Business of Comdisco Ventures Group:
BUSINESS OF COMDISCO VENTURES GROUP
Overview
Comdisco Ventures group provides venture leases, venture debt and direct
equity financing to venture capital-backed companies. Comdisco Ventures group's
relationships with established venture capital firms help it identify what it
believes are the best positioned companies in the most attractive high growth
industries. Comdisco Ventures group offers a broad range of equity-linked
financing products, which complement equity from venture capital firms and debt
from venture-oriented banks and asset-based lenders. Comdisco Ventures group
also plans to offer a number of additional services to its network of
customers. During the last two years, some of Comdisco Ventures group's notable
customers include Ariba, Ask Jeeves, Avici Systems, Be Free, Copper Mountain
Networks, Corvis, Critical Path, E-Loan, E.piphany, eToys, Extreme Networks,
Gadzoox Networks, NextCard, Niku, Northpoint Communications, Optical Networks,
Siara Systems and StratumOne Communications.
Comdisco Ventures group provides its customers with financing
"commitments"--agreements to provide up to a stated dollar amount of financing
over a stated period of time. Comdisco Ventures group was formed in 1987 as a
division of Comdisco, Inc. It has been operated as a division since that time
and is not a separate legal entity. Since 1987, Comdisco Ventures group has
committed approximately $2.8 billion in venture leases, venture debt and direct
equity financings, including $738 million in fiscal 1999 and $1.2 billion in
the first nine months of fiscal 2000. Of the over 870 companies Comdisco
Ventures group has helped finance, over 185 have gone public and over 145 have
been acquired, in each case providing Comdisco Ventures group with the
opportunity to liquidate its equity position in those companies.
Net earnings increased 150% to $42.8 million for fiscal 1999, as compared
to $17.2 million for fiscal 1998, and were $74.4 million in the first six
months of fiscal 2000.
The Market for Venture Financing
The emergence of Internet-related, communications and other high-
technology companies has been unprecedented in the last few years. The need for
capital to support the growth of these companies has likewise been
unprecedented. More specifically, a typical start-up company today has to raise
more capital faster than a similarly situated company a few years ago.
Several factors are behind this change. Technological advances have
accelerated, making product and service life cycles shorter. Innovative
companies must get their products to market as fast as possible before a
competitor renders their product obsolete. Getting to market faster requires
greater capital expenditures.
There is also a perception that the public equity markets reward a price
premium to companies that can establish the largest market share, build the
most compelling brand or create a new market niche early on. To gain this so-
called "first mover advantage," some companies today spend heavily on product
development, brand awareness, sales force expansion and infrastructure. All
these efforts accelerate the need for capital.
According to the National Venture Capital Association and Venture
Economics, venture capital firms invested a record $48.3 billion in portfolio
companies in 1999, representing a 151.6% increase over the $19.2 billion they
invested in 1998. Additionally, those same sources report the number of
companies receiving financing increased 25.6% in 1999 to 3,649 while the
average venture capital investment per company has also increased
significantly, to $13.2 million in 1999 from $6.6 million in 1998.
Historically, two primary sources of capital for start-up companies have
been venture capitalists and venture-oriented banks and asset-based lenders.
While the availability of venture capital has increased along with the volume
of start-up activity, venture capital generally represents the most dilutive
and
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intrusive type of financing. Venture capitalists generally require substantial
ownership and exercise substantial control when they make an investment in a
company. Typically these positions are reflected in significant equity
holdings, contractual shareholder rights and representation on the company's
board of directors.
Start-up companies also turn to venture-oriented banks and asset-based
lenders for financing. While these financings generally result in no or minimal
dilution of ownership of existing equity holders, they typically involve high
monthly cash disbursements, limitations on the use of funds and adherence to
restrictive financial covenants.
Comdisco Ventures group believes these two primary sources of capital do
not fully meet the capital needs of start-up companies in the current economic
environment. Additionally, their disadvantages highlight the need for less
costly and less dilutive financing sources, creating opportunities for
alternative capital providers, like Comdisco Ventures group.
