Venture
Capital for Tiny Technology
Fellow
Shareholders:
As
most
of you know, our Company instituted in 2003 mandatory retirement for senior
executives, as of December 31 of the year in which they attain the age of 65.
As
I recently celebrated my 65th
birthday, this 2007 annual letter to shareholders will be the last in which
I
will have the opportunity to express my thoughts to you about our Company and
our business. As it seems appropriate for me to comment in this letter on
management succession and on my personal vision for our Company, I have asked
my
colleagues to make an exception to our usual practice of co-signing our letters
to shareholders. Accordingly, I have undertaken to write it from the perspective
of my future role as an outside shareholder, as well as from my current position
as Chief Executive Officer.
In
my
assessment, our Company enters the final year of my service with clear-cut
strengths and weaknesses. Our Company's two greatest weaknesses, in my judgment,
are our relatively small asset size and the exposure of our industry, the
venture-capital industry, to the currently rocky economy and capital markets.
Our Company's greatest strengths, in my judgment, are our people, including
all
of our employees and our board of directors; our portfolio; our debt-free,
highly liquid balance sheet; our position as a leader with respect to venture
capital for nanotechnology; our relationships with sources of deal flow; and
most importantly, our reputation - not only for fair dealing, responsible
conduct, technical excellence, and leadership in our chosen field of venture
capital for tiny technology, but also for making successful
investments.
Since
we
began making new investments strictly in tiny technology in the second half
of
2001 and since we began reinvesting our after-tax capital gains, rather than
paying them out through cash dividends and stock buy-backs, our Company has
grown rapidly. In the last five years, our net assets have increased at a
compound annual rate of 38.4 percent, from $27,256,046 at December 31, 2002,
to
$138,363,344 at December 31, 2007. Over the same period, our net asset value
per
share (NAV) has increased at a compound annual rate of 20.1 percent, from $2.37
to $5.93. Our net assets are now at an all-time high, and our NAV is within
a
penny of its all-time high. But we are still a small firm by contemporary
venture-capital industry standards.
Even
though our balance sheet at December 31, 2007, is quite liquid, with no debt
and
$60,523,602 in cash and U.S. Treasury securities (42.4 percent of our total
assets), our deal flow exceeds our financial capacity. This imbalance is good
in
that it forces us to be highly selective, but it causes us to incur significant
opportunity cost. We cannot always take full advantage of the flow of
opportunities that our standing, as the venture-capital firm with perhaps the
largest number of nanotechnology-related companies in its portfolio, brings
us.
Nor can we take full advantage of the capabilities of our investment team.
Another
reason that our Company needs to continue growing its assets is to drive down
cash expenses as a percentage of net assets. In recent years, the expenses
that
a publicly traded business development company must incur to meet regulatory
requirements have escalated dramatically, pursuant to the Sarbanes-Oxley Act
of
2002, Rule 38a-1 for investment companies, expanded compensation disclosure
and
analysis requirements, FASB Statement No. 157 for the valuation of assets,
etc.
In
2002,
we had fewer investments and one office instead of two, but otherwise our
business was the same as it is now. We got along fine with one internal
accountant, a single outside accounting firm, no corporate compliance
consultants, and no internal lawyers. Our business structure is very simple
- no
inventories, no receivables, no off-balance sheet entities, no debt, no
preferred stock, one wholly-owned subsidiary, essentially all of our assets
held
by one custodian - yet our independent registered public accounting firm charged
us approximately $290,000 in 2007 and will charge us up to an estimated $340,000
in 2008. The same firm charged us $55,500 in 2002. Today, in order to fulfill
our regulatory requirements, we find ourselves having to employ two internal
accountants; three accounting firms, including our independent registered public
accounting firm; three law firms for counsel unrelated to our investment
activities; a compensation consulting firm; a compliance consultant; an
asset-valuation consulting firm; and two internal lawyers; and we now have
to
hold many more Board committee meetings. In 2007, our directors' and officers'
liability insurance premium expenses were $521,884, versus $68,216 in 2002.
In
2007, our legal expenses were $323,366, versus $149,954 in 2002. To put all
of
this corporate-governance overhead into perspective, we have only 13 full-time
employees!
