Case Study

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technology ventures - management dell’imprenditorialità e dell’innovazione
Richard C. Dorf, Andrew J. Nelson, Roberto Vona
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A P P E N D I X

B

Cases

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TREXEL

We’ve never met a customer who wasn’t interested in our technology.
—David Bernstein, CEO of Trexel

David Bernstein hung up the phone with Alex d’Arbeloff, Trexel’s largest investor, and contemplated an upcoming Board of Directors meeting scheduled for June 25, 1998. The meeting was only 10 weeks away and Bernstein,
Trexel’s president and chief executive ofﬁcer, needed to present a coherent vision of the company’s new strategy. Bernstein believed that Trexel’s patented technology for manufacturing foamed plastics had the potential to revolutionize much of the worldwide plastics industry. His innovative process technology, known as MuCell, allowed the Woburn, Massachusetts company to produce foamed plastic utilizing 25% to 50% less material than traditional solid plastics without a signiﬁcant decrease in the strength of the plastic. Bernstein believed the market for products produced via this technology could be in excess of 50 billion pounds of material per year representing potential worldwide annual revenues of over $100 billion. To date, Trexel had entered into numerous development partnerships with manufacturers, but no commercial products had made it to market. Bernstein was torn between his desire to pursue a variety of applications for the technology and the view of d’Arbeloff, and others, that he needed to limit Trexel’s focus to one speciﬁc application.
Bernstein and his investors had been conﬁdent that they could make sizeable inroads into the plastics business through a variety of potential applications, but time, money and human resource constraints had hindered Trexel’s ability to fully capitalize on the opportunity. Bernstein was excited by the technology, but unsure of the best way to exploit its potential:
The sheer size of the market for this platform technology is incredible. Unfortunately, it takes a lot of work to bring a technology from the laboratory to

Entrepreneurial Studies Fellow Matthew C. Lieb prepared this case under the supervision of Lecturer
Michael J. Roberts as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 1999 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston,
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Plastic Foaming Technology

the marketplace. I understand our investors’ desire to focus on a single area given our inability to get any of our products into commercial production so far, but I’m just not convinced that committing to a single product is in our best interest right now. I would be more comfortable hedging our bet by pursuing multiple applications.
Bernstein knew that he needed to carefully analyze the many potential markets for MuCell in order to choose the best application(s) on which to focus. A wholehearted commitment to a speciﬁc market segment had the potential for earning substantial returns, but also the possibility of committing the company’s limited resources to a single area that might never pay off.

PLASTIC FOAMING TECHNOLOGY
Traditional Technology
Traditional foaming of plastic had been in existence for almost 30 years and was used in the manufacturing of a variety of products such as meat trays, dinnerware products and disposable cups (see Exhibit 1 for sample of products using traditional foaming technology). In the classic foaming process, plastic “pellets” were mixed with a gas (e.g., butane) under pressure. This mixing created cells (a cell was one air bubble and the plastic material around it) as the gas continually reacted with the plastic in a closed environment. This process required an extruder (a large machine that mixed the chemicals and plastic) to churn out foamed plastic products. The traditional methodology had several limiting characteristics arising from the fact that the technology produced relatively large and unevenly sized and shaped cells that could not be distributed uniformly within the plastic. The large size and lack of uniformity among the cells resulted in suboptimal strength and fatigue properties. Further limiting the effectiveness of traditional foaming was the inconsistency in product quality that arose from the difficulty in controlling the process.
Finally, the “blowing” agents (chemicals used to create the air in the cells) in the traditional process also presented a regulatory challenge. Most of the agents were ﬂammable, required special handling and regulatory approval for their use and release.

Trexel’s Foamed Plastic Technology
Trexel’s technology was originally developed at the Massachusetts Institute of
Technology’s (MIT) Polymer Processing Laboratory. In the early 1980s,
Dr. Nam P. Suh, who headed the Mechanical Engineering Department at MIT, invented a microcellular foam process for thermoplastic polymers based on a precise process that utilized carefully controlled thermodynamic reactions within plastic raw material to create foam with small, evenly distributed and uniformly sized cells. MIT scientists developed a technique that utilized nonﬂammable gases—such as carbon dioxide and nitrogen—which were mixed

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with the plastic raw material under a carefully controlled set of temperature and high pressure conditions (see Exhibit 2 for a process system diagram).
Once the pressure was released, the evenly distributed gas “vaporized” and uniform air distribution in the plastic was achieved instantaneously (see Exhibit 3 for key differences between Trexel’s process and the traditional foaming process). Bernstein described the theory and advantages of Trexel’s MuCell foaming technique:
The primary motivation for all foaming is to use less material—you can use air instead of $1.35 per pound plastic. The trick, however, is to arrange the cells—the tiny bubbles—in such a way that they preserve the properties of the original solid material. Our technology permits a perfectly controlled approach to foaming. Indeed, it is so precise that we can create plastic that is signiﬁcantly lighter than traditional plastics while preserving a high proportion of the key properties of the material. For instance, we can produce some products with a 30% weight reduction while sacriﬁcing only a 10% reduction in stiffness. If the 10% strength reduction does not affect the performance of the product, then we have created a process that can save manufacturers a lot of money. This weight to strength tradeoff allows us to do things with plastics that have never been done before. To do this, we mix a gas, like nitrogen, into the solution of liquid plastic under high pressure. Then we remove the pressure—like popping off a champagne cork—and the gas expands, instantly becoming embedded in the plastic as tiny, uniformly sized bubbles.
The beneﬁts of the MuCell process were threefold. First, the process allowed for the use of foamed plastics in applications that had previously relied on solid plastics because of the inherent limitations of traditional foaming. The use of MuCell plastics in place of solid material plastic reduced production costs by 20% to 25% as a result of decreasing both the amount of raw material used and the volume of production waste. MuCell technology typically produced products with a density and weight reduction relative to those products made from traditional foaming technologies, without a proportional drop in the strength of the materials. The second distinct advantage of the MuCell process was the improved mechanical properties of the foamed plastic (see Exhibit 4 for mechanical property differences) relative to conventional foamed plastics. Speciﬁcally, the tensile (breaking or tearing) and compressive strengths of MuCell materials were greater than that of conventional foams. MuCell products also demonstrated improved performance at cold temperatures. The third key advantage of Trexel’s technology relative to the traditional methods was the reduced environmental impact. The nonﬂammable “blowing agents” in the MuCell process were more environmentally friendly than the ozone-depleting chemicals required for traditional foaming.
MuCell had received the Environmental Protection Agency’s approval as a
“safe alternative foam technology.”

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Background

BACKGROUND
The Company
Dr. Suh founded Trexel in 1982 in an effort to capitalize on the commercial viability of numerous breakthroughs he had made in the polymer arena. Suh licensed various technologies from MIT and began engaging in ad hoc development efforts across a wide range of applications and products for the polymer industry. Bernstein described the philosophy of Trexel during this early phase: The eighties were a time when the company was struggling to ﬁnd its focus. There were six or seven people here who were constantly chasing the next great idea. They were producing gauges and other devices for the polymer industry prior to 1993 when they ﬁrst began working with microcellular foam. The process had been invented at MIT in 1982, but was not patented as a continuous—rather than batch—process until 1992. It was not until 1995 that Trexel fully licensed all of the necessary MIT patents required to proceed with commercializing the MuCell process. As soon as the licensing agreement was in place, the company began to focus more on MuCell. Although the scientists could only produce MuCell using a batch process, which is completely incompatible with commercial production, they were able to ﬁnd development partners. The quality of the batch produced products was so good that people were eager to sign on with Trexel despite the fact that the company was not even close to being able to produce MuCell at commercial scale. Trexel signed MuCellrelated deals for a variety of foamed plastic products—plates, pipe insulation, paper coating—all sorts of things. Unfortunately, the company was overly optimistic regarding what could really be accomplished given the state of the technology. The truth was that at this time, Trexel’s theory for producing microcellular foam was really impressive, but the actual foam produced was a long way from being commercially viable. Lab conditions are drastically different from commercial manufacturing conditions. It’s one thing to produce nice sheets of MuCell plastic in a laboratory and quite another to control the process so that you can make plastic products of different dimensions at a large scale in a manufacturing plant. The company had been unsuccessful in trying to raise outside equity, but even without external capital, strong customer interest in forming partnerships allowed them to use these development deals to “bootstrap” the technology development.
By 1994, the company had still not achieved commercial production of any products, but the progress of the technology was evident. Advances had been made in adapting the foamed plastic to different shapes at various levels of production. By 1995, Trexel’s development efforts began to attract a great deal

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of attention from customers as companies saw the potential cost savings and improved product characteristics that MuCell made possible in the laboratory.
The signiﬁcant level of interest from major producers of plastic products prompted Dr. Suh to pursue a venture capital investment that would enable
Trexel to more rapidly commercialize the technology. Dr. Suh needed to look no further than MIT’s Mechanical Engineering Department for funding. The chairman of the Visiting Committee for the department was fabled Boston entrepreneur and angel investor Alex d’Arbeloff. d’Arbeloff, the chairman and
CEO of Teradyne, Inc., was extremely interested in the commercial viability of the MuCell technology. d’Arbeloff assembled a group of investors and, in
November of 1995, purchased 30% of Trexel for $2.2 million with the condition that a new CEO would be hired to run the business.

Bernstein Joins the Trexel Team
Concurrent with the equity infusion, d’Arbeloff recruited Bernstein (see
Exhibit 5 for management biographies) to be the president and CEO of the company. Bernstein, a 1976 graduate of Harvard Business School, had worked in a variety of managerial roles at Teradyne and Thermo Electron where he specialized in commercializing and marketing advanced technologies. Bernstein reﬂected on the opportunity:
Alex d’Arbeloff, whom I really respected, was intrigued by the technology and wanted to bring me in to turn it into a viable business. I was immediately impressed by the technology. The company had been able to create some remarkable foamed plastics in the lab at small production volumes, so the potential of MuCell seemed enormous. Personally, I was excited to work in an environment that allowed me to implement decisions quickly. I had grown weary of the numerous layers of approval required to make something happen in larger organizations and was looking for something entrepreneurial. I liked the technology and I had a great deal of experience constructing licensing deals, so this opportunity was both exciting personally and a good ﬁt with my previous experiences.
Strategically, Bernstein saw an opportunity to move Trexel’s technology from the laboratory to commercial production by bringing in more skilled engineers, instilling a disciplined product management approach and by changing the fundamental business model. He commented on his vision of the business model:
My predecessor had formed a number of development agreements with manufacturers to get the ball rolling towards commercialization of the technology. Strategically, I saw an opportunity to shift away from complete reliance on development partners to a more self-sustaining model. My view was that we could use the cash ﬂow from the development agreements to fund our own internal projects. Under this scenario, we would take the knowledge and cash from our development programs and apply them to

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Background

internally developed products that were technologically similar to the development partnership projects. As our knowledge increased, we would eventually be able to capture the full value of the technology by manufacturing certain products in-house. Development contracts allowed us to spend other people’s money to learn more about the technology.
Bernstein made signiﬁcant changes almost immediately. His ﬁrst move was to strengthen the company’s intellectual property protection. Bernstein felt that the potential of Trexel’s technology was so great that it was only a matter of time before other companies attempted to copy the process and beat Trexel to key market segments. The original MIT patents covered supercritical ﬂuid, but it was clear to Bernstein that each application of the core technology to a speciﬁc plastic might also be patentable. Bernstein saw an opportunity to bolster the company’s patent portfolio by implementing a formal process by which engineers documented their efforts and submitted patent applications in a routine fashion. This process, though often administratively cumbersome, was a critical step in building a base of protection for Trexel’s long-term intellectual capital interests. To further shore up the company’s position in the intellectual property arena, Bernstein retained the services of Wolf, Greenﬁeld and Sachs, a Boston law ﬁrm specializing in patent law. Bernstein agreed to pay his patent attorneys close to $250,000 per year to protect Trexel’s intellectual property interests. Though expensive, Bernstein felt the legal fees were well worth the money: Without those patents, our company had little to go on. When you are in the business of licensing technology, you must have patents to protect that technology; otherwise your work turns into nothing more than a consulting arrangement. Wolf, Greenﬁeld and Sachs were expensive, but good.
They ﬁled close to one thousand claims and were able to get us broad protection for those claims entered into the patent process, including coverage in Europe and Asia (see Exhibit 6 for sample patent).

Three-pronged Business Strategy
Conﬁdent that Trexel’s intellectual property would be sufﬁciently protected,
Bernstein turned his attention to the company’s business strategy. Bernstein’s goal was to implement a plan that would produce royalty revenues sufﬁcient to cover the company’s operating expenses within two years. He envisioned a three-part strategy where Trexel would continue to engage in large-scale development partnerships in an effort to generate cash as well as technological improvements. The partnerships would then allow Trexel to take the money and know-how from the partnership deals and quickly apply them to simple products that would be developed in-house. Production capability developed through internal development projects would eventually lead to Trexel’s own full-scale production of high value-added product lines. Bernstein described his view of the situation:

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When I joined the company, it was clear to me that these development agreements were hard to manage. “Handing off ” the technology to a partner was very difﬁcult because they were worried about their business today, not the potential of our technology down the road. Most partners simply could not afford to pull skilled employees off of revenue generating projects to work on MuCell development deals that held great future potential, but limited short-term beneﬁts. We would propose next steps that needed to be taken to push the technology ahead and our partners would almost always agree with us. Unfortunately, we would come back to the same customers the following month only to ﬁnd out that they hadn’t even run their machine for weeks because the primary engineer for the project had been sent to Taiwan to work on something they deemed more urgent. Customers were—understandably—concerned with present revenue more than “the future.” Nevertheless, while I was somewhat ambivalent about the development projects as they were structured now—even going so far as to cancel over $1 million in development deals—I believed that I couldn’t afford to cut them all off until I had a working revenue model that could effectively replace the development partner revenue.
Development projects
The goal of the development projects was to demonstrate commercial feasibility for speciﬁc MuCell-enhanced products that would quickly lead to scale production and long-term royalty revenue. Development project deals would give customers an exclusive license in exchange for an up front development payment and a multi-year royalty agreement. Exclusivity agreements typically had a number of common characteristics. They offered exclusive use of the MuCell process for a speciﬁc product application (i.e., low-density polystyrene meat trays) over a three-year to ﬁve-year period assuming the customer achieved production levels sufﬁcient to generate a minimum royalty payment and garner a minimum share of the speciﬁc product market.
Turnkey licensing
The knowledge gained from the development partnerships would allow Trexel to quickly license the technology for related products in a turnkey manner.
Bernstein believed that Trexel’s engineers would be able to rapidly transfer the technology developments from the partnership projects to similar products that were outside the bounds of the development projects’ exclusivity agreements.
Trexel would only target large-scale makers of technologically “simple” products with the turnkey licensing model.
Identiﬁcation and retention of right to high value-added products
Bernstein saw enormous potential in retaining the right to develop certain products in-house. The commercial viability and market potential of the MuCell technology would only come to light through development projects and turnkey

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Background

licensing. As the technology evolved, Bernstein hoped to identify speciﬁc products that represented extremely attractive cost/performance characteristics.
Once these products were identiﬁed, Trexel would make strategic acquisitions enabling the company to manufacture products internally.

Implementing the Strategy
In early 1996, Bernstein set out to implement the three-pronged strategy by ﬁrst focusing on what he believed were the “right” kind of development projects. Trexel focused its marketing efforts on billion-dollar companies that maintained signiﬁcant research and development budgets. These companies could see the potential of Trexel’s technology and wanted to get involved early. They had the resources to invest money in development and the patience to wait for the technology to mature to commercial viability. By September of 1996,
Trexel had already entered into 11 development partnerships. These partnerships included MuCell products such as polystyrene sheets for arts and crafts applications, polypropylene pipe systems, building insulation foams made from recycled bottles, PVC tubing, and polystyrene meat trays. These development agreements accounted for $5 million in revenue to Trexel, in addition to agreements on future royalties that, if the projects were successful, could generate over $20 million dollars per year.
Each partnership project entailed slightly different technical challenges and varying degrees of partner participation. In some cases, Trexel allowed customers to design their own MuCell facility while Trexel served as a consultant. Other arrangements called for Trexel to design and install the equipment in Trexel’s own facility and conduct all experimentation in-house. Bernstein commented on the development projects:
Customers were so eager to reap the beneﬁts of the MuCell technology that they were willing to pay anywhere from $300,000 to $400,000 up front— in addition to signing royalty agreements—to become development partners. I ﬁgured that if customers were paying us good money under development agreements they would have an incentive to get the technology into production. We signed lots of development contracts that essentially made us a technology job shop where we focused our attention on whatever products the development partners speciﬁed. Our arrangement with Sarto Plastics was pretty typical. They paid us $300,000 in development fees and agreed to pay a future royalty on sales. We, in turn, gave them exclusive rights to use the technology for disposable food service items.
While the development revenue earned under these agreements was clearly a positive aspect of the early business model, the actual development results were disappointing. It became, in Bernstein’s words, “addictive to accept $300,000 even if we weren’t sure we could deliver results.” The promise of the technology was clear, but the shift from laboratory success to market acceptance was a long way off. Bernstein described the technological obstacles confronting Trexel engineers:

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Our technology produces extremely small and perfectly sized cells because the gas uniformly and instantaneously comes out of the solution the instant pressure is dropped. It is extremely difﬁcult to control the results of this
“mini-explosion” because there is no room to adjust the outcome once the plastic has been formed—the outcome is instantaneous and permanent. The traditional technique provides a larger margin for error because the cells are formed over a period of time ranging from 30 to 40 seconds. As a result, the products can be shaped and adjusted somewhat with dies and other tooling devices before the ﬁnal product is completely formed.
MuCell’s instantaneous cell creation was especially problematic in the foaming of extruded plastic products with a thickness of greater than 1 mm.
This problem was exacerbated when creating products with varying thickness.
For instance, creating a container that was 1 mm thick in certain areas and
4 mm thick in others posed an enormous engineering challenge because of uneven pressure relationships at the time the material exited the die. Essentially, the desired characteristics of the products simply surpassed the initial capabilities of the technology. In the end, none of these development contracts appeared close to yielding products ready for commercial production.
Bernstein offered his view:
On the positive side, the revenue from development partners gave us the opportunity to hold our venture capital ﬁnancing in reserve—which was great from a cash management perspective. Unfortunately, our inability to actually produce market-ready products resulted in the alienation of some big customers. We simply were not able to quickly match the technology’s performance to the expectations of our development partners. For example, we were working with a garden hose manufacturer on a project that appeared to have great promise. We developed a hose that used 45% less plastic than the old process. Unfortunately, the foamed plastic wasn’t good under this kind of pressure and the hoses leaked. To make this application viable, we needed the manufacturer to use a different material formulation.
Regrettably, the manufacturer’s hose division was a small part of their overall business which relied on PVC materials. They were using hoses as a way to utilize the excess PVC material generated from their other business and, as a result, were reluctant to use any other material in the manufacturing of their hoses. In many cases, both Trexel and our development partners had unrealistic expectations of the beneﬁts that the technology could deliver for particular applications—many of the applications simply weren’t well suited to the MuCell process without signiﬁcant modiﬁcations.
Trexel had learned a great deal about the technology and its limitations through development programs despite the lack of commercial production.
Trexel engineers had successfully developed an assortment of new dies and tools that could be used with existing production machinery in the application of the MuCell process. Strategically, this was an important development because equipment modiﬁcations were more agreeable to potential users of the

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Background

MuCell technology than full-scale capital expenditures for MuCell-speciﬁc equipment. As a result, achieving commitments from potential partners would be easier going forward as capital equipment modiﬁcations became less of an issue. Another key learning point for Bernstein and his team was in their understanding of certain types of materials. The plastic industry was comprised of a variety of different plastic materials that exhibited a wide range of characteristics. Initially, Bernstein and his engineers believed that MuCell would work with almost any plastic compound. The reality was that certain materials (i.e.,
“rubbery” compounds) simply were not well suited to the MuCell process while others, such as polypropylene, worked well with Trexel’s technology.
In April of 1996, Bernstein began to think about focusing more proactively on speciﬁc products rather than responding to the broad array of development partner interests. Though the development projects were moving ahead—six companies were in the process of installing MuCell production lines in their facilities—commercial results were not yet being realized. Trexel’s customersponsored development focus was not producing the short development cycles that Bernstein and his investors had anticipated. Bernstein was convinced that the company’s focus needed to be more on Trexel’s internally driven development efforts. To that end, he embarked on a search for a speciﬁc product that met Trexel’s objective of getting a product to market. Analysis by Trexel’s scientists, marketers and Bernstein himself led to the decision to focus on wire insulation. The thin shape of wire allowed for easier application of the Trexel technology at its current state of evolution. Additionally, the inherent shortcomings of existing insulation products provided Trexel with an opportunity to signiﬁcantly improve upon the current products in this market. Bernstein described the rationale behind focusing on wire insulation:
I ﬁnally had the insight that we needed to get something—anything—into production quickly. We had to get one project working. We picked wire insulation because the product is thin—which typically makes things easier for us. In addition, the air bubbles make foamed plastic a better insulator than solid plastic.
Finally, the existing materials are extremely expensive: customers were using
Teﬂon, which costs $12 per pound. Reducing raw material costs by 40% for a
$12 per pound material is much more valuable than saving 40% on a material like polyoleﬁn which only costs $.40 per pound. Thus, MuCell was potentially very valuable in this application.
Bernstein signed a deal with a $1 billion wire and cable supplier to exchange processing knowledge and to set up a pilot wire and cable line at the customer’s facility. Trexel’s engineers, working closely with representatives from the wire and cable manufacturer, were able to produce a wire insulation product that represented signiﬁcant cost savings for the customer relative to their old production process. Unfortunately, the savings were not sufﬁcient to overcome a more practical problem—the insulation did not stick to the wire.
The plastic insulation would swell up when exiting the extruding machine, causing a separation between the wire and the insulation. Trexel engineers were

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not able to resolve the problem and the partnership ended with no marketable product to speak of.

Modifying the Strategy: “Fast Track Development”
Though the wire insulation deal did not produce a product, Bernstein was intrigued by the shorter development cycle that the engineers had achieved. In the spring of 1997, Bernstein attempted to bring the lessons from the wire insulation partnership into a formal marketing program dubbed “Fast Track Development.”
The ﬁnancial performance of the company at this time was still lagging
Bernstein’s expectations despite the previously described development contracts and earnings (see Exhibit 7 for ﬁnancial information). The product development results were simply not coming fast enough. Bernstein knew that the success of the company would eventually be a result of tangible products succeeding in the marketplace. He felt that in order to implement a more market-oriented development process, Trexel would have to be the key driver in the move towards commercialization. In Bernstein’s words, “development efforts needed to be more directed by Trexel than by Trexel development partners—we needed to be more pragmatic than visionary at this stage of the process.”
Up until April of 1997, Trexel’s development activity had been focused on commercializing the MuCell process in order to obtain royalty revenue and to conﬁrm the adaptability of the process to the rigors of commercial scale production. Unfortunately, 1997 year-to-date royalty revenue was nonexistent.
Bernstein hoped to remedy the current situation by engaging in fewer customer sponsored initiatives and focusing more on internally directed development. Bernstein described his decision to move even more of the development effort in-house:
At this point in time, we had greatly improved our own understanding of the technological feasibility of MuCell. Unfortunately, the time to market for everything we were doing was simply too long. I made the decision to focus on the internal development of speciﬁc products. My goal was to shift our customer focus away from companies willing to spend several hundred thousand dollars on “high risk” development projects. We wanted customers who were more committed to investing their time and money in transferring Trexel-developed products to their own factories and producing products quickly.
To make this shift, Trexel would require an additional $2 million in ﬁnancing. The funding would be used to purchase production equipment and to hire additional engineers and marketing staff. Bernstein went back to d’Arbeloff and the other initial investors to raise the capital required for the further development of MuCell. Impressed by the unending interest from potential customers and the progression of the technology, investors agreed to the terms of
Trexel’s series C ﬁnancing which raised $2.16 million in exchange for 13% of

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Background

the company (see Exhibit 8 for ownership positions). Bernstein described his investors’ rationale: d’Arbeloff and the others continued to be enthusiastic about Trexel because of the strong interest from the world’s plastics manufacturers. Typically, ventures develop a technology and hope they can ﬁnd a market for it. In our case, the market was already screaming for our technology, so it was up to us to deliver.
With an infusion of capital and a modiﬁed business model, Bernstein again set out to get MuCell products into commercial production. To speed up commercialization, Bernstein reﬁned the plan for the Fast Track Development program. Fast Track Development called for a smaller initial ﬁnancial investment from partnering companies in exchange for a stronger commitment to the rapid initiation of actual production of simple products using the MuCell technology. Bernstein planned to roll out the Fast Track Product Development program at the National Plastics Exposition (NPE) in June of 1997.
Interest in the new program proved to be extremely strong. The NPE show generated interest from nearly 50 companies that manufactured products that seemed to be a good ﬁt with the MuCell technology. Table A illustrates the range of products that companies were interested in producing in partnership with Trexel.
Bernstein was excited by the interest that Fast Track Development was generating:
At this point, we didn’t want money, we wanted answers. We intentionally marketed to organizations that had products that seemed to ﬁt with what we had learned about the material and process characteristics of our technology.
We quickly eliminated any customers who demanded that we develop samples before installing a production line in their facility. I knew that if we could get customers to commit to a MuCell production line in their plants early on, they would then have an incentive to really make the technology work. If you have space on your production ﬂoor being taken up by a MuCell line, your commitment to making the line work will be much stronger than if the equipment is sitting on Trexel’s plant ﬂoor. In addition to our refusal to make samples, we also asked ourselves three questions. Is this a material and application that we understand and can transfer with little effort? Is the customer capable of

TABLE A Potential fast track development products from the NPE trade show.
Marine ﬂotation

Seat cushions

Razors

Beverage containers

Refrigerator liners

Raincoats

Wine bottle corks

Gaskets

Label backing

Shoe soles

Power cables

Graphic arts production

Tape

Highway signs

Aircraft parts

Dashboard covers

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Cases

working independently at his facility when the time comes? Does the customer have a target product that represents an interesting market opportunity? If and only if the answer to all of these questions was “yes” were we willing to undertake the project. In the end, we took less money up front in exchange for a commitment on the part of customers toward rapid development in their own facilities. The Fast Track Development initiative changed the economics of Trexel’s business model. Table B highlights the shift from the previous partnership model to the Fast Track Development model.
Under this new model, Trexel explored partnerships with 67 companies spanning a wide range of applications. Table C highlights the range of potential product partnerships.
In the end, Bernstein chose to engage in only the projects that he believed would be most likely to quickly produce successful commercial products. Many potential partnerships were not developed because the customers required product samples in advance of committing to a production line at their facility. He eventually signed nine Fast Track Development deals for products such as cushioned shoe inserts, strips to seal the doors of automobiles and disposable food service plates. Unfortunately, technological limitations, resource constraints

TABLE B Fast track development vs. traditional development contracts Traditional development contract
Payment:

$500,000

$50,000

6-12 Months

1 Month

24 Months Plus

6 Months

At least 3 years subject to performance

1 Year

Negotiation:
Term:
Exclusivity:

Fast track development

TABLE C Sample of potential fast track development partnerships
Partner

Product

Material

Rogers Corporation

Shoe inserts

Santoprene

Norton Plastics

Weather stripping

Polyvinyl chloride (PVC)

Blind Systems Inc.

Vertical blinds

Polyvinyl chloride (PVC)

Tray Form Plastics

Meat trays

Polystyrene

3M

Thin-ﬁlm labels

Polypropylene (PP)

Owens-Illinois

Bottle cap liners

Polystyrene (PS)

Mattel

“Hot Wheels” tracks

Polyethylene (PE)

Anderson Windows

Window proﬁles

Polyvinyl chloride (PVC)

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Background

and a lack of follow-through on the part of development partners hindered the development of market-ready products. Bernstein described one failed Fast
Track Development project:
The shoe insert opportunity seemed very promising to us early on. Rogers
Corporation was really committed to the technology and they were willing to do everything we asked of them. Unfortunately, as often happens with a developing technology, the customer kept getting more and more speciﬁc about the product requirements, and we couldn’t get all of the aspects of the technology to match exactly to the customer’s speciﬁcations.
The material they needed to use for the inserts was simply not viscous enough for our process. The low viscosity prevented us from getting the proper cell structure in the foam because we couldn’t apply the appropriate pressure to the material. The technology fell just short of meeting expectations. In May of 1998, it became clear to Bernstein that Trexel’s success would be dependent upon a more drastic change in the business model than ever before. Despite the evolution from long-term development contracts to the more streamlined Fast Track Development program, the actual results—measured by the success of commercial products—continued to disappoint Bernstein and
Trexel’s investors. Bernstein’s view of Trexel’s most likely path to success was becoming clearer in his own mind:
Despite the popularity of the Fast Track Development program, it became very clear to me that success would never come if we continued to rely so heavily on our partners for development. Customers simply don’t have the staying power to endure the process changes that MuCell required of them.
Our partners found it difﬁcult to dedicate the required resources to Trexelsponsored projects because of the developmental nature of MuCell. Further complicating things was the fact that most marketing people want our products to be more than just cheaper than the existing products. For example, one customer was demanding that our drinking straws perform better than their current drinking straws. It didn’t seem to be enough to simply save them money on a commodity-like product.
In my mind, success would only come if we could control every step in the process. We needed to control the material, dimensional requirements, and tooling of equipment to make this technology ready for commercial production. In the end, this is not a turnkey technology and, therefore, it is extremely difﬁcult to launch products in partnership with customer’s marketing and engineering departments without constant support from Trexel.
Alex d’Arbeloff and the other investors agreed with Bernstein’s assessment of the situation. It was Bernstein’s responsibility to articulate Trexel’s strategy including which speciﬁc application or applications the company would pursue. This impending meeting with the Board of Directors would set the stage

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Cases

for Trexel’s future. Bernstein now turned his attention to deciding which project(s) he would recommend.