Comdisco Ventures Group's Solution
Comdisco Ventures group believes it provides significant value to
entrepreneurs and their venture capital investors through flexible financing
products and services which allow entrepreneurs to build their companies
quickly, while minimizing the dilution of their equity ownership positions.
Comdisco Ventures group has proven its ability to understand the capital
needs of its customers and to develop and customize attractive financings to
meet those needs. Currently, Comdisco Ventures group's primary financing
products are venture leases, venture debt and direct equity financings. Venture
leases are leases with warrants that compensate Comdisco Ventures group for
providing the leases at more attractive financing terms than leases without
warrants. Venture debt is a high-risk loan with warrants or a conversion-to-
equity feature with more flexible terms and security conditions than more
traditional debt financing. The warrants or conversion feature of venture
leases and venture debt generally provide Comdisco Ventures group the ability
to buy equity at a price based on the price paid by venture capitalists. The
opportunity to realize higher returns from the exercise of the warrants or from
the conversion feature enables Comdisco Ventures group to offer more flexible
financing and security terms. Direct equity financings involve Comdisco
Ventures group's purchase of convertible preferred stock and common stock from
its customers. Comdisco Ventures group also provides other ancillary
financings, including convertible debt, bridge loans, expansion loans,
acquisition financings and landlord guarantees.
Venture leases and venture debt can be utilized at various stages of a
company's development and for various purposes including the following:
. early stage capital to supplement the initial venture capital
raised and support growth requirements;
. expansion capital between venture capital rounds to enable an
emerging company to reach milestones and increase the prospect of
raising future capital at higher valuations; and
. late stage capital to provide financial flexibility to deal with
the uncertainty of a liquidity event such as an initial public
offering or the sale of the company.
As a result of the specialized nature of venture leases and venture debt,
Comdisco Ventures group must have expertise in technology-related industry
sectors, access to capital, the ability to assess risk, relationships with
venture capital firms, access to deal flow, and the ability to structure
transactions appropriately.
Comdisco Ventures group currently offers equipment procurement, exchange,
and upgrade services to its customers. Comdisco Ventures group plans to
introduce existing Comdisco group services to its customers. We expect that
Comdisco Ventures group customers will use web hosting and web availability
services, business continuity services, and network management services.
Comdisco has hired
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a full time sales person to coordinate with Comdisco Ventures group
introduction of these services, Comdisco Ventures group currently intends to
develop other services to its network of customers beginning in the second half
of fiscal 2001. It is anticipated that, when introduced, these services will be
designed to save Comdisco Ventures group's customers' time, effort and money as
they race to build their businesses.
Comdisco Ventures Group's Strategy
Comdisco Ventures group intends to expand its position as a provider of
venture leases and venture debt and introduce complementary services to venture
capital-backed companies. Its strategy is to continue to leverage its
management experience and resources to capitalize on the growing demand for
financing by venture capital-backed companies. Components of Comdisco Ventures
group's strategy include:
. leveraging relationships with established venture capitalists;
. providing capital through products that meet the varied needs of
venture capital-backed companies;
. maintaining a diversified customer base;
. expanding funding sources;
. capitalizing on the Comdisco affiliation and resources; and
. developing complementary service offerings that respond to the
changing needs of venture capital-backed companies.
Leveraging Comdisco Ventures group's relationships with established venture
capitalists
Comdisco Ventures group has developed long-term working relationships
with twenty to thirty of these firms by participating in numerous transactions
with them over the years. These venture capital firms serve as an important
referral source for leads. Additionally, since the venture capital firms have
already invested in these customers, Comdisco Ventures group benefits
indirectly from their diligence and expertise in starting and building new
companies. This working relationship affords Comdisco Ventures group continued
access to attractive financing opportunities. Comdisco Ventures group believes
that these venture capital firms view Comdisco Ventures group as an important
financial partner for their customers, both at the initial and subsequent
stages of growth, due to Comdisco Ventures group's financial resources, varied
financing products and industry expertise. Comdisco Ventures group believes
that, as a general rule, Comdisco Ventures group's financing products serve as
an effective source of financial leverage for the return on the venture capital
firms' equity investments in the same manner as traditional debt provides
financial leverage for more mature companies. Moreover, Comdisco Ventures
group's flexibility has been and could be useful in those rare situations that
require a specifically crafted financial solution. Comdisco Ventures group also
provides advice as to the financeability of particular companies to assist
venture capital firms and entrepreneurs in preparing business plans.
