing novel and proprietary application and infrastructure software not yet susceptible to the open source trend. An example in our current portfolio is Skytide, which develops business intelligence products enabling an entirely new class of data that cannot be analyzed today, while requiring minimal changes in how a customer implements and supports them.

Complexity

There's an unfortunate nickname for complex and expensive software that customers purchase, but then never fully implement: "shelfware." Customers large and small have been vocal in their frustration about the complexity and cost of software ownership.

In our opinion, Software-as-a-Service (SaaS) is a much better option - for customers, vendors, and investors as well.

Much has been written about the advantages of SaaS business models. For customers, SaaS requires zero implementation and offers the ability to pay based on actual usage. Costs are more predictable and customers continually renew their service, forcing vendors to focus on customer satisfaction.

For vendors, SaaS generates predictable revenues, lower support and upgrade costs, better operating margins and the potential to actually collect more lifetime revenue from a customer than a single implementation would have generated.

For investors (including El Dorado), SaaS offers the predictability that comes with recurring revenues and at least for now, valuations that are at a premium to traditional software vendors (today, much of this premium can be attributed to scarcity). In reality, most SaaS companies see lower (but perhaps more sustainable) growth rates and need more time to reach profitability on a GAAP basis. However, we believe they will retain their premium valuation as investors become more educated on the key metrics of the model (deferred revenues and renewal rates) and new valuation models are created.

We feel strongly that SaaS models result in a win-win-win for customers, vendors and investors. In our portfolio, GetActive Software is singularly focused on making non-profits successful using a SaaS model and BlueRoads is delivering channel management software as a service to Fortune 500 customers.

At EDV, we'll be investing EDV VII against these themes and expecting all of our software companies to be mindful of the structural shift at the core of those changes: the customer is back in charge.

EDV Portfolio News

Voxify Raises $10 Million in Series B Financing
Voxify, the first company to create Automated Agents for call centers with the conversational skills to handle advanced customer service calls, raised $10 million in a Series B financing round led by Sigma Partners. The company's previous investors, El Dorado Ventures and Palomar Ventures, also participated. Shanda Bahles serves on the Voxify board.

Cortina Systems Acquires Azanda Network Devices
Cortina Systems, a provider of integrated circuits that allow network systems designers to economically integrate bandwidth, computing power and storage into a single piece of equipment, acquired Azanda Network Devices, maker of the industry's leading traffic management and ATM SAR (Segmentation and Reassembly) products. Azanda's support and development team has joined Cortina and has been integrated into Cortina's team. Tom Peterson serves on the Cortina board.

Aprio Technologies Names New CEO
Aprio Technologies named Mike Gianfagna as its new president and chief executive officer. Before joining Aprio, Gianfagna served as vice president of marketing at eSilicon Corporation, and prior to that he was vice president and general manager of the System Level Design Group at Cadence Design Systems. Aprio is the technology leader in design-for-manufacturing (DFM) solutions that enable a fast path from design to successful manufacturing. Tom Peterson serves on the Aprio board.

Tom Keffer Takes the Helm at Skytide
EDV Technology Partner Tom Keffer has been named CEO of Skytide, an EDV portfolio company that develops business intelligence products enabling an entirely new class of data that cannot be analyzed today while requiring minimal changes in how a customer implements and supports them. Tom is the 1996 winner of EDV's Entrepreneur of the Year Award, which he received for the job he did running Rogue Wave Software, a leading provider of software solutions for creating and managing enterprise systems using object-oriented technology. Scott Irwin and Shanda Bahles serve on Skytide's board.

Skinstore.com Opens Korean Web Site
Skinstore.com, a purveyor of high quality personal care products operated by EDV portfolio company Salu, launched a site for Korean customers at www.skinstore.co.kr. You can visit the company' U.S. site at www.skinstore.com. Tom Peterson sits on the Salu board.

What We're Looking For

• Semiconductors and systems (RF, sensors, multimedia, wireless)
• Communications
  (Wireless, VOIP)
• Software and services
  (SaaS, technology-neglected industries)

PhotoTLC, Inc.
El Dorado Ventures recently invested in PhotoTLC, Inc., the leading provider of digital photo products, including photo restorations and photo gifts, for America's largest retailers. PhotoTLC provides its products in partnership with retailers large and small, both at 14,000 "brick and mortar" locations, as well as in e-commerce partnerships.

El Dorado Ventures Closes EDV VII at $200 Million
El Dorado Ventures closed its seventh early-stage venture capital fund in March at $200 million. The fund will make seed and early-stage investments in the semiconductors and systems, communications, software and services sectors. El Dorado Ventures expects to invest EDV VII in approximately 20 new companies over the next three years. The firm now has more than $750 million in capital under management.

Scott Irwin Promoted to General Partner; Gary Kalbach Named Founding Partner
Scott Irwin, who joined El Dorado Ventures in 2000, was named a General Partner of the firm with the closing of EDV VII. He joins Shanda Bahles, Charles Beeler and Tom Peterson as General Partners of the fund. Gary Kalbach, who co-founded El Dorado Ventures in 1986, remains with the firm as Founding Partner but will not play an active role in investing EDV VII.

EDV Tech Partner Vint Cerf Wins A.M. Turing Award
ACM, the Association for Computing Machinery, named Robert Kahn and EDV Tech Partner Vint Cerf the winners of the 2004 A.M. Turing Award for pioneering work on the design and implementation of the Internet's basic communications protocols. The Turing Award, considered the "Nobel Prize of Computing," is named for British mathematician Alan M. Turing and carries a $100,000 prize. Cerf and Kahn were honored for developing TCP/IP, the transmission format of the Internet.

EDV Presents 2004 Entrepreneur of the Year Award to Larry Abramson of Appshop/USi
El Dorado Ventures presented its 2004 Entrepreneur of the Year Award to Larry Abramson, who is currently serving as Senior Vice President, Worldwide Sales and Marketing for USi. Previously, he was CEO of Appshop, an EDV portfolio company acquired by USi in 2004. Appshop is a leading provider of application outsourcing and professional services for the complete Oracle applications lifecycle. EDV's Entrepreneur of the Year award is given by the firm annually to recognize the outstanding achievements of one or more of the entrepreneurs supported by El Dorado Ventures. Abramson was recognized for leading Appshop to profitability after a very challenging restructuring.

EDV Moves to New Offices
Please update your contacts file: El Dorado Ventures has moved to new offices at the Quadrus office complex.
Our new address is:
2440 Sand Hill Road
Suite 200
Menlo Park, CA 94025
Our phone and fax remain the same:
(650) 854-1200 (phone)
(650) 854-1202 (fax)

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