Potential Applications
Bernstein’s task of choosing speciﬁc applications on which to focus future development efforts was a daunting one. The sheer number of potential applications required a great deal of market analysis and technological understanding on the part of Trexel’s management team. Rigorous analysis and frequent debates eventually led to a list of ﬁve potential areas of focus for Trexel. Each of these ﬁve applications had several attractive characteristics, which only made it more difﬁcult for Bernstein to eliminate options. While d’Arbeloff and the other investors wanted to pick a single application on which to focus,
Bernstein was not yet convinced that eliminating some applications in order to concentrate on others was in the best interest of the company. Regardless, it was now up to Bernstein to select only the most promising application(s) for
Trexel’s MuCell technology.
Molded structural foam
Products made from this process included garbage cans, computer monitor and keyboard housings, beverage carriers and swimming pool panels. Bernstein and his management team estimated that the 100 worldwide structural foam molding companies collectively churned out over one billion pounds of material each year (at a cost of $.40 per pound) generating over $2 billion in revenue on an annual worldwide basis. Plastic products made using this process required enormous machines costing over $1 million each. Uniloy/Milacron was the dominant force in the manufacturing of this equipment, garnering over
80% of the world market share for such machinery. There were approximately
300 installed structural foam machines with approximately 20 to 30 new machines forecasted to come on line each year for the foreseeable future.
At the end-user level, the MuCell process resulted in a 30% material cost savings and an increase in the speed of manufacturing. In fact, Trexel’s engineers had proven that a typical structural foam molding machine utilizing the
MuCell process could operate at twice the speed of the same machine utilizing traditional process technology. Trexel engineers were conﬁdent in their ability to produce commercially viable products in the structural foam molding arena because the technological adaptation was nearly identical to what they had already been working on in other areas.
Bernstein’s revenue model for structural foam molding combined a consulting contract, an equipment sale and a licensing agreement. First, Trexel would allow original equipment manufacturers (OEM’s) to develop equipment speciﬁcally for the MuCell process. By giving the OEM’s the know-how to develop MuCell equipment, Trexel would be providing the OEM’s with an additional product line to sell to customers. In exchange for the opportunity to sell MuCell equipment, OEM’s would agree to sell the equipment at a price

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Background

comparable to other plastic manufacturing equipment, thus eliminating equipment cost as a barrier to end user adoption of the MuCell process. Once the equipment was purchased from the OEM’s by plastic manufacturers, Trexel would negotiate a deal for a consulting contract, the sale of a proprietary
Trexel-made supercritical ﬂuid delivery system and a seven-year licensing agreement. The consulting contract called for Trexel to earn $15,000 for advising the plastic manufacturer on implementing the initial production line. This was expected to be a one-time fee. Trexel would manufacture, at a cost of
$36,000, the crucial supercritical ﬂuid delivery system, which would be sold to the plastic manufacturer for approximately $73,000. The seven-year licensing agreement called for the plastic manufacturer to pay Trexel either $25,000 or 20% of the total savings that the plastics company would realize by instituting the MuCell technology, whichever was greater. After the ﬁrst year, the licensing agreement would revert to a ﬁxed contract based on the licensing fees paid to Trexel in the initial 12 months, thus eliminating the need for Trexel to monitor the actual production of the plastic manufacturer after the ﬁrst year.
Injection molding
This process was used in the manufacturing of a wide range of plastic products including buckets, ties for garbage bags, trays and nearly every plastic part under the hood of an automobile. Injection molding was an attractive segment from a technology perspective because the difﬁculties in controlling the MuCell
“nucleation” were made easier by the use of physical molds. Since the plastic was foamed directly into a mold, it was signiﬁcantly easier for Trexel engineers to control the “mini-explosion” that often plagued the MuCell process.
The market for injection molding was estimated to be over $40 billion annually with over 25,000 injection molding machines expected to be sold annually over the coming years. While the signiﬁcant installed base of over 100,000 machines was attractive, the opportunity for applying Trexel’s microcellular process was more limiting. One of the inherent shortcomings of the MuCell process was the difﬁculty in making products that required a glossy ﬁnish. Trexel’s marketing team estimated that there were nearly 5,000 potential customers using injection molding machines that could be adapted for MuCell production. Ultimately, 20,000 existing injection molding machines could be equipped to utilize the MuCell process while an additional 5,000 applicable machines would be purchased annually over the coming years. Trexel believed that 50% of the market would use the MuCell process for producing commodity resins while the remaining 50% would use Trexel’s technology to produce more complex engineering resins. The manufacturers could expect to realize cost savings of nearly 25% by instituting a MuCell production line.
Bernstein believed that Trexel could enter into similar consulting arrangements as outlined in the structural foam plan, but would sell the supercritical ﬂuid delivery system for $50,000, twice the cost of developing the delivery system for injection molding. Licensing agreements for injection molding would be ﬁxed contracts based on the type of resin being used by the plastic manufacturer.

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Commodity resin producers would pay $25,000 per year for seven years for each of the MuCell machines that the company utilized. Engineering resin producers would be charged $35,000 per machine per year for seven years.
Blow molding
Over ﬁve billion pounds of blow molded products were produced worldwide in
1997. The primary application for blow molding was the manufacturing of bottles for consumer packaged goods. Shampoo, motor oil, milk and a variety of household cleaning items were all bottled in blow molded plastic containers.
With the exception of milk bottles, the majority of the MuCell-compatible blow molding was produced by 20 companies who collectively operated 200 highvolume machines that each generated close to eight million pounds of material annually. Milk bottles represented another relatively promising application. The three major milk bottle manufacturers operated nearly 1,500 blow molding machines accounting for over 1.5 billion pounds of blow molded plastic each year. Trexel’s marketing team believed that an additional 300 milk bottle manufacturing machines would be sold each year over the next several years.
The technological feasibility of applying the MuCell process to blow molding appeared very promising. The use of molds made controlling the rapid cell nucleation process easier for Trexel’s engineers. Additionally, the tubular shape of most blow molded products had proven to be relatively “MuCell-friendly” in the past. Trexel’s engineers were conﬁdent that blow molded products could be produced using 25% less material than in traditional blow molding. The current cost of blow molding material averaged $.40 per pound. Bernstein believed that Trexel could command a $25,000 annual licensing fee per milk bottle machine for ﬁve years. In addition, he anticipated Trexel being able to garner
20% of the net cost savings as a royalty payment from the applicable non-milk bottle blow molding machines, which would convert to a ﬁxed contract after the ﬁrst year. Similar to the structural foam revenue model, Trexel expected to earn $15,000 per customer in consulting fees and an additional $73,000 per machine for the supercritical ﬂuid delivery system.
PVC extrusions
Trexel’s management believed that the PVC extrusion market held great promise for the MuCell technology. PVC extrusion, in a form suitable for MuCell, was applied almost exclusively to three product lines: exterior siding for houses, vertical window blinds and interior paneling. The market for PVC exterior siding was comprised of ﬁve companies who collectively represented 90% of the
North American market and operated close to 100 machines producing nearly two billion pounds of material each year. Vertical window blinds and interior paneling were produced by 20 manufacturing companies located primarily in
North America, Europe and South America who operated a total of 400 machines each producing one million pounds of material each year. Bernstein saw two key advantages to focusing on the PVC market. First, the thin shape and long production runs used in making PVC extrusion products ﬁt well with

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Decision Time

the capabilities of MuCell at the current time. Second, Trexel’s engineers believed they could produce the necessary PVC products using 25% less material with no loss of stiffness. Existing PVC material cost manufacturers nearly $.50 per pound.
The risks in this application were two-fold. First, there was a risk in gaining commitment from partners because of the signiﬁcant changes in both the equipment platform and manufacturing process required to produce PVC extrusion using the
MuCell technology. Second, the production of exterior siding would require the approval of the industry building code committee. The interests of entrenched players in the industry might make the required approval difﬁcult to receive.
The revenue model for PVC extrusions called for Trexel to receive
$50,000 in a one time consulting fee from each customer who adopted the technology. Trexel would also charge $73,000 for the supercritical ﬂuid delivery system required for each MuCell machine. The licensing arrangement would be structured such that Trexel would receive 20% of the cost savings realized by manufacturers in the ﬁrst year, which would again convert to a ﬁxed contract in subsequent years.
Meat trays and food packaging
Trexel had already demonstrated an ability to successfully manufacture meat trays on commercial extrusion lines in limited quantities. As a result, Bernstein and his managers were attracted to this potential application which utilized nearly two billion pounds of material each year. This market was comprised of
15 major companies operating a total of 400 machines. Trexel’s engineers had already been successful in producing meat trays that offered both appearance and performance improvements over the traditional products in addition to eliminating the need for using harmful hydrocarbons in the manufacturing process. Experience had proven that Trexel could offer development partners a savings of $.035 per pound of material if they instituted the MuCell process.
Revenue from the production of meat trays and food packaging would come from a $60,000 per machine annual ﬁxed licensing agreement which would run for the life of Trexel’s patents in addition to a one time $50,000 consulting fee and the $73,000 supercritical ﬂuid delivery system sale.

DECISION TIME
Bernstein began to sort through the ﬁles he kept on each of the potential applications that Trexel was evaluating:
We’ve tried to think through our choices in a systematic, disciplined way.
Unfortunately, every time we think we have a plan, we learn something new about the technology, the market or the customer that forces us to rethink our strategy.
With the board meeting approaching, Bernstein knew it was time to focus on selecting the application(s) that would form the basis for Trexel’s next round of development efforts.

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Cases

EXHIBIT 1 Sample of plastic products using traditional foaming technology and other nonfoamed plastic products with MuCell potential
Sample of products using traditional foaming process technology

Sample of non-foamed plastic products with MuCell potential

Meat trays

Bottles

Disposable ﬂatware

Automotive parts

Weather stripping

Computer housings

Pallets

Television housings

Barrels

Phone housings

Art board

Buckets

Trash cans

Manifolds

Crates

Food trays

Wire insulation

Cutlery

EXHIBIT 2 MuCell process system diagram

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Decision Time

EXHIBIT 3 Trexel technology vs. traditional technology: nucleation comparison

MuCell Process
Large number of
Nucleated clusters uniformly distributed.
No competition with growth. Traditional Process
Nucleation clusters initially sparse. Cell growth by diffusion competes with nucleation for gas.

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Cases

EXHIBIT 4 Trexel technology vs. traditional technology: mechanical property comparison.

Compressive
(amount of pressure required to crush the material)

Compressive Strength
(lbs./sq. inch)

100

75

50

25

0
2

4

6

Density (lbs./cubic ft.)
MuCell PS Foam

Conventional PS Foam

Flexural
(stiffness of the material)

Flexural Strength
(lbs./sq. inch)

400

300

200

100

0
2

4

6

Density (lbs./cubic ft.)
MuCell PS Foam

Conventional PS Foam

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EXHIBIT 5 Trexel management team biographies
David P. Bernstein, President & CEO
Mr. Bernstein, who has held several executive positions in ﬁnance, general management, sales and marketing, focuses on the commercialization and marketing of advanced technologies. He spent nine years with Teradyne, a leading manufacturer of electronics testing equipment, where, as Vice President of Sales and Support, he built a 250-person worldwide organization to sell and service $150 million annually in capital equipment sales. While at Teradyne, he also negotiated a $250 million OEM agreement with the General Electric Company. As a Vice President of Thermedics
Detection, a Thermo Electron Company, he built and managed a worldwide business selling operationally critical equipment to the Coca-Cola and Pepsi-Cola companies and establishing a worldwide support organization to service it.
He also negotiated successful OEM and licensing relationships with leading European bottling equipment companies.
Mr. Bernstein received a B.A. from Harvard College and an M.B.A. from Harvard Business School.
Matt Pallaver, Executive Vice President
Mr. Pallaver is responsible for the marketing development of Trexel projects in Asia, Europe and North America. He joined Trexel in 1993, after more than 15 years on marketing development, including seven years of management in new product development and commercialization with Siemens, Control Data, and Sperry Corporation. Mr. Pallaver received a B.S. in Mechanical Engineering from the Illinois Institute of Technology and an M.B.A. from the University of
Oklahoma.
Dr. Richard Straff, Vice President, Research and Commercialization
Dr. Straff joined Trexel after 20 years with Hoechst Celanese. His experience includes diverse technical-management and research-management assignments in injection molding applications and new product developments for optical ﬁbers, liquid-crystal polymers, polyester products, and other engineering plastics. He received a B.S. in Metallurgy, an M.S. in
Polymer Materials, and a Ph.D. in Polymer Science from the Massachusetts Institute of Technology.
Daniel Szczurko, Vice President, Business Development
Mr. Szczurko is responsible for identifying and licensing product development programs to the plastics industry. He has
20 years of sales and marketing experience in new technologies, in addition to an extensive record of early technology concept sales to Fortune 100 companies in a variety of instrumentation and automation technologies. As Director of
Strategic marketing for Thermedics Detection, a subsidiary of Thermo Electron, Mr. Szczurko was responsible for marketing analytical instrumentation in the areas of chromatographic, x-ray, and chemiluminescent, and ﬂuorescent technology. He received a B.A. in Industrial Economics from Duquesne University.
Dr. Lee Chen, Research Director
Dr. Chen has more than 15 years of experience in polymer process development, screw and tooling design, and the application of computer modeling and simulation to polymer processes. He also has performed extensive research in extrusion, reactive extrusion, and polyurethane foam. Before joining Trexel, Dr. Chen was the Manager of Process
Research and Development with BICC Cables Corporation. A recipient of the Shanghai Government Award for
Outstanding Scientists and Technologists, Dr. Chen has authored many articles and studies in the area of mass ﬂow effects, residence time distribution, and non-plug-ﬂow solid conveying. He received a B.S. and an M.S. in Mechanical
Engineering from Beijing Institute of Chemical Technology and a Ph.D. in Chemical Engineering from the University of Pittsburgh.
David Pierick, Vice President, Injection Molding Programs
Mr. Pierick has experience in injection molding technologies, polyoleﬁn product development, and polyoleﬁn structure/property relationships. Prior to joining Trexel, he acquired an international reputation as Manager of Product
Development and Technical Sales at Montell Polyoleﬁns. Mr. Pierick also has held the positions of Plant Engineer and
Plant Manager for the Rehrig Paciﬁc Company, a manufacturer of injection molded crates for the beverage industry. Mr.
Pierick has authored publications on screw design and product performance. Mr. Pierick received a B.S. in Mechanical
Engineering from the University of California at Los Angeles, an M.S. in Polymer Processing from the University of
Lowell, and an M.S. in Polymer Science from University of Ferrara, Italy.

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EXHIBIT 6 Trexel patent

Cases

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Decision Time

EXHIBIT 7 Trexel Financial Statements
Income Statement

Fiscal Year 1996
$ 1,248,300
$ 456,700

Net Revenue
R&D Project Expenses
Gross Proﬁt

Fiscal Year 1997
$ 2,338,000
$ 861,000

$

791,600

$ 1,477,000

R&D Expenses (Internal)
SG&A

$
$

281,300
541,300

$
$

Total Operating Expenses

$

822,600

$ 1,401,200

$

(31,000)

$

75,800

$

45,700

$

95,300

$

14,700

$

171,100

Income (Loss) from Operations
Interest Income, net
Net Income
Balance Sheet

818,300
582,900

31-May-97
Fiscal Year 1996

31-May-98
Fiscal Year 1997

$ 1,491,700
$ 345,000
$
83,200

$ 2,730,918
$ 338,861
$ 173,235

$ 1,919,900

$ 3,243,014

$
$

$
$

Assets
Current Assets
Cash
Accounts Receivable
Ppd. Exp. And Other Current Assets
Total Current Assets
Property, Plant & Equipment, net
Other Assets, net
Total Assets
Liabilities & Stockholder's Equity
Current Liabilities
Accounts Payable and Accrued Expenses
Deferred Revenue
Current Portion of Long Term Debt
Total Current Liabilities
Capital Lease Obligations
Stockholder's Equity
Preferred Stock, Series C at liquidation value
Preferred Stock, Series B at liquidation value
Preferred Stock, Series A at liquidation value
Common Stock, par value $.01
APIC
Accumulated Deﬁcit
Total Stockholder's Equity
Total Liabilities and Equity

383,200
203,800

941,054
140,809

$ 2,506,900

$ 4,324,877

$
$
$

234,800
27,600
17,300

$
$
$

91,527
200,830
136,128

$

279,700

$

428,485

$

34,400

$

456,560

$
–
$ 2,200,000
$ 550,000
$
16,400
$ 1,018,500
$ (1,592,100)

$ 2,158,056
$ 2,200,000
$ 550,000
$
16,361
$ 997,935
$ (2,482,520)

$ 2,192,800

$ 3,439,832

$ 2,506,900

$ 4,324,877

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Cases

EXHIBIT 8 Trexel Shares and Options Outstanding
Shares
Non-MIT Shares

1,581,525

MIT Shares

210,634

Series A Preferred (as converted)

118,945

Series B Preferred (as converted)

1,000,000

Series C Preferred (as converted)

599,460

Total

3,510,564
Options

Outstanding Options

710,765

Ungranted Options

110,950

Total

821,715

Questions
1.
2.
3.

Is the transfer of technology from universities to industry important? Why or why not?
What's different about “clean” technology ventures as compared to other technology-intensive enterprises?
What criteria should you use to evaluate the projects at Trexel? Which project (molded structural foam, injection molding, blow molding, PVC extrusions, or meat trays and food packaging) should Bernstein recommend to the board? Why?

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Biodiesel Incorporated

BIODIESEL INCORPORATED
Joshua Maxwell shut down his laptop and looked out the window. From the second ﬂoor of the Graduate School of Management’s new building, he could see a number of cars driving on the nearby freeway and sitting in the adjacent parking lot.
Josh was in his last term of the full-time MBA program at UC Davis. He would soon be graduating and entering a new chapter of his life. While he had the luxury of having several management-level job offers from which to choose, he was unsure whether he wanted to follow such a traditional route.
There was one opportunity in particular that had recently come across his path which gave him pause.

Background
The previous term, Josh had been enrolled in Professor Dorf’s class on Business and Sustainability. While the class was offered at the GSM, it was open to the entire university. In this class, he met Hannah Long, who was in her ﬁnal year of her undergraduate studies in Agricultural Economics, and Matthew
Hammond, who was a senior in the Mechanical Engineering department.
The three began working on a class project, which would ultimately turn into a formidable business opportunity. The impetus for their collaboration began with a lecture-discussion regarding the challenges and opportunities in the emerging renewable energy industry.

The Challenge
Dependence on energy is a worldwide reality. Energy powers the machines and equipment around us in order to make life more convenient and efﬁcient. In our everyday lives, energy is synonymous with the forms that it can assume.
The major generation sources—petroleum, coal, natural gas and nuclear—are non-renewable resources and have detrimental effects on the environment. In our daily lives, the two most common forms of this energy are liquid fuel (reﬁned from petroleum) and electricity.1
Increasingly, developed and developing countries alike are consuming liquid fuel for the purposes of mobility, food production, and the facilitation of trade.
All of these functions essentially provide a substitute for human effort. Due to the widespread consumption of petrol-based liquid fuel, an incredibly large global infrastructure and set of surrounding institutions have grown around the support of such consumption. The petrochemical fuel industry manifests itself in the form of oil ﬁelds and reserves, pipelines, transport ships, and fueling stations.
Prepared by MBA candidate Benjamin Finkelor; Assistance from MBA candidate Sonja Yates and Paul
Yu-Yang under the supervision of Professor Richard C. Dorf, Graduate School of Management of UC Davis.
1
Technically speaking, liquid fuel is a form of energy, and electricity is considered a carrier of energy.
For the purposes of this proposal, the distinction is not signiﬁcant.

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The way energy is used worldwide is not sustainable. It is well-documented that the use of these fuels is depleting the world’s natural resource reserves, harming communities in terms of health and displacement, and polluting the air and water in local environments. The drilling, reﬁning, and transporting of oil leads to spills on land and in oceans, and when petrol-based fuels are used to power machines and automobiles, the air is polluted with greenhouse gases and particulate matter such as carbon dioxide, carbon monoxide, sulfur, and nitrous oxide emissions.
In spite of the drawbacks, the current energy industry is committed to the continuation of these ways, primarily because of considerable assets and investment in the existing form of infrastructure.
The challenge, which became clear to the team from class discussion and further brainstorming, is to ﬁnd a form of fuel or technology that can mitigate the current negative affects on the environment of petrol-based fuel while utilizing the existing infrastructure. The urgency of this challenge is heightened by the astounding projected growth in the global population and per-capita consumption of liquid fuels.

The Concept
Matthew’s coursework in engineering coupled with a bit of networking with fellow engineers suggested the emerging technology of biodiesel as a possible solution to this challenge. As the group explored the environmental beneﬁts and the viability of the diesel fuel substitute, the three began to realize the potential of the biodiesel market.
Biodiesel is a vegetable- and/or animal-based product that serves as a substitute for traditional diesel fuel. Although its chemical composition is dissimilar from the petrol-based diesel, biodiesel will still work in diesel engines built in and after 1996 with no modiﬁcation. For engines made before that time, modiﬁcations can be made to allow for the use of biodiesel fuel. The choice of biodiesel as a product of biomass is an intentional one. Producing a product that can be utilized by the existing infrastructure and social patterns of use2 increases the likelihood of its adoption. “Entrepreneurs must locate their ideas within the set of existing understandings and actions that constitute the institutional environment yet set their innovations apart from what already exists.”3 This economic viability is coupled with a signiﬁcant potential to the environment: biodiesel showcases an innovation that is a step in the right direction for air quality.
Biodiesel’s greatest promise to sustainability as a renewable energy source is its lower emissions over conventional diesel. Compared to traditional diesel, biodiesel achieves signiﬁcant reductions in harmful emissions. Additionally, the
2

JoAnne Yates, “The Structuring of Early Computer Use in Life Insurance,” Journal of Design History,
12(1999): 5–22.
3

A. Hargadon and Y. Douglas, “When Innovations Meet Institutions,” Administrative Science Quarterly,
46(2001): 476.

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Biodiesel Incorporated

ozone-forming impact of biodiesel is nearly half of that of petroleum fuel. Further beneﬁts can be counted when looking at lifecycle effects. If biodiesel is obtained using soybeans as an example, the amount of CO2 taken up by soybeans and released upon burning the fuel, is a near zero sum balance. Contrast this with petroleum products where release of CO2 is unidirectional into the atmosphere. Because biodiesel is biodegradable and dependent on organic material as opposed to fossil fuels, the energy source is considered renewable. Production of biodiesel begins with feedstock, preferably in the form of oils or fats. Oils can be processed from oleic varieties of plants such as soy, canula, sunﬂower and safﬂower. Fats can come directly from grease such as and tallow/lard and recycled cooking grease from restaurants. The oils or fats are mixed with alcohol and a catalyst in a process that forms esters resulting in biodiesel deﬁned as mono-alkyl esters of long chain fatty acids and glycerin.
Ultimately, the large-scale production of biodiesel would generate a dramatic impact on the economic value of the feedstocks involved. For example, according to one study, if biodiesel demand over the next ten years were to increase to 200 million gallons, a commensurate amount of soy oil would be required and net average farm income would increase by $300 million per year.
A bushel of soybeans would increase by an average of 17 cents over the tenyear period.4 The potential economic beneﬁt to farmers seems considerable.
Even with such economies of scale, however, the wholesale price of
100 percent biodiesel would rarely be lower, and therefore cost-competitive, with traditional diesel fuel. Barring some crisis that would drive up the price of crude oil or reduce the capacity of diesel reﬁneries, the current regulatory structure and assets devoted to petrol-diesel will more often than not yield a lower price with petrol-based diesel. Biodiesel as a fuel additive however, does provide a cost-competitive potential. Studies have shown that splash-mixing even 1 percent biodiesel with traditional diesel “can increase the lubricity of petroleum diesel by up to 65 percent.”5 This is not to mention the sulfur- and other emissions-reducing beneﬁts that splash-mixing provides. As more consumer and regulatory pressure is placed on traditional diesel users, biodiesel producers will be able to charge the premium necessary to offset higher relative costs. Markets for 100 percent biodiesel will grow as well in such specialty markets as the marine industry, railroads, electricity generators, and even agriculture.

Biodiesel Incorporated
Josh, Hannah, and Matthew presented a compelling business case for their ﬁnal class project: Biodiesel Incorporated. This new venture would enlist and
4

National Biodiesel Board, “Beneﬁts of Biodiesel,” www.biodiesel.org.
“Biodiesel Carries New Weight in Premium Diesel Market,” Biodiesel Bulletin, Sept. 2002. http://www.biodiesel.org/news/bulletin/2003/080403.pdf. 5

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develop a series of local producer’s cooperatives in an effort to capitalize on the emerging biodiesel market as described in the following list:
■
■

■

Members would grow feedstock crops and gather crop residues with high fat content.
Capital equipment costs would be shared and spread over membership.
Oils would be extracted from the collected biomass and biodiesel would be produced using these oils.
Biodiesel Incorporated would distribute the biodiesel locally using the existing petroleum-based infrastructure.

Advantages of the Cooperative Business Form
The cooperative model has been successfully used to allow small farmers to maintain a competitive edge against the larger corporate farming organizations.
“Today, there are more than 4,000 agricultural cooperatives in the U.S., with a total net income of nearly $2 billion and net business volume of more than
$89 billion.”6 A coop is owned and controlled by the members, with selfreliance and self-help being key characteristics—ideal for the implementation of emerging and disruptive innovations such as biodiesel.
Biodiesel Incorporated will:
■
■

■

Utilize the collective purchase power of the coop to obtain necessary capital-intensive equipment and to gain economies of scale.
Increase negotiating power, allowing it to
■ Stabilize crop prices and biodiesel output
■ Gain access to higher-volume contracts
Serve to unite rural communities and preserve agricultural economy

Biodiesel Incorporated offers the unique service of both the bargaining and manufacturing of biodiesel on behalf of its farmer members. It will serve to control the production of agricultural products (i.e., the biomass feedstock), the price and terms set for members’ production, and price and terms for biodiesel output.

Questions
1. What are the key factors in determining if this is a viable business opportunity for Josh, Hannah, and Matthew?
2. What market drivers should they research and be aware of?
3. What are the ﬂaws in the current business strategy?
4. What type of ﬁnancing should they use if they choose to go forward with this? 5. What types of distribution channels should they go into?
6. How can they improve their chances for success?
7. What is the next step?
6

http://co-operatives.ucdavis.edu/Agricultural Co-operatives.htm.

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Yahoo! 1995

YAHOO! 1995

I guess, three and a half years ago, if we were looking to start a business and make a lot of money, we wouldn’t have done this.
—Jerry Yang, 1997

It was April of 1995—a key decision point for Jerry Yang and David Filo. These two Stanford School of Engineering graduate students were the founders of
Yahoo!, the most popular Internet search site on the World Wide Web. Yang and
Filo had decided that they could transform their Internet hobby into a viable business. While trying to decide between several different ﬁnancing and partnering options that were available to them, they attended a meeting with Michael Moritz, a partner at Sequoia Capital. Sequoia, one of the leading venture capital ﬁrms in
Silicon Valley, had been discussing the possibility of investing in Yahoo!.
Michael Moritz leaned forward in his chair. As he looked across the conference table at Jerry and Dave, he laid out Sequoia’s offer to fund Yahoo!:
As you know, we have been working together on this for some time now.
We have done a lot of hard work and research to come up with a fair value for Yahoo!, and we have decided on a $4 million valuation. We at Sequoia
Capital are prepared to offer you $1 million in venture funding in exchange for a 25 percent share in your company. We think that with our help, you have a real chance to make Yahoo! something special. Our ﬁrst order of business will be to help you assemble a complete management team, after which we should be able to really start helping you to develop and manage your site’s vast amount of content.
Right now, the biggest risk that you guys run is not making a decision.
You have to make a decision, because if you don’t, someone else is going
This case was prepared by Michael K. Chang and Matthew Garman, graduate students at Stanford University’s School of Engineering, and Thomas J. Kosnik, consulting professor, Stanford School of Engineering, as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Some facts have been disguised. Dialogue between case actors has been reconstructed from multiple sources based on their recollection of past events, and is not intended as a verbatim quotation at the time of the meeting.
Copyright © 1998 by Stanford University. To order copies or request permission to reproduce materials, call 1-650-723-2973, or email Professor Tom Kosnik, Director of Case Development, Stanford Technology
Ventures Program, at kosnik@stanford.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of The Stanford Technology
Ventures Program.
Revised August 22, 2001.

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to run you over. You might get run over by Netscape. You might get run over by AOL. You might get run over by one of these other venture-backed start-ups. It is imperative that you make a decision now if you are going to survive. To help you make a decision, I am going to give you a deadline: tomorrow. If you don’t want to do business with Sequoia, that’s OK.
I’ll be disappointed, but that’s OK. But you are going to have to call me by 10 A.M. tomorrow morning to tell me yes or no.1
Yang and Filo gazed around the Sequoia conference room and noticed the many posters of companies such as Cisco, Oracle, and Apple that were hung from the walls—all success stories from past Sequoia investments. They wondered if Yahoo!’s poster would someday join that group. The two were excited at the possibilities; however, they still had some decisions to make. There were several other ﬁnancing options available, and they were still not sure if they wanted to accept Sequoia’s funding. Yang responded:
That sounds like a pretty fair offer, Mike. Let us talk this over tonight, and we will get back to you by tomorrow after we weigh all of our options. However you have to realize that we’re still grad students, and we don’t even usually wake up by 10 A.M., so can you give us until noon?

Yahoo!
Yahoo! was an Internet site that provided a hierarchically organized list of links to sites on the World Wide Web. It offered a way for the general public to easily navigate and explore the Web. Users could click through multiple topic and category headings until they found a list of direct links to Web sites related to their interest. In addition, Yahoo! offered a central place where people could go to just to see what was out there. This made it easy for people with little previous exposure to the Web to start searching through Yahoo!’s lists of links, often just to see if they could ﬁnd something of interest. In a little over a year since its inception, it had become one of the most heavily visited sites on the Web.
But Yang and Filo believed Yahoo! had the potential to be much more that a way for Web surfers to ﬁnd what they were looking for. In 1995, John
Taysom, a vice president of marketing of Reuters, a London-based provider of news and ﬁnancial data, called Jerry Yang to explore the idea of a Yahoo!Reuters partnership. It seemed to Taysom that afﬁliating with Yahoo! could help
Reuters to build a distribution network on the Web.
“The ﬁrst thing Jerry said to me,” Taysom remembers, “was ‘if you hadn’t called me, I would have called you.’” Jerry got the news feed vision. He had been thinking about it for months. He further surprised Taysom by informing him that as far as he was concerned, Yahoo! was “not just a directory but a media property.”2
1
2

Michael Moritz, personal interview, November 10, 1998.
Rob Reid (1997), Architects of the Web, John Wiley and Sons, New York, p. 253.

