Hello,

Do you expect to make more personal compensation next year than this year?  Feeling more confident or less confident in the President’s Economic team?  Your thoughts on Newt or Mitt?  Annually we ask our readers to weigh in and share their level of confidence in themselves, the economy and their businesses.  Last year we heard significant confidence – was it warranted?

Semaphore is conducting its fourth annual survey of Private Equity and Venture Capital partners, principals and professionals supporting the industry. The purpose of this survey is to gather input from our industry friends and clients with the results reported to all current subscribers of the Semaphore PE Signals Blog and our monthly Semaphore Reporter, as well as the subscribers of Term Sheet.

By participating you’ll get to gauge your expectations with your peers, competitors and industry colleagues. The survey will take 2-3 minutes and respondent identity will not be reported to us.  Results will be published in the Semaphore Reporter and the Semaphore PE Signals Blog as well as in Term Sheet and on our website www.sema4usa.com .  Take the plunge.

Click here to take the survey.

Click here to see last year’s results.

Semaphore Forms Joint Venture with Topline Strategy

to Provide Technology Due Diligence

As you may have read in our last S4 Reporter, Cris Miller, the founding director of our Technology Due Diligence Practice retired last Friday September 30^th. With Cris’ departure, we decided to form a Joint Venture with Topline Strategy, a Boston-based provider of strategy consulting services to technology companies, in which Topline will take over day-to-day management of the practice.  It will operate under the name The Semaphore Technology Diligence Practice.

Over the last 5 years, we have formed a close partnership with Topline Strategy, working on dozens of engagements together. Together we’ve been able to provide our clients more complete answers to questions about their technologies and the markets for those technologies. 

With the retirement of Cris Miller, who was the driving force behind our Technology Due Diligence practice, we thought the best way to continue our commitment to clients as well as grow the practice was through a Joint Venture with Topline Strategy. Through our long partnership, the Topline team has demonstrated a true understanding of Technology Due Diligence as well as built strong relationships with our principal technologists and major clients. Having them take the business forward was a natural.  We have been working together on the creation of, and transition to this, Joint Venture for the last three months.

As part of the agreement Cris Miller will be joining Topline Strategy as an advisor and Topline Strategy will continue to work closely with our Private Equity Advisory group, providing both strategy consulting and technology due diligence services to Semaphore’s clients and portfolio companies.

As Topline Strategy will be the operating partner in our Joint Venture, going forward, please feel free to contact Jon Klein (jon@toplinestrategy.com) with any questions about Technology Diligence or visit its website www.toplinestrategy.com. Of course, you can also reach me (mdisalvo@sema4usa.com) if you have any questions.  I know you join us in wishing Cris well in his retirement as Topline and Semaphore  continue to fulfill our common promise and commitment to aiding investors and the M&A community with the right knowledge and correct solutions to ensure success.

Mark S. DiSalvo is the President and CEO of Sema4 Inc., dba Semaphore (www.sema4usa.com), a leading global professional services provider of Private Equity funds-under-management. Semaphore currently holds fiduciary obligations as General Partner for seven Private Equity and Venture Capital funds, is a New Markets Tax Credit lender and advises General and Limited Partners as well as corporations around the world. Semaphore’s corporate offices are in Boston with principal offices in New York and London.

Blog 3 of 3 in the Due Diligence Often Discovers Discrepancies series

I expect that there are many folks out there who will challenge our analysis.  I’ve anticipated some of the objections and have addressed what I think are the three major ones below.

 1. Shouldn't some of the points that we reallocated from Watson to Ken have gone to Brad, lowering Ken's revised total? While that is true, Brad would have also taken additional points from Watson. If we had data from Brad, we expect that the gap between Watson and Ken would be narrower, but that Ken would still enjoy a solid lead.