Providing capital through products that meet the varied needs of venture
capital-backed companies.
Comdisco Ventures group currently offers a broad range of financing
alternatives to venture capital-backed companies. The success of Comdisco
Ventures group has been fueled, in part, by its ability to understand the
capital needs of its customers and to develop and customize attractive
financings to meet those needs. Currently, Comdisco Ventures group's primary
financing products are venture leases, venture debt and direct equity
financings through the purchase of convertible preferred stock and common
stock. See "--Comdisco Ventures Group's Products," beginning on page 76 for a
description of these products.
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Maintaining a diversified customer base
Comdisco Ventures group provides financing products to customers
diversified across many industry sectors. This diversification reduces the
impact to Comdisco Ventures group should there be a downturn in any sector. The
following chart illustrates customer industry sector diversification by
aggregate commitments from October 1, 1996 through June 30, 2000.
[GRAPH]
Communications & Networking 27%
Computer Hardware & Semiconductors 7%
Internet 40%
Life Sciences 8%
Other Products & Services 2%
Software & Computer Services 16%
Comdisco Ventures group often provides financings to several venture
capital-backed companies in a specific emerging industry sector in order to
increase the likelihood of aligning itself with the most successful venture
capital-backed companies within that sector. Because most venture capitalists
have significant equity ownership, board representation and strategic alignment
with management of the companies in which they invest, they can be limited in
their abilities to invest in multiple companies within a single industry
sector. Comdisco Ventures group, due to its limited ownership and lack of
strategic involvement, for example, typically no board representation,
generally avoids these kinds of conflict limitations. This allows Comdisco
Ventures group to diversify its financings across several start-ups within an
industry sector.
Expanding Comdisco Ventures group's funding sources
Historically, Comdisco Ventures group has funded its financing activities
through cash flows from its operations, as well as inter-group borrowings from
Comdisco. As demand for its financing products has grown, and to reduce the
balance sheet risk to Comdisco stockholders, Comdisco Ventures group has
explored possible alternative sources of funds for its financing activities,
including selling shares of Comdisco Ventures group stock to the public in the
offering contemplated by the prospectus. Comdisco Ventures group may, depending
on market conditions, form funding vehicles in which it seeks to raise capital
from third parties.
Capitalizing on the Comdisco affiliation and resources
As a division of Comdisco, Comdisco Ventures group is able to bring a
number of benefits to its customers:
. Equipment Procurement. As a result of our experience in leasing
and remarketing equipment and our equipment purchasing power,
Comdisco Ventures group is able to offer its customers an
equipment procurement service designed to save them time, effort
and money.
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. Technology Services. Comdisco Ventures group offers a range of
Comdisco's technology services to its customers in order to help
them build their businesses more quickly. These services include
continuity services, web availability and other hosting services,
and managed network services.
. Post-Venture Stage Services. Comdisco Ventures group can also
introduce Comdisco as a potential customer for, or partner to, a
customer as the customer evolves beyond the start-up stage.
Developing complementary service offerings that respond to the changing needs
of venture capital-backed companies
In addition to financing products, Comdisco Ventures group currently
intends to develop and provide value-added services to its network of customers
beginning in the first half of fiscal 2001. Comdisco Ventures group will charge
its customers for the use of these services. The fees will be payable in cash
or equity or a combination of cash and equity. These services, when developed,
will also be designed to allow Comdisco Ventures group's customers to take
advantage of opportunities provided by the other members of Comdisco Ventures
group's network of customers. Comdisco Ventures group also plans to introduce
Comdisco group services to its customers.
Comdisco Ventures Group's Products
Typically, Comdisco Ventures group's products are structured as
commitments by it to provide financing in one or more advances during a
specified period of time. The total commitment made available to a customer may
or may not be drawn upon and used by that customer over the life of the
commitment, although Comdisco Ventures group generally must keep those
committed but undrawn amounts available for the customer. Comdisco Ventures
group also may receive the right, as part of a commitment, to purchase a
specific amount of equity in a planned future equity round of its customer.