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Yahoo! 1995

Yang further believed that: “Primarily we’re a brand. We’re trying to promote the brand and build the product so that it has reliability, pizzazz, and credibility. The focus of the business deals we are doing right now is not on revenues but on our brand.”3

Dave and Jerry at Stanford
David Filo, a native of Moss Bluff, Louisiana, attended Tulane University’s undergraduate program in computer engineering. In 1988, Filo ﬁnished his undergraduate work and enrolled in Stanford’s master’s program in electrical engineering. Completing his master’s degree, he opted to stay at Stanford and try for his PhD in electrical engineering. Extremely competent in the technical arena, Filo had been described by many as a quiet and reserved individual.
Jerry Yang was a Taiwanese native who moved to California at the age of
10. Yang was raised by his widowed mother and grew up in San Jose with his younger brother, Ken. Yang was a member of the Stanford class of 1990 and completed both his bachelor’s and master’s degrees in electrical engineering.
Yang also opted to stay at Stanford for a PhD in electrical engineering. Also technically competent, Yang was considered much more outgoing than Filo.
Yang and Filo met each other in the electrical engineering department at
Stanford; Filo was Yang’s teaching assistant for one of his classes. They also both worked in the same design automation software research group. They became close friends while teaching at the Stanford campus in Kyoto, Japan.
Upon returning to the Stanford campus, they moved into adjacent cubicles in the same trailer to conduct their graduate research. They both enjoyed working together, as their individual personalities perfectly complemented each other, forming a unique combination.
Their ofﬁce was not much to look at, but it served as a place for them to work on their research as well as a place from which they could run their website. “The launching pad (for Yahoo!) was an oxygen-depleted, double-wide trailer, stocked by the university with computer workstations and by the students with life’s necessities… that prompted a friend to call the scene ‘a cockroach’s picture of Christmas’.”4 Michael Moritz remembered his early visits to
Jerry and Dave’s cube:
With the shades drawn tight, the Sun servers generating a ferocious amount of heat, the answering machine going on and off every couple of minutes, golf clubs stashed against the walls, pizza cartons on the ﬂoor, and unwashed clothes strewn around . . . it was every mother’s idea of the bedroom she wished her sons never had.5

3

Jerry Yang (1995) interview in Red Herring (October), online back issue, p. 9.
Randall E. Stross (1998) “How Yahoo! Won the Search War,” Fortune, http://www.pathﬁnder.com.fortune/1998/980302/yah.html, p. 2.
5
Rob Reid (1997), Architects of the Web, John Wiley and Sons, New York, p. 254.
4

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Mosaic and the World Wide Web
In 1993, the University of Illinois-Urbana Champagne’s National Center for
Supercomputing Applications (NCSA) revolutionized the growth and popularity of the World Wide Web by introducing a Web browser they had developed called Mosaic. Mosaic made the Web “an ideal distribution vehicle for all kinds of information in the professional and academic circles in which it was known.”6 It provided an easy-to-use graphical interface that allowed users to travel from site to site simply by clicking on speciﬁed links. This led to the widespread practice of surﬁng the Web, as people spent hours trying to ﬁnd new and interesting sites. This easy-to-use browser for navigating the Internet was estimated to have 2 million users worldwide in just over one year.

Creating Jerry’s Guide to the World Wide Web
With Mosaic’s introduction in late 1993, Filo and Yang, along with thousands of other students, began devoting large amounts of time to surﬁng the Web and exploring the vast content available. As they discovered interesting sites, they made bookmarks of the sites. The Mosaic Web browser had an option to store a bookmark list of your favorite sites. This feature allowed users to return directly to a page that they had visited, without having to navigate through several different links. As the popularity of the Web quickly increased, so did the total number of sites created, which in turn led to an increase in the number of interesting sites that Filo and Yang wanted to bookmark. Eventually, their personal list of favorite Web sites grew large and unwieldy, due to the fact that the earliest versions of Mosaic were unable to sort bookmarks in any convenient manner.
To address this problem, Filo and Yang wrote software using Tcl/TK and
Perl scripts that allowed them to group their bookmarks into subject areas. They named their list of sites “Jerry’s Guide to the World Wide Web” and developed a Web interface for their list. People from all over the world started sending
Jerry and Dave e-mail, saying how much they appreciated the effort. Yang explained: “We just wanted to avoid doing our dissertations.”7
The two set out to cover the entire Web. They tried to visit and categorize at least 1,000 sites a day. When a subject category grew too large, subcategories were created, and then sub-subcategories. The hierarchy made it easy for even novices to ﬁnd websites quickly. “Jerry’s Guide” was a labor of love— lots of labor, since no software program could evaluate and categorize sites.
Filo persuaded Yang to resist the engineer’s ﬁrst impulse to try to automate the process. “No technology could beat human ﬁltering,” Filo argued.8

6

Rob Reid (1997), Architects of the Web, John Wiley and Sons, New York, p. 11.
Randall E. Stross (1998), “How Yahoo! Won the Search War,” Fortune, http://www.pathﬁnder.com.fortune/1998/980302/yah.html, p. 2.
8
Randall E. Stross (1998), “How Yahoo! Won the Search War,” Fortune, http://www.pathﬁnder.com.fortune/1998/980302/yah.html, p. 3.
7

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Yahoo! 1995

Though engineers, Yang and Filo had a great sense of what real people wanted. Consider their choice of name. Jerry hated “Jerry’s Guide,” so he and
Filo opted for “Yahoo!,” a memorable parody of the tech community’s obsession with acronyms (this one stood for “Yet Another Hierarchical Ofﬁcious
Oracle”). Why the exclamation point? Said Yang: “Pure marketing hype.”9

Yahoo!’s Growing Popularity
At ﬁrst, Yahoo! was only accessible by the two engineering students. Eventually, they created a Web interface that allowed other people access to their guide. As knowledge of Yahoo!’s existence spread by word of mouth and e-mail, more people began using their site, and Yahoo!’s network resource requirements increased exponentially. Stanford provided them with sufﬁcient bandwidth to the Internet, but bottlenecks came from limitations in the number of
TCP/IP connections that could be made to the two students’ workstations.10
Additionally, the time required to maintain the site was becoming unmanageable, as Yang and Filo found themselves continually updating their Web site with new links. Classes and research fell behind as Yang and Filo devoted more and more time to their ever-expanding hobby.

Competing Services
A number of businesses already existed in the Internet search space. While none offered the same service that Yahoo! did, these companies could deﬁnitely provide potential competition to any new business that Yahoo! would start.
Among the competitors were Architext, soon to be renamed Excite, Webcrawler at the University of Washington, Lycos at Carnegie Mellon, the World Wide
Web Worm, and Infoseek, founded by Steven Kirsh. AOL and Microsoft in
1995 represented larger competitors who could enter the market either by building their own capability or acquiring one of the other start-ups.
Yahoo!’s human-crafted hierarchical approach to organizing the information for intuitive searches was a key component of its value proposition. Rob Reid, a Venture Capitalist with 21st Century Internet Venture Partners, explained how this made Yahoo! unique among Internet search providers.
The Yahoo! hierarchy is a handcrafted tool in that all of its . . . categories were designated by people, not computers. The sites that they link to are likewise deliberately chosen, not assigned by software algorithms. In this,
Yahoo! is a very labor intensive product. But it is also a guide with human discretion and judgment built into it—and this can at times make it almost uncannily effective. . . .
9

Randall E. Stross (1998), “How Yahoo! Won the Search War,” Fortune, http://www.pathﬁnder.com.fortune/1998/980302/yah.html, p. 3.
10
Mark Holt and Marc Sacoolas (1995), “Chief Yahoos: David Filo and Jerry Yang,” Mark & Marc
Interviews, May, http://www.sun.com/950523/yahoostory.html.

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This is the essence of Yahoo!’s uniqueness and (let’s say it) genius. It isn’t especially interesting to point to information that many people are known to ﬁnd interesting. TV Guide does this. So do phone books, and countless Web sites that cater to well-deﬁned interest groups. . . . But
Yahoo! is able to build intuitive paths that might be singularly, or even temporarily important to the people seeking it. And it does this in a way that no other service has truly replicated.11
However, if Yahoo!, as a business, was to survive and ﬂourish in the face of increasingly well-funded competition, it would quickly need to ﬁnd some outside capital.

Leaving Stanford and Starting the Business
Yang and Filo had been in Silicon Valley long enough to realize that what they really wanted to do was to start their own business. They split much of their free time between their Internet hobby and sitting around thinking up possible business ideas.
“A considerable period of time passed before it occurred to them that the most promising idea was sitting under their noses, and some of the credit for their eventual illumination belongs to their PhD adviser, Giovanni De Micheli.
Toward the end of 1994, De Micheli noted that inquiries to Yahoo! were rising at an alarming rate. In a single month, the number of hits jumped from thousands to hundreds of thousands daily. With their workstations maxed out, and the university’s computer system beginning to feel the load, De Micheli told them that they would have to move their hobby off campus if they wanted to keep it going.”12
By fall of 1994, the two received over two million hits a day on their site.
It was then that Jerry and Dave commenced the search for outside backing to help them continue to build up Yahoo!, but with only modest hopes. Yang thought they might be able to bootstrap a workable system, using personal savings to buy a computer and negotiating the use of a network and a Web server in return for thank-you banners. Unexpected overtures from AOL and Netscape caused them to raise their sights, although both companies wanted to turn Filo and Yang into employees.
If they were going to abandon their academic careers (as they soon did, six months shy of their doctorates), they reasoned that they should hold out for some control. Filo and Yang had three main potential options to explore: (1) sell Yahoo! outright; (2) partner with a corporate sponsor; (3) start an independent business using venture capital ﬁnancing.

11

Rob Reid (1997), Architects of the Web, John Wiley and Sons, New York, pp. 243–244.
James, Lardner, (1998), “Yahoo! Rising,” U.S. News, May 18, http://www.usnews.com.usnews/issue/80518/18yaho.html, p. 3.
12

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Yahoo! 1995

The Search for Funding
Looking to receive funding and create a credible business out of Yahoo!, Filo and Yang began preliminary discussions with potential partners in October
1994. One of the ﬁrst people who contacted them was John Taysom, a vicepresident of marketing at Reuters, the London-based media service. Taysom was interested in integrating Reuters’ news service into Yahoo!’s Web pages.
Yahoo! would gain the advantage of being able to provide news services from a well-known source, while Reuters would be able to begin developing its own presence on the Internet. Unfortunately, since Yahoo! did not generate revenues, it was in a poor negotiating position. Talks between the two were cordial, but they also progressed very slowly.
Yahoo! also talked to Randy Adams, founder of the Internet Shopping Network (ISN), a company that styled itself as “the ﬁrst online retailer in the world.” ISN, funded by Draper Fisher Jurvetson, was one of the ﬁrst venture funded Internet companies. It had recently been purchased by the Home Shopping Network, in order to expand its possible exposure. ISN was interested in being a host site for Yahoo!, offering them the chance to ﬁnally generate some revenue. However, there were also deﬁnite possible disadvantages that came from being associated with a shopping network.
Another company that approached Yahoo! was Netscape Communications
Corporation. Founded in April 1994 by Jim Clark, who also founded Silicon
Graphics, and Marc Andressen, who created the NCSA Mosaic browser with a team of other UIUC students and staff, Netscape was a hot private company developing an improved browser based on the old Mosaic technology.
Andressen contacted Yang and Filo over e-mail and, in Yang’s words said,
“Well, I heard you guys were looking for some space. Why don’t you come on into the Netscape network? We’ll host you for free and you can give us some recognition for it.”13 This was a fortuitous contact that allowed Yahoo! to move itself off of Stanford’s campus. By early 1995, Yahoo! was running on four Netscape workstations.
Soon after, Netscape offered to purchase Yahoo! outright in exchange for
Netscape stock. The advantage of this option was that Netscape was already planning its initial public offering and had tremendous publicity and momentum behind it. Coupled with high proﬁle founders and backers like Clark,
James Barksdale, former president and CEO of AT&T Wireless Services, and the venture capital ﬁrm Kleiner Perkins Cauﬁeld & Byers, this offer was a potentially lucrative one for the two Yahoo! founders. Additionally, Netscape’s company culture was more in tune with what the two students were looking for, in comparison to some of the more established market players.

13

Jeff Ubois (1996), “One Thing Leads to Another,” Internet World, January, http://www.Internetworld.com/print/monthly/1996/01/yahoo.html, p. 1.

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Corporate Partnerships
Yahoo! was also feeling tremendous pressure to partner or accept corporate sponsorship from other large content companies and online service providers like America Online (AOL), Prodigy, and Compuserve. These companies offered the carrot of money, stock, and/or possible management positions. They argued that if Yahoo! did not partner with them, as large players they could develop their own competing services that would cause Yahoo! to fail. One potential disadvantage with corporate funding was the potential taint that came with such sponsorship. Yahoo! had started as a grass-roots effort, free of commercialization. A second disadvantage was the lack of control that the two
Yahoo! founders would have over their creation. “Building Yahoo! was fun, particularly without adult supervision. (Dave) and Jerry were also worried that selling to AOL would have ‘most likely killed’ Yahoo! in the end.”14
With partner discussions beginning to heat up, Yang requested help from Tim
Brady, a friend and second-year Harvard Business School student. As a class project, Brady generated a business plan for Yahoo! during the 1994–1995 Christmas vacation. (See the Appendix for excerpts of the business plan circa 1995.)
With Brady’s business plan in hand, Filo and Yang began to approach different venture capital ﬁrms on nearby Sand Hill Road. Venture capital ﬁrms brought experience, valuable contacts in the Silicon Valley, and most importantly, money. However, they also required substantial ownership in return for their services. One venture ﬁrm that the Yahoo! founders approached was
Kleiner Perkins Cauﬁeld & Byers. KPCB had an excellent reputation as one of the most prestigious VC ﬁrms in the Silicon Valley, and their list of successful investments included Sun Microsystems and Netscape. KPCB showed a deﬁnite interest in Yahoo!; however, Vinod Khosla of KPCB and Geoffrey
Yang of Institutional Venture Partners had just invested $0.5M in Architext
(later renamed Excite), another company started by Stanford engineering students that was developing a search-and-retrieval text engine. Architext was receiving increased press coverage, with a March 1995 Red Herring magazine spotlighting the company and its venture capital partners. KPCB proposed to fund Yahoo!, but only if they agreed to merge with Architext.

Sequoia Capital
Another venture capital ﬁrm that Yahoo! approached was Sequoia Capital. It was during partnership discussions with Adams at the Internet Shopping Network that Yang and Filo were ﬁrst introduced to Michael Moritz, a partner at
Sequoia Capital. Moritz went to visit Jerry and Dave, who were at the time still operating out of their tiny Stanford trailer. Said Yang, “The ﬁrst time we sat down with Sequoia, Mike (Moritz) asked, ‘So, how much are you going to charge subscribers?’ Dave and I looked at each other and said, ‘Well, it’s

14

Rob Reid (1997), Architects of the Web, John Wiley and Sons, New York, p. 256.

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Yahoo! 1995

going to be a long conversation.”15 Fortunately, Moritz, who came from a journalistic background at Time was ﬂexible in his thinking. Some of the major advantages that Moritz brought to the negotiating table were his contacts with publications and knowledge about how to manage content. Moritz talked about the roots of Sequoia’s interest in working with Yang and Filo. “I think we are always enamored with people that seem to be on to something, even if they can’t deﬁne that something. They had a real passion and a real spark.”16
Sequoia Capital had a long tradition of success in the venture capital market, citing that the total market capitalization for Sequoia backed companies exceeded that of any other venture capital ﬁrm. Sequoia’s trademark modus operandi was funding successful companies using only a small amount of capital. Its list of successful investments included Apple Computer, Oracle,
Electronic Arts, Cisco Systems, Atari, and LSI Logic. Said Moritz, Sequoia preferred “to start wicked infernos with a single match rather than 10 million gallons of kerosene.”17
In February 1995, Filo and Yang were weighing a number of possibilities and in no hurry to accept any of them, when Michael Moritz made them an offer.
Sequoia Capital would fund Yahoo! for $1 million and would help them to assemble a top management team. In return, Sequoia would receive a 25 percent share of the company. Additionally, Moritz gave them only 24 hours to accept the deal before it was pulled off the table. “I felt a need to deliver them from the agony of indecision,” claimed Moritz. With the deadline quickly approaching, Yang and
Filo sat down to weigh their options. The decisions that they made that night would determine the direction of their careers as well and the future of Yahoo!

The Decision
Sitting in their tiny ofﬁce on the Stanford campus, Jerry and Dave shared a late-night pepperoni and mushroom pizza as they explored their options and tried to come to a decision. It was already getting pretty late, and they only had until noon the next day to make their decision.
Yang took a bite from his pizza as he looked over the terms sheet that
Sequoia had given them.
We have some pretty tough decisions to make, and Michael has really forced the issue now with this 24-hour deadline. As I see it, we have a couple of options. The ﬁrst is to accept Sequoia’s offer and launch Yahoo! as our own company. We would be giving up a signiﬁcant percentage of
Yahoo!, but we really need the money if we are going to survive. Moritz and the rest of the resources at Sequoia could also prove to be invaluable as we try to assemble the rest of our management team.
15

Jerry Yang, “Found You on Yahoo!” Red Herring, October 1995, p. 3.
Michael, Moritz, personal interview, November 10, 1998.
17
Anthony, Perkins, Red Herring, June 1996.
16

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Our second option is to accept corporate sponsorship. This would allow us to get the funding we need and still retain 100 percent ownership of Yahoo!. However, I am worried about selling out to corporate America.
We were fortunate to be able to develop our site in an educational setting as a noncommercial free site. I am afraid if we accept the corporate sponsorship, it will taint Yahoo!’s image.
Finally, we could agree to merge with an existing corporation. The word is that Netscape is pretty close to their IPO, and Architext has some really big time investors behind it. If we merge with Netscape or Architext in exchange for stock options, it could mean a lot of money for us in the next couple of years.
Filo got up from his seat and kicked aside some of the empty pizza boxes that had started to accumulate. He walked over to Yahoo!’s tiny ofﬁce window and stared at Stanford’s Hoover Tower, which was barely visible in the distance.
It’s true that we could make some money if we sell to Netscape or
Architext, but we would have to give up primary control of Yahoo! if we did. We would never know what we could have done if we would have maintained control of the site ourselves.
There is also a fourth option you forgot to mention. I’m excited by
Sequoia’s offer, but I’m wondering if maybe we are giving up too much of our company. A fourth option could be to not decide tonight and look for better terms with another VC ﬁrm. I know Michael said that we should decide quickly, but I would hate to give up 25 percent of our company, only to ﬁnd out in a week that another ﬁrm would have offered us $3 million for the same percentage. I know that time is really important, and we like working with Michael Moritz. On the other hand, I don’t want to be regretting our decision two months from now.
As they grappled with the alternatives facing them, Filo and Yang began to envision life outside of the Stanford trailer in which Yahoo! was born. It was well past 2 A.M., and they had to make a decision in less that ten hours. What should they do?

Questions
1. What makes Yahoo! an attractive opportunity (and not just a good idea)?
2. How will Yahoo! make money (i.e., business model)?
3. Identify the major risks in each of these categories: technology, market, team, and ﬁnancial. Rank order them.
4. What are the advantages and disadvantages of each of the funding options they could pursue? Which one do you recommend?

Video Resources
Visit http://techventures.stanford.edu to view a video of the founders of Yahoo! and others discussing the outcome of the case.

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Yahoo! 1995

EXHIBIT 1 Yahoo! Founders and Potential Investor
Jerry Yang
Jerry Yang was a Taiwanese native who was raised in San Jose, California. He co-created the Yahoo! online guide in April of 1994. Jerry took a leave of absence from Stanford University’s electrical engineering PhD program after earning both his BS and MS degrees in electrical engineering from Stanford
University.
David Filo
David Filo, a native from Moss Bluff, Louisiana, co-created the Yahoo! online guide in April 1994 and took a leave of absence from Stanford University’s electrical engineering PhD program in April 1995 to co-found Yahoo!, Inc. Filo received a BS degree in computer engineering from Tulane University and a
MS degree in electrical engineering from Stanford University.
Michael Moritz, Partner, Sequoia Capital
Moritz was a general partner at Sequoia Capital since 1988 and focused on information technology investments. Moritz served as a director of Flextronics
International and Global Village Communication, as well as several private companies. Between 1979 and 1984, Moritz was employed in a variety of positions by Time, Inc. Moritz had an MA degree in history from Oxford University and an MBA from the Wharton School.

Appendix Selected Excerpts from the Yahoo! Business Plan.
Yahoo!’s ﬁrst business plan was developed by Tim Brady as part of a course project at the Harvard Business School. The plan was continuing to evolve during discussions between Jerry Yang and David Filo at Yahoo! and Michael
Moritz of Sequoia Capital. For this case, the company has provided excerpts of this business plan that are not proprietary.
The case writers thank Mr. J. J. Healy, director of corporate development, and others at Yahoo! for their efforts in providing this original archival information to enhance the learning experience of future entrepreneurs.
Business Strategy
Yahoo!’s goal is to remain the most popular and widely used guide to information on the Internet. The Internet is in a period of market development characterized by extremely high rates of both user trafﬁc growth and entry of new companies focused on various products and services. By virtue of its early entry, Yahoo! has developed its current position as the leader in this segment.
Yahoo!’s ability to expand its position and develop long-term, sustainable advantages will depend on a number of things. Some of these relate to its current position and others relate to its future strategy.
Today, Yahoo! solves the main problem facing all Internet users. It is next to impossible for users, faced with millions of pieces of information scattered

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globally on the Internet, to easily ﬁnd that what is relevant to them without a guide like Yahoo! Not only is the amount of information huge, it is expanding almost exponentially.
All enhancements to Yahoo! will be governed by the goal of making useful information easy to ﬁnd for individuals.
We believe that Yahoo’s enormous following has been generated by the following list:
■

■

■

Yahoo! was ﬁrst company to create a fast, comprehensive and enjoyable guide to the Internet, and in so doing, built a strong brand early and created momentum.
The unique interest-area based structure of Yahoo! makes it an easier and more enjoyable way for the user to ﬁnd relevant information than the classic search engine approach where key words and phrases are used as the starting point.
Through its editorial efforts, Yahoo! has continually built a guide which is noticeably better than its competition through a combination of comprehensiveness and high quality.

The company will focus on the directory and the guide business and generate revenue from advertising and sponsorship.
Yahoo!’s strategy is to:
■

■

■

Continue to build user trafﬁc and brand strength on the primary server site through product enhancements and extensions as well as through an aggressive marketing communications program.
Develop and integrate the leading technology required to maintain a leadership position. Underlying the extremely appealing guide is
Yahoo!’s scaleable core technology in search engine, database structure, and communication software. These core technologies are relevant to the user’s experience to the extent that it enables Yahoo! customers’ access to a broader array of high quality information in an intuitive way, faster than any competitors product. Yahoo! is discussing a full license to advanced web-wide search engine technologies, web-wide index data, and crawler services with Open Text of Waterloo, Canada.
Yahoo! will be the ﬁrst guide with a seamless integrated directory/webwide search product. The proposed agreement with Open Text also includes ongoing joint development of advanced search and database technologies leveraging the strengths of both companies. All jointly developed products will be distributed by Yahoo! allowing the company to continue to introduce advanced features on a regular and aggressive basis. Extend the reach to a broader audience through establishment of contractual relationships with Internet access providers such as MSN,
America Online, and Compuserve and very popular web sites.

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■

■
■

Extend the reach and appeal to international users through partnerships with international access providers who can operate foreign mirror sites for Yahoo and add localization in the form of foreign language, local advertisers, and local content.
Retain the users (“readership”) of Yahoo! through constant enhancements to the content and interface of the guide.
Rapidly extend the product line by introducing regional guides, vertical market guides, and more importantly, individually personalizeable guides. Our intention is to be the ﬁrst to market in all of most of these categories and outrun our competition by constantly “changing the competitive rules and targets.” Our introduction of personalized guides will be a ﬁrst in the market and will leverage core technology owned both internally as well as through our license with Open Text.

Market Analysis
The Internet, whose roots trace back almost 20 years, is experiencing a period of incredibly rapid growth in the area of online access base and user population. According to IDC and a recent report by Montgomery Securities, there are approximately 40 million users of the Internet, a majority using it only, for email. However, it is estimated that about 8 million people have access to the Internet and World Wide Web. Most of these access the Web from the workplace because of the availability of high bandwidth hardware and communications ports there. It is expected that over the next two to four years as higher bandwidth modems, home-based ISDN lines and cable modems are adopted, that both the growth and penetration of Web access into the home will increase dramatically. IDC estimates that by 2000, 40 percent of the homes and 70 percent of all businesses in the United States will have access to the Internet. In the Western European and Japan markets, the comparable penetration rates might be as high as 25 percent and 40 percent respectively.
If this holds true, there will be as many as 200 million users on the Internet and Web by the year 2000.
Market Segmentation and Development
We believe that between now and the year 2000 there will be three principal user groups driving the growth of the Web:
■

■
■

Large businesses using the Internet for both internal wide area information management and communication as well as intrabusiness communication and commerce.
Small home based businesses using it for retrieval of information relevant to the business as well as for vendor communication and commerce.
The individual user/consumer using it initially to ﬁnd and access information which is relevant to their personal entertainment and learning and later to make purchases of products and services.

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We also believe that the evolution of the Internet will include three stages of market development:
■
■
■

Availability and proliferation of enabling technology.
Establishment of widespread access and communication services.
Widespread distribution of high value content.

We are currently in the ﬁrst stage of market development consisting primarily of infrastructure building and including rapid growth in the adoption and sale of computer, network, and communication products and entering into the second stage involving the initial establishment of “access” service based businesses. Internet Market Size
Estimates of the amount of current and projected revenue for Internet related business vary. However, primary research conducted by both Montgomery
Securities as well as Goldman Sachs indicate that the total served market for
Internet hardware, software, and services will total approximately $1B in 1995, up from approximately $300M in 1994. Projections are that these categories might grow to a total of $10B by the year 2000. Several research ﬁrms including Forrester and Alex Brown & Sons have estimated the revenues to be produced by Web-based advertising at approximately $20M in 1995, $200M in
1996, and over $2B by the year 2000.
Market Trends
During the current, rapidly expanding stages of market and industry development, the following trends are clear:
■

■
■

■

There is large scale adoption of enabling technology in the areas of network hardware and software, as well as communication hardware and software. The World Wide Web with its inherent support of multimedia begs for the adoption of higher and higher bandwidth platform and communication hardware and software.
Telecommunication companies and newly entering Internet access providers are rushing to put in place basic “hook-ups” in high bandwidth form.
The price for high-speed computer and communication “port” hardware and software of adequate bandwidth to support acceptable levels of transport and display is still somewhat high. Partly for this reason, the adoption of fully capable ports onto the Web is still principally occurring at businesses.
With the availability of 28.8K baud modems, ISDN lines and high performance/low price personal computers, home adoption of Internet access is on the rise and slated to have extremely high growth over the next ﬁve years. Adoption of cable modems could accelerate this trend. Confirming Pages

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Yahoo! 1995

■

■
■

Formerly closed network online services such as America Online, Compuserve, and Prodigy are now offering Internet access and opening up their services. Other companies such as Microsoft as well as divisions of
MCI, AT&T, and others are attempting to put in place Internet online services in which a range of programming content is presented.
Companies such as Yahoo! which provide means to navigate the Web are growing rapidly as measured by amount of end user trafﬁc.
These high trafﬁc sites already provide a high volume platform for delivering electronic advertising.

During this stage, and sustainably for all stages to come, there is one fundamental need which users have: The location of meaningful information easily and quickly on this large and exponentially growing source called the Internet.
Competition
Yahoo! intends to effectively beat any emerging competitors by:
■
■

■
■

Establishing broader distribution earlier than any other competitor in order to maintain the Yahoo! guide as the most widely used in its class.
Broadening the product line faster than the competition through the introduction of vertical market focused guides and personalizeable editions of the guide.
Staying ahead of the competition with regular core product updates which continue to make it faster, easier to use, and more effective.
Delivering high quality audiences and compelling results to advertisers.

Risks
The main risks facing Yahoo! are:
■
■

■

■

The ability to increase trafﬁc and enhance the Yahoo! brand. Management believes it can achieve both these goals.
Ability to introduce key new products faster and better than the competition. We believe that our current core technologies and platform will allow us to do this if supplemented by funded expansion of product development and marketing functions.
Ability to develop an international presence and leading brand internationally before the competition. At the present time, Yahoo! is being pursued by a number of very high visibility and capable international afﬁliates. The funded addition of limited marketing and business development resources will allow us to respond to these opportunities in a timely way.
The introduction of competitive products internally developed by access providers. While there is no assurance that this will not happen, we have secured relationships with several of the leading providers already in which the Yahoo! product is featured and are in advanced discussions

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■

Cases

with others. We believe that many of the access providers already respect Yahoo!’s strong brand, comprehensive guide and focus and are concluding that they will not be inclined to reinvent this late in lieu of a mutually favorable afﬁliate business relationship with Yahoo!.
Ability to scale our support of both the trafﬁc through our main site as well as mirror sites of our afﬁliates. If the demands of trafﬁc outgrow the bandwidth of servers we install, then response rates might go down and lead to customer dissatisfaction. Yahoo! has successfully scaled and operated its server site. We believe we will be able to support the needed growth.
That the growth of the Internet industry as a whole slows signiﬁcantly, or that the adoption of the Web as a signiﬁcant platform for advertising does not grow as projected. These are both out of Yahoo!’s control.
However, the company believes that the industry is in a secure phase of adoption which should fuel growth.

Yahoo!’s sustainable advantages
The Internet is in a period of market development characterized by extremely high rates of both user trafﬁc growth and entry of new companies focused on various products and services. By virtue of its early entry, Yahoo! has developed its current position as the leader in its segment. Yahoo!’s ability to sustain and grow its position will depend on a number of things. Some of these relate to its current core advantages and others relate to future execution of its strategy.
At present, Yahoo!’s core strategic advantages include:
■

■

It’s strong brand. The company executed early and well with its unique, context focused, quick and intuitive guide and beneﬁted from the widespread adoption of the Yahoo! product. The guide is the standard in the world of Web navigation.
Yahoo!’s scalable core technology in search engine, database structure, and communication software. These core technologies are relevant to the user’s experience to the extent that it enables the Yahoo! customer’s access to a broader array of high quality information in an intuitive way, faster than any competitor’s product.