2. What about Game 1? Watson did even better in Game 1 than it did in Game 2. Wouldn't that have kept Watson the winner? Probably not. The reason Watson racked up such a huge total on Game 1 was that it answered 29 of 32 questions correctly in Double Jeopardy.  I didn't have a tape, but I believe Ken and Brad also knew many of those answers and were shut out by the buzzer. Allocating those responses across players would have put one or both players within striking distance when they got to Final Jeopardy. Watson blew Final Jeopardy with a comically bad answer to an easy question.  So, what would likely have happened is it would have been in second if not third place heading into Game 2

3. What about the humans' own "unfair advantage".  Humans tend to ring in before they know the answer and then have several seconds to figure it out. If they had to answer right away like Watson, wouldn't Watson cream them?  While this is true, I take exception to the notion that this represents an advantage for the humans.  Instead, this represents a fundamental difference in how computers and humans process information.  While it can take humans a few seconds to work out the right answer, we can intuit nearly instantaneously whether or not we will be able answer the question. Great Jeopardy players have great intuition and rarely get questions wrong after they ring in, as Ken Jennings demonstrated by getting just 1 question wrong in Game 2. Watson on the other hand seemed to either come to an answer very quickly or never got there. It doesn't have intuition and more time didn't appear to help it significantly. Changing the rules to take out the intuition factor would shift the advantage to Watson but would be counter the goal of the contest - figuring who is better at answering questions.

Let us hear your objections and observations.

__________________________________________

This article was contributed by Jon Klein. Jon is the founder and general partner of The Topline Strategy Group, a strategy consulting and market research firm specializing in emerging technologies. Jon brings a unique blend of strategy consulting and hands on operating experience to The Topline Strategy Group and works closely with Semaphore on a variety of engagements.

Blog 2 of 3 in the Due Diligence Often Discovers Discrepancies series.

As I said in my previous Watson blog earlier this week, Watson, a computer built by IBM, faced off against Ken Jennings and Brad Rutter, the two greatest Jeopardy players of all time and trounced them.  In a two day match, Watson earned $77,174 to Ken Jennings' $24,000 and Brad Rutter's $21,600. While the results seem to show that the human race's crown as Jeopardy masters has been passed, a deeper analysis of the facts tell a different story.  I have no doubt that one day a computer will be Jeopardy champion, but that day isn't today. What you saw wasn't a fair match among opponents but rather something that was closer to an infomercial demonstration where the product produces "too good to be true" results based on a tilted playing field.

Now back to the game...In Jeopardy, you're not allowed to push the buzzer right away. You have to wait until Alex finishes reading the question.  At that point, a light goes off and then you can ring in to answer.  If you try and anticipate the light and ring in too early, you are locked out for a quarter second, meaning that there is next to no chance to win the buzzer race. This is where Watson's unfair advantage comes in.  If during the period Alex is reading the question, Watson comes up with an answer that it thinks is right (based on my observation, that would be an answer that it has scored as having an 80% or more probability), it can ring in just 10 milliseconds after the light goes off - enabling it beat the human contestants, with their mere mortal reflexes, to the buzzer every time.  So, even when the human contestants know the answers, Watson gets all of the points. The Jeopardy results didn't accurately reflect Watson's question answering ability, they reflected the combination of its question-answering ability plus its superhuman reflexes.

So how would Watson have fared if it had to rely on just its question-answering ability?  To answer that question, we analyzed the results of Game 2 of the two-game series (Ideally we would have analyzed both games, but since we only TIVO'ed Game 2 and the match isn't available online, it'll have to do). In Game 2, the three contestants scored as follows:

-                Watson: $41,413

-              Ken Jennings: $19,200

-              Brad Rutter: $11,200

 However, final scores aren't necessarily a good measure of how each player fared. They are highly dependent on how players bet in the Final Jeopardy, who gets Daily Doubles and how much they bet on Daily Doubles. Taking out Final Jeopardy and Daily Doubles, the players scored as follows:

-                Watson: $25,200

-              Ken Jennings: $14,600

-              Brad Rutter: $5,600

In watching the game, it was pretty easy to tell when Ken Jennings wanted to ring in but was beaten to the buzzer by Watson.  He held the buzzer chest high and you could see when he pressed the trigger and lost. Since Brad Rutter kept his buzzer below the podium, it wasn't possible to tell when he tried to ring in.  But, the data from Ken Jennings is enough to figure out the impact of reflexes.  Of Watson's $25,200, $19,200, all but $6,000 worth, was won on questions where Ken Jennings tried to ring in.  Had Watson and Ken had equal reflexes, it stands to reason that Ken would have buzzed in first in half those cases.  Adjusting for reflexes (including the possibility that Ken would have rung in first and gotten it wrong, hurting him instead of helping him) would add $9,088 to Ken's score and taken off $9,344 from Watson, giving revised scores for those two players of:

-                Watson: $15,856

-              Ken Jennings: $23,688

Since both Watson and Ken Jennings got the Final Jeopardy question right, instead of losing, Ken would have had a sizable victory over Watson.  In conclusion, we’ll end this post with our own game of Jeopardy.