The
good
news is that the avalanche of new regulations with which we have had to deal
with seems to have run its course, and the costs of complying with the
regulatory requirements of a publicly traded venture-capital firm should now
be
basically fixed. Thus, as our net assets grow, our expenses that are unrelated
to our actual investment activities should drop as a percentage of our net
assets. And we will continue to have two members of our investment team, which
we refer to internally as our deal team, do double duty by serving also as
our
Chief Executive Officer and as our Chief Financial Officer, thereby saving
considerable overhead expense.
In
the
long run, I expect our capital base to become one of our Company's greatest
strengths. Because we are now reinvesting our after-tax long-term capital gains,
the magic of compound interest should serve us well. Indeed, our number one
financial goal is to keep growing our net assets rapidly and to finance that
growth entirely through retained earnings from net realized long-term capital
gains. Our portfolio has not produced a significant capital gain since late
2005. Now that more of the companies in our portfolio are becoming reasonably
mature, such capital gains should once again be forthcoming, especially when
market conditions permit venture capital-backed companies to resume making
initial public offerings (IPOs).
If
credit
markets remain frozen, if the banking system remains dysfunctional, and if
the
recession becomes deep and prolonged, the venture-capital industry will
certainly not be immune to the distress. Even though our portfolio companies
are
financed primarily by equity, and the venture-capital industry in general is
currently well funded, most of our portfolio companies that are outside of
the
life sciences are directly or indirectly affected by the level of industrial
activity. The weak stock-market conditions that tend to accompany the earlier
stages of a recession affect the venture-capital industry adversely as well,
as
such an environment is not conducive to IPOs. In the first two months of 2008,
a
larger dollar amount of IPOs was cancelled globally than in the first two months
of any other year on record.
No
matter
what conditions our Company faces in ensuing years, I am confident that it
will
be in very good hands. Having long subscribed to the belief that the most
important job of a CEO is to prepare for his succession, our Board and our
management have planned and implemented succession carefully over the last
five
years. The members of our ongoing management team are young and energetic,
but
thoroughly experienced in every aspect of their jobs. Our President and Chief
Operating Officer, Douglas W. Jamison, M.S., will be 39 years old when he
succeeds me as Chairman and CEO on January 1, 2009. Doug has been with our
Company for five years and has done outstanding work on both the investment
and
management sides of our business, including serving very capably as our Chief
Financial Officer, while mastering every aspect of our operations. Our current
Chief Financial Officer, Daniel B. Wolfe, Ph.D., who joined us in July of 2004,
will be 31 years old when he succeeds Doug as our President and Chief Operating
Officer while retaining his responsibilities as Chief Financial Officer. Both
Doug and Daniel have excellent administrative, management, and leadership
skills. Sandra M. Forman, J.D., 41, who joined us from our outside counsel,
Skadden, Arps, Slate, Meagher & Flom LLP, in August of 2004, will continue
to round out our top management team. Sandra serves us in the triple roles
of
General Counsel, Chief Compliance Officer, and Director of Human Resources.
She
also works with our deal team on the legal aspects of our deal
documents.
Our
Board
requires a fairly large number of outside Directors in order to spread the
onerous, time-consuming committee work that is necessary to comply with the
myriad regulations that govern our Company. We are exceedingly fortunate to
have
a high-quality, active Board that is committed to our Company's success. Several
years ago, our outside Directors elected to use 50 percent of their pre-tax
Board fees to buy shares of our common stock in the open market. In essence,
they are working for us, the shareholders, in return for stock in our Company
rather than cash.
On
November 2, 2006, we created the position of Lead Independent Director, which
has aided us significantly in corporate governance. Dugald A. Fletcher has
served in that capacity since then, and he has provided our Board with ethical
and effective leadership of the highest order. Although we had originally
envisioned rotating the role of Lead Independent Director every two years,
we
are very pleased that Dugald has agreed to continue in that role through Doug's
first year as Chief Executive Officer.