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Barbara’s Options

BARBARA’S OPTIONS
Introduction
Barbara Arneson strolled through the campus of the University of Maryland at
College Park on a Spring evening in 2009. She often came to the quad at the end of a day for some quiet reﬂective time. Tonight she was mulling over her career options and the path her life would take in the next few years. Graduation was only ﬁve days away, and tomorrow Barbara would pick up her parents at the airport for a short visit and the ceremony. She hoped to be able to share her career decision with them and then relax over the next few days.
Having completed an undergraduate degree in biology a year prior, Barbara would soon be receiving her masters degree in computer science from Maryland before beginning a career in high technology. Barbara felt lucky that she had been offered a number of career options, thanks to the strong high-tech economy and growth of investment in the new ﬁeld of bioinformatics, which applied software and Internet technology to the process of identifying and using genetic information for the life sciences industries. Barbara’s personal objective was to work in product development and eventually move into management and maybe someday start her own company. As an interim step, she thought she might return to graduate school for an MBA in a few years.
On this beautiful evening, however, Barbara had to make a decision between two attractive job offers.

Barbara’s Dilemma
Barbara had interviewed extensively with high-technology companies, and had decided BioGene Systems, Inc., and InterWeb Genetics Corp. were her top choices. She had hoped to receive an offer from at least one of them, but had received offers from both. Now she had a tough decision.
BioGene was a 7-year-old company that was successful and had grown rapidly. Its product-development group was highly regarded technically, and
Rasha Motwani, to whom Barbara would report, had more than 10 years of development experience in several product areas in which Barbara was interested. She liked Rasha and felt she would learn a lot from her.
InterWeb was a start-up that had been funded about a year ago by two venture capital investors, both of whom had successfully funded technology companies. The InterWeb team was hard at work on its ﬁrst product, which would
This case was created and revised by various instructors and teaching assistants at Stanford University.
This case is prepared as basis for class discussion rather than to illustrate effective or ineffective handling of a situation. This case is based on a combination of experiences rather than on a particular person.
Copyright © 2009 by the Board of Trustees of the Leland Stanford Junior University and Stanford Technology Ventures Program (STVP). No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Stanford Technology Ventures Program.

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launch in about a year. Barbara would be joining a team of about 10 engineers, most of whom had extensive experience in the areas relating to the product they were developing. The technical team leader was Robert Jackson, one of the company founders, who was only a few years older than Barbara and had a reputation as a technical “visionary.”
Barbara had been trying to decide for several days. As she strolled toward her dorm, she reﬂected on her thoughts. “Okay, I’ve been trying to make a decision on the basis of my key priorities, namely the types of projects I would be working on, the quality of the people I would be working with, and the opportunities for personal growth. Although BioGene and InterWeb are not directly comparable—each has potential strengths and weaknesses—the fact is that I think I would be equally happy with either one. For me, the decision is a toss-up. I guess the only way to determine which is better is to evaluate the ﬁnancial offers. Because both proposed similar salaries and beneﬁts, that means analyzing the stock option offers.”

The Stock Option Packages
Not all companies offer stock options to new college graduates. Because of
Barbara’s success at school and a hot job market in bioinformatics, both BioGene and InterWeb had included a stock option package in their offers.
A stock option gives an individual the right to purchase, during a ﬁxed time period called the “term,” a certain number of shares of stock from the company at a ﬁxed price, called the “exercise price.” The option expires at the end of the term, but it can be “exercised” (or bought) all or partially during the term, usually subject to certain conditions such as “vesting.” Options have no ﬁnancial risk to the employee—if the value of the stock remains below the exercise price, he or she need not ever exercise the option.
BioGene had offered Barbara options for 6,000 shares at an exercise price of
$16.00 per share. BioGene had gone public in June 2008 at $10 per share, and the stock was currently selling for roughly $16. In extending the offer to Barbara,
Karen Hershﬁeld, manager of recruiting for BioGene, had said, “We have a proven record of rapid, proﬁtable growth, and we expect that kind of growth to continue.
You should receive a handsome return on this option package.”
InterWeb had offered 60,000 shares at an exercise price of $0.10 per share.
Because the company was private, this price reﬂected an arbitrary pricing decision at the time of the venture capital investment received by the company.
Robert Jackson, in discussing the offer with Barbara, had commented, “The great thing about going with a start-up is that if it is successful, everybody gets rich. Our business plan shows that we should be in a position to do our IPO
(initial public offering) in 3 or 4 years, and because companies usually go public at $10 to $15 per share, you can see that this option could be worth almost a million dollars!”
Both options had identical restrictions. Vesting was 25% per year with a term of 4 years. This meant that at the end of one year of employment, Barbara

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Barbara’s Options

had the right to exercise 25% of the shares at her discretion any time. At the end of two years of employment, she would vest for another 25%, and so on.
If at any time she left the company, she could, within 90 days, exercise any options for which she was vested, but any unvested options would terminate.
Any unexercised portion of the option would expire at the end of 10 years from the start of employment.
Having decided that she would be equally satisﬁed with joining either company, Barbara was understandably excited by the prospect of big ﬁnancial gains on stock options. She had even begun day-dreaming about what she could do with a ﬁnancial windfall—travel abroad for a year, buy a new car for her parents, and pay for an MBA without worrying about 2 years of no salary and huge loan payments. Because she had learned a lot about ﬁnancial analysis in her entrepreneurship courses, she had obtained and analyzed ﬁnancial data from both companies, as shown in Exhibits 1 and 2. She also had analyzed the opportunity and strategies of both companies, and felt each had excellent prospects of achieving its objectives. She had examined stock market data for public high-tech companies and knew that the price/earnings (PE) ratios of bioinformatics companies averaged 25. InterWeb had offered a lot more shares than BioGene, but there was a higher element of risk. She knew that many start-ups failed to be successful.
She recalled that autumn day 5 years ago when her parents had dropped her off at school for the start of her freshman year. When she picked them up at the airport tomorrow, she wanted to share her career decision with them and make them proud of her.

Questions
1. What is the number of shares outstanding at BioGene as of May 31, 2009?
What is its current PE ratio? Why do you think it is higher than the current average of other bioinformatics companies (Hint: consider the recent annual growth rates of revenues and proﬁts)?
2. What is Barbara’s potential percentage ownership in each ﬁrm?
3. Compare the ﬁrms in 4 years (i.e., 2013) when the stock options will be fully vested. Assuming Barbara remains employed until that time, which stock option offer is better? Make sure to include the cost of the stock options and state all critical assumptions.
4. In addition to compensation matters, what other factors would you suggest
Barbara consider in making her decision?

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EXHIBIT 1 BioGene Systems proﬁt and loss history.
FY05

FY06

FY07

FY08

FY09

10.1

17.1

25.6

42.4

74.6

Cost of revenue

4.0

6.8

10.2

17.0

29.8

Gross margin

6.1

10.3

15.4

25.4

44.8

Engineering

1.2

2.1

3.1

5.1

9.0

Marketing

2.5

4.3

6.4

10.6

18.7

G&A

0.6

1.0

1.5

2.5

4.5

Total expenses

4.3

7.4

11.0

18.2

32.2

Pretax proﬁt

1.7

2.9

4.4

7.2

12.7

Taxes

0.7

1.2

1.7

2.9

5.1

Revenue

Expenses:

After-tax proﬁt

1.0

EPS (earnings per share)

1.7

2.6

4.3

7.6

$0.06

$0.08

$0.12

$0.19

$0.33

Note: (1) All numbers in millions except EPS. (2) Stock is traded on NASDAQ. Closing price on
5/31/09 was $16.25. (3) End of ﬁscal year for 2009 is June 30. FY09 numbers are estimates by stock market analysts and consistent with guidance by management.

EXHIBIT 2 InterWeb proforma proﬁt and loss projections from business plan. FY08

FY09

FY10

FY11

FY12

FY13

Sales

0.0

0.0

5.0

20.0

41.0

62.0

Cost of sales

0.0

0.0

2.0

8.0

16.4

24.8

Engineering

0.7

1.0

1.5

2.4

4.9

7.4

Marketing

0.3

0.5

1.3

5.0

10.3

15.5

G&A

0.1

0.2

0.3

1.2

2.5

3.7

Total expenses

1.1

1.7

3.1

8.6

17.7

26.6

Ϫ1.1

Ϫ1.7

0.0

3.4

7.0

10.5

0.0

0.0

0.0

0.2

2.8

4.2

Ϫ1.1

Ϫ1.7

0.0

3.2

4.2

6.3

Pretax proﬁt
Taxes
After-tax proﬁt

Note: (1) 118.6 million shares outstanding as of 5/31/09. Management’s business plan requires no additional venture capital or other funding. (2) End of ﬁscal year for 2009 is June 30.

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SolidWorks

SOLIDWORKS
In August, 1994, 12 months after Jon Hirschtick left a great job to found a new venture in the software industry, SolidWorks, the deal was looking good. The seed capital discussions had shifted into high gear as soon as Michael Payne joined the SolidWorks team. After working on the deal for nine months, Axel
Bichara, the Atlas Venture vice president originating the project, ﬁnally got a syndicate excited about it: Atlas Venture, North Bridge Venture Capital Partners, and Burr, Egan, Deleage & Co. presented an offer sheet to SolidWorks two weeks after Michael was on board.
This process was particularly interesting because Jon and Axel had worked together for most of the past eight years. They met at MIT in 1986 and cofounded Premise, Inc., a computer aided design (CAD) software company, in 1987. After Premise was bought by Computervision, they joined that team as managers. Now, they sat on opposite sides of the table for Axel’s ﬁrst deal as the lead venture capitalist.
Jon and the other founders thought the valuation and terms were fair, but the post-money* equity issue was unresolved. They had to decide how much money to raise. Did they want enough capital to support SolidWorks until it achieved a positive cash ﬂow, or should they take less money and attempt to increase the entrepreneurial team’s post-money equity?
If they took less money now, they could raise funds later, when SolidWorks might have a higher valuation. But they would be gambling on the success of the development team and the investment climate. If their product was in beta testing with high customer acceptance, raising more money would probably be fast and fun, but if they hit any development snags, the process could take a lot of time and yield a poor result.

Jon Hirschtick: 1962–1987
Jon grew up in Chicago in an entrepreneurial family. He fondly remembers helping with his father’s part-time business by traveling to stamp collectors’ shows across the Midwest. In high school, he was self-employed as a magician.
The entrepreneurial impulse continued during his undergraduate years. Jon recalls the blackjack team he played with at MIT:
We raised money to get started. At the same time, we developed a probabilistic system for winning at blackjack. The results were amazing! We tripled our money in the ﬁrst six months, doubled it during the next six months, and doubled it again in the next six months. We produced a 900

This case was written by Dan D’Heilly and Tricia Jaekle under the direction of Professor William
Bygrave. Funding provided by the Ewing Marion Kauffman Foundation and the Frederic C. Hamilton
Chair for Free Enterprise Studies. © Copyright Babson College, 1995. All rights reserved.
*Post-money valuation: the value of a company’s equity after additional money is invested.

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percent annualized return. I learned a useful lesson: you really can know more than the next guy and make money by applying that knowledge. We tackled blackjack because people thought it was unbeatable; we studied it, and we won. The same principle applies to entrepreneurship. Opportunities often exist where popular opinion holds that they don’t.
Jon’s introduction to CAD came from a college internship with Computervision during the summer of 1981. Computervision was one of the most successful start-up companies to emerge during the 1970s. By the early 1980s, it dominated the CAD market.
After earning a master’s degree in mechanical engineering at MIT, Jon managed the MIT CAD laboratory. He supervised student employees, coordinated research projects, and conducted tours for visitors.

Axel Bichara: 1963–1987
Axel was born in Berlin and attended a French high school. In 1986, while studying at the Technical University of Berlin for a master’s degree in mechanical engineering, he won a scholarship to MIT. Axel had worked in a CAD research lab in Germany, so he selected the CAD laboratory for his work-study assignment at MIT.

Early CAD Software
CAD software traces its roots to 1969, when computers were ﬁrst used by engineers to automate the production of drawings. CAD was used by architects, engineers, designers, and other planners to create various types of drawings and blueprints. Any company that designed and manufactured products (e.g., Ford, Sony, Black & Decker) was a prospective CAD software customer.

An Entrepreneurship Class: January 1987
Visitors to the MIT CAD lab often complained about problems that Jon knew he could solve. He enrolled in an entrepreneurship class to write a business plan for a CAD start-up company, Premise, Inc. Jon described the decision to quit his job and start a company:
I once heard Mitch Kapor [founder of Lotus Development Company] use a game show metaphor to describe the entrepreneurial impulse. He said,
“Part of the entrepreneurial instinct is to push the button before you know the answer and hope it will come to you before the buzzer.” That’s what happened for us: we didn’t know how to start a company, or how to fund it, but Premise got rolling, and we came up with answers before we ran out of time.
Jon and Axel were surprised and delighted to ﬁnd each other in the entrepreneurship class. They had worked together for the past month on a project at

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SolidWorks

the CAD lab, and they decided to become partners in the ﬁrst class session.
Axel recalled: “It was a coincidence that we enrolled in the same class, but it was clear that we should work together. Jon had had the idea for a couple of months, and we started work on the product and the business plan immediately.”
Axel took the master’s exam at MIT in October 1987 and at Technical
University of Berlin in July 1988. He was still a student at both universities when he and Jon started Premise. Axel graduated with highest honors from both institutions.

Premise, Inc.: 1987–1991
Premise went from concept to business plan to venture capitalist-backed startup in less than six months. As Axel remembered:
The class deadline for the business plan was May 14. On June 1, we had our ﬁrst meeting with venture capitalists, and by June 22, we had a handshake deal with Harvard Management Company for $1.5 million. We actually received an advance that week. It was much easier than it should have been, but the story’s 100 percent true.
In the ﬁrst quarter of 1989, Premise raised its second round of capital.
Harvard Management and Kleiner Perkins Cauﬁeld & Byers combined to finance the product launch. The product shipped in May to very positive industry reviews, but sales were slow. Premise’s software didn’t solve a large mass-market problem. As Jon later recalled: “I’ve seen successful companies get started without talent, time, or money—but I’ve never seen a successful company without a market. Premise targeted a small market. I had a professor who said it all, ‘“The only necessary and sufﬁcient condition for a business is customers.’”
By the end of 1990, the partners had decided that the best way to harvest
Premise was an industry buyout. They hired a Minneapolis investment banking ﬁrm to ﬁnd a buyer. Wessels, Arnold & Henderson was considered one of the elite investment banking ﬁrms serving the CAD industry. Premise attracted top-level service providers because of the prestige of its venture capitalist partners.
Jon explained: “Several bankers wanted to do the deal, and a big reason was because they wanted to work with our venture capitalists. We had top venture capitalists, and that opened all kinds of doors. This is often under-appreciated.
I believe in shopping for venture capital partners.”
Wessels, Arnold & Henderson were as good as their reputation. As Axel recalled: “We sold Premise to Computervision on 7 March 1991. Computervision bought us for our proprietary technology and engineering team. It was a good deal for both companies.”

Computervision: 1991–1993
As part of the purchase agreement, Jon and Axel joined the management team at Computervision. They managed the integration of Premise’s development

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team and product line for one year before Axel left to study business in Europe.
Jon stayed on after Axel’s departure.
Revenues for the Premise team’s products grew 200 percent between
1991 and 1993, and perhaps as important as direct revenue, their technology was incorporated into some of Computervision’s high-end products. In
January 1993, Jon was promoted to director of product definition for another CAD product. He stayed in this position for eight months. After two years at Computervision, he was ready for new horizons. He resigned effective August 23, 1993. (See Exhibit 1 for excerpts from his letter of resignation.) After a holiday in the Caribbean, Jon purchased new computer equipment, called business friends and associates, and began working on a business plan.
He didn’t have a clear product idea, but his market research suggested that the time was ripe for a new CAD start-up.

EXHIBIT 1 Excerpts from Jon Hirschtick’s letter of resignation from Computervision (CV).
This is my explanation for wanting to leave CV. . . . The other day you asked me whether I was leaving because I was unhappy, or whether I really want to start another company. I strongly believe that it is because I really want to work on another entrepreneurial venture.* I want to try to build another company that achieves business value. . . .
I am interested in leaving CV to pursue another entrepreneurial opportunity because I seek to:
1. Be a part of business strategy decisions. I want to attend board meetings and create business plans, as I did at
Premise.
2. Select, recruit, lead, and motivate a team of outstanding people. I believe that one of my strengths is the ability to select great people and form strong teams.
3. Represent a company with customers, press, investors, and analysts. I enjoy the challenge of selling and presenting to these groups.
4. Work on multidisciplinary problems: market analysis, strategy, product, funding, distribution, and marketing. I am good at cross-functional problem-solving and deal-making.
5. Work in a fast-moving environment. I like to be in a place where decisions can be made quickly, and individuals
(not just me) are empowered to use their own judgment.
6. Work in a customer-driven and market-driven organization. I ﬁnd technology and computer architecture interesting only as they directly relate to winning business. I want to focus on building products customers want to buy.
7. Have signiﬁcant equity-based incentives. I thrive on calculated risks with large potential rewards.
8. Be recognized for having built business success. I measure “business success” by sales, proﬁtability, and company valuation; I want to directly impact business success. Recognition will follow. I admit that this ego-need plays a part in my decision.
Summary
I’ve decided I want to work on an entrepreneurial venture. . . . This is more a function of what I do best than any problems at CV. . . . I don’t have any delusions about an entrepreneurial company being any easier. I know ﬁrst-hand that start-up companies have at least as many obstacles as large established companies—but they are the obstacles I want. *Underlines in original.

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SolidWorks

CAD Software Market in the 1990s
By the 1990s, the hottest CAD software performed a function called solid modeling. Solid modeling produced three-dimensional computer objects that resembled the products being built in almost every detail. It was primarily used for designing manufacturing tools and parts. Solid modeling was SolidWorks’ focus. The key beneﬁts driving the boom in solid modeling were:
1. Relatively inexpensive CAD prototypes could be accurate enough to replace costly (labor, materials, tooling, etc.) physical prototypes.
2. The elimination of physical prototypes dramatically improved time-tomarket.
3. More prototypes could be created and tested, so product quality was improved. However, not all CAD software could manage solid modeling well enough to effectively replace physical prototypes.
Most vendors offered CAD software based on computer technology from the 1970s and 1980s. IBM, Computervision, Intergraph, and other traditional market leaders were losing market share because solid modeling required software architecture that worked poorly on older systems.
As one of the industry’s newest competitors, Parametric Technology
Corporation (PTC) was setting new benchmarks for state-of-the-art solid modeling software. (It was an eight-year-old company in 1994.) CAD was a mature and fragmented industry with many competitors, but PTC thrived because other companies tried to make older technology perform solid modeling functions.
Worldwide mechanical CAD software revenues were projected at $1.8 billion for 1995, with IBM expected to lead the category with sales of $388 million.
PTC was growing over 50 percent annually and had the second highest sales, with $305 million in projected revenue. Industry analysts predicted 3 percent to 5 percent revenue growth per year, with annual unit volume projected to grow at 15 percent. The downward pressure on prices was squeezing margins, so many stock analysts thought that the market was becoming unattractive.
However, PTC traded at a P/E between 21 and 40 in 1994.

Axel after Computervision: 1992–1994
After ﬁve years in the United States, Axel decided to attend an MBA program in Europe. From his experiences at Premise and Computervision, he had become intrigued with the art and science of business management, and he was ready for a geographic change.
INSEAD was his choice. Located in Fontainebleau, an hour south of Paris,
INSEAD was considered one of the top three business schools in Europe.
The application process included two alumni interviews, and one of Axel’s interviewers was Christopher Spray, the founder of Atlas Venture’s Boston

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ofﬁce. Atlas Venture was a venture capital ﬁrm with ofﬁces in Europe and the
United States. It had $250 million under management in 1994.
Since Axel had a three-month break before INSEAD started, Chris asked him to consult on a couple of Atlas Venture’s projects. Axel found he enjoyed evaluating business proposals “from the other side of the table.” He graduated in June 1993 and joined the Boston ofﬁce of Atlas Venture as a vice president with responsibility for developing high-tech deals.
Axel reﬂected on the relationship between business school training and venture capital practice:
I was qualiﬁed to become a venture capitalist because of my technical and entrepreneurial background; business school just rounded out my skills. You do not need a bunch of MBA courses to be a successful venture capitalist. Take ﬁnance, for example, I learned everything I needed from the core course. People without entrepreneurial experience who want to be venture capitalists should take as many entrepreneurship courses as possible.

Jon Founds SolidWorks: 1993–1994
Jon’s business plan focused on CAD opportunities. He explained:
I knew that this big market was going through major changes, with more changes to come. From an entrepreneur’s perspective, I saw the right conditions for giving birth to a new business. I also knew I had the technical skills, industry credibility, and vision needed to make it happen. This was a pretty rare situation.
SolidWorks’ product vision evolved slowly from Jon’s personal research and from discussions with friends. He was careful to avoid using research that
Computervision might claim as proprietary. He was concerned about legal issues, because he would be designing software similar to what Computervision was trying to produce. Axel explained:
Both Computervision and SolidWorks wanted to produce a quality solid modeling product. Solid modeling technology was still too difﬁcult to learn and use. Only PTC’s solid modeling software really worked well enough.
The rest made nice drawings but could not replace physical prototypes for testing purposes.
There were only 50,000 licensed solid modeling terminals in the United
States, and most of them belonged to PTC, but there were over 500,000 CAD terminals. There were two main reasons PTC did not have a larger market:
(1) its products required very powerful computers, and (2) it took up to nine months of daily use to become proﬁcient with PTC software. Solidworks’ goal was to create solid modeling software that was easier to learn and modeled real-world parts on less specialized hardware (see Table 1).

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SolidWorks

TABLE 1 Competitive positioning grid.
Computer aided drafting and add-ons

Production solid modeling Windows

Autodesk

SolidWorks

ϳ$5K per station

Bentley

VAR channel

CADKEY

Low-end:

High-end:
UNIX

Applicon

ϳ$20K per station

PTC

CADAM

Direct sales

This vision was not unique in the industry. Many CAD companies were developing solid modeling software, and the low-end market was wide open.
SolidWorks’s major advantage was its ability to use recent advances in software architecture and new hardware platforms—it wasn’t tied to antique technology. Attracting talented developers was the top priority in this leading-edge strategy. Team Building
Jon’s wife, Melissa, enthusiastically supported his decision to resign from
Computervision. Jon explained: “Some spouses couldn’t deal with a husband who quits a secure job to start a new company. Melissa never gave me a hard time about being an entrepreneur.”
Jon described his priorities in October 1993, when he decided to launch
SolidWorks:
I knew I needed three things: good people, a good business plan, and a good proof-of-concept.* I needed a talented team that could set new industry benchmarks, but there was no way I could get those people without a persuasive prototype demonstration.
The venture capitalists wanted a solid business plan, but that wouldn’t be enough. They wanted a strong team. I needed fundable people who were also CAD masters. Venture capitalists couldn’t understand most complex technologies well enough to be conﬁdent a high-tech business plan was really sound, so they looked at the team and placed their bets largely on
*

Proof-of-concept is a term that refers to a computer program designed to illustrate a proposed project.
Also referred to as a prototype, it is used for demonstration purposes, and it is limited but functional in ideal circumstances.

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that basis. If the proof-of-concept attracted the team, then the team and the business plan would attract the money. I needed a team that could create the vision and make venture capitalists believe it was real.
Jon worked on ﬁnding the team and developing the proof-of-concept concurrently; but the proof-of-concept was his ﬁrst priority. He worked on it daily.
In his search for cofounders, Jon talked to dozens of people; he even posted a notice on the Internet, but “none of those guys worked out.”
Recruiting posed another dilemma—how to get people to work full time without pay, while the company retained the right to their output? He resolved this problem by creating consulting agreements that gave SolidWorks ownership of employees’ work and made salaries payable at the time of funding. As it turned out, this arrangement only lasted nine months. Jon described his approach to recruiting:
I always paid for the meal when I talked with someone about SolidWorks.
I wanted them to feel conﬁdent about it, and that meant that I had to act with conﬁdence. The deal I offered was: no salary, buy your own computer, work out of your house, and we’re going to build a great company.
I’d done it before, so people signed on.
Axel described Jon’s management style as, “visionary, he’s a talented motivator, and a strong leader.”

Robert Zuffante: CAD Engineer/Consultant
A major development in 1993 was the addition of super-star consultant Bob
Zuffante as manager of proof-of-concept development. Jon needed time to write the business plan and recruit his team. He had been working on the prototype for over a month when Bob took over development. Jon recalled the situation:
I hadn’t seen him since we were students together at MIT, but when I thought about the skills I needed, my mental Rolodex came up with his name. I always thought about working with him again. We talked in late
November, and about a month later, he began work on the prototype.
Bob knew Jon and Axel from MIT, where he earned a master’s degree in mechanical engineering. He had worked in the CAD industry for over 10 years and had managed a successful consulting business. His arrival at SolidWorks allowed Jon to focus on other pressing issues.

Scott Harris: CAD Marketer
Scott Harris worked at Computervision for 11 years, where he managed development and marketing activities. Most notably, Scott was the founder and manager of Computervision’s product design and deﬁnition group. He also managed the 11-person solid modeling development group and acted as technical liaison between Computervision’s customers and R&D engineers.

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Scott was let go by Computervision during a large-scale layoff. He was skeptical when Jon ﬁrst told him about the SolidWorks vision, but he became a believer after seeing a proof-of-concept demonstration. Scott stopped looking for a job and started working full time for SolidWorks almost immediately. Scott was impressed, “The prototype was the embodiment of a lot of the things I was thinking about. This was the way solid modeling should perform.” Scott started with SolidWorks about six weeks after Bob signed on. He became involved in the marketing sections of the business plan and in the product deﬁnition process. He ran focus groups, conducted demonstrations for potential customers, and analyzed the purchasing process. He kept the development team focused on customer needs—how did customers really use CAD software, and what did they need that current products lacked?

The Business Plan
When Bob came on in January, Jon turned to the business plan with a passion.
The plan went through a number of versions as Jon and his advisors wrestled with key issues such as positioning, competitive strategy, and functionality. By the end of March, the plan was polished enough for Jon to show it to venture capitalists. Axel recalled:
Jon and I decided that the business plan was ready to show in April, so I scheduled a presentation at Atlas. Jon gave the presentation to Barry [Fidelman, Atlas general partner] and myself—market, team, and concept. Overall, Barry was encouraging, but not excited. He thought Jon’s story was not crisp enough; he was looking for money to take on some very large companies, and the CAD market was not that attractive. It was a rocky start. Initial Financing Attempts
In addition to negotiating with Atlas Venture, Jon met with other venture capital firms and rewrote the business plan several times. Axel described the rationale behind this process:
If you talk to too many people and you do not make a good impression, it will be much harder to get funding, because the word on the street will be, “this deal will not ﬂy.” Meet with four or ﬁve venture capitalists at most, then revise the plan if you are not getting the right response. After each major revision, show it again to the lead venture partner.
While there were promising discussions with several venture capitalists,
Atlas did not want to be the sole investor, and SolidWorks did not win support from other venture capitalists during the spring or summer.
Jon was contacted by an established CAD software company in May
1994. It wanted to acquire SolidWorks—essentially the development team and

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the prototype. The proposal was attractive; it included signing bonuses and stock. Scott recalled his excitement: “This was a big shot in the arm. It meant that other industry insiders respected our vision and talent enough to put up their money and take the risk. This was like an cold bucket of Gatorade on a hot day.”
Jon stopped seeking venture capital for about a month while he considered the buyout offer. If the offer was a boost to morale, the way the team rejected it was even more meaningful. Jon talked to each person (several other programmers had joined during the spring), and they were unanimous in wanting to continue toward their original goal. Afﬁrming their commitment reinvigorated the team.

Turning Point: Michael Payne, CAD Company Founder
The most signiﬁcant advance that summer began with a due diligence meeting set up by Atlas Venture. Atlas wanted the SolidWorks team to meet its agent,
Michael Payne, who had recently resigned from PTC. Michael had cofounded
PTC, the number one company in CAD software. He was one of the most inﬂuential people in the industry.
Michael had grown up in London. He earned his bachelor’s degree in electrical engineering from Southampton University and his master’s degree in solid-state physics from the University of London. He came to the United
States and worked many years for RCA designing computer chips. Michael continued his education at Pace University, where he earned an MBA. His senior CAD development experience began in the 1970s, when he ran the
CAD/CAM design lab at Prime Computer. He was subsequently recruited by
Sam Geisberg, the visionary behind PTC. Michael recalled their ﬁrst meeting in 1986: “Sam had some kind of crazy prototype, and I said, ‘Hey, we can do something with that. This is what we should be working on.’”
PTC was founded in 1986 with Michael as vice president of development, and within ﬁve years the company had created a new set of CAD industry benchmarks. For FY 1993, PTC sales were $163 million, it earned a pretax proﬁt margin over 40 percent, and it reached a market capitalization* of
$1.9 billion. Michael’s reputation as a development manager was outstanding.
Remarkably, PTC had never missed a new product release date, and it released products every six months. This was considered a near-impossible feat in software development. He left PTC in April 1994 during a management dispute, about two months before the due diligence meeting with SolidWorks.
Jon had never met Michael but knew by reputation that he was a tough character. The SolidWorks team was worried about two possibilities: that
Michael would say they were on the wrong track, or that he might take their ideas back to PTC. Jon recalled the meeting:
*

Market capitalization is the value of the company established by the selling price of the stock times the number of shares outstanding.