Category: Man vs. Machine  

$1,000 Clue: As of February 16, 2011, although not the fastest to the buzzer, these biological beings were still the best at answering Jeopardy questions.

Question: What are Humans?

Look for our next blog and the final on this series where our partner and colleague Jon Klein of The Topline Strategy Group explores what he feels are the three top objections.

This article was contributed by Jon Klein. Jon is the founder and general partner of The Topline Strategy Group, a strategy consulting and market research firm specializing in emerging technologies. Jon brings a unique blend of strategy consulting and hands on operating experience to The Topline Strategy Group and works closely with Semaphore on a variety of engagements.

Our partner and colleague Jon Klein of The Topline Strategy Group explores one very public example.

Earlier last month, Watson, a computer built by IBM, faced off against Ken Jennings and Brad Rutter, the two greatest Jeopardy players of all time and trounced them.  Or was it rigged?

First we'll look at the Watson backstory.  When the project was approved, management explicitly required that the technology could be commercialized.  Back in the 1990's IBM invested heavily in a project that resulted in Deep Blue, a chess playing phenomenon that went on to beat the best human player, Gary Kasparov.  While the company won bragging rights, it turned out that there were no commercial applications for the technology.  IBM didn't want to make that mistake again. When Watson was approved, it was done so with the belief that its question answering technology could be applied to many fields including healthcare, as an expert diagnostic assistant to help doctors, and retail, as a next-generation recommendation engine.

 Over the years, I have seen many mind blowing demonstrations of gee-whiz technologies that never achieved commercial success.  Each time investors got frustrated with the progress of the business, the management team would cook up another demo which promised that a breakthrough was just around the corner...and in the process, relieved the investors of several million more dollars. The most egregious cases are the ones that have created some of the most high profile public flops (think the Apple Newton). My analysis is that IBM execs just witnessed one of the best gee-whiz demos of all time and before they sink in any more money, they should have independent market and technology due diligence performed on Watson’s commercial prospects. The critical question they need to answer is:  Can this generalized question-answering technology actually provide enough value over the purpose-build expert systems that already exist in fields like medicine to justify its cost? It’s a question that the Watson team cannot answer. They have too much personally invested in the program to come up with any answer other than ‘Yes’.

Look for our next blog coming soon where we'll get to know how the game was rigged in Watson's favor.

                        __________________________________________

This article was contributed by Jon Klein. Jon is the founder and general partner of The Topline Strategy Group, a strategy consulting and market research firm specializing in emerging technologies. Jon brings a unique blend of strategy consulting and hands on operating experience to The Topline Strategy Group and works closely with Semaphore on a variety of engagements.

Posted by Mark DiSalvo on Tuesday, January 25, 2011 @ 12:30PM

Is 2011 a Wasteland or Playground?

By Mark S. DiSalvo

It seems my industry colleagues have continued to be wrongly optimistic about their personal income against a backdrop of continued and decided lack of confidence in the economy and their national governments.  That appears to be the clear read comparing the raw data from the 3^rd annual Semaphore Confidence Survey with last year’s results. 

Let’s start with pay.  At the start of last year 78% of the over 500 respondents to the 2010 Confidence Survey believed they would earn more money than the prior year.  The truth was that only 36% of this year’s respondents reported they did in fact earn more than the prior year.  Importantly though is that only 11% of respondents earned more money two years ago against that prior year baseline, clearly signaling at least a change in how some shops are valuing their talent. This must be counterweighted by the realization that 45% earned less than last year – carry not being what it used to be.  Nonetheless, not unlike last year, my colleagues firmly believe that the next year will provide the big score as nearly 75% of this year’s respondents believe they will earn more money than last year.  If they are right, then next year the national deficit will be on the decline despite no increase in upper tier taxes or capital gains and the real estate market will be certain to see significant rebound.