Our
deal
team is a blend of venture capitalists that we have recruited from other
venture-capital firms and home-grown venture capitalists that we have recruited
from non-venture capital professional backgrounds. You might wish to review
their biographic information on pages 15 and 16 of our Proxy Statement. Alexei
A. Andreev, Ph.D., M.B.A., 36, and Michael A. Janse, M.B.A., 39, joined us
from,
respectively, Draper Fisher Jurvetson and ARCH Venture Partners. Alexei and
Mike
manage our Palo Alto, California, office and serve our Company as Executive
Vice
Presidents and Managing Directors. Before becoming venture capitalists, Alexei
had worked as a research scientist in a nanotechnology lab in Russia, and Mike
had worked in the semiconductor industry. We have had the privilege of
co-investing frequently with their former firms, Draper Fisher Jurvetson and
ARCH Venture Partners, which are distinguished, among other things, for their
nanotechnology expertise. Our Palo Alto office has become increasingly important
to our Company. Nearly two-thirds of our portfolio by value now consists of
investments on the West Coast.
In
our
New York City office, which both works on deals and handles the overall
management and administrative duties of the Company, Doug Jamison joined us
from
the University of Utah's technology-transfer office, where he had managed that
office's intellectual property in physics, chemistry, and the engineering
sciences. Daniel Wolfe joined us from his doctoral program at Harvard with
the
Whitesides group, which is renowned for its work in nanotechnology. While
earning his Ph.D., Daniel had also conducted a technology consulting practice.
Having now acted as chief financial officers of a publicly held company, both
Doug and Daniel bring financial expertise to our investee companies. Misti
Ushio, Ph.D., 36, serves us as a Vice President and Associate. Misti joined
us
from Columbia University's technology-transfer office, where she had managed
that office's intellectual property in nanotechnology, after working for 10
years at Merck & Co., Inc.
These
five members of our deal team (I am the sixth) bring to bear their individual
training, experiences, talents, and points of view. But they have certain
essential qualities in common. Each is intelligent, well educated, accomplished,
ambitious, and energetic. Each has demonstrated good investment judgment and
is
an effective networker. Most importantly, each has high integrity. They function
and are compensated as a team, rather than as a collection of individuals.
They
are aware that they have the opportunity to accomplish something together and
with our Company's permanent capital that no one of them could hope to
accomplish alone. They, along with Sandra, want to do great deals and build
a
great enterprise in which they are major shareholders.
While
I
fully expect that our Company will always have to deal with disappointing
developments in its portfolio that will result in writedowns and writeoffs,
I
cannot remember being as optimistic about the potential returns from our
portfolio as I am today. Moreover, our deal flow is constantly bringing new
opportunities to our door and allowing us to be quite selective in our
investments. In 2007, we saw more than one new investment opportunity per
business day, from which we added seven deals to our portfolio.
Over
the
last couple of years, venture capital-backed companies that completed IPOs
in
the United States were on average over eight years old. At December 31, 2007,
the median age of our active portfolio companies was 6.5 years form the date
of
founding. As another measure of maturity, the aggregate revenues of our
portfolio companies in 2007 were approximately $194 million. Eleven of our
portfolio companies produced 95 percent of these revenues; some of the others
were in pre-revenue stages of development.
We
have
never before had so many portfolio companies approaching a reasonable level
of
maturity. Two
of
our portfolio companies have been considering with their advisors the
possibility of filing for initial public offerings (IPOs) in 2008. There can
be
no assurance that either of them will file for an IPO in 2008, and a variety
of
factors, including stock market and general business conditions, could lead
either or both of them to terminate such considerations.
Acquisitions of portfolio companies, whether at a profit or a loss, can take
place at any stage of maturity. Historically, seven of our portfolio companies
have completed IPOs that eventually enabled us to sell our shares at a profit.
Another 11 of our portfolio companies have been acquired on terms that were
profitable to us.
Cleantech
is an important example of the utilization of nanotechnology to create advanced
materials for the solution of problems. Indeed, a rapidly growing part of our
portfolio consists of companies that are utilizing nanotechnology for Cleantech
solutions. We classify eight of our investments as belonging to this "Tiny
Tech
for Cleantech" subset of our portfolio. We currently value these eight
investments at $26,096,758, versus their cost to us of $15,782,498. Thus, at
current value, Cleantech is now fully one-third of the value of our entire
venture-capital portfolio. So far, we have not written down any of these
investments (though I would be surprised if some of them do not eventually
encounter some sort of adversity that will result in writedowns or writeoffs).