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Bob and I were on one side of the table and Michael and Axel on the other.
I decided to gamble on a dramatic entrance. Before we told him anything about SolidWorks, I asked Michael to show his cards. I asked him to tell us what he thought were the greatest opportunities in the CAD market.
Michael mentioned many of the things we were targeting. I couldn’t imagine a better way to start the meeting.
We presented our plan and prototype. Michael asked us a lot of tough, confrontational questions. Afterwards, he told Atlas Venture, “These guys have a chance.” Coming from him, that was high praise.
The due diligence meeting was also the beginning of a dialogue between
Michael and Jon about joining SolidWorks. Over the next couple of months,
Michael decided to join the team. Jon described the synergy between them:
You almost couldn’t ask for two people with more different styles, but we got along well because we were united in our philosophy and vision. We found that our stylistic differences were assets; they created more options for solving problems.
Michael talked about his motivation for joining the SolidWorks team:
I couldn’t go work for a big company because I didn’t have any patience for petty politics. A start-up was my only option. The larger the company, the more focused it would be on internal issues rather than on making a product that customers would buy. Customers don’t care about technique, they care about the beneﬁts of the technology.
Jon focused on CAD features that he knew customers wanted, and he had a prototype demonstrating that he could do it. It was also quicker and easier than what was on the market. Being able to develop it was another matter. They still had to build it. Implementation, that’s where he would be useful. He told them, “Give me whatever title you want; I just want to run development.” Team Adjustments
Michael’s arrival created an imbalance in the SolidWorks team, and it took time to sort it out. In fact, Michael didn’t join the team until the last week in August.
Jon described his thoughts about team cohesion:
When I decided to start SolidWorks, I had three goals: (1) work with great people, (2) realize the vision of a new generation of software, and (3) make a lot of money. We didn’t go looking for Michael Payne, but when he came along, it was an easy decision. It can be hard to bring in strong players, but if those are your three goals, the decision falls out of the analysis rather naturally. Bob and I had to give up the reins in some areas so Michael could come on board. We weren’t looking for a top development manager

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because we thought we already had two. The change took some getting used to, but it was clearly the right thing to do.
Jon focused on team building, and Michael became the development manager. There were still big talent gaps, especially in sales and ﬁnance, but those positions could be ﬁlled when they were closer to the product launch. Michael was satisﬁed, “We didn’t have a vast team, but you don’t start out with a vast team, and we had a terriﬁc nucleus.”

September 1994
Atlas arranged for Jon to talk with venture ﬁrms interested in joining the investment syndicate. The team met with Jon Flint of Burr, Egan, Deleage & Company and Rich D’Amore of North Bridge Venture Partners. After completing their due diligence investigations, both ﬁrms joined the syndicate. Jon
Hirschtick recalled the situation:
I was pleased that Jon Flint and Rich D’Amore decided to invest. I had met Jon many years earlier and thought very well of him. Rich also impressed me as a very knowledgeable investor. Both had excellent reputations and I looked forward to having them join our board.
An offer sheet was presented to SolidWorks two weeks after Michael ofﬁcially joined the SolidWorks management team. Now the team had to decide how much money they really wanted. Michael’s last venture, PTC, only needed one round of capital, and this team wanted to go for one round, too. SolidWorks’ monthly cash burn rate was projected to average about $250,000 and they planned to launch the product in a year, so they needed $3 million for development. Sales and marketing would also need money; they decided that
$1 million should be enough to take them through the product launch to generating positive cash ﬂow. To that total, they added a $500,000 safety margin. SolidWorks asked Atlas to put together an offer sheet based on raising
$4.5 million.
SolidWorks received the offer sheet during the ﬁrst week of September. It gave a $2.5 million pre-money valuation with a 15 percent post-money stock option pool.* For SolidWorks’ business plan projections, see Exhibit 2. These terms were fairly typical for a ﬁrst round deal, but the SolidWorks team didn’t like what happened to their post-money equity when they ran the numbers.

Questions
1. Why has this deal attracted venture capital?
2. Can the founders optimize their personal ﬁnancial returns and simultaneously ensure that SolidWorks has sufﬁcient capital to optimize its chance of succeeding? What factors should the founders consider?
*

The pool of company stock reserved for rewarding employees in the future.

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3. How can the venture capitalists optimize their return? What factors should they consider?
4. After you have answered questions 2 and 3, structure a deal that will serve the best interests of the founders, the company, and the venture capital ﬁrms.

EXHIBIT 2 Business plan projections.
1994
Revenue

$

1995
—

$

175,000

1996

1997

1998

$ 3,010,000

$8,225,000

$17,115,000

$

Cost of sales

$

—

$

31,500

541,800

$1,480,500

$ 3,080,700

Sales and marketing

$

71,919

$

765,920

$ 1,930,000

$3,030,000

$ 5,822,500

R and D

$ 605,544

$ 1,126,208

$ 1,350,000

$1,500,000

$ 2,050,000

G and A

$ 185,954

$

$

650,000

$ 800,000

$ 1,050,000

Total expenses

$ 863,417

$ 2,368,803

$ 4,471,800

$6,810,500

$12,003,200

Operating income

$ (863,417)

$(2,193,803)

$(1,461,800)

$1,414,500

$ 5,111,800

445,175

Margin analysis
Cost of Sales

18.0%

18.0%

18.0%

18.0%

Gross Proﬁt

82.0%

82.0%

82.0%

82.0%

Sales and marketing

437.7%

64.1%

36.8%

34.0%

R and D

643.5%

44.9%

18.2%

12.0%

G and A
Operating income (before taxes)

254.4%

21.6%

9.7%

6.1%

Ϫ1253.6%

Ϫ48.6%

17.2%

29.9%

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Cases

ARTEMIS IMAGES
Christine Nazarenus tried to retain her optimism. Thirteen had always been a lucky number for her, but Friday, the thirteenth of July, 2001, had the earmarks of being the unluckiest day of her life. She was more than disappointed. She was shattered. Yet she knew that she had hard facts, not just gut feel, that offering images and products on the World Wide Web was the wave of the future. She was sure that the management team she had put together had the creativity and skills to turn her vision into reality. Managing her own company had seemed the obvious solution, but she hadn’t counted on how overwhelming the start-up process would be. Now, two years later, she was trying to ﬁgure out what went wrong and if the company could survive.
It had been so clear on day one. Archived photographs and images had tremendous value if they could be efﬁciently digitized and catalogued. Sports promoters and publishers had stores of archived information, most of it inaccessible to those who wanted it. Owners and fans represented only part of the untapped markets that the Internet and digital technology could serve. She had conceived a simple business model: digitize documents using the latest technology, tag them with easy-to-read labels, and link them to search engines for easy retrieval and widespread use. But over the ensuing months, so many factors affected the look, feel and substance of the company that Artemis Images would become.
So many things seemed outside her control that she wondered how she could have been so sure of herself back in February of 1999. Enthusiastically, Chris had approached a number of friends and acquaintances to help in the formation of a new “dot.com” company that seemed a sure bet. Frank
Costanzo, a former colleague from Applied Graphics Technologies (AGT), shared Chris’s enthusiasm, as did long-time friend George Dickert. George, in turn, contacted Greg Hughes, who was enrolled in a Business Planning course. Grateful for the opportunity to help launch a real company, Greg took the idea and honed it as part of a class assignment. The plan was a conﬁrmation of Chris’s conﬁdence in the venture. But as she looked over the original plan, she knew there was a lot of work yet to do. Greg understood the business idea, but he didn’t understand the work involved to actually run a business. George and Frank understood digital technology and project management, but, like Chris, had never launched, much less worked for, a startup company. Chris knew that she had the technology and talent she needed
© 2002 by Joseph R. Bell, University of Northern Colorado, and Joan Winn, University of Denver.
Published in Entrepreneurship Theory & Practice, 28(2) Winter 2003. The authors wish to thank Chris
Nazarenus and the staff of Artemis Images for their cooperation in the preparation of this case. Special thanks to Herbert Sherman, Southampton College, Long Island University, and Dan Rowley, University of Northern Colorado. This case is intended to stimulate class discussion rather than to illustrate the effective or ineffective handling of a managerial situation. All events and individuals in this case are real, but some names may have been disguised.

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Artemis Images

and felt conﬁdent that the four friends could construct a business model that would put Artemis ahead of the current image providers. Greg’s business plan looked like the perfect vehicle to appeal to investors for the funds they needed to proceed.

The Business Idea
In 1999, Chris had been working for three years as VP-Sales out of the
Colorado ofﬁce of AGT, a media management company that provided digital imaging management and archiving services for some of the largest publishers and advertisers in the world. AGT had sent Chris to Indianapolis to present a content management technology solution to the Indianapolis Motor Speedway
Corporation (IMSC) as it prepared marketing materials for the 2001 Indy 500.
IMSC is the host of the 80-plus-year-old Indy 500, the largest single-day sporting event in the world, NASCAR’s Brickyard 400, the second-largest singleday sporting event in the world, and other events staged at the track. Chris’s original assignment was a clear one: IMSC needed to protect its archive of photographs, many of which had begun to decay with age. The archive included ﬁve million to seven million photographs and dynamically rich multimedia formats of video, audio, and in-car camera footage.
Chris discovered that the photo archives at IMSC were deluged with requests (personally or via letters) from fans requesting images. She was amazed that a relatively unknown archive had generated nearly $500,000 in revenues in 1999 alone. Further discussions with IMSC researchers revealed that requests often took up to two weeks to research and resulted in a sale of only $60 to $100. However, IMSC was not in a position, strategically or ﬁnancially, to acquire a system to digitize and preserve these archives. Not willing to leave the opportunity on the table, Chris asked herself, “What is the value of these assets for e-commerce and retail opportunities?” Without a doubt,
IMSC and some of her other clients (Conde Nast, BBC, National Motor
Museum) would be prime customers for digitization and content management of their collections.
Chris knew that selling photos on the Internet could generate substantial revenue. She conceived of a business model where the system would be ﬁnanced through revenue-sharing, rather than the standard model where the organization paid for the system up front. IMSC was interested in this arrangement, but it was outside the normal business practices of AGT. AGT wanted to sell systems, not give them away. They couldn’t see the value of managing other organizations’ content.
As Chris told the story, her visit to the archives at IMSC was her Jerry
Maguire experience. In the movie, Jerry is sitting on the bed when everything suddenly becomes clear and now he must pursue his dream. Like Jerry, Chris believed so passionately that her idea would bear fruit that when AGT turned down Chris’s request for the third time, she quit her job to start Artemis Images on her own.

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Building a Team
When AGT was not interested in Chris’s idea of on-site digitization and sale of IMSC’s photo archives, Chris was not willing to walk away from what she saw as a gold mine. She contacted her friends and colleagues from AGT. Swept up in the dot.com mania, Chris named her company “e-Catalyst.” e-Catalyst was incorporated as an S-corporation on May 3, 1999, by a team of four people: Christine Nazarenus, George Dickert, Frank Costanzo, and Greg Hughes.
(See Exhibit 1 for proﬁles of these partners.) Expecting that they would each contribute equally, each partner was given a 25 percent interest in the company. Chris fully expected them to work as a team, so no formal titles were assigned, largely as a statement to investors that key additions to the team might be needed and welcomed. As another appeal to potential investors—and to broaden the team’s expertise—Chris and George put together a roster of experts with content management, systems and technology experience as their ﬁrst advisory board. Greg’s professor and several local business professionals agreed to serve on the board of advisors, along with an Indy 500 winning driver-turned-entrepreneur, and Krista Elliott Riley, president of Elliott Riley, the marketing and public relations agency that represented Indy 500 and

EXHIBIT 1 Artemis Images management team 1999–2000.
Christine Nazarenus, 34, was formerly vice president of national accounts for AGT, one of the top three content management system providers in the world securing million dollar deals for this $500 million company. She is an expert in creating digital workﬂow strategies and has designed and implemented content management solutions for some of the largest corporations in the world including Sears, Conde Nast, Spiegel, Vio, State Farm, and
Pillsbury. Ms. Nazarenus has extensive general management experience and has managed a division of over one hundred people. Chris holds a BA in communications from the
University of Puget Sound.
George Dickert, 32, most recently worked as a project manager for the Hibbert Group, a marketing materials distribution company. He has experience with e-commerce, Web-enabled fulﬁllment, domestic and international shipping, call centers and CD-ROM. He has overseen the implementation of a million-dollar account, has managed over $20 million in sales, and has worked with large companies including Hitachi, Motorola, ON Semiconductor, and
Lucent Technologies. Mr. Dickert has an MBA from the University of Colorado. George and
Christine have been friends since high school.
Frank Costanzo, 40, is currently a senior vice president at Petersons.com. Petersons.com has consistently been ranked as one of the top one hundred sites worldwide. Mr. Costanzo is an expert in content management technology and strategy and was previously a vice president at AGT. Mr. Costanzo has done in-depth business analysis and created on-site service solutions in the content management industry. He has worked on content management solutions for the world’s top corporations including General Motors, Hasbro,
Bristol-Meyers Squibb, and Sears.
Greg Hughes, 32, is currently a senior sales executive with one of the largest commercial printers in the world. Mr. Hughes has 10 years’ sales experience and has sold million-dollar projects to companies like US West, AT&T, R. R. Donnelly, and MCI. His functional expertise includes ﬁnancial and operational analysis, strategic marketing, fulﬁllment strategies and the evaluation of start to ﬁnish marketing campaigns. Mr. Hughes has an MBA from the University of Colorado.

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Le Mans Sports Car teams and drivers. Chris felt conﬁdent that her team had the expertise she needed to launch a truly world-class company.
Chris and George quit their jobs and took the challenge of building a company seriously. They contacted one of the Rocky Mountain region’s oldest and most respected law ﬁrms for legal advice. They worked with two lawyers, one who specialized in representing Internet companies as general counsel and one who specialized in intellectual property rights. With leads from her many contacts at AGT, Chris contacted venture capitalists to raise money for the hardware, software licensing, and personnel costs of launching the business.
The dot.com bust of 2000 did not make things easy. Not wanting to look like “yet another dot.com” in search of money to throw to the wind, Chris and her team changed their name to Artemis Images. Artemis, the Greek goddess of the hunt, had been the name of Chris’s ﬁrst horse as well as her ﬁrst company, Artemis Graphics Greeting Cards, her ﬁrst entrepreneurial dabble at the age of 16. Chris had always been enthralled with beautiful images.

Artemis Images’s Niche
In her work at AGT, Chris had observed that many organizations had vast stores of intellectual property (photos, videos, sounds and text), valuable assets often underutilized because they exist in analog form and may deteriorate over time.
Chris’s vision was to preserve and enable the past using digital technology and the transportability of the World Wide Web. Chris envisioned a company that would create a digitized collection of image, audio and video content that she could sell to companies interested in turning their intellectual property into a source of revenue.
Publishers and sports promoters were among the many organizations with large collections of archived photos and videos. Companies like Boeing, General
Motors, and IMSC are in the business of producing planes, cars, or sporting events, not selling memorabilia. However, airplane, car, and sports fans are a ready market for photos of their favorite vehicle or videos of their favorite sports event.
Proper storage and categorization of archived photos and videos is complex and expensive. In 2000, the two common solutions were to sell the assets outright or to set up an in-house division devoted to managing and marketing them. Most organizations were unwilling to sell their assets, as they represented their priceless brand and heritage. Purchasing software and hiring specialized personnel to digitize and properly archive their assets was a costly proposition that lay beyond the core competence of most companies. Chris’s work with
AGT convinced her that there were literally thousands of companies with millions of assets that would be interested in a company that would digitize and manage their photo and video archives.
Chris understood a company’s resistance to selling its archives, and the high cost of obtaining and scanning select images for sale. However, she also understood the value to an organization of having its entire inventory digitized, thus creating a permanent history for the organization. She proposed a revenue

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Cases

sharing model whereby Artemis Images would digitize a client’s archives but would not take ownership. Instead, her company would secure exclusive license to the archive, with 85 percent of all revenue retained by Artemis Images and
15 percent paid to the archive owner. She expected that the presence of viewable archives on the Artemis Images website would lure buyers to the site for subsequent purchases.
The original business model was a “B2C” (business-to-consumer) model.
Starting with the IMSC contract, Artemis Images would work with IMSC to promote the Indy 500 and draw the Indy race fans to the Artemis Images website. Photos of the current-year Indy 500 participants—and historical photos including past Indy participants, winners, entertainers, celebrities (e.g., Arnold
Palmer on the Indy golf course)—would be added to IMSC’s archived images and sold for $20 to $150 apiece to loyal fans. A customer could review a variety of photo options on the Artemis website, then select and order a highresolution image. The order would be secured through the Web with a credit card, the image transferred to the fulﬁllment provider, and a hard copy mailed to the eager recipient. The website was sure to generate revenue easier than
IMSC’s traditional sales model of the past.
Having established the model with IMSC content in the auto racing market,
Chris and George built the business plan around obvious market possibilities that might appeal to a wider range of consumers and create a comprehensive resource for stock photography. Since the Artemis Images team had prior business dealings with two of the three largest publishers in the world, publishing was the obvious target for future contracts. Future markets would be chosen similarly, where the Artemis team had established relationships. These markets would be able to build on the archive already created and would bring both consumer-oriented content and saleable stock images. Greg made a list of examples of some industries and the content that they owned:
■
■
■
■
■

Sports: images of wrestling, soccer, basketball, bodybuilding, football, extreme sports
Entertainment: recording artists, the art from their CDs, movie stars, pictures of events, pictures from movie sets
Museums: paintings, images of sculpture, photos, events
Corporations: images of food, ﬁshing, planes, trains, automobiles
Government: coins, stamps, galaxies, satellite imaging

As Chris and George worked with Greg to put together the business plan, they began to see other revenue-generating opportunities for their virtualarchive company. Customers going to IMSC or any other Artemis client’s website would be linked to Artemis Images’s website for purchase of photos or videos. Customer satisfaction with image sales would provide opportunities to sell merchandise targeted to speciﬁc markets and to syndicate content to other websites. For motor sports, obvious merchandise opportunities would include
T-shirts, hats, and model cars. For landscapes, it might be travel packages or

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hiking gear. Corporate customers might be interested in software, design services, or ofﬁce supplies. Unique content on Artemis Images’s website could be used to draw trafﬁc to other companies’ sites. Chris and her team planned to license the content on an annual basis to these sites, creating reach and revenues for Artemis Images.
Another potential market for Artemis Images lay in the unrealized value of the billions of images kept by consumers worldwide in their closets and drawers. These images were treasured family heirlooms which typically sat unprotected and underutilized. Consumers could offer their photographs for sale or simply pay for digitization services for their own use. If just 10% of the U.S. population were to allow Artemis Images to digitize their archive and half of these people ordered just one 8" ϫ 10" print, Artemis Images could create a list of 25 million consumers and generate revenues of approximately
$250 million. Because images suffer no language barriers, the worldwide reach of the Internet and the popularity of photography suggested potential revenues in the billions.
Working together on the business plan, the Artemis team brainstormed ways they could attract customers to the Artemis Images site by providing unique content and customer experiences. A study by Forrester Research analyzed the key factors driving repeat site visits and found that high-quality content was cited by 75 percent of consumers as the number one reason they would return to a site. The Artemis team wanted to create a community of loyal customers through additional unique content created by the customers themselves. This would include the critical chats and bulletin boards that are the cornerstone of any community-building program. Artemis Images could continuously monitor this portion of the site to add new fan experiences to keep the experience “fresh.” Communities would be developed based on customer interests.
As the company gained clients and rights to sell their archived photos and videos, Artemis would move toward a “B2B” (business-to-business) model. Chris and George knew marketing managers at National Geographic,
CMG World Wide, the BBC, Haymarket Publishing (includes the Formula 1 archive), Conde Nast, and International Publishing Corporation. These large publishers controlled and solicited a wide range of subject matter (fashion, nature, travel, hobbies, etc.) yet often had little idea of what existed in their own archives or had difﬁculty in getting access to it. Finding new images was usually an expensive and time-consuming proposition. Artemis Images could provide the solution. For example, Conde Nast (publisher of Vogue,
Bon Appetit, Conde Nast Traveler, House & Garden, and Vanity Fair) might like a photo for its travel magazine from the National Geographic archives.
They would be willing to pay top dollar for classic stock images, given the number of viewers who would see the image. Price-per-image was typically calculated on circulation volume, much like royalty fees on copyrighted materials. Similarly, advertising agencies use hundreds of images in customer mockups. For example, an agency may desire an image of a Paciﬁc island.

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If Artemis Images held the rights to Conde Nast and National Geographic, there might be hundreds of Paciﬁc island photos from which to choose. As with the B2C concept, a copy of the image would be transferred through the
Web with a credit card or on account, if adequate bandwidth were available
(only low-resolution images would be available to view initially), or via overnight mail in hard copy or on disk.
The transition from B2C to B2B seemed a logical progression, one that would amass a large inventory of saleable prints and, at the same time, draw in larger per-unit sales. The basic business model was the same. Artemis would archive photos and videos that could be sold to other companies for publication and promotion brochures. Chris and George expected that this model could be replicated for other vertical markets including other sports, nature, entertainment, and education.
While the refocus on the B2B market seemed a surer long-term revenue stream for the company, both B2B and B2C were losing favor with the investing community. Chris and George refocused the business plan as an application service provider (ASP). With the ASP designation, Artemis Images could position itself as a software company, generating revenue from the licensing of its software processes. In 2000, ASPs were still in favor with investors.
Artemis Images’s revenue would come from three streams: (1) sales of images to businesses and consumers, (2) syndication of content, and (3) sales of merchandise. Projected sales were expected to exceed $100 million within the ﬁrst four years, with breakeven occurring in year three. (See Exhibits 2, 3, and 4 for projected volume and revenues.)
To implement this strategy, Artemis Images, Inc., needed an initial investment of $500,000 to begin operations, hire the team, and sign four additional content agreements. A second round of $1.5 million and a third round of
$3 million to $8 million (depending on number of contracts) were planned, to scale the concept to 28 archives and over $100 million in assets by 2004.
(See Exhibit 5 for funding and ownership plan.)

The Content Management Industry
According to GISTICS, the trade organization for digital asset management, the content management market (including the labor, software, hardware, and physical assets necessary to manage the billions of digital images) was projected to be a $2 trillion market worldwide in the year 2000 (1999 Market
Report). Content could include images, video, text and sound. Artemis
Images intended to pursue two subsets of the content management market.
The ﬁrst was the existing stock photo market, a business-to-business market where rights to images were sold for limited use in publications such as magazines, books, and websites. Deutsche Bank’s Alex Brown estimated this to be a $1.5 billion market in 2000. Corbis, one of the two major competitors in the digital imaging industry, estimated it to be a $5 billion market by 2000.

0

0

0

0

0

18,000 22,500

Subtotal
12,000

10

24,000

9,000

15,000

4

Qtr 1

2001

4

Qtr 2

Source: e-Catalyst Business Plan, February 28, 2000.

1

Qtr 4

Quarter

Onsites (cumulative)

2000

Year

ONSITE OPERATIONS (by quarters)

19,500

Merchandise Orders 15,600 19,500

56,500
16

41,800 52,250

Subtotal

25,500

31,000

16

17,000 21,250

Stock Photos
16

24,800 31,000

Licensing Deals

6,000

0

11,250

3,750

7,500
5,250

9,000

15,000

12,000

11

25,500

10,500

6,750

9,000

Jul-01

21,600

0
7,200

1

13

14

34,000 42,500 42,500

42,500

93,000

Aug-03

36,000

15

60,000

15,000

45,000

Aug-02

18,000

2

30,000

7,500

22,500

Aug-01
9,750

9,000

7

Qtr 3

19,500

16

16

16

10

Qtr 4

13

Qtr 1

2002

13

Qtr 2

70,200 23,400 23,400

16

16

Qtr 3

58,500

16

42,500 42,500
16

Qtr 4
19

7,200

16

24,000

22

Qtr 1

25

425,000

620,000

Total

240,000

156

450,000

150,000

300,000

Total

109,200

26

204,750

68,250

136,500

Total

28

Qtr 3

58,500

16

28

Qtr 4

390,000

192

135,500 1,045,000

42,500

93,000

Dec-03

36,000

16

60,000

15,000

45,000

Dec-02

18,000

7

33,750

11,250

22,500

Dec-01

Qtr 2

11,700

16

61,100

42,500

18,600

2003

46,800 23,400

16

9,000
15,000

Oct-03 Nov-03
74,400 37,200

Sep-03

28,800 14,400

16

51,000 33,000

15,000 15,000
16

3,600

6

15,000

Oct-02 Nov-02

7,200

5

36,000 18,000

Sep-02

14,400

4

10,500

4,500

Oct-01 Nov-01

27,000 18,750

9,000

18,000

Sep-01

60,750 145,600 79,700 79,700 135,500 116,900 79,700

29,750

31,000 111,600 37,200 37,200

Jul-03

43,200 14,400 14,400

12

66,000 33,000 33,000

12,000 15,000 15,000

54,000 18,000 18,000

Jul-02

7,200

1

31,500 14,250 15,750

4,500

27,000

Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03

9,600 12,000

9

Consumer Photos

Volumes 2003

Merchandise Orders

8

6,000

Stock Photos

7,500

12,000 15,000

Consumer Photos

Licensing Deals

6,000

0

7,500

0

7,500

Jan-02 Feb-02 Mar-02 Apr-02 May-02 Jun-02

0

Merchandise Orders

Volumes 2002

0
0

Licensing Deals

0

Stock Photos

Subtotal

0

Jan-01 Feb-01 Mar-01 Apr-01 May-01 Jun-01

Consumer Photos

Volumes 2001

EXHIBIT 2 Anticipated sales volume and on-site operations.

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609

610
$
$
$
$
$

Stock Photos

Subtotal

Syndication

Merchandise

Total

Mar-01

Apr-01

45,000 $

0 $

$1,495,213 $1,873,183 $2,181,517 $2,498,183

Jul-02

Jun-03

Jul-03

$10,040,717 $9,610,795 $9,744,128

$4,812,752 $5,736,773 $6,507,607 $7,278,440

Total

743,628

Oct-03

$10,144,128

175,500

$ 2,850,000

$ 7,118,628

$ 6,375,000

351,000 $
$11,256,153 $10,929,923

438,750 $

$ 2,583,333 $ 2,716,667

$ 8,234,070 $ 7,862,256

$ 6,375,000 $ 6,375,000

526,500 $ 175,500 $ 175,500 $

$ 2,183,333 $2,316,667 $2,450,000

$1,650,000 $1,783,333 $1,916,667 $2,050,000
$ 117,000 $ 146,250 $ 146,250 $ 146,250 $

$ 7,330,884 $7,118,628 $7,118,628

Sep-03

$ 3,967,820

$ 1,859,070 $ 1,487,256 $

Aug-03

$ 4,402,883 $ 4,302,307

108,000

$ 1,250,000

$ 2,609,820
216,000 $

983,333 $ 1,116,667
270,000 $

359,820

Oct-02
$ 2,250,000

719,640 $

Sep-02

$ 3,149,550 $ 2,969,640

633,333 $ 741,667 $ 858,333 $

May-03

899,550 $

Aug-02

$ 2,250,000 $ 2,250,000

324,000 $ 108,000 $ 108,000 $

$ 5,100,000 $6,375,000 $6,375,000

Merchandise

Source: e-Catalyst Business Plan, February 28, 2000.

Jun-02

54,000

$ 1,804,743

108,000 $

108,333

$ 1,642,410

66,667 $

$ 1,743,108 $ 1,884,487

135,000 $

33,333 $

179,910

Oct-01
$ 1,462,500

359,820 $

Sep-01

$ 1,574,775 $ 1,709,820

54,000 $

$ 2,230,884 $ 743,628 $ 743,628

Syndication

$3,045,752 $3,807,190 $4,444,690 $5,082,190

Apr-03

$2,550,000 $3,187,500 $3,825,000 $4,462,500

Mar-03

Subtotal

Feb-03

Stock Photos

Jan-03
$ 495,752 $ 619,690 $ 619,690 $ 619,690

Consumer Photos

May-02

449,775 $

Aug-01
$ 1,125,000 $ 1,350,000

16,667 $

$ 3,836,793 $3,459,487 $3,576,153

90,000 $

Total

Revenues 2003

54,000 $

8,333 $

$ 2,879,460 $2,609,820 $2,609,820

$ 283,333 $ 358,333 $ 441,667 $ 533,333 $
90,000 $

162,000 $

0 $

$ 1,800,000 $2,250,000 $2,250,000

$

90,000 $

675,000 $ 787,500 $1,012,500

$ 1,079,460 $ 359,820 $ 359,820 $

Merchandise

72,000 $

Jul-01

$ 1,376,730 $1,029,743 $1,263,077

Syndication

$1,139,880 $1,424,850 $1,649,850 $1,874,850

Apr-02

$ 900,000 $1,125,000 $1,350,000 $1,575,000

Mar-02

$

45,000 $

0

0 $ 194,925 $ 757,425

0 $

0 $

Jun-01

539,730 $ 179,910 $ 179,910 $

May-01

$ 1,214,730 $ 967,410 $1,192,410

0 $ 562,500 $

0 $ 149,925 $ 712,425

0 $

0 $ 149,925 $ 149,925 $

Subtotal

Feb-02

Feb-01

Stock Photos

0 $

0 $

0 $

0 $

0 $

0 $

$ 239,880 $ 299,850 $ 299,850 $ 299,850

Jan-02

Jan-01

Consumer Photos

Revenues 2002

$

Consumer Photos

Revenues 2001

EXHIBIT 3 Projected monthly revenue stream

89,955

Nov-01

27,000

54,000

87,750
$9,817,897

$

$2,983,333

$6,746,814

$6,375,000

$ 371,814

Nov-03

$3,867,243

$

$1,383,333

$2,429,910

$2,250,000

$ 179,910

Nov-02

$1,850,288

$

$ 158,333

$1,664,955

$1,575,000

$

449,775

Dec-01

135,000

216,667

899,550

Dec-02

270,000

438,750
$11,789,487

$

$ 3,116,667

$ 8,234,070

$ 6,375,000

$ 1,859,070

Dec-03

$ 4,936,217

$

$ 1,516,667

$ 3,149,550

$ 2,250,000

$

$ 2,488,942

$

$

$ 2,137,275

$ 1,687,500

$

Total
2,728,635

608,333
819,000

Total
5,997,000

1,800,000

Total
12,393,80

2,925,000
$107,668,800

$

$ 28,600,000

$ 76,143,800

$ 63,750,000

$

$ 40,397,000

$

$ 10,100,000

$ 28,497,000

$ 22,500,000

$

$ 14,393,468

$

$

$ 12,966,135

$ 10,237,500

$

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EXHIBIT 4 Pro forma ﬁnancial summary 2000.
Summary proﬁt and loss statement
2000

2001

2002

2003

Total

Revenues

$

0

$14,393,468

$40,397,000

$107,668,800

$162,459,268

Cost of sales

$

0

$ 5,186,454

$11,398,800

$ 30,457,520

$ 47,042,774

Gross proﬁt

$

0

$ 9,207,014

$28,998,200

$ 77,211,280

$115,416,494

Operations

$ 439,847

$13,623,571

$27,109,143

$ 47,078,657

$ 88,251,217

($ 439,847)

($ 4,416,556)

$ 1,889,057

$ 30,132,623

$ 27,165,277

$

$

0

$ 10,322,805

$ 10,322,805
$ 16,842,472

Net income before tax
Taxes (38%)
Net income

$

0

0

($ 439,847)

($ 4,416,556)

$ 1,889,057

$ 19,809,818

2000

2001

2002

2003

Cash and equivalents

$ 428,020

$ 4,490,768

$ 4,958,270

$ 21,508,477

Accounts receivable

$

0

$ 2,488,942

$ 4,936,217

$ 11,789,487

Inventories

$

0

$

0

$

0

$

0

Prepaid expenses

$

0

$

0

$

0

$

0

Depreciable assets

$

0

$

0

$

0

$

0

Other depreciable assets

$

0

$

0

$

0

$

0

Summary balance sheet
Assets

Depreciation

$

0

$

0

$

0

$

0

Net depreciable assets

$

0

$

0

$

0

$

0

Total assets

$ 428,020

$ 6,979,710

$ 9,894,487

$ 33,297,964

Accounts payable

$ 367,867

$ 1,836,113

$ 2,861,833

$ 5,589,379

Accrued income taxes

$

0

$

0

$

0

$

866,113

Accrued payroll taxes

$

0

$

0

$

0

$

0

Total liabilities

$ 367,867

$ 1,836,113

$ 2,861,833

$ 6,455,492

Capital contribution

$ 500,000

$10,000,000

$10,000,000

$ 10,000,000

Stockholders’ equity

$

$

$

$

Liabilities and capital

0

0

0

0

Retained earnings

($ 439,847)

($ 4,856,403)

($ 2,967,346)

$ 16,842,472

Net capital

$ 60,153

$ 5,143,597

$ 7,032,654

$ 26,842,472

Total liabilities and capital

$ 428,020

$ 6,979,710

$ 9,894,487

$ 33,297,964

Source: e-Catalyst Business Plan, February 28, 2000.