Our peers demonstrated their personal income optimism with their LPs pocketbooks too. In the beginning of 2010, fully 98% thought they would make up to six investments.  The year did not go as strong as hoped with only 11% doing six deals or more, but 76% closed 1-3 deals. Further, those deals were as large as expected with 73% self reporting their deals were in excess of $25 Million in each discrete investment when they anticipated 76% of their deals would be above $25 Million in size at the time of last year’s survey. 

And in what are we investing?  Unlike the year before when our respondents chose three new investment areas in the top three, the industry stayed rather consistent. Enterprise Technology and Health Care were 1 and 3 and Social/Community Technology took the second spot in that list, breaking the top 5 for the first time.  Sustainable Energy/Cleantech and Gaming (not even top ten last year) were 4^th and 5^th.  Last year the survey indicated investors were apparently smelling money and opportunity in Obama-care. As one person noted, “…when you mess with 16% of the economy something’s got to break our way.” We’ve yet to see if that comment is correct or merely hopeful but investors intend to remain active, according to our survey, in that space.

The just over 500 who did reply this year were similar to last year’s mix of VC and Buy-out pros, with a slightly higher representation of operating executives responding.  One thing for sure is that this year’s mix of survey takers were very high on themselves believing that 78% (63% last year) were confident in their business and  84% (77% last year) confident in the person who sits down in front of their computer each morning. They even had increasing confidence in their bosses with 75% expressing that view - a full 25 points higher than last year and triple the year before.

This personal and professional confidence does not extend itself to America’s political leaders.  While respondents were hard on President Obama and his economic team with only 36% expressing confidence in the President; it was more that triple the 11% expressed last year.  His economic team did not fare as well with 49% (55% a year ago) dissing Larry Summers et al.  

A 7X return is spectacular in a year but when it comes to Congress it is de minimis as its favorability improved over last year’s 0% reply of confidence in Congress to 7% with 77% (65%) stating no confidence in the folks under the Capitol Dome.  Apparently it does not matter which party is in control of the Congress. State governments and state legislatures earned a doubling of confidence to 27% (you should know that the top states replying were MA, CA, NY, NJ, NC and IL).  While confidence has skyrocketed for the President and crept upward, however marginally, for other pols in America, international respondents had crushingly poor opinions of their governments with fully 71% having no or little confidence in their countries leaders, more than double the 31% of a year ago.  The preponderance of our international respondents were from the UK with most  replies coming, in order, from Germany, Switzerland, Japan, France and China. 

To see the highlights of the results of the 2011 Semaphore Confidence Survey please click here.  If you want to do your own comparison, the 2010 Semaphore Confidence Survey results are here.

As usual there was a bit of entertainment offered by our none-too-shy contributors. One offered that “This was a terribly written survey,”…alas.  There was the usual partisanship with strong comments about “not believing the positions the Republicans are taking” counterbalanced by charging that Obama “is a socialist with desire to make US a 3^rd world country”.  While there is little danger of we becoming Sweden in a hurry there were many serious comments reflecting state budget shortfalls, pension liabilities, and a belief in significant New Year investment opportunity with many industry recommendations.  One notable recommendation offered was “I have never felt as strongly about the investment opportunity presented by vertical farming,” who knew? 

A cottage industry has grown about the infamous response in our inaugural survey “PE is dead and I wish my boss were too.”   Many wondered where “he” was and hoped he would surface. He didn’t.  One survey taker suggested that “he must be serving time without access to internet.”  Many have tried their hand at PE Killer’s NY Post style headline writing skills (maybe he got laid off from Wall Street in ‘08 and is now working for Murdoch?).  One offered that “VC is a wasteland. PE is a playground (unless your name is Guy Hands.)”  Ouch! We’ll check back next year to see what side of the seesaw we will actually experience in 2011.  