Cleantech
has been a successful area for us historically. Although Molten Metal
Technology, Inc., was not a nanotechnology-enabled company, it was classic
Cleantech, as an environmental-remediation company. We sold our shares of Molten
Metal on Nasdaq in 1993 for $30,660,765; we had purchased these shares as the
seed investor in 1989, at a cost of $110,000. Our other previous Cleantech
investment was a battery company, NanoGram Devices Corp. We sold our shares
in
NanoGram Devices in 2005 for $2,749,955, 23 months after our $813,210
investment. (For more information on our thoughts on Cleantech, please see
a
paper by my colleague, Alexei Andreev, on our website, www.TinyTechVC.com.
You
can find this paper after clicking on the "Cleantech" tab.)
After
I
retire from my management role, how do I envision our Company's future? I think
that our Company now has the elements in place to enable rapid growth in NAV
in
the years ahead. These enabling elements include: a strong management team,
deal
team, board of directors, and solid corporate governance; a legacy of successful
investments; a pipeline of investee companies ranging from seed-stage
investments to companies that now have significant revenues; a wide range of
excellent relationships with, among others, research universities,
entrepreneurs, engineers, scientists, venture-capital firms, large corporations,
law firms and investment banks; a robust deal flow; a position as the
venture-capital firm with perhaps the most nanotechnology-enabled portfolio
companies; a position as one of the more experienced venture-capital firms
in
Cleantech investing; a liquid balance sheet built on permanent equity capital
and the ability to reinvest after-tax capital gains for growth; and a good
reputation. These enabling elements are the building blocks of a foundation
for
a corporation built to last with permanent equity capital.
As
noted
above, our Company's NAV is within a penny of its all-time high. But I do not
think that our Company's stock can be a true growth stock until our Company
can
finance rapid growth in NAV entirely through retained earnings. Strictly
internal financing of growth will require either some very large capital gains
or more frequent capital gains from our portfolio as companies in it mature.
If
our
Company is to realize my dream and become a significant financial institution,
it has just gotten started, and its real growth lies ahead. In investment
theory, risk and reward go together. I am mindful that venture capital is a
risky field and that our Company is a risky investment, and you should be too.
But if nanotechnology is the transforming technology that I think it is, and
our
people are as good as I think they are, our Company will be what I think it
can
be.
It
has
been a privilege to have the opportunity to serve our Company over the years.
I
have enjoyed working with my colleagues and our portfolio companies and have
greatly appreciated your patient support as shareholders while we built the
foundation for growth that we have today. I hope that you can come in person
to
this year's annual meeting of shareholders. And I hope that no matter how big
our Company grows to be, we will always stay humble. After all, our Company
will
still be TINY!
|
|
|
Charles
E. Harris
|
|
Chairman
and Chief Executive Officer
|
|
Managing
Director
|
March
13,
2008
This
letter may contain statements of a forward-looking nature relating to future
events. These forward-looking statements are subject to the inherent
uncertainties in predicting future results and conditions. These
statements reflect the Company's current beliefs, and a number of important
factors could cause actual results to differ materially from those expressed
in
this letter. Please see the Company's Registration Statement on Form N-2 and
Annual Report on Form 10-K for the year ended December 31, 2007, as well as
subsequent SEC filings, filed with the Securities and Exchange Commission for
a
more detailed discussion of the risks and uncertainties associated with the
Company's business, including but not limited to the risks and uncertainties
associated with venture capital investing and other significant factors that
could affect the Company's actual results. Except as otherwise required by
Federal securities laws, the Company undertakes no obligation to update or
revise these forward-looking statements to reflect new events or uncertainties.
Shareholders
are advised to read the Company’s Proxy Statement for the 2008 Annual Meeting of
Shareholders when it becomes available because it contains important
information. The Company’s proxy statement will be available, free of charge, on
the Securities and Exchange Commission’s website (www.sec.gov) and on the
Company’s website (www.TinyTechVC.com). Additional information about the
Company, such as the Company’s Annual Report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to those reports filed
or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of
1934, are also available free of charge at www.sec.gov and www.TinyTechVC.com.
The
reference to the websites www.TinyTechVC.com and www.sec.gov have been provided
as a convenience, and the information contained on such websites is not
incorporated by reference into this letter.