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APPENDIX B

EXHIBIT 5 Artemis images original funding plan.
Projected Plan

Round 1

Round 2

Round 3

Round 4

Exit

Round 2
1-Jan

Round 3
1-Mar

Round 4
1-Jun

Exit
3-Dec

Financing assumptions:
2003 Revenues

$110,000,000

2003 EBITDA

$ 30,000,000

2003 Revenue growth rate
2003 Valuation

40%
$440,000,000

Valuation/revenue

4

Valuation/EBITDA

14.67

Round 1 Financing

$

500,000

Round 2 Financing

$

1,500,000

Round 3 Financing

$

3,000,000

Round 4 Financing

$

5,000,000
Round 1
Oct-00

Number of shares outstanding
Total number of shares outstanding prior to ﬁnancing

6,000,000

7,200,000

9,000,000

11,250,000

11,250,000

Shares issues this round

1,200,000

1,800,000

2,250,000

1,406,250

1,406,250

Total number shares outstanding after ﬁnancing 7,200,000

9,000,000

11,250,000

12,656,250

12,656,250

$440,000,000

Valuations
Premoney valuation

$2,500,000

$6,000,000

$12,000,000

$40,000,000

Amount of ﬁnancing

$ 500,000

$1,500,000

$ 3,000,000

$ 5,000,000

0

Postmoney valuation

$3,000,000

$7,500,000

$15,000,000

$45,000,000

$440,000,000

$0.42

$0.83

$1.33

$3.56

$34.77

47.41%

Price per share
Resulting ownership
Founders

83.33%

66.67%

53.33%

47.41%

Round 1 investors

16.67%

13.33%

10.67%

9.48%

9.48%

Round 2 investors

0.00%

20.00%

16.00%

14.22%

14.22%

Round 3 investors

0.00%

0.00%

20.00%

17.78%

17.78%

Round 4 investors

0.00%

0.00%

0.00%

11.11%

11.11%

100.00%

100.00%

100.00%

100.00%

100.00%

Founders

$2,500,000

$5,000,000

$ 8,000,000

$21,333,333

$208,592,593

Round 1 investors

$ 500,000

$1,000,000

$ 1,600,000

$ 4,266,667

$ 41,718,519

Round 2 investors

$

0

$1,500,000

$ 2,400,000

$ 6,400,000

$ 62,577,778

Round 3 investors

$

0

$

0

$ 3,000,000

$ 8,000,000

$ 78,222,222

Round 4 investors

$

0

$

0

$

0

$ 5,000,000

$ 48,888,889

Total

$3,000,000

$7,500,000

$15,000,000

$40,000,000

$440,000,000

Payback to investors

Round 1

Round 2

Round 3

Round 4

3.25

3

2.75

2.5

Times money back

83.44

41.72

26.07

9.78

Internal rate of return (IRR)

290%

247%

227%

149%

Total
Value of ownership

Holding period (years)

Source: e-Catalyst Business Plan, February 28, 2000.

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Commercially produced images were also in demand by consumers. Industry insiders believed that this market was poised for explosive growth in 2000, as
Web-enabled technology facilitated display and transmission of images directly from their owners to individual consumers. The archives from the Indianapolis
Motor Speedway was an example of this business-to-consumer model. Historically, consumers who bought from the archive had to visit the museum at IMSC or write a letter to the staff. Retrieval and fulﬁllment of images then required a manual search of a physical inventory, a process which could take as long as two weeks. Web-based digitization and search engines would reduce the search time and personnel needed for order fulﬁllment and allow customers the convenience of selecting products and placing orders on-line. The Daily Mirror, a newspaper in London, had displayed its archived images on its own website and had generated over $30,000 in sales to consumers in its ﬁrst month of availability. IMG, a sports marketing group, placed a value of $10 million on the IMSC contract.

Competition
There were a variety of stock and consumer photo sites ranging from those that served only the business-to-business stock photo market to amateur photographers posting their pictures. Most sites did not offer a “community,” the Internet vehicle for consumer comments and discussion, a powerful search engine, and ways to repurpose the content (e-greeting cards, prints, photo mugs, calendars, etc.). In addition, the archives available in digital form were limited because other content providers worked from the virtual world to the physical world versus the Artemis Images model of working from the physical world to the virtual world. Competitors had problems with integrated digital workﬂows and knowing where the original asset resided due to the distributed nature of their archives. They scanned images on demand, which severely limited the content available to be searched on their websites.
Chris and Greg evaluated the ﬁve major competitors for their business plan: www.corbis.com: Owned by Bill Gates with an archive of over 65 million images, only 650,000 were available on the Web to be accessed by consumers for Web distribution (e-greeting cards, screen savers, etc.).
Only 350,000 images were available to be purchased as prints. The site was well designed and the search features were good, but there was no community on the site. The niche Corbis pursued was outright ownership of archives and scanning on demand. Corbis had recently acquired the
Louvre archive, for a reported purchase price of over $30 million. www.getty-images.com: An archive of over 70 million images. In 1999, this site was only a source to link to their other wholly owned subsidiaries, including art.com. There were no search capabilities, no community. This website functioned only as a brochure for the company. Like Corbis, Getty was focused on owning content and then scanning on demand. www.art.com: A good site in design and navigation, this site was a wholly owned subsidiary of Getty and was positioned as the consumer window to

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a portion of the Getty archive. Similar to Corbis, customers were able to buy prints, send e-greeting cards, etc. Despite the breadth of the Getty archive, this site had a limited number of digitized images available. www.mediaexchange.com: Strictly a stock photo site targeted toward news sources, the site was largely reliant on text. It was difﬁcult to navigate and had an unattractive graphical user interface. www.thepicturecollection.com: Strictly a stock site offering the Time photo archive, this site was well designed with good search capabilities.
Searches yielded not only a thumbnail image but a display of the attached locator tags, or metadata. www.ditto.com: The world’s leading visual search engine, ditto.com enabled people to navigate the Web through pictures. The premise was two-fold: deliver highly relevant thumbnail images and link to relevant
Web sites underlying these images. By 2000, they had developed the largest searchable index of visual content on the Internet.
Exhibit 6 shows a comparison of Artemis Images to the two major players in the stock photography market, Getty and Corbis. This table illustrates only revenues from stock photo sales and does not include potential revenue from consumer sales, merchandise, advertising or other potential revenue sources.
According to its marketing director, Corbis intended to digitize its entire archive, and was in the process of converting analog images into digital images, with 63 million images yet to be converted. While Getty and Corbis were established players in the content industry, they were just recently feeling the effects of e-commerce:
■
■
■

In 1999, Corbis generated 80 percent of its revenues from the Web versus none in 1996.
Getty’s e-commerce sales were up 160 percent between 1998 and 1999.
34 percent of Getty’s 1999 revenues came from e-commerce versus 17 percent in 1998.

Strategy
Artemis Images intended to provide digitization and archive management by employing a professional staff who would work within each client-company’s organization, rather than in an off-site facility of its own. Chris’s model was to provide digitized archive services in exchange for (1) exclusive rights to market the content on the Internet, (2) merchandising rights, and (3) promotion of Artemis Images’s URL, effectively co-branding Artemis Images with each client-partner. Chris envisioned a software process that would be owned or licensed by Artemis, and which could be used for digitizing different archive media, such as photos, videos, and text.
Chris and George expected Artemis Images to partner with existing sellers of stock photography and trade digitizing services for promotion through their sales channels. Artemis Images would pursue these relationships with traditional

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EXHIBIT 6 Anticipated sales volume comparisons.
Stock photo market
Artemis
Images

Cumulative number of images digitized
% digitized**

Artemis
Images

Artemis
Images

Getty

Corbis

Indy Archive
2000*
Archive size

Artemis
Images
2000

2001

2002

1999

1999

5,000,000

5,000,000

50,000,000

95,000,000

70,000,000

65,000,000

345,600

345,600

6,796,800

21,542,400

1,200,000

2,100,000

7%

7%

14%

23%

1.71%

3.2%

# of image sales needed to hit revenue target

0

0

151,484

623,493

1,646,667

666,666

% of archive that must be sold to hit revenue target***

0

0

0.30%

0.16%

2.35%

1.00%

Revenues****

0

0

$22,722,600

Revenue per image in archive

0

0

$0.45

$0.98

$ 3.53

$ 1.54

Revenue per digitized image

0

0

$3.25

$4.30

$205.83

$47.62

$93,523,950 $247,000,000 $100,000,000

*Artemis Images had already secured an exclusive content agreement from the Indianapolis Motor Speedway Corporation.
**Estimates based on scanning 1,920 images a day per scanner, 2 scanners per archive. As scanning technologies improve, the throughput numbers were expected to go up.
***The percentage of the Artemis Images archive that needed to be sold to hit revenues projections varied between 0.03% and 0.22%, as compared to an actual 2.35% for Getty and to 0.6% for Corbis.
****The Artemis Images revenue numbers were based on selling a certain number of images at $150 per image; $150 was the minimum average price paid for stock photographs. Corbis was privately held; this ﬁgure was an estimate.

sales and marketing techniques. Sales people would call on the major players and targeted direct mail, trade magazine advertising and PR would be used to reach the huge audience of smaller players. In addition, content partners were expected to become customers, as they were all users of stock photography.
As Artemis Images gained clients, the company would have access to some of the ﬁnest and most desirable content in the world. Chris knew that the workﬂow expertise of the management team would put them in a good position to provide better quality more consistently than either Corbis or Getty. This same expertise would allow Artemis to have a much larger digital selection, with a website design that would be easily navigable for customers to ﬁnd what they needed.
Using on-site equipment, the client’s content would be digitized, annotated
(by attaching digital information tags, or metadata) and uploaded to the corporate hub site. Metadata would allow the content to be located by the search

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engine and thus viewed by the consumer. For example, a photo of Eddie
Cheever winning the Indy 500 would have tags like Indy 500, Eddie Cheever, win photo, 1998, etc. Therefore, a customer going to the website and searching for “Eddie Cheever” would ﬁnd this speciﬁc photo, along with the hundreds of other photos associated with him. The Artemis corporate database was intended to serve as the repository for search and retrieval from the website.
The traditional content management strategy forced organizations to purchase technology and expertise. Artemis Images’s model intended to alleviate this burden by exchanging technology and expertise for exclusive web distribution rights and a share of revenues. The operational strategy was to create an infrastructure based on installing and operating digital asset management systems at their customers’ facilities to create a global digital archive of images, video, sound and text. This would serve to lock Artemis Images into long-term relationships with these organizations and ensure that Artemis Images would have both the historical and the most up-to-date content. Artemis Images would own and operate the content management technology, with all other operational needs outsourced including Web development, Web hosting, consumer data collection, and warehousing and fulﬁllment of merchandise (printing and mailing posters or prints). Artemis Images would scan thousands of images per day, driving down the cost per image to less than $2.00, versus the Corbis and Getty model of scan-on-demand, where the cost per image was approximately
$40.00. The equipment needed for both the content management and photo production would be leased to minimize start-up costs and ensure greater ﬂexibility in the system’s conﬁguration.
The original plan was to purchase and install software and hardware at their main ofﬁce in Denver, Colorado, contract with a Web development partner, and set up the ﬁrst on-site facility at Indianapolis Motor Speedway Corporation. The Denver facility would serve as a development lab, to create a standard set of metadata to be used by all of their partners’ content. This consistency of annotation information was intended to allow for consistent search and retrieval of content. Artemis Images’s goal was to build a world-class infrastructure to handle content management, consumer data collection, and e-commerce. This infrastructure would allow them to amass a large content and transaction volume by expanding to other market segments. Developing their own structure would ensure standardization of content and reduced implementation time. Outreach for news coverage and the development of community features would be negotiated concurrently. The time line in Exhibit 7 illustrates the Artemis Images development plan.

Financial Projections
Revenues were expected to come from four primary sources:
Consumer photos: IMSC’s archive sold approximately 53,000 photos in
1999 to a market limited to consumers who visited the archive or wrote to its staff. Artemis Images based its projected sales on an average of

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Three phases of development
Phase one
First six months
M1

M2

M3

M4

M5

Phase two
Second six months
M6

M7

M8

Phase three
Third six months

M9 M10 M11 M12

Daytona 500

Indy 500*

M13 M14 M15 M16 M17 M18

Brickyard 400

US Grand Prix F1

Website up
“soft launch”

Order equipment
–Pindar Systems
–Noritsu
–Servers/Storage/etc.

Web infrastructure building site Technical documentation
Contracts
–IMS
–Pindar
–XOR
Hire team
Lease office space
Secure 3 new archive agreements
IMS On-site preparation Customer service staff hired (Web)

Website testing

3 new archives Website launch
Disney Delphi 200

3 new archives Direct mail & advertising campaigns for B2B content

Full time
Hire sales teams for 2001
(refer to Organization Chart in appendix)

Technical team training
& system configuration

3 new archives Continuing Ramp-up of Direct Mail/Marketing and Advertising

3 new archives Continue to expand breadth of content

Assessment of archive:
–Revenue streams
–B2B
–B2C
–Audio
–Video

*11 other IRL Races in season

Phase one
This phase was intended to take Artemis Images from initial funding to operationally being ready to sell images and take orders. The three main components included establishing the on-site facility at IMSC, construction and testing of the website and establishing the fulfillment operations. Phase one assumed money was in the bank.
Phase Two
This phase assumed that three additional archives had been secured and implemented, at least one of which would include breadth of content. Focus would be sales and ramping up revenues. B2B and B2C marketing strategies were to be executed and evaluated. Toward the end of Phase two three more archives would be secured.
Phase Three
Phase three continued to build more archives and breadth of content. Marketing and sales would continue to be core focus for revenue development. Audio and video content assessed based on the state of market and technology
(e.g., bandwidths) and a decision would be made on timing to enter this market.

EXHIBIT 7 Artemis Images development time line.
Source: e-Catalyst Business Plan, February 28, 2000.

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15,000 images sold per archive in 2001, increasing to 20,000 images per archive in 2003. Price: $19.99 (8" ϫ 10").
Stock photos: Stock photos ranged in price from $150 to $100,000, depending on the uniqueness of the photo. Competitors Getty and
Corbis, two of the leaders in this market, sold 2.35 percent and 0.6 percent of their archive, respectively. Based on an average selling price of $150, Getty generated approximately $6.00 in revenue for each image in its archive; Corbis generated approximately $1.85. Artemis Images constructed ﬁnancial projections based on sales of 0.30 percent of its archive in 2001 and 0.16 percent of its archive in 2002. Artemis
Images’s margin was based on a return of $0.20 per image in its archive for 2001, increasing to $0.60 per image in 2003.
Syndication: The team’s dot.com experience led them to believe that websites with exclusive content were able to syndicate their content to other websites. They anticipated that Artemis Images would generate revenues of $100,000 per year from each contract for content supplied as marketing tools on websites. Existing companies with strong content had been able to negotiate ﬁve new agreements per week for potential annual revenues of $5 million.
Merchandise: According to America Online/Roper Starch Worldwide, approximately 30 percent of Internet users regularly make purchases.
Artemis Images used a more conservative assumption that only 1 percent of unique visitors would make a purchase. Estimates of the average purchase online varied widely, ranging from Wharton’s estimate of
$86.13 to eMarketers’s estimate of $219. The Artemis Images team viewed $50 per purchase as a conservative ﬁgure.
Chris and George felt conﬁdent that Artemis Images would be able to reach the revenue projections for number of photos sold. IMSC’s archive had sold approximately 53,000 photos in 1999, an increase of 33 percent over 1998.
These sales had been generated solely by consumers who had visited the archive in person, estimated at 1 million people. In other words, one out of every 28 possible consumers actually purchased an image. Chris and George assumed that if even one out of 160 unique visitors to the website purchased a photo, the Artemis website would generate 42 percent more than IMSC’s
1999 ﬁgures (see Exhibit 6 for projected sales volume). Chris and George believed that this projection was reasonable in light of the fact that IMSC did not market its archive and signiﬁcant publicity and advertising would accompany Artemis Images’s handling of the archive. As breadth of content and reach of the Web increased, 2002 revenues should easily be double those of 2001.
Since the team previously had conﬁgured and sold content management systems, they were familiar with the costs associated with this process, including both equipment and personnel. They carefully conducted research to stay abreast of recent improvements in technology and intended to be on the lookout for cost reductions and process improvements.

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Artemis Images

The Launch: Problems from the Start
Chris dove into the Artemis Images project with a vengeance. Having secured a ﬁve-year contract for exclusive rights and access to the IMSC archive, she found a dependable technician who was eager to relocate to Indianapolis to start the scanning and digitizing process. A reputable, independent photo lab agreed to handle printing and order fulﬁllment. Chris’s visit to the Indy 500 in
May 2000 was a wonderful networking opportunity. She met executives from large companies and got leads for investors and clients. She secured an agreement with a Web design company to build the Artemis Images site, careful to retain ownership of the design. She contacted over 100 potential venture capitalists and angel investors.
Personally, she was on a roll. Financially, she was rapidly going into debt. Frank and Greg, legal owners of the company, had long since contributed ideas, contacts, or legwork to the Artemis Images launch. While conﬁdent that his work on the business plan would appeal to investors, Greg viewed the start-up company as a risk to which he was unwilling to commit.
Likewise, Frank decided to hold onto his job at Petersons.com, a unit of
Thompson Learning, until the first round of investor funding had been secured. Frank continued to offer advice, but he had a wife and two preschool-age children to support.
Each meeting with a potential funder resulted in a suggestion on how to make the business more attractive for investment. Sometimes they helped, sometimes they just added to Chris’s and George’s frustration. Beating the bushes for money over two years was exhausting, to say the least. The lack of funds impacted the look and feel of the business and severely strained relationships among the founding partners. Heated discussions ensued as to the roles that each was expected to play, the reallocation of equity ownership in the company, and the immediate cash needed to maintain the
Indianapolis apartment and pay the scanning technician and Web developers, not to mention out-of-pocket expenses needed to manage and market the business.
Chris and George appealed to their families for help. George’s father contributed $5,000. Chris’s mother tapped into her retirement, mostly to pay
Chris’s mortgage and to fund Chris’s trips to potential clients and investors in
London, New York, and Boston. By May 2001, Chris’s mother’s contribution had exceeded $200,000. A $50,000 loan from a supportive racing enthusiast provided the impetus for Artemis Images to reorganize as a C-corporation. All four original partners had stock in the new company, but Chris held the majority share (66 percent), George held 30 percent, and Frank and Greg’s shares were each reduced to 2 percent. Financial projections were revised downward
(see Exhibit 8).
The site was ofﬁcially launched on May 18, 2001. It was beautiful. Chris held her breath as she put in her credit card late that evening when the site went live. The shopping cart failed and the order could not be processed. Chris knew she was in trouble.

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EXHIBIT 8 Revised pro forma ﬁnancial summary 2001
Summary Proﬁt and Loss Statement
2001

2002
*

2003

2004

Total

Revenues

$ 5,312

$373,779

$2,294,116

$4,735,400

$7,408,607

Cost of sales

$ 1,700

$ 43,368

$ 265,312

$ 564,480

$ 874,860

Gross proﬁt

$ 3,612

$330,411

$2,028,804

$4,170,920

$6,533,747

Operations

$52,499

$328,550

$1,235,363

$2,035,430

$3,651,842

Net income before tax
Taxes (38%)
Net income

($48,887)
$

0

($48,887)

$

1,861

$ 793,441

$2,135,490

$2,881,905

$

0

$ 283,638

$ 811,486

$1,095,124

$

1,861

$ 509,803

$1,324,004

$1,786,781

Summary Balance Sheet
Assets

2001

2002

2003

2004

Cash and equivalents

$45,113

$ 78,260

$ 675.347

$2,615,573

Accounts receivable

$

0

$ 13,610

$ 222,950

$ 462,200

Inventories

$

0

$

0

$

0

$

0

Prepaid expenses

$

0

$

0

$

0

$

0

Depreciable assets

$

0

$

0

$

0

$

0

Other depreciable assets

$

0

$

0

$

0

$

0

Depreciation

$

0

$

0

$

0

$

0

Net depreciable assets

$

0

$

0

$

0

$

0

Total assets

$45,113

$ 40,574

$ 898,297

$3,077,773

$ 4,000

$ 12,355

$

61,882

$ 105,868

Liabilities and capital
Accounts payable
Accrued income taxes

$

0

$

0

$ 283,638

$1,095,124

Accrued payroll taxes

$

0

$

0

$

$

Total liabilities

$ 4,000

$ 12,355

$ 345,520

$1,200,992

Capital contribution

$90,000†

$ 90,000

$

90,000

$

90,000

Stockholders’ equity

$

$

$

0

$

0

Retained earnings

0

0

0

0

($48,887)

($ 61,781)

$ 462,777

$1,786,781

Net capital

$41,113

$ 28,219

$ 552,777

$1,876,781

Total liabilities and capital

$45,113

$ 40,574

$ 898,287

$3,077,773

Notes: *Approxinately two-thirds of these transactions were executed by Artemis staff and friends to test the website.
† Chris’s mother’s contribution to her daughter for mortgage and living expenses is not included.

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Artemis Images

The Crash
From the ﬁrst, the website had problems. The Web development contract stipulated that the website for the Indy 500 would go live by May 8, 2001, to coincide with the month-long series of events held at the Indianapolis Motor Speedway leading up to the Indy 500 on May 27. However, the Web development took longer than anticipated, and the site was ﬁrst operational on May 18. Having neglected to test the Web interface properly, serious failures were encountered when the site was activated. The site went down for 24 hours, only to face similar problems throughout the following week, again shutting down on May 27.
More technical difﬁculties delayed the reactivation of the site until May 31, after the Indy racing series had ended.
Throughout June, consumer trafﬁc was far less than originally anticipated.
The site was not easily navigable. The shopping cart didn’t work. Yet the Web builder demanded more money. Fearful of a possible lawsuit, investors stayed away. The crash of the dot.coms added kindling to the woodpile. Chris and
George started to rethink their original business model. They were held hostage, as they owned no tangible assets.
Website tracking data indicated that between May and July there had been at least $40,000 worth of attempted purchases. Chris read through hundreds of angry e-mails, and tried manually to process orders. Orders which were successfully executed resulted in spotty fulﬁllment. Many photos ordered were never shipped, were duplicated, or were incorrectly billed. At the same time, she tried to negotiate with the software developers’ demand for payment and keep alive a $250,000 investment prospect.
On July 9, 2001, the Web development company threatened an all-or-nothing settlement. They wanted payment in full for the balance of the contract even though the sites didn’t work. Absent full payment, they would shut down the sites within the week. The investor offered to put up 80 percent of the balance owed on the full contract to acquire the code to ﬁx it. The company refused.
On Friday, July 13, Chris had to tell IMSC that in less than 48 hours the sites would be shut down. The investor took his $250,000 elsewhere.
On Tuesday, July 17, Chris called an emergency meeting with George.
George had had enough. The stress was affecting his health, his relationships, and his lifestyle. He believed that his family had already contributed more money than he had a right to ask. He was putting in long hours with no money to show for his efforts. His girlfriend had been putting pressure on George to quit for some time. Now he had run out of reasons to stay.
Chris was devastated. How could she face the people in Indianapolis? It was hard for her to come to grips with having let them down. Having put so much of herself into this venture, she wasn’t sure she could let go. At the same time, she wasn’t sure how to go on.
Chris reﬂected, “At one time, I deﬁned success by my title, my salary, and my possessions. Working for AGT, I had it all. I started Artemis Images because
I really cared about IMSC and making the Indy motorsports images available

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to its fans. Now, I realize that there is a profound satisfaction in building a company. I can see my future so clearly, but living day to day now is so hard.
And I’m still enthralled with beautiful images.”

Questions
1.
2.
3.
4.

Discuss why Chris started her company. What was the opportunity?
What is your evaluation of the team’s qualiﬁcations for this business?
Discuss the division of ownership among the team.
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Sirtris Pharmaceuticals: Living Healthier, Longer

SIRTRIS PHARMACEUTICALS: LIVING
HEALTHIER, LONGER
"You can live to be a hundred if you give up all the things that make you want to live to be a hundred."
Woody Allen

One Saturday in February 2007, Dr. David Sinclair and Dr. Christoph Westphal co-founders of Sirtris Pharmaceuticals, a Cambridge, MA-based life sciences ﬁrm, navigated the company’s narrow hallways and cramped ofﬁces to a conference room for their regular weekend strategy planning session.
When they reached the conference room, Sinclair and Westphal reviewed their activities during the past week. Sinclair, who was an associate professor of pathology at Harvard Medical School and co-chair of Sirtris’s Scientiﬁc
Advisory Board, had had interviews with Charlie Rose, the Wall Street Journal, and Newsweek. Westphal, who was Sirtris’s CEO and vice chairman, had closed a $39 million round of ﬁnancing, bringing the total amount of invested capital in the company to $103 million.
Sinclair and Westphal were riding a wave of interest generated, in part, by their company’s promising research into age-related diseases, such as diabetes, cancer, and Alzheimer’s. The company’s research into disease, however, only partly explained its appearance on the covers of Scientiﬁc American, Fortune, and the Wall Street Journal. According to their suggestive headlines—“Can
DNA Stop Time: Unlocking the Secrets of Longevity Genes” (Scientiﬁc American), “Drink wine and live longer: The exclusive story of the biotech startup searching for anti-aging miracle drugs” (Fortune) and “Youthful Pursuit:
Researchers seek key to Antiaging in Calorie Cutback” (Wall Street Journal)—
Sirtris was hoping to develop drugs that could treat diseases of aging, and in so doing had the potential to extend the lifespan of human beings1.
1

Leonard Guarente and David Sinclair, “Can DNA Stop Time: Unlocking the Secrets of Longevity
Genes,” Scientiﬁc American, March 2006; David Stipp, “Researchers seek key to antiaging in calorie cutback,” Wall Street Journal, October 30, 2006. David Stipp, “Drink Wine and Live Longer: The exclusive story of the biotech startup searching for anti-aging miracle drugs,” Fortune, February 12,
2007. See Appendix for cover of the Wall Street Journal article.
Professor Toby Stuart and Senior Researcher David Kiron, Global Research Group, prepared this case, with advice and contributions from Alexander Crisses (MBA 2008). HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
Copyright © 2008 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA
02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

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The Sirtris team had, in fact, established a link between resveratrol, a compound found in red wine-producing grapes, and sirtuins, a newly discovered family of enzymes with links to improved longevity, metabolism and health in living things as diverse as yeast, mice and humans. Sinclair and Westphal were building Sirtris around the development of sirtuin-activating drugs for the diabetes market. The Sirtris team had developed its own proprietary formulation of resveratrol, called SRT501, and was developing new chemical entities (NCEs) that were up to 1000x more potent activators of sirtuins than resveratrol.
In today’s strategy session, which included Dr. Michelle Dipp, Sirtris’s senior director of corporate development and Garen Bohlin, the company’s chief operating ofﬁcer, the team was discussing their upcoming move to new laboratory space in another part of Cambridge, and three of the more pressing strategic issues facing the ﬁrm.
■

■

■

In-licensing. One issue was whether to in-license compounds from a biotech company to diversify Sirtris’s drug development platform beyond its narrow focus on SIRT1, one of seven sirtuin variants in the human body. Several members of the Sirtris executive team were advocating a more balanced risk portfolio as the company started to increase investment in its drug development efforts.
Partnership with Pharma. As is almost always the case in biotech, the team was in discussions about a partnership with a few large pharmaceutical ﬁrms. They were considering (a) what it would mean for the organization to become tied to a pharmaceutical company at this stage of its development and (b) whether to postpone a deal until Sirtris had more clinical data. Was this the right point in the company’s history to do a deal?
Nutraceuticals. Sinclair received a near-constant stream of emails and phone calls from the public requesting Sirtris’s proprietary version of resveratrol, SRT501. For some time, he had contemplated selling
SRT501 as a nutraceutical, an off-the-shelf health supplement that would not require FDA approval. This idea raised many questions about market opportunity, commercialization strategies, and the potential impact of a nutraceuticals offering on the Sirtris brand and the all-star group of scientists that had allied themselves with the organization.