Comdisco Ventures group usually receives a fee for providing its financing
commitment based on the original amount committed. Comdisco Ventures group's
commitment to finance is typically subject to the absence of any material
adverse change or any default under the loan or lease and compliance by its
customers with other loan or lease requirements.
Comdisco Ventures group generally will receive warrants to purchase
equity securities or the right to convert some of its debt into equity
securities of its customers in connection with the commitment. Warrants
typically represent less than 5% of the customer's ownership at the date of
origination. The terms of the warrants or equity conversion, including the
expiration date, exercise price and terms of the equity security for which the
warrant may be exercised, will be negotiated individually with each customer,
and will likely be affected by the price and terms of securities issued by the
customer to its venture capitalists and other holders. Based upon Comdisco
Ventures group's experience, it is anticipated that most warrants will be
exercisable for a term of three to ten years. The equity securities for which
the warrant will be exercised generally will be convertible preferred stock or
common stock.
Venture leases
Comdisco Ventures group's venture leasing activities consist primarily of
the direct origination of non-cancelable, full-payout leases. These leases
cover a variety of equipment including computers, servers and other information
technology equipment, laboratory and scientific equipment, testing equipment,
production equipment and software. The rental rate and all other transaction
terms are individually negotiated with Comdisco Ventures group's customers. The
leased equipment is owned by Comdisco Ventures group through Comdisco, which in
turn purchased the equipment from a variety of manufacturers.
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Substantially all equipment leases that Comdisco Ventures group
originates have specified non-cancelable initial terms ranging from two to five
years. The general terms and conditions of all of these leases are
substantially similar and are embodied in a master lease agreement. For each
lessee, the lease term, rent interval, lease rate factor and other specific
terms for each piece of leased equipment are set forth on equipment schedules,
which also incorporate the terms and conditions of our master lease agreement.
The lessee is also required to provide to Comdisco Ventures group monthly and
annual financial information.
Comdisco Ventures group may also structure transactions as a loan secured
by the underlying equipment, and Comdisco Ventures group considers these kinds
of arrangements as part of its venture equipment financing activities.
Factors considered in determining which financing structure to use
include the customer's desire to keep the equipment at the end of the
financing, Comdisco Ventures group's need for security, the flexibility at the
end of the financing and accounting and tax treatment. For example, a customer
that wants to keep the equipment at the end of the term may prefer the secured
loan structure and be treated as the owner of the equipment at inception of the
financing. On the other hand, a customer that does not want to keep the
equipment at the end of the term, or wants flexibility to return the equipment,
may prefer the lease structure whereby it has the right to return the equipment
at the end of the lease and may treat the transaction as an operating lease.
Under the lease structure, Comdisco Ventures group, through Comdisco, is the
owner of the equipment and is generally in a better position than an unsecured
lender in the event of default. In addition, under the lease structure,
Comdisco Ventures group, through Comdisco, is responsible for the remarketing
of the equipment at the end of the term. Under the loan structure, Comdisco is
not responsible for remarketing at the end of the term.
During fiscal 1999 and 1998, Comdisco Ventures group originated leases
through approximately 230 and 180 separate transactions, respectively,
representing total commitments of approximately $332 million and $221 million,
respectively.
In the nine months ended June 30, 2000, Comdisco Ventures group
originated leases through approximately two hundred and fifty separate
transactions, representing total commitments of approximately $536 million.
Venture debt
Historically, Comdisco Ventures group's venture debt activities have
consisted primarily of the direct origination of debt financings to customers
pursuant to subordinated, secured loan agreements. These loans bear fixed
interest rates over the prime rate and are usually repaid in thirty-six monthly
installments. Typically, the customer makes several months of interest-only
payments, the balance being amortizing installments of principal and interest.
In addition, fees may be paid to Comdisco Ventures group at closing.