Mark S. DiSalvo is the President and CEO of Sema4 Inc., dba Semaphore (www.sema4usa.com), a leading global professional services provider of Private Equity funds-under-management and technology diligence services. Semaphore currently holds fiduciary obligations as General Partner for seven Private Equity and Venture Capital funds, is a New Markets Tax Credit lender and advises General and Limited Partners as well as corporations around the world. Semaphore’s corporate offices are in Boston with principal offices in New York and London.

Posted by Cris Miller on Wednesday, October 13, 2010 @ 9:30AM 

Marketing Due Diligence

Last Thursday there was a Happening…Monsters of Pork… at Petit Robert as part of a spectacular program of market oriented seminars and symposia under the brand Future M.  The pork party was a real experience.  I had been to the location before for quite an elegant lunch.  The restaurant has changed hands, not quite as fancy, more bistro than formal dining.  There were 100s of people and to this grizzled veteran they all appeared under 15…well maybe under 30.  Most of the folks I talked to did not know why they were there, other than to be part of a happening.  And it was that. Every half an hour, in a separate room, they packed patrons in and dissected a pig.  Knives and cleavers flew while hog-heads fell, ribs retrieved and internal organs separated.  A bit of food was passed and quickly disappeared, although generous vodka drinks were served, so no one seemed to mind.  I missed the pulled pork as it did not show up in the hour and a half I was there.  A great time was had by all.   The Miller rating for a Boston “happening scene” - 90.  The Miller rating for leads/new business – 0 (but you never know).  Who knows, maybe I’ll kill a wild bore someday and will have learned plenty.  For sure, there was nothing boring about this event.  Thanks BzzAgent.

Posted by Cris Miller on Thursday, September 23, 2010 @ 10:45PM 

I field calls from GPs and CEOs all the time.  Invariably they are doing a deal, whether investment or acquisition, and need either verification that the technology and/or markets targeted are real or a product exists and someone wishes to buy it in the future.  Less often we get calls from Board of Directors.  Those calls are less exact as to what the caller requires.  A lot of it is because the Board member making the call carefully ensures that they have not lost confidence in the CEO (even if that is not the case) and are fulfilling independent diligence on the company itself, the markets or an acquisition opportunity.  

A while ago we had a call for help from the Board of Directors of a growth stage technology company.   After discussion, it was evident there was agreement that the firm needed to conduct both technology and market due diligence for their company.  Initially the request was for a technology review to determine the viability of commercializing the core platform technology upon which two successful products had been built. 

The CEO was a technology wizard while the Board was comprised of non-technologists and retired business people.  After Semaphore’s chief technologist had reviewed the platform product’s architecture, patent and documentation, we had a review session with the CEO.  The discussion immediately dropped into techno-jargon only the brightest geeks could comprehend and appreciate.  The conclusion was that the product was adequate for internal use but was deficient in form and substance for outside consumption.

The CEO reviewed the findings with the Board who had market/business questions about the size of the market for such a product, the competition for such a product and the value of the product.  Our market research/strategy group took the baton and came back with some interesting results that were presented directly to the Board.  It was intuitively obvious to the casual observer that:

1. The product in its current condition was a non-starter
2. The market for the product if it were “cleaned up” would have 5 world class competitors and 10 mid-market competitors
3. The product in its new state would be woefully deficient in features, so much so  that its value would be difficult to sell at any price
4. The effort should be scuttled

The lesson learned here was in order to get the correct answers, the Board needed to be educated to the best of its understanding.  To accomplish that education, independent technical and market due diligence was necessary.  The readily available technical answer alone was not sufficient since the product could have been improved.  It took the market diligence, in concert with an agreed technology product plan, to make the business case not to proceed with the questioned direction. 

Crispin Miller is the head of the Diligence Practice at Sema4 Inc., dba Semaphore (www.sema4usa.com), a leading global professional services provider of Technology and Marketing diligence, and Private Equity funds-under-management services.  Semaphore currently holds fiduciary obligations as General Partner for seven Private Equity and Venture Capital funds, a New Markets Tax Credit lender and advises General and Limited Partners as well as corporations around the world. Semaphore’s corporate offices are in Boston with principal offices in New York and London.