Anti-Aging Science
The quest for long life has spurred the imagination of people in virtually every era in human history. Ancient Greeks imagined immortal gods, the sixteenth century Spanish adventurer Ponce de Leon searched for the fountain of youth, and twenty-ﬁrst-century scientists test rodents for life-extending biological compounds. Until the 1990s, the only proven means of increasing life-span in any animal was to reduce its calorie intake. In 1935, Cornell University researchers discovered that reducing calorie intake in rodents by 40% increased their lifespan

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Sirtris Pharmaceuticals: Living Healthier, Longer

by an average of 30-40%. Conventional wisdom became that calorie reduction
(CR) activates an evolutionary adaptive process that lowers metabolism to help animals through periods of food shortages or droughts.
Decades passed before scientists could shed light on the biological mechanism triggered by CR. When new information arrived in the 1980s and early
1990s, it contradicted what had become the conventional wisdom. The new work indicated that instead of lowering metabolism, calorie reduction is a biological stressor that activates a defensive metabolic response. Few scientists paid much attention to the shift in view, as few serious scientists focused their academic careers on anti-aging studies.
Longevity research began to gain traction as an academically credible ﬁeld of study in the early 1990s, after MIT professor Leonard Guarente and his laboratory traced the molecular pathway of calorie reduction in yeast to sirtuins
(silent information regulators), which are proteins (enzymes) that are found in all cells. (See Exhibit 1 for timeline of scientiﬁc milestones in longevity research.) In humans, there are seven types of sirtuins in different parts of cells and in different parts of the body. Sirtris was focusing 90% of its R&D on one sirtuin, called SIRT1 in humans. For simplicity, any reference to sirtuins, unless otherwise noted, is to the family of sirtuins or SIRT1.
David Sinclair
In 1993 while sightseeing in Sydney, Australia, Guarente was taken to dinner by some local yeast researchers, a group that included David Sinclair, then a young doctoral candidate at the University of New South Wales. During the dinner, Guarente mentioned that he had two students working on aging in yeast.
“I was incredibly excited by Lenny’s work,” said Sinclair. “I asked him why the longevity ﬁeld was so pre-occupied with looking for genes that ended life, rather than genes that could extend it. By the time we ﬁnished dinner, I told him I was going to work with him at MIT.”
Sinclair grew up in St. Ives, near Sydney Australia, the eldest son of parents who both worked in the medical diagnostics industry. In high school, he was known as a talented class clown and risk-taker, a young man who aced science classes but could not resist setting off minor explosions in chemistry lab.2
Two years after their ﬁrst meeting, Sinclair made good on his promise and joined Guarente’s MIT lab as a postdoctoral fellow. Sinclair quickly established himself as a creative and productive researcher, publishing a 1997 article in Cell with Guarente that described how the yeast equivalent of SIRT1 increased the longevity of yeast. When yeast cells divide (a sign of aging in yeast cells), they spin off extra copies of genetic material called extrachromosomal rDNA circles (or ERCs). With each successive cell division, ERC copies accumulate in the nucleus. The original cell, faced with copying both its original genetic material and an increasing number of ERCs, soon runs out
2

David Stipp, “Drink Wine and Live Longer,” Fortune, February 12, 2007.

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of energy and eventually dies. But when an extra copy of the sirtuin gene was added to the cell nucleus, the formation of ERCs was repressed and the cell’s life span was extended by 30 percent.
In 1999, Sinclair left Guarente’s lab for a tenure track position at Harvard
Medical School, but continued to collaborate with Guarente.3 They found that extra copies of the sirtuin gene extended the life span of roundworms by as much as 50 percent. “We were surprised not only by this commonality in organisms separated by a vast evolutionary distance but by the fact that the adult worm body contains only non-dividing cells,” wrote Guarente and Sinclair in their 2006 Scientiﬁc American article.4
The search was on for sirtuin activating compounds, or STACs. This was a high-stakes search. “No chemical or drug had ever increased the activity of sirtruins” said Dr. Dipp, affectionately known within the ﬁrm as “The General”.
“A compound that could activate sirtuins would increase the speed of cellular metabolism. It could have far reaching implications for human healthcare.”
In 2003, Sinclair discovered that resveratrol, a compound found in red wine, activated sirtuins in yeast cells, a discovery which indicated that in fact it might be possible to develop a drug that could activate the sirtuin enzyme.
One way to activate the sirtuin enzyme was to optimize the effects of resveratrol by giving it in highly puriﬁed form. Another was to mimic the effects of resveratrol using an entirely new, more potent chemical structure. Sirtris was pursuing both approaches through its SRT501 and new chemical entity drug development projects.
When Sinclair’s Nature article was published September 11, 2003, it was hailed by many scientists as a seminal paper, but it also drew criticism from members of the scientiﬁc community, including former colleagues from Guarente’s MIT laboratory. The article also drew the attention of Dr. Christoph
Westphal, who had recently been promoted to general partner at Polaris Venture Partners, one of the larger Boston-area venture capital funds.
Christoph Westphal
In his four years at Polaris, Westphal had had several successful investments and stints as founding CEO. Between 2000 and 2004, Westphal co-founded ﬁve companies and served as the original CEO at four of them. In all cases,

3

Dr. Sinclair obtained a BS with ﬁrst-class honors at the University of New South Wales, Sydney, and received the Commonwealth Prize for his research. In 1995, he received a Ph.D. in Molecular Genetics and was awarded the Thompson Prize for best thesis work. He worked as a postdoctoral researcher with
Dr. Leonard Guarente at M.I.T. until being recruited to Harvard Medical School at the age of 29.
Dr. Sinclair has received several additional awards including a Helen Hay Whitney Postdoctoral Award, and a Special Fellowship from the Leukemia Society, a Ludwig Scholarship, a Harvard-Armenise
Fellowship, an American Association for Aging Research Fellowship, and is currently a New Scholar of the Ellison Medical Foundation. He won the Genzyme Outstanding Achievement in Biomedical Science
Award for 2004. http://medapps.med.harvard.edu/agingresearch/pages/faculty.htm, Accessed 1.4.07.
4
Leonard Guarente and David Sinclair, “Can DNA Stop Time: Unlocking the Secrets of Longevity
Genes,” Scientiﬁc American, March 2006.

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Sirtris Pharmaceuticals: Living Healthier, Longer

Westphal recruited a CEO to replace him and remained on the board as lead investor once he got the company off the starting blocks. Two went public—
Alnylam and Momenta—and had a combined market value of $1.4 billion in early 2007. Philip Sharp, a Nobel Prize winning biologist and Sirtris advisor, described Westphal’s business and science acumen: “Christoph's combination of skills is very rare. I haven't seen his equivalent in 30 years of working in biotech.”5 In 2002, MIT’s Technology Review recognized Westphal as one of the country’s top 100 Young Innovators under 35.
The son of two doctors, Westphal was a former McKinsey consultant and physician, who sped through an MD/Ph.D. program at the Harvard Medical
School in less than six years. A polyglot (English, French, German, and
Spanish) and accomplished musician (cello), Westphal was described by several
Sirtris board members as having “extraordinary energy” and a “rock star” reputation in the biotechnology world. “He has an unusual combination of abilities— to understand the science and its commercial potential, and explain it all clearly in an understated way that resonates with investors,” said John Freund, Managing Director and cofounder of Skyline Ventures as well as a Sirtris director at the time of the case.
Westphal had a distinctive approach to building biotech companies—his own mode of operation. Westphal’s major successes, Alnylam and Momenta, both went public before many market watchers believed them to be ready for an IPO.
In both cases, Westphal teamed with world-renowned authorities (Alnylam with
Paul Schimmel, a prominent scientist at the Scripps Institute and biologist Philip
Sharp; Momenta with Robert Langer, an MIT Institute Professor and one of the world’s most proliﬁc scientist/entrepreneurs). Westphal described the elements he looked for and the approach he took in starting and building companies:
You need fantastic science. Second, you need a great story. Third, you need great venture capital support and lots of money. I am a big believer in raising as much money up front as possible.
Applying this model and exploiting an ever-growing network among the biotech industry’s prominent players, Westphal had clearly developed a successful approach to launching early stage companies and then passing the
CEO’s baton to a different leader. In 2003, Westphal was looking for his next investment opportunity, when he encountered Sinclair’s paper in Nature. Westphal quickly realized that this was a novel and possibly watershed discovery if it could be extended to humans. Westphal phoned Sinclair to discuss the prospects of commercializing his discovery.

Launching Sirtris
At the time, Sinclair had been thinking of commercializing his work for many years. In 1999, he almost joined his mentor, Guarente, in launching Elixir
Pharmaceuticals, a longevity-oriented biotech company. Several years later, as
5

David Stipp, “Drink Wine and Live Longer,” Fortune, February 12, 2007.

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Sinclair ﬁnalized the 2003 Nature paper, he began exploring opportunities to form a company of his own.
Sinclair described his initial meeting with Westphal, “He came in and refused to sign a nondisclosure agreement. So, I told him I wouldn’t talk to him. And he said, ‘David, if I walk out of this ofﬁce, I’m not coming back. So I suggest you tell me as much as you can.’” I wound up telling him more than I normally would have. It soon became apparent that he’s one of the smartest people I’d ever met. But it took me months to realize that he’s also a nice guy.”6
After their initial meeting, Westphal expressed an interest in starting a company with Sinclair, but could not do so until he found someone to replace him as CEO of Acceleron, one of the companies he had launched while at Polaris.
Meanwhile, Sinclair continued discussions with other investors. Westphal reentered the picture six months later, expressing a readiness to invest and pull the venture together. Sinclair and Harvard (the owner of several pieces of intellectual property that would be licensed by Sirtris) decided to move forward with Westphal as the founding CEO.
After an agonizing decision process, Westphal chose to join Sirtris as its full-time CEO. Unlike his other start-ups, his plan this time was to remain with the company, which meant that he would be leaving behind the venture capital life and a high six-ﬁgure salary. Westphal explained his decision:
Many people thought it was too risky to leave a successful VC career. I was taking a $500,000 paycut and my wife and I had just purchased an expensive house in Brookline close to Fenway Park. At the time, David had no data that showed resveratrol activated sirtuins in mammals or could affect mammalian glucose levels or insulin, although we hoped all that would prove true. My VC friends were telling me that I was not being rational. In some ways they were right, but I was excited about Sirtris in a way I had not yet been at my other companies.
Scientiﬁc Advisory Board
Westphal set out to attract a world-class Scientiﬁc Advisory Board (see Exhibit 2 for details on the SAB). Virtually all early-stage biomedical companies create boards of scientiﬁc advisors. Among other roles, SAB members advise the company on matters related to scientiﬁc and experimental strategies; they sometimes assist in securing access to intellectual property produced by SAB members; and they serve as portals that keep the company abreast of developments in the broader scientiﬁc community.
Sirtris’s goal was to collect the brightest scientists in the ﬁeld of sirtuin research, including those who would generate IP for Sirtris and be the “eyes and ears” of the company. Sinclair explained the formation of the Sirtris SAB:
“Christoph said, ‘Give me a list of the top 10 people in your ﬁeld.’ Within a

6

David Stipp, “Drink Wine and Live Longer,” Fortune, February 12, 2007.

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week or two, we were having conference calls with all of these people. In one case, an academic was going to start a rival company, and Christoph ﬂew out to St. Louis and convinced him to join us instead.” One observer described the
Sirtris SAB and board of directors in the following terms (see Exhibit 3 for
Sirtris Board of Directors):
Since combining forces with Sinclair, Westphal has organized what is arguably the most pedigree-rich scientiﬁc advisory board in biotech, including MIT’s Sharp; Robert Langer, one of medicine’s most proliﬁc inventors, also of MIT; Harvard gene-cloning pioneer Thomas Maniatis; and Thomas Salzmann, formerly executive vice president of Merck’s research arm. The group now numbers 27, among them many of the world’s leading experts on sirtuins. Westphal also assembled an impressive list of directors—they include Alkermes’s Pops; Aldrich, the Boston hedge fund manager and biotech veteran; and Paul Schimmel, a prominent scientist at the Scripps Research Institute in La Jolla, Calif., who has cofounded half-a-dozen biotech concerns. Westphal’s right arm at Sirtris is chief operating ofﬁcer Garen Bohlin, formerly a senior executive at Genetics Institute, a biotech now owned by Wyeth.7

Growing Sirtris
During the spring and summer of 2004, Westphal and Sinclair went on a road show to local Boston-area venture capital groups. In August, they obtained a
$5 million seed (Series A) round of ﬁnancing from Polaris Ventures, Cardinal
Partners, Skyline Ventures and Techno Venture Management (“TVM”). Sinclair described their early efforts to raise capital:
Christoph was very good at getting us in to talk with the majority of VCs in the Boston area over a short period of time. Although a lot of people said
“no” to us, Christoph set a small window of time to invest and more than a few people started getting nervous about being left out. The short timeframe built its own momentum and helped drive interest in the company.
In November 2004, Westphal and Sinclair secured another $13 million in a Series A-prime round. (See Exhibit 4, which details ﬁve investment rounds; including investors, dates and investment amounts. See also Exhibit 5, which details pre-IPO ﬁnancing at three comparable biotechnology ﬁrms.) Regarding the ﬁrst two funding rounds, Westphal explained their ability to raise funds before the ﬁrm had any mammalian data:
We were very early in terms of the science. We raised $18 million without any mammalian data, something that is almost unheard of in today’s world of biotechnology. Part of our success was getting people bit by the

7

David Stipp, “Live Forever?,” Fortune, February 5, 2007.

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Sirtris bug. We had a long-term vision of where we could go with the biology and the anti-aging message is extremely powerful, especially when you are talking to a bunch of aging, overweight guys who are prime targets for the drugs you want to develop.
Sirtris had several decisions to make about how to focus its drug development efforts. Sinclair had theorized that sirtuins played a role in diabetes, cancer, heart disease, neurodegenerative diseases and diseases related to mitochondrial disorders. One thing was clear: there would be no effort to claim anti-aging effects from any drug the ﬁrm produced, since the FDA did not recognize aging as a disease. The ﬁrm decided to develop a drug for diabetes, a large market with epidemic numbers of type II diabetes in developed and developing countries, and an orphan drug8 for the mitochondrial disease MELAS
(mitochondrial encephalopathy, lactic acidosis, and stroke-like symptoms syndrome), a rare genetically inherited disorder. (See Exhibit 6 for details on the global diabetes market.)
Between 2004 and 2005, Sinclair began conducting experiments that sought a connection between resveratrol and sirtuins in mice. “By early 2005,
David started getting data in his lab that showed resveratrol was going to extend lifespan in a mammal,” Westphal said, “At Sirtris, we had evidence you could lower glucose and insulin in mice. All of a sudden, we were getting real proof that this actually could be a drug; that this could actually be a very valuable company.” Sirtris began hiring its R&D team, successfully stafﬁng leadership positions with executives who had had long stints at large pharmaceutical and biotech companies – including Millenium Pharmaceuticals, Alkermes, and
GlaxoSmithKline – identifying small molecules, developing drugs and advancing drugs through clinical trials.
With their mammalian data in hand, Sinclair and Westphal went back on the road seeking additional capital to ﬁnance Sirtris’s R&D efforts. In March
2005, Sirtris closed on a $27 million Series B-round of ﬁnancing.
In the next year, Sirtris made three signiﬁcant advances. (See Exhibit 7 for a timeline of Sirtris scientiﬁc proofs of principle.) First, the company created a formulation for SRT501 that kept resveratrol in its active form and increased its absorption into the bloodstream. The result was that SRT501 could get ﬁve times more resveratrol into the blood stream than the best other preparations currently available. Second, Sirtris began conducting clinical trials in India, assessing SRT501 as a diabetes therapy. The transition from an
R&D-only company to a clinical-stage company was, as Westphal remarked in a press release, “an important milestone in our plan to develop a rich
8

Orphan drug status was a special designation by the FDA that granted drug makers a seven-year marketing monopoly along with tax reductions for an approved drug for diseases afﬂicting less than
200,000 people. The purpose of the orphan drug classiﬁcation was to provide an incentive to drug makers to focus some of their R&D on smaller, less proﬁtable markets. Some of the more well-known targets of orphan drugs include cystic ﬁbrosis and snake venom.

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Sirtris Pharmaceuticals: Living Healthier, Longer

pipeline of therapeutics to treat diseases of aging." Third, and perhaps most signiﬁcantly, Sinclair completed several experiments examining the effects of high doses of resveratrol on obese mice. In one experiment, middle-age mice fed high calorie diets with resveratrol were compared to a control group fed similar diets but without resveratrol. Remarkably, the mice fed resveratrol could run further; were leaner; and, lived 30% longer than the high fat, noresveratrol mice in the control group. (See Exhibit 8 for a picture of mice on diets with and without the drug.)
Sirtris researchers were exhilarated by these ﬁndings in part because the data suggested that sirtuins could play a role in managing or even delaying the onset of type-II diabetes. They were also excited because in the past experimental data with the rat model (Zucker-fa/fa) had tended to foreshadow a higher probability of success for drugs in human trials.
In April 2006, Sirtris closed on a $22 million Series C round of ﬁnancing, and obtained a $15 million line of venture debt from Hercules Technology
Growth Capital.
Throughout 2006, Sirtris continued to gain momentum as Sinclair’s research made its way into high proﬁle academic journals, newspapers, and other media. In June 2006, Sirtris announced that it had successfully completed dosing eighty-ﬁve human subjects in a Phase 1 safety and pharmacokinetic trial of SRT501. In October 2006, an article about Sinclair’s work appeared on the front page of the Wall Street Journal. The following month, papers published in Cell and Nature demonstrated that resveratrol increased the stamina of mice two-fold and signiﬁcantly extended their lifespans. The 2006 Nature article also demonstrated that sirtuin activation increased within the cell the number of functional mitochondria, the powerhouses that sustain a range of cellular activities including glucose metabolism.
The discovery that sirtuin activation increased the number of functional mitochondria was, Sinclair suggested, “quite intriguing” since the number of functional mitochondria was known to decline with age. Moreover, it was wellknown in the scientiﬁc community that people with above average numbers of functional mitochondria, such as famed cyclist Lance Armstrong, had above average stamina levels.
In late fall of 2006, Sinclair received an unsolicited email from Red Sox owner John Henry requesting a meeting. Westphal described the meeting with
Henry:
He visits David and me here at Sirtris. And he's a very shy, wonderful gentleman. After we present him the company, he says, “How can I be helpful to you?” And I look at him, and I say, “I think you could invest $50 million in the company.” And he says, “I don't think I can do $50 million, but I think I can do $20 million.” And I said, “Can we close in two weeks?”
John teamed up with Peter Lynch, the legendary former fund manager of
Fidelity’s Magellan Fund, who did extensive due diligence, and they said,
“OK.” Everyone wanted in after that.

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By February 2007, Westphal closed on another round of ﬁnancing, raising
$35.9 million, from company executives, venture ﬁrms that had contributed to previous rounds, as well as John Henry and Peter Lynch. Westphal explained their fundraising success:
We’ve always been able to raise money, I think because we had money.
We weren’t desperate. They [potential investors] knew that they couldn’t get away with trying to hammer us on the valuation, because if we don’t get the valuation we want we just won’t raise the money.

Moving Forward
Nutraceuticals
Westphal and Sinclair had a long-running debate over the commercial opportunity represented by their proprietary formulation of resveratrol (SRT501).
Sinclair had a strong belief that there would be great public demand for this formulation long before the results of the clinical studies on SRT501 were completed, and that Sirtris, one way or another, should start selling SRT501 to the public as a nutraceutical. Sinclair received an average of 30-50 emails a day from people requesting information on how to obtain resveratrol.
For a biotech company focused on drug development, a Sirtris foray into nutraceuticals would not be unprecedented. For instance, Sigma-Tau Pharmaceuticals, a 50-year old Italy-based drug company specializing in rare diseases, had developed a nutraceuticals business around its FDA-approved drugs for metabolic and renal conditions (carnitine deﬁciency) as well as cancer
(antineoplastic therapy). Sigma-Tau had two nutraceutical divisions and sold physician-recommended and clinically tested dietary supplements for patients with ulcerative colitis or irritable bowel syndrome.
The opportunity in nutraceuticals might be substantial. The global nutraceuticals market, which included sales of health and nutritional supplements, such as vitamin C and ﬁsh oil, had estimated annual sales of $120 billion, and was growing at a compound annual growth rate of 7%.9 For example, the market for glucosamine chondroitin, a joint-health supplement most commonly taken by the elderly, exceeded $1 billion, and had been expanding at a double-digit rate.10 The economics of the nutraceuticals marketplace were compelling. Total manufacturing costs for small molecule drugs were typically low, often in the range of 25 cents per pill or less. Other costs would depend on the commercialization strategy, of which there were numerous options. Current vendors of formulations of resveratrol that were far less bioavailable than SRT501 were charging prices in the vicinity of $1 per capsule.

9

http://biz.yahoo.com/bw/080220/20080220005585.html?.v=1. Accessed February 22, 2008.
Eric Nagourney, “Study Sees Little Beneﬁt in Chondroitin for Arthritis,” New York Times, April 17, 2007.

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Westphal, however, had doubts about whether the timing was right for such a venture, and whether the ﬁrm should even market a nutraceutical under its corporate brand. There were several issues:
The nutraceuticals market was unpredictable. It was, by and large, unregulated. No FDA approval was necessary for selling supplements. No evidence was necessary to prove a product’s effectiveness or even its composition. Sinclair had tested resveratrol pills and found that some brands on the market had no active resveratrol at all. Other brands had only trace amounts of active resveratrol, far too little to have any meaningful effects on humans. Even if Sirtris had a scientifically proven product, it was not clear that science alone would be enough to differentiate Sirtris’s offering from the dozen or so resveratrol supplement providers. How would the company distinguish itself? A final concern was the potential for consumer allegations about resveratrol’s safety. “The potential that someone could attribute a death to SRT501 consumption could easily derail a nutraceuticals business,” said Sinclair.
Another issue concerned Sirtris’s identity. Was the company a scientiﬁcally rigorous enterprise focused on developing FDA-approved medicines that physicians would prescribe to improve the health of patients with agingrelated disorders? Would the corporate brand suffer if it started selling 501 as a nutraceutical, especially if it became, in part, a nutraceutical retailer like the makers of glucosamine? On one hand, the Sirtris ofﬁce walls were plastered with pictures of Sinclair and Westphal with Nobel prize winning biologists and luminaries from the venture capital world. On the other hand, there were the pictures of Sinclair and Westphal with celebrities, including Barbara Walters and Mel Gibson. Rich Aldrich, one of the company’s original investors and current board member, summarized the issues this way: “The Sirtris story is a balance. It’s carefully constructed from the core science and Christoph and David’s public outreach. It’s not clear if a nutraceutical approach will taint that story or extend it.”
Even if they did consider the nutraceuticals business, what was the business case for market entry? How much of a return would warrant their participation in the market? And how would market entry be achieved? Should the company set up a subsidiary or create a spin-off company devoted to SRT501?
Would the subsidiary have the Sirtris name, e.g., Sirtris Health, or would the subsidiary have a different name, as Lexus is to Toyota? Some Sirtris executives were favoring a wholly owned nutraceutical subsidiary with a different name, in order to make clear that the Sirtris brand was focused on drugs based on their NCE development platform. “Our long-term investors like this option because they are in this company for the NCEs. They’re not in it for the 501 data,” said Westphal.
Yet another issue was retail format. How would a nutraceutical be sold: its own retail stores, the Internet, supplement stores, such as GNC? Would developing its own retail distribution take away from its drug development? Would partnering with a GNC retailer reduce control over the brand?

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Pharmaceutical Deal
Throughout 2006, new evidence emerged from laboratories around the world conﬁrming Sinclair’s hypothesis of a connection between resveratrol, sirtuins and metabolic activity in mammals. Several pharmaceutical companies began talking with Westphal about a possible drug development partnership.
He anticipated that the terms of a deal could include a signiﬁcant upfront cash payment, an equity purchase agreement, non-milestone-based (i.e., guaranteed) R&D support that would be likely to step up over a four to ﬁve year period, and payments tied to clinical development milestones. Sirtris would also receive royalties on sales of any drugs resulting from its SIRT activation program (See Exhibit 9 for more details on the terms of a deal that might be possible and Exhibit 10 for details of three deals between big pharma and other private biotechnology ﬁrms.) As an alternative, the team also believed that they could ink a deal with terms similar to those in
Exhibit 9 but in which the pharmaceutical partner would take a 51% equity stake in the company.
As Westphal, Sinclair, and Dipp resumed the conversation they had been having in early 2007 about the reasons for and against a deal, one positive aspect that continued to come up was that having a drug development deal was often a condition of having a successful initial public offering. Sirtris executives were hoping to take the company public at some point in the not-toodistant future. A successful IPO could deliver some of the ﬁnancial resources a company needs to move drug development from the laboratory through clinical trials. “The typical biotech playbook says to get a partnership deal done, then ﬁle for an IPO. Public investors are often reassured by the prior involvement of a pharmaceutical company,” said Westphal. Several board members intent on satisfying the company’s capital needs had already voiced their interest in exploring whether a deal could be completed on attractive terms. Jeff
Leiden, a life sciences venture capitalist and the former president and chief operating ofﬁcer of Abbott Pharmaceuticals and a friend of Westphal’s, noted that a typical biotechnology company would not be a strong IPO candidate until it had developed some clinical data, successfully made headway on two different research programs, established intellectual protection around its discovery of one or more new chemical entities, and signed at least one signiﬁcant deal with a pharmaceutical company.
Another reason to contemplate a deal was that it might be a relatively inexpensive source of additional capital. Pharmaceutical partners were often willing to purchase an equity stake at a premium to VC investors. As well, they might be willing to ﬁnance Sirtris’s R&D programs.
There were reasons not to do a deal. Westphal and Sinclair were building a company that they hoped would have great medical and investment impact.
Even though Westphal had been the founding CEO of several companies, this was the ﬁrst company that he had actively managed beyond the ﬁrst two years.

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This was also Sinclair’s ﬁrst company. How would a deal affect the founders’ control over the company and its future?
Another reason to consider deferring a deal was Sirtris’s promising development of new chemical entities (NCEs). Resveratrol is a naturally occurring substance and because it was already on the market as a nutraceutical, intellectual property protection related to it would be limited to “methods of use” patents, which would cover the use of resveratrol to treat particular diseases, such as diabetes, as well as formulation work. Sirtris had recently made strides in synthesizing new compounds that could be as much as 1000 times more potent than resveratrol at activating SIRT1 and that would be eligible for NCE composition of matter patents. Partnering with a large pharmaceutical company would require out-licensing these new compounds without knowing their full value. If Sirtris waited for new NCE data to arrive, it might be able to arrange a more lucrative deal than what might have been doable in early 2007. Of course, if the NCE data came in and it did not produce the results Sirtris was expecting, the pharma deal terms would be substantially worse, assuming that the pharmaceutical companies remained interested at that point.
In-Licensing or Expanding the Scientiﬁc Base
From the very beginning of the company, Sirtris executives had had an internal debate over how much of the company’s resources to focus on SIRT1 versus alternative sirtuin targets. The biotechnology industry was littered with companies and drug development projects that had stalled in moving from mouse studies and toxicity screens to human trials. Several board members were advocating that the ﬁrm diversify its product development platform. There were two main alternatives. One was to investigate the six other human sirtuins. The other was to in-license from another biotechnology ﬁrm a compound that had a better known mechanism of operation.
The study of sirtuins was still in its infancy, so investigating the clinical possibilities of other sirtuins would require a great deal of basic research, ﬁnancing and time. (See Exhibit 11 for Sirtris ﬁnancial data, 2004-2006.) Even so, the clinical role of the other human sirtuins offered tantalizing commercial options. SIRT3, for instance, was found in mitochondria and was considered a potential drug target, but little was currently known about its functional role.
Developing a research platform based on SIRT3 might complement the company’s own drug development efforts in other mitochondrial disorders, including diabetes and MELAS.
Several members of the SAB and the board of directors considered the inlicensing option to be an appealing alternative, although others disagreed. It would balance their investment in SIRT1, which was absorbing 90% of the ﬁrm’s R&D expenditures. Dr. Dipp explained that, after investigating more than one hundred potential compounds to in-license, Sirtris had found a few antidiabetic compounds that had better characterized effects than sirtuin-activating compounds. “It would be what we call “me-too” drugs. We know how they

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work, and if we could get them on the market they would get at least a small percentage of market share. It’s something to have in your back pocket.”
When the ﬁrm launched in 2004, Sinclair and Westphal debated whether to in-license a compound and decided against doing so. “I was the only person at the company,” said Sinclair, “who thought that SIRT1 activation was the right bet to make. I told Christoph, ‘don't stop it until you know it's wrong.’ If
I'm wrong, ﬁnd out sooner than later, and then in-license something.” Westphal offered another view, “For the ﬁrst eight months of this company, I was sitting there like a venture guy thinking that resveratrol will not be a great drug. It's a great story, but we'll have to bring in other stuff to build the company around.” Even though new experimental data seemed to conﬁrm that resveratrol activated SIRT1, and that SIRT1 activation could be clinically important, Sinclair,
Westphal, Bohlin and Dipp continued to debate whether to focus the ﬁrm’s time, money, and other resources on that one target or divert more of the ﬁrm’s resources to additional targets, including non-sirtuins. They still did not have evidence that SIRT1 had the effects in humans that Sinclair believed they would one day see.

Conclusion
After discussing these three issues for several hours, Sinclair and Westphal decided to summarize their views on the decisions they needed to make.
At a general level, they remained convinced that sirtuin-activating drugs, if they could be successfully developed, would have a revolutionary impact on human disease. However, they recognized that Sirtris was still many years from completing development of these drugs, much less manufacturing and selling them. To reach that distant point would require successfully navigating technical and regulatory hurdles that had stymied the majority of other biotechnology companies at similar points in their history. According to a pharmaceutical industry association report, only one in ﬁve compounds entering clinical trials gained FDA approval.11 And, only 30% of approved drugs recovered the average development cost of a new medicine.12 Given all of the unknowns about what could happen Sinclair and Westphal described several options for addressing the risks they faced:
One approach would be to fully “hedge their bets:” Sirtris could try to complete a pharmaceutical deal, in-license a compound with better known effects, and consider a nutraceuticals business around SRT501.
Another approach would be to “swing for the fences” (or, in a frequently used metaphor in the industry, “one shot at gold”). This would continue the
11

PhRMA Pharmaceutical Proﬁle Industry Report, 2007. http://www.phrma.org/ﬁles/Proﬁle%202007.pdf, Accessed February 28, 2008.
12
PhRMA Pharmaceutical Proﬁle Industry Report, 2007. http://www.phrma.org/ﬁles/Proﬁle%202007.pdf, Accessed February 28, 2008.