These subordinated loans typically have been secured by a lien on all of
the customer's assets, which, in most cases, is subordinated to the lien of the
customer's senior lenders. Comdisco Ventures group's loan documents usually
contain cross-default provisions and may have specific provisions governing
future financing or pledging of assets. Occasionally, Comdisco Ventures group
makes unsecured loans to companies in anticipation of an acquisition, initial
public offering, or a longer term venture financing. These unsecured loans are
typically short-term or payable on demand by Comdisco Ventures group. These
unsecured loans involve more risk than secured loans because Comdisco Ventures
group is a general creditor of the customer and has no priority claim on any
specific assets. However, the unsecured loans are made in anticipation of
events that should provide sufficient funds for repayment of the unsecured
loans. Because the unsecured loans involve more risk than secured loans,
unsecured loans command better economic terms, and therefore typically provide
higher interest rates, shorter terms, and higher warrant coverage and
conversion features. Comdisco Ventures group believes that the increased risk
from unsecured loans is not material because the amount of such unsecured loans
is small.
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During fiscal 1999 and 1998, Comdisco Ventures group committed $3.3
million in three unsecured transactions, and $2.5 million in two unsecured
transactions, respectively, representing about 0.9% and 3.7% respectively, of
total subordinated loan commitments. In the nine months ended June 30, 2000,
Comdisco Ventures group committed $7.7 million in two unsecured transactions,
representing about 1.5% of total subordinated loan commitments. One $7 million
unsecured loan was refinanced into a convertible loan three months later.
Comdisco Ventures group believes that the overall percentages of unsecured
loans to total subordinated loan commitments is not likely to materially change
in the future.
During fiscal 1999 and 1998, Comdisco Ventures group originated
subordinated loans through approximately 145 and 30 separate transactions,
respectively, representing total commitments of approximately $367 million and
$68 million, respectively.
In the nine months ended June 30, 2000, Comdisco Ventures group
originated subordinated loans through approximately one hundred and thirty-five
separate transactions, representing total commitments of approximately $522
million.
Hybrid Fund began funding subordinated loan financings in the third
quarter of fiscal 2000. Comdisco Ventures group will participate in the returns
generated by the fund as the sole limited partner and as a member of the
general partner of Hybrid Fund. See "--Hybrid Fund," on page 86.
Direct equity financings
Through December 31, 1999, Comdisco Ventures group provided equity
financing to its customers by directly purchasing common or convertible
preferred stock. Comdisco Ventures group generally purchases equity at a
valuation based on the most recent previous financing round to venture
capitalists or, as applicable, a current or contemplated financing round.
During fiscal 1999 and 1998, Comdisco Ventures group made direct equity
investments with approximately ninety and thirty-five customers, representing
approximately $39 million and $7 million, respectively.
In the nine months ended June 30, 2000, Comdisco Ventures group made
direct equity investments with approximately 140 customers, representing
approximately $113 million. As of June 30, 2000, Comdisco Ventures group has
made total direct investments with an original investment value of
approximately $174 million. Both of these amounts include the direct equity
investments made by Hybrid discussed below.
Hybrid Fund began funding direct equity financings beginning in the
second fiscal quarter of 2000, and since inception, Hybrid has made direct
equity investments with approximately 25 customers representing approximately
$17 million. Comdisco Ventures group will participate in the returns generated
by the fund as the sole limited partner and as a member of the general partner
of Hybrid Fund. See "--Hybrid Fund," on page 86.
Overview of Financing Commitments and Equity Holdings of Comdisco Ventures
Group
Comdisco Ventures group believes that it is one of the largest sources of
venture leases and venture debt in its market.
New lease, debt and equity commitments
The following table illustrates total new lease, debt and direct equity
commitments made by Comdisco Ventures group during each of the last five fiscal
years and the first six months of fiscal 2000.
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Total New Commitments By Fiscal Year
1995-Current
(in millions)
<TABLE>
<CAPTION>
First
nine months
1995 1996 1997 1998 1999 2000
----- ------ ------ ------ ------ -----------
<S> <C> <C> <C> <C> <C> <C>
Leases............................ $77.3 $103.5 $144.3 $220.6 $332.1 $ 535.6
Debt.............................. 2.5 7.5 19.5 67.7 367.1 521.6
Equity............................ 1.6 3.1 3.7 7.4 39.0 106.9
----- ------ ------ ------ ------ --------
Total........................... $81.4 $114.1 $167.5 $295.7 $738.2 $1,164.1
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