Posted by Jon Klein of The Topline Strategy Group on Thursday, July 14, 2010 @ 2:15PM

Blog series 4 of 4

Conducting Pipeline Interviews

There are two keys to conducting Pipeline Interviews. First, make sure to interview accounts at a variety of stages in the pipeline. The reasons why prospects don’t progress past the first meeting  usually concern the fundamental fit of the product while prospects that drop out later in the pipeline  typically don’t close due to issues related to value proposition. You have to conduct interviews with accounts at different stages to get the whole picture.

Second, never interview live prospects. Since they haven’t yet fallen out of the pipeline, you don’t know for sure that they aren’t going to buy. Therefore, they aren’t reliable data points as to why prospects don’t buy. In addition, the last thing you want to do is interfere with a sales opportunity.

            __________________________________________

This article was contributed by Jon Klein. Jon is the founder and general partner of The Topline Strategy Group, a strategy consulting and market research firm specializing in emerging technologies. Jon brings a unique blend of strategy consulting and hands on operating experience to The Topline Strategy Group and works closely with Semaphore on a variety of engagements.

To read the full White Paper, please go to Semaphore News and click on the May 3, 2010 link titled - White Paper – Market Due Diligence

Posted by Jon Klein of The Topline Strategy Group on Thursday, June 17, 2010 @ 10:00AM

Blog Series 3 of 4

Pipeline Interviews: The Missing Piece

At this point, you may be thinking, "The analysis addressed the overall market size, the potential penetration of the market, and the company's likely share. Shouldn't that be enough?" Actually, it isn't. The typical due diligence process is based on the critical assumption that the accounts that have purchased a solution from the company or its competitors are fundamentally the same as accounts that have not yet purchased. Given enough time, the non-buyers will eventually buy a solution if it has a strong value proposition.

But what if that assumption is wrong? What if the accounts who haven't bought are somehow fundamentally different than the ones that already have purchased in a way that isn't obvious from segmentation factors like size or industry? If that is the case, then ‘I haven't purchased yet' becomes ‘I'm never going to purchase' and the market is far smaller than calculated. And, if the market is smaller than you calculated, the company may never reach its revenue projections.

Pipeline Interviews: Interviews with Accounts that Fell Out of the Pipeline without Making any Purchase

So how do you sort out whether or not you have an ‘I'm never going to purchase' problem? The answer is through Pipeline Interviews. Only prospects that have had sales interaction with the company but decided not to purchase anything can answer this question. They know whether their decision not to buy is primarily a timing issue or is due to something more fundamental.

Continuing with the CRM for Law Firms example, it turns out that approximately 30% of law firms with over 100 people have a fundamentally different selling model than one that is supported by a CRM. Examples include firms who primarily serve consumers and those that focus on a very narrow subspecialty and act as a subcontractor to general practices. These types of firms will never buy a CRM system since it doesn't fit their business.

In this case, the market turns out to be about 70% as large as calculated using traditional methods.   We have conducted numerous due diligence projects over the years where the market turned out to be a fraction of the size originally believed, including:

• A company providing translation management software where the real market turned out to be only 10% of the original target: $1B+ companies with 25% or more of their sales overseas. Many industries, such as aviation, do business solely in English everywhere, regardless of local language and do not need translation. Others, such as packaged goods companies, develop custom materials in each market and do not need translation either.
• A company providing software simulations for training repair technicians on maintaining products found that the real market was only 25% of the original target: $500M+ companies that provide low and medium tech equipment such as lawn mowers, pumps, and oil field equipment. Because the process of repairing each product is unique, a separate simulation is required for each product. For the cost of a simulation to outweigh its benefits, the product either has to have very large sales (over $100M/year) or a very long lifecycle (10+ years). The Pipeline Interviews revealed that most companies did not have a single product with sufficient sales (they had a wide range of smaller products) or a long enough lifecycle to make a simulation economical.

                  _______________________________________________________

This article was contributed by Jon Klein. Jon is the founder and general partner of The Topline Strategy Group, a strategy consulting and market research firm specializing in emerging technologies. Jon brings a unique blend of strategy consulting and hands on operating experience to The Topline Strategy Group and works closely with Semaphore on a variety of engagements.

To read the full White Paper, please go to Semaphore News and click on the May 3, 2010 link titled - White Paper - Market Due Diligence