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ﬁrm’s focus on a sirtuin-activating drug development platform. If successful,
Sirtris could become, as one pharmaceutical executive suggested, “the Google of biotech.” However, an IPO would be less likely in the interim, since markets often prefer that biotech ﬁrms have a validating deal with a large pharmaceutical company.
A third approach would be a “middle of the road” path that incorporated some hedging, such as pursuing an in-licensing deal, but also accepted some risk, e.g., deferring a potential pharmaceutical deal. Alternatively, Sirtris could try to complete a pharmaceutical deal now, but forego in-licensing and the nutraceuticals project.
The company seemed to have arrived at a critical juncture in its development. What approach should Sinclair and Westphal take? And why?

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EXHIBIT 1 Anti-Aging Science Timeline
1884:

William Jones MD reports that a fasting spider lives unusually long, 204 days.
[Longevity in a fasting spider, Science 3: 4, Jan. 4, 1884]

1934

Clive McCay and Mary Crowell of Cornell University report delayed aging in rats on limited calorie diets. [McCay, C. M., and M. F. Crowell. 1934. Prolonging the life span. Science Monthly 39:405–414]

1986

Roy Walford and Richard Weindruch show limited-calorie diet produces
“youthful” old mice. [Walford R. Weindruch R, Journal Nutrition 116: 641,
1986; The Retardation of Aging and Disease by Dietary Restriction, 1988]

2000:

Leonard Guarente of MIT mimics calorie restriction’s prolonged lifespan effects in yeast cells. [Science 289: 2126, 2000]

2003

David Sinclair of Harvard extends life of yeast cells with resveratrol. [Nature
425: 191, Sept. 11, 2003]

2004

Marc Tatar of Brown University and David Sinclair of Harvard report resveratrol extends life of roundworms. [Nature 430: 686, July 14, 2004]

2006:

Italian researchers are ﬁrst to report resveratrol prolongs the lifespan of a vertebral animal (cold-water ﬁsh). [Current Biology 16: 296, Feb. 7, 2006]

2006

David Sinclair and colleagues demonstrate resveratrol extends life of warm-blood mammal (mice) and overcomes deleterious effects of a high-fat diet. [Nature
444: 337, Nov. 1, 2006]

2006

JAMA. 2006 Apr 5;295(13):1539-48.

2006

Lagouge, M. et al., Resveratrol improves mitochondrial function and protects against metabolic disease by activating SIRT1 and PGC-1alpha. Cell. 2006
Dec 15;127(6):1109-22.

2007

Civitarese, A.E. et al., Calorie Restriction Increases Muscle Mitochondrial Biogenesis in Healthy Humans. PLoS Med. 2007 Mar 6;4(3).

Source: Adapted from http://www.longevinex.com/article.asp?storyϭTime%20Of%20Research
%20Involving%20Calorie%20Restriction%20and%20Longevity, accessed February 25, 2008; and
Sirtris documents.

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EXHIBIT 2 Sirtris Scientiﬁc Advisory Board
BioPharma expertise

Sirtuin expertise

Tom Salzmann, Co-Chair SAB
Former EVP Merck

Biochemistry
John Denu, Wisconsin
Anthony Sauve, Cornell
Vern Schramm, AECOM
David Sinclair, Co-Chair SAB, HMS
Eric Verdin, UCSF

Julian Adams
President and CSO, Inﬁnity
Peter Hutt
Former FDA General Counsel
Bob Langer
MIT, NAS, NAE, IOM, Co-Founder Momenta, AIR

Mouse Genetics, Phenotypes
Fred Alt, HMS, NAS, HHMI
Johan Auwerx, ICB

Tom Maniatis
Harvard, NAS, Co-Founder GI, Acceleron

Structural Biology
Cynthia Wolberger, JHU, HHMI

Phil Sharp
Co-Founder Biogen and Alnylam, NAS, Nobel Prize

Links to Disease
Ron Kahn, Joslin, NAS
Jeff Milbrandt, Washington University
Jerrold Olefsky, UCSD
Pere Pulgserver, HMS
Eric Ravussin, Pennington Institute
Li-Huei Tsai, MIT, HHMI

Ted Sybertz
SVP Genzyme, Schering (Zetia)
Eric Gordon
Former head of Medicinal Chemistry at BristolMyers, Founder of Vicuron Pharmaceuticals
Chris Walsh
Harvard, NAS, IOM, Genzyme, Vicuron
Source: Company.
HHMI = Howard Hughes Medical Institute
ICB = Mouse Clinical Institute in Strasburg, France
NAS = National Academy of Sciences
NAE = National Academy of Engineering
AECOM = Albert Einstein College of Medicine

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EXHIBIT 3 Sirtris Board of Directors (as of February 2007)
Name

Background

Richard Aldrich (F)

Founder, RA Capital

John Clarke

Managing General Partner, Cardinal Partners

Alan Crane

Momenta

John Freund

Managing Director, Skyline Ventures

Stephen Hoffman, Ph.D., M.D.

Managing Director, TVM Capital

Wilf Jaeger

Three Arch Partners

Stephen Kraus

Bessemer Venture Partners

Richard Pops (F)

Chairman, Alkermes

Paul Schimmel, Ph.D. (F)

Professor, The Scripps Research Institute

David Sinclair, Ph.D. (F)

Associate Professor, Harvard Medical School

Christoph Westphal, M.D., Ph.D. (F)

CEO and Vice Chair, Sirtris Pharmaceuticals, Inc.

Source: Company.
F = Founder

EXHIBIT 4 Sirtris Investors and Investment Rounds
Round

Date

Investors

Investment

Pre-$ Valuation

A

Aug. 2004

Polaris Venture Partners, Cardinal
Partners, Skyline Ventures and TVM

$5 M

$2.8 M

A1

Oct. 2004

Polaris Venture Partners, Cardinal
Partners, Red Abbey, Skyline Ventures,
TVM and The Wellcome Trust

$13M

$10.9M

B

Mar. 2005

Three Arch Partners, Cargill Ventures,
Novartis Bioventures Fund, Polaris
Venture Partners, TVM, Red Abbey,
Cardinal Partners, Skyline Ventures, and The Wellcome Trust

$27 M

$32.5M

C

Apr. 2006

Bessemer Venture Partners, Genzyme
Ventures, QVT Fund LP, Alexandria
Real Estate Equities, Inc. Polaris Venture
Partners, TVM Capital, Cardinal Partners,
Skyline Ventures, Three Arch Partners,
The Wellcome Trust, Novartis
Bioventures Fund, Cargill Ventures, ,
Cycad Group, Hunt Ventures, and Red Abbey

$22 M
($22 million in Series
C-equity placement, plus
$15 million in venture debt ﬁnancing from
Hercules Technology
Growth Capital)

$95.4M

C1

Feb. 2007

John Henry Trust, Peter Lynch and several investors from previous rounds

$35.9 million

$184M

Source: Company.

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EXHIBIT 5 Pre-IPO Financing of Comparable Biotechnology Companies
Company

Round/Date

Investors

Investment

Anesiva
(IPO 2004)

2Q2001

InterWest Partners, Alta Partners, J.P. Morgan Partners

$13 million

2Q/2002

Bear Stearns Health Innoventures, Alta Partners, HBM
BioVentures, J.P. Morgan Partners, InterWest Partners, MIC
Capital, China Development Industrial Bank (CDIB Ventures)

$50 million

4Q/2003

Bristol Myers Squibb

$45 million

2Q/1998

Mayﬁeld, Sevin Rosen Funds,
Individual Investors

$5.3 million

3Q/1999

International BM Biomedicine Holdings, Vulcan Capital,
Mayﬁeld, Sevin Rosen Funds, NMT New Medical
Technologies, Duke University, Individual Investors

$20 million

4Q/2000

Credit Suisse, Alta Partners, Lombard Odier Darier
Hentsch, Mayﬁeld, Sevin Rosen Funds, Vulcan Capital,
NMT New Medical Technologies, Duke University,
Individual Investors

$50 million

2Q/2001

GlaxoSmithKline

$14 million

Cytokinetics
(IPO 2004)

Momenta

2Q/2002

Cardinal Partners, Polaris Venture Partners

$4.4 million

(IPO 2004)

2Q2003

Atlas Venture, MVM Limited, Polaris Venture Partners,
Cardinal Partners

$19 million

1Q2004

Mithra Group, Polaris Venture Partners,
Atlas Venture, MVM Limited, Cardinal Partners

$20 million

Source: Adapted from Growthink Research.

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EXHIBIT 6 Diabetes Market Data
Incidence of diabetes in the U.S. Millions
15.4

14.7

13.6

2002

2004

2006

Worldwide market for diabetes/metabolic drugs by class ($ millions)

2005

$7,831

Insulins
$5,214

Glitazones
DPP-IV Inhibitors
Anti-Obesity
GLP-1 Analogs
Sulfonylureas
Thyroid Drugs
Other Oral Agents

Source: Company.

2010p

$0

$2,875
$714

$75

$2,118
$2,039

$2,099
$1,573
$659
$493
$1,718
$2,026

$16,033
$9,393

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643

EXHIBIT 7 Proof of Principle for SIRT1 Activators
Pre-clinical Therapeutic

Nature 2006 Nov 16:444(7117):337-42.
Cell. 2006 Dec. 15; 127(6):1109-22.
Unpublished

Human Physiological

PLoS Medicine. 2007 Mar 6:4(3).
JAMA. 2006 Apr 5;295(13) 1539-48.

Human Genetic

Cell. 2006 Dec 15;127(6):1109-22.

Source: Company.

EXHIBIT 8 Effects of High Doses of Resveratrol in Mice

Two mice fed the same high-calorie diet in a Sirtris-sponsored study: The svelte one on the left received high doses of resveratrol. Source: Company.

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EXHIBIT 9 Potential Sirtris Pharma Deal Terms
■

Five year term.

■

19.9% OR 51% equity stake at a 50% premium to most recent share price.a

■

$75 million upfront for an exclusive option to join Sirtris in developing and marketing compounds from its SIRT1 Activator Program.

■

5 years of guaranteed R&D support totaling $100 million. Payments to step up over time. $10 million in year one.

■

A combination of royalties, possibly manufacturing proﬁts, and co-promotion fees that equate to approximately a 50/50 split of proﬁts in the U.S. This is a signiﬁcant point for Sirtris since the SIRT 1 activator program is a core program, and the one that represents 90% plus of the ﬁrm’s value.

■

The pharmaceutical company will lead marketing and country speciﬁc development ex-U.S., Sirtris to receive substantial, double digit royalties on ex-U.S. sales.

■

Roughly $200 million in milestones concurrent with risk reducing progress. Roughly
15% upon successful completion of safety/PK of a SIRT 1 activator NCE in humans;
Roughly 25% based on observation of glucose effects in phase 1b of NCE in man;
Roughly 30% upon successful completion of a phase 2a efﬁcacy study for an NCE in man; and roughly 30% upon completion of phase 2b studies.

a: Two different equity stakes were under discussion—19.9% or 51% of Sirtris’s equity. All other terms would remain the same in both scenarios.
Source: Company.

Source: Adapted from Recombinant Capital.
NOTE: All deals inked when biotech was still private.

Sandoz/Novartis

A strategic alliance covering joint product development and commercialization in the area of complex pharmaceutical products.
The collaboration will apply
Momenta’s novel technological capabilities related to complex sugars and the leadership of Sandoz in the generic pharmaceuticals industry to pursue the joint goal of commercializing products.
Under the terms of the agreement,
Sandoz and Momenta will jointly manage product development and commercialization.

A broad strategic collaboration to discover, develop and commercialize novel small-molecule therapeutics targeting mitotic kinesins for applications in the treatment of cancer and other diseases.

GlaxoSmithKline

Momenta Pharmaceuticals was founded based on proprietary technology developed at MIT that enables high throughput, detailed characterization and engineering of sugars.
IPO in June 2004

Jointly develop and commercialize
Corgentech's E2F Decoy
(edifoligide sodium), a first-of-its-kind E2F Decoy treatment currently in Phase III development for the prevention of vein graft failure following coronary artery bypass graft (CABG) and peripheral artery (i.e., leg) bypass graft surgery.

Bristol-Myers Squibb Company

Anesiva is a late-stage biopharmaceutical company that seeks to be the leader in the development and commercialization of novel therapeutic treatments for pain.
The Company has four drug candidates in clinical development for multiple potential indications.
IPO in 2004 (formerly called
Corgentech—this was the name when it went public).
Cytokinetics is a biopharmaceutical company dedicated to the discovery, development and commercialization of novel classes of small-molecule therapeutics, particularly in the ﬁeld of cytoskeletal pharmacology.
IPO in April 2004

Agreement

Deal Partner

Company

Bristol-Myers Squibb will make an initial payment to Corgentech of $45 million comprising cash and an equity investment in
Corgentech, with the potential for an additional $205 million in clinical and regulatory milestone payments. Bristol-Myers Squibb and Corgentech will share development costs in the U.S. and Europe based on a pre-agreed percentage allocation.
GSK has committed funding of approximately $50 million over the minimum 5-year research term, including a $14 million upfront cash payment and a $14 million purchase of Cytokinetics preferred stock. In addition, GSK could make milestone payments to Cytokinetics ranging from $30-50 million per target for products directed to each of over
10 mitotic kinesins that will be the subject of collaborative activities.
Sandoz has committed $600,000 in an upfront cash payment and has the right to purchase
$5-10 million in Momenta equity. R&D payments estimated to be $12 million and up to
$50 million in contingent payments to accompany development milestones.

Terms

EXHIBIT 10 Comparison Agreements between Comparable Biotechnology Start-ups and Large Pharmaceutical Companies

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EXHIBIT 11 Sirtris Financial data 2004–2006 (in thousands, except share and per share amounts)
Period from
March 28, 2004
(date of inception) through December 31, 2004

Period from
March 25, 2004
(date of inception) through December 31, 2006

Year Ended
December 31,
2005
2006

Statement of operations data:
Revenue
Operating expenses:
Research and development
General and administrative

$

—

$

68

$

—

7,062
3,865

14,242
4,340

22,494
8,904

1,889

10,927

18,582

31,398

(1,889)
45
—

Loss from operations
Interest income
Interest expense

(10,859)
1,143
—

(18,582)
2,447
(878)

(31,330)
3,635
(878)
$(28,573)

Net loss

$

(1,844)

$

(9,716)

$

(17,013)

Net loss per share—basic and diluted

$

(0.93)

$

(3.16)

$

(3.52)

Pro forma net loss per share— basic and diluted
Shares used in computing pro forma net loss per share—basic and diluted
Source: Company.

68

1,190
699

Total operating expenses

Weighted average number of common shares used in net loss per share— basic and diluted

$

1,995,468

3,087,716

4,854,646
$

(0.20)

85,603,228

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Sirtris Pharmaceuticals: Living Healthier, Longer

Appendix Wall Street Journal Cover

Source: David Stipp, “Researchers seek key to antiaging in calorie cutback,” Wall Street Journal, October 30, 2006.

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Questions
1. What made Sirtris an attractive opportunity (and not just a good idea) at the time that Christoph Westphal joined as CEO? How will Sirtris make money? 2. Identify the major risks in each of these categories: technology, market, team, and ﬁnancial. What is the most important category and risk?
3. Should Sirtris do the deal with the pharmaceutical company? Why or why not? Should Sirtris launch a neutraceuticals business? Why or why not? 4. Assume that Christoph Westphal and his team have just been told that
J.P. Morgan Securities, which is a reputable investment bank, is eager to help Sirtris go public soon by ﬁling for an Initial Public Offering (IPO).
Furthermore, assume that Glaxo Smith Kline (GSK) has also just contacted them to discuss an offer to buy Sirtris entirely. What are the advantages and disadvantages of each of these three options that they could pursue in order to ﬁnance and operate the venture (e.g., stay private for now and fund the company with more venture capital and corporate partnerships, take the company public via an IPO, or agree to be acquired to become an operating division of an established company)?

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Cooliris: Building an Aϩ Team

COOLIRIS: BUILDING AN A؉ TEAM
Introduction
It was well past 2AM on a warm evening in July 2007 at the Kleiner Perkins
Cauﬁeld Byers (KPCB) incubator in California. Josh Schwarzapel, the young and energetic co-founder of Cooliris, checked his email again to see if their top recruit had accepted the Cooliris employment offer. Across the gray cubicle wall, the technical team, Austin and Kyan, were coding steadily on the next product release. Although Austin and Kyan had been working feverishly for months, they urgently needed more engineers if they were to make the next release deadline.
Three months earlier, when the Cooliris co-founders received their ﬁrst round of funding from KPCB, Josh had accepted the challenge to help Cooliris expand by building a world-class technical team. At the time Josh had felt full of conﬁdence: how difﬁcult could it be for a young company to attract great talent when it had the backing of one of the world’s most successful venture capital ﬁrms, an incredible technical vision, an early product with great traction, and another product in the pipeline?
Much to Josh’s surprise, however, it had been challenging to build the team. Josh understood the importance of an outstanding team to the success of a new venture. As a student at Stanford studying entrepreneurship, Josh had heard luminaries in the ﬁeld highlight the necessity of a world-class team for eventual success. But, as he struggled to ﬁnd and attract such a team, Josh began to realize that his courses had not prepared him well for how to build such a team. Nonetheless, in Cooliris’ high-accountability culture, pointing the ﬁnger at an issue from his formal education would not excuse a failure.
Soujanya Bhumkar, the company’s CEO, had been supportive and helpful along the way, but Josh could sense the pressure: from the investors, from Soujanya, and worst of all from the team who had been forced to work long hours as they waited for the much needed new hires.
Now, in the early hours of the morning, Josh once again began to ask himself difﬁcult questions. Why had he struggled to recruit a great team? In the past he had always been successful, both as a student at Stanford and a collegiate volleyball player. What had gone wrong? Inevitably, Josh began to ask himself . . . “Is it me? Have I failed?”

This case was prepared by Nathan Furr via the Stanford Technology Ventures Program at Stanford
University with assistance from Josh Schwarzapel, Soujanya Bhumkar, and Professor Thomas Byers, as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Some facts have been disguised.
Copyright © 2009 by Stanford University. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of The Stanford
Technology Ventures Program.
Revised October 2009.

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COOLIRIS BACKGROUND AND HISTORY
At the time of Cooliris' founding, the Internet underwent a transformation frequently referred to as Web 2.0. During the ﬁrst major Internet wave spanning the late 1990s, entrepreneurs and corporations focused primarily on establishing a presence on the Internet using standard interface design to communicate with their audience. However, as the Internet evolved, a second wave emerged during the early 2000s that shifted the focus from corporate-generated content to user-generated content and from proprietary interfaces to modular interfaces that could be recombined (sometimes referred to as “mashable”). As part of this movement, a host of new websites, many of them funded by venture capitalists, sprung up to empower everyday users to become content publishers by posting blogs, making proﬁles, publishing videos, and sharing photos. Social networks such as MySpace and Facebook became household names and social networking, or the connecting of users to each other in online communities, became a common buzzword for many online ventures.
With the democratization of content creation and publishing, however, the sheer volume of content became a very real problem for most web users. As millions of participants posted billions of new photos, videos, and blogs, the quantity and type of information expanded exponentially. Narrow search terms returned hundreds of thousands of results, and information coming from one’s social graph on sites like Facebook and MySpace was becoming too lengthy to consume. In short, a growing challenge for Internet users was how to interact with and process the exploding volume of new content. It was this challenge that led to the founding of Cooliris.
Soujanya, Josh and Austin Shoemaker founded Cooliris in January 2006 around the idea that the Internet had indeed become a fundamental element in the lives of billions of people, but the user interaction metaphors had changed very little since the ﬁrst browsers. In their view, the Internet had always been characterized by a clunky, non-intuitive navigation experience based on the table format inherent in HTML code. Although ﬂash animations and video content had enriched basic text, the way people interacted with the Internet was still constrained within the 2D framework of the original browsers.
The initial idea for Cooliris had emerged earlier in 2005 during a conversation between Soujanya and a friend, Mayank Mehta. As the two talked about how to make the Internet a more rich experience, Mayank suggested the idea of creating a mouse-over preview of embedded links to other web pages. The preview would allow the user to see the content underneath the link in a contextual window without leaving the original page, thereby creating a more multi-dimensional media experience. Soujanya, a former engineer turned serial entrepreneur, was struck by the insight and began discussing it with colleagues to get their feedback.
During this period, Josh and Soujanya met for coffee to discuss ideas. Josh caught the vision of a better Internet experience and connected Soujanya with
Austin, a fellow student with exceptional technical capability. Together they

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Cooliris Background and History

laid out a plan for Cooliris and their ﬁrst product: Cooliris Previews. The team began development right away, self-funded on Soujanya’s credit card and working part time while Josh and Austin ﬁnished school. By September of 2006, the team had released Cooliris Previews as a free Internet browser plug-in.
Over the course of a few months, the product began to get signiﬁcant traction, becoming a featured plug-in for Firefox and attracting thousands of users who desired a richer online experience. The success of Previews validated the primary Cooliris hypothesis that users desire a richer interaction with content, and so the team developed the concept for a second product: PicLens. The new
PicLens product would allow users to view online photos from photo sharing sites or online image searches as full-screen slideshows rather than as lowquality thumbnail images or larger ﬁles that had to be downloaded individually. PicLens felt like a natural next step for the young company, but as the team built the product, their vision of the company began to evolve into something bigger. The team realized that the challenge of improving web navigation extended beyond a browser add-in to the fundamental way in which users access, discover, and navigate information. The team began soliciting feedback from investors and industry friends on how to take their ideas to the next level.
In one such meeting, Randy Komisar, a partner at KPCB, suggested that his ﬁrm might be able to provide some funding and incubate the company in their adjacent ofﬁces. After several weeks of follow-on meetings with the KPCB partnership, Cooliris received and signed a term sheet for investment, taking up residence in the KPCB incubator next door to ofﬁces of such famous venture capitalists as John Doerr and Brook Byers.

Cooliris Hiring Process
After receiving funding and moving into their new ofﬁces on Sand Hill Road, the Cooliris team identiﬁed several critical next steps for the company. The team and investors decided that one of the most critical action items should be to hire a top-notch technical team to execute on the Cooliris vision. As Josh and Soujanya deﬁned their recruiting strategy, they both agreed that they needed to recruit people who were both entrepreneurial and technically brilliant. Furthermore, they ﬁrmly believed in the wisdom of hiring great team members right from the beginning. As Guy Kawasaki of Garage Technology
Ventures said, “A players hire A players, B players hire C players, and C players hire bozos.”
As the team discussed recruiting, hiring great team members seemed a comparatively easy task given their recent round of prestigious funding and their exciting technical vision. In Josh’s eyes, new recruits would get in on the ground ﬂoor of an exciting opportunity, operate in a highly supportive setting, and be mentored by industry-leading venture capitalists. In this positive light, the recruiting task seemed easy.
Excited about his new role and freshly graduated from college, Josh took the lead on recruiting the new team. Initially, Josh anticipated that recruiting

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should take about half of his time, leaving the other half of his time open for business development. Conventional entrepreneurial wisdom suggested that the
Cooliris team should start the recruiting process by tapping their social networks for potential hires. Aware of the competition for great technical talent, however, Josh developed an incentive to motivate his extended social network to proffer the best technical candidates: Cooliris would pay $1,000 for a candidate recommendation that led to a hire. Josh soon ﬂooded his own extensive social network with the news about the exciting opportunity to join the Cooliris team. Similarly, KPCB and the entire Cooliris team reached out to their social networks to ﬁnd the best potential recruits available. At the same time, Josh recognized that the Cooliris team might not know or have links to all the best technical people. To ﬁll this gap, Josh also searched online databases such as
LinkedIn and Google, looking for technical talent at similar companies using search terms such as “3D graphics engineer.” Finally, Josh posted advertisements on LinkedIn and the San Francisco Bay Area edition of Craigslist.
Over the course of the next few weeks, Josh’s search effort yielded mixed results. Not surprisingly, tapping the team’s social networks produced the best leads. Searching for candidates on LinkedIn and Google also produced candidates, but not at the caliber the team desired. In contrast to searches, advertisements on LinkedIn and Craigslist typically produced subpar candidates.
Later, Josh discovered that the reason the ads proved so disappointing was because candidates with signiﬁcant talent ignored ads in general; these candidates were already receiving good offers through other channels.
In the end, after an exhaustive initial search, Josh reviewed over 1,200 resumes in search of the ideal team. Of the resumes browsed, Josh reached out to potential hires who he estimated had at least a 50% chance of being an “A player.” Once Josh had ﬁltered through the initial list of resumes, he then reached out to candidates via an introductory email explaining the Cooliris opportunity and the team’s interest in the candidate (see EXHIBIT 1 for the text of a sample email). In total, Josh contacted 400 candidates via email to invite them to talk more with Cooliris.
In the end, the Cooliris team brought in 50 candidates for a ﬁrst round interview. Because the incubator was located behind the main KPCB ofﬁce, it was a little difﬁcult to ﬁnd. Furthermore, the doors to the incubator were always locked. To solve this problem, Josh gave candidates instructions on how to drive around to the back of the building to where the incubator was located.
He told candidates to call once they arrived so that he could personally meet them and show them into the Cooliris ofﬁces.
At the beginning of the interview, a candidate would sign a non-disclosure agreement after which either Josh or Soujanya would give the candidate a tenminute outline of Cooliris’s vision and the products that had already been developed. At the same time, because the company was in stealth mode and had some very high potential ideas, Josh and Soujanya were careful not to reveal too much about the future direction of the company or some of their upcoming products. Therefore, in a typical interview, after a brief presentation

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about the company, the interviewer spent the rest of the hour screening the candidate for his or her technical ability. Josh and Soujanya also experimented with interviewing candidates by themselves or with the entire team.
After a thorough examination of the candidates’ abilities during the ﬁrst round, the Cooliris team decided to invite nine candidates back for a ﬁnal round interview. The ﬁnal interview lasted at least two hours and focused on a deeper technical discussion. Although the Cooliris team was still evaluating the candidate for ﬁt and talent, in the ﬁnal round interview the Cooliris team revealed a little more about the exciting future of the company. Lastly, the interview always included a long chat with Soujanya about expectations. In particular,
Soujanya believed that it was important to have open and clear communication about the potential upsides as well as the risks involved; otherwise, both the candidate and the Cooliris team would be entering into a relationship under false pretences—a bad start to any relationship.
Of the nine candidates who received ﬁnal round interviews, the team decided to extend offers to ﬁve high-potential candidates. Josh and Soujanya carefully crafted the offers to be as ﬁnancially competitive as possible, benchmarking against what Google might pay for a similar position as well as giving candidates potential upside through equity in the company. It now seemed that Cooliris could ﬁnally add needed resources to the skeleton technical team who had already been stretched to the maximum.

Two Unanswered Questions
Then came the surprise. Despite the apparent excitement that candidates exhibited during the interviews, of the ﬁve offers extended, four offers were turned down. Fortunately, the ﬁfth candidate verbally accepted the offer before departing for a long-planned trip to Europe. Although the yield for his efforts seemed slim, Josh felt that if they could at least hire one candidate then the last few months would not be wasted effort. Indeed, recruiting had taken an immense amount of time—much more than the 50% of his time that he expected. He had worked late nights, weekends, and holidays, all in an effort to succeed in building a technical team.
In the end, though, even the ﬁfth candidate decided not to join Cooliris.
Shortly after returning from Europe, the candidate emailed to say he had second thoughts and decided he would pass on the opportunity. The candidate’s retraction came as a shock and led Josh to reﬂect seriously on the failure of the recruiting process. What had the last two and a half months been about?
Why had he failed to build a great technical team? What could he have changed to make the process successful? And ﬁnally, the most challenging question of all, could it be him? Was the problem that he lacked what was needed to be an entrepreneur? These questions plagued him, but, on another level, Josh realized their challenges boiled down to two key questions. First, who is actually an “A player” and second, how do you attract those people to join your team?
Soujanya peeked over the rim of Josh’s cubicle and with his usual earnestness

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suggested that Josh get some rest: “Hey Josh, it’s okay. Let’s talk about it in the morning.” Josh nodded in agreement, grabbed his bag and headed for the door. The entire weekend was blocked out for the team to meet and discuss what had gone wrong in the recruiting process and what, if anything, could be changed. As he headed home, Josh wondered what he should suggest at the meeting. Were the team’s standards too high? Should they hire whomever they could ﬁnd to help? What was the problem? Why couldn’t they recruit worldclass team members?

Questions
1. You have just raised your ﬁrst round of ﬁnancing and want to build a team that can innovate in a completely new area: how would you go about identifying the right candidates and striking a balance between ingenuity and experience? Where exactly would you search for them?
How do you successfully attract your top choices to join your venture?
2. Make a list of what Cooliris is doing right and doing wrong, if anything, with its current recruiting process? How should they improve it?
3. How should recruiting processes differ for hiring various functional positions in this venture? For example, do the same rules apply to hiring engineers as sales and business development talent?

EXHIBIT 1: Email to Potential Candidates
Hi (candidate name here),
I took a look at your proﬁle and you are deﬁnitely the kind of guy that we would like to work with for our startup, Cooliris. To give you context, we're leveraging 3D graphics to build an immersive media environment for browsing web content (check out our downloadable app at www.cooliris.com). We've recently raised Series A investment from Kleiner Perkins (the same investors as Google, Amazon, Intuit etc.) and are working with people like Bill Joy
(Chief Scientist at Sun Microsystems) and Randy Komisar (former CEO of
Lucas Arts).
We'd be willing to explore both full time and contracting options with you, although we would greatly prefer people open to full time. Would you be interested in chatting further?
Sincerely,
Josh Schwarzapel
Cofounder and VP of Business Development www.cooliris.com

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