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US market review

July 18, 2001: Investors in US venture capital funds continue to see decreases in their portfolios in the first quarter as returns were negative for the second straight period. This mirrors the decrease in valuations of information technology companies in both the public and private markets. The venture industry saw its first negative return for any 12-month period ever, according to results announced today by Venture Economics (VE) and the National Venture Capital Association (NVCA). The following data is the product of the VE/NVCA preliminary quarterly Private Equity Performance Index (PEPI) results for the quarter ending March 31, 2001.

Returns in venture capital investments posted a –8.9% loss for the 3 months ending 3/31/2001, marking the fifth consecutive quarterly drop from the heights that peaked in the fourth quarter of 1999. When combined with the revised –13.4% loss in the 4th quarter of 2000, investors suffered a –21.1% loss for the six months ending 3/31/2001.

Figure 1.Venture Economics’ US Private Equity Performance Index™ (PEPI)

Investment Horizon Returns as of 3/31/2001 Fund Type/ Month 3/ Month 6/ Year 1/ Year 3/ Year 5/ Year 10/ Year 20

Early&Seed/ -9.1/ -23.1/ -2.6/ 84.4/ 60.5/ 35.0/ 22.9

Balanced/ -9.9/ -19.9/ -11.7/ 46.0/ 37.7/ 24.8/ 16.9

Later Stage VC/ -6.8/ -19.2/ -7.0/ 29.2/ 27.2/ 25.7/ 17.8

All Venture/ -8.9/ -21.1/ -6.7/ 55.7/ 43.4/ 28.7/ 19.1

All Buyouts/ -3.6/ -8.7/ -9.1/ 7.3/ 12.3/ 14.5/ 16.8

Mezzanine/ 1.6/ 5.0/ 14.0/ 11.9/ 11.4/ 12.3/ 11.7

All Private Equity/ -5.5/ -13.6/ -8.2/ 22.1/ 23.3/ 20.6/ 18.2

*Venture Economics’ Private Equity Performance Indexä is calculated quarterly from Venture Economics’ Private Equity Performance Database (PEPD). The PEPD tracks the performance of over 1,400 US venture capital and buyout funds formed since 1969. Returns are net to investors after fees and carried interest. Three- and 6-month returns are un-annualised.

For the first time ever, 12-month returns for the venture industry turned negative with a –6.7% loss for the year ending 3/31/2001. However, it is important to note that a very large portion of the investments reflected in the 3-month, 6-month and 1-year IRR’s are based on money invested but not yet harvested. This means that interim valuations play a huge role in these calculations. The smallest 12-month return previously was in the year ending 12/31/1984, with a 1.4% return, and the smallest in recent memory was in the year ending 12/31/1990, with a 1.8% return. Both years are significant in that they also followed tremendous spurts in technology investment and in the IPO market. When compared to the freefall in the public markets, investors in VC funds in Q1 still fared well, as the S&P 500 returned –12.1% and –22.6% for the quarter ending and year ending 3/31/2001, respectively, while NASDAQ returned –25.5% and –60.8% for those same time periods.

Long-Term Performance is More ImportantWhile the short-term news is bad, investors continue to invest in this asset class for the long run. According to Jesse Reyes, Vice President, Venture Economics, “While the markets continue to focus on the short-term changes in the technology areas VCs like to invest in, institutional investors who have been in these investments for a long time know that long-term investment performance is what you are looking for. They are focusing on the bottom right corner (i.e., 10- and 20- year performance statistics) in making their private equity investment decisions. What is important to the institutions that back the private equity industry is that they select the good managers from the bad. It’s times like these where these differences will truly be sorted out.”“It is inevitable that as returns move from triple-digit levels to the more traditional 20% IRRs that there will be some flat and down quarters along the way. That said, with valuations at their lowest levels in recent quarters, the current environment has opened up some excellent investment opportunities in a wide range of industry categories,” stated Mark Heesen, president of the National Venture Capital Association.Younger Funds Suffer MoreVintage year results (that is, results measured for funds by the year they started investing) continue to show that most of the performance downturn has occurred in younger funds, which by their nature typically have a good portion of their portfolio still actively invested; thus, the returns results are largely unrealized. One measure to use is the Realized Return or Total Distributed Proceeds to Total Invested Capital. By this measure, older funds have seen less degradation with the current market volatility, while funds formed more recently show more volatility in their performance. Figure 2 indicates, for example, that investors in funds that were formed in 1990 and thus near the end of their lives showed a 27.7% annualized return since inception and actually showed a modest increase in Q1 of 2001 of 0.2%. This can be compared to the 94.1% return enjoyed by investors who invested in funds that started in 1996 and the 58.8% return to funds that started investing in 1998 and 15.3% return to funds formed in 1999, which invested well into the Internet boom.Figure 2. Vintage Year Results for Selected YearsResults as of 3/31/2001 Annualized Realized Year of Return Return Return for Fund Since Inception (DPI) 2001 Q1 Formation (percent) (times) (percent) 1990 27.7% 2.60 0.2% 1996 94.1% 3.81 -19.0% 1998 58.8% 0.55 -8.9% 1999 15.3% 0.12 -7.4% Venture Economics & The National Venture Capital AssociationHowever, Figure 2 also demonstrates what portion of returns has actually been realized as distributions and how much is unrealized. The DPI, or distribution to paid in ratio, for funds formed in 1990 shows that these funds returned a total of 2.60 times invested capital while funds formed in 1998 have only returned 55% of invested capital. However, investors in the 1996 funds have received an astounding 3.8 times their invested capital back already. Not surprisingly, funds formed in 1999 are still quite young and have not yet begun to bear fruit, thus returning only 12% of capital to their investors. Time will tell whether funds formed in 1998 or 1999 will keep up with their older brethren, but the odds seem to be against it in the current valuation climate considering how much capital was devoted to the Internet industry by those two vintage years well into the peak of the boom. Full vintage year results and quartile statistics are currently available to subscribers via Venture Economics’ VentureXpert database.For more information about Venture Economics’ performance analysis see the methodology section at www.ventureeconomics.com,