Tuesday, October 10, 2006

Nuova Systems & Cisco: New Corporate VC Model?

So, let's take a couple steps back first.

Exactly one year ago, in October 2005, I got a call from my buddy Tom Lyon. He's just joined Nuova Systems and wants to tell me about it (and pick my brain). He sets the hook by telling me that this is the new gig for the power executive team that left Cisco just a few months prior. Hmm...

Tom and I go way back -- he served on my Board of Advisors at Allocity (acquired by EMC) and he founded a company, Ipsilon (also funded by Mohr Davidow Ventures), subsequently acquired by Nokia at which time he became the CTO of Nokia Internet Communications. And, oh yeah, we both were early on at Sun Microsystems. Tom's a better networking guy than I will ever be. He's also one of the nicest guys you'll ever meet.

Now, back a bit farther to July 2005.

Mario Mazzola, Chief Development Officer for Cisco, and three other senior executives all retire from Cisco at the same time. SearchStorage.com covers it in Cisco storage chiefs retire en masse:
Cisco Systems Inc. confirmed the retirement of four of its top executives Thursday night, including chief development officer Mario Mazzola and senior vice presidents Luca Cafiero, Prem Jain and Soni Jiandani.

All four were founding members of Cisco's Fibre Channel switching startup and "spin-in" Andiamo Systems Inc., and built the company's storage business from zero to become a major force in the industry.

But, of course, they didn't retire. They left to start a new company. It was called Nuova Impressa at that time and is now called Nuova Systems. When Tom called to invite me into the fold on the new gig, I was thrilled. So, in October 2005, I met with the four Cisco execs and a number of the other members that they had already added to their dream team. We covered both marketing and technology aspects of topics like datacenter virtualization, utility computing, grid computing, system management, next-generation datacenter interconnects, what large IT shops are buying, and the like.

From what I could glean about what they planned to build, this was going to be a company to watch. Definitely going big, high scalability, high performance, with a very nice architecture.

In addition to the four Cisco execs, they have added other exceptional talent, including:

  • Ed Bugnion (Founder & CTO of VMware)

  • Tom Lyon (#7 guy at Sun, founder of Ipsilon & Nokia Internet's CTO)

  • Ben Stoltz (Sun/Terraspring)

  • Joe Eykholt (ex-Sun hard-core kernel SMP/threads guy)

  • Peter Newman (Ipsilon switch architect)

  • Satya Nishtala (Sun Ultrasparc hardware Distinguished Engineer; did the Sun Starfire SMP system interconnect)

Very impressive.

Now, fast-forward to August 2006.

From the Nuova Systems website in Cisco Announces Investment to Focus on Data Center Development:
Cisco has committed certain technology and $50 million of funding to Nuova Systems with the possibility of up to $42 million in additional funding in the future. The subsidiary will be approximately 80% owned by Cisco, with the remaining 20% interest held by employees of the subsidiary. Because of Cisco's majority ownership interest, the accounts of the subsidiary will be consolidated with the accounts of Cisco starting in fiscal year 2007.

As part of the agreement, Cisco has the option to purchase the remaining 20% interest in this subsidiary. Should Cisco decide to exercise this option, the transaction would occur in late fiscal year 2008 or early fiscal year 2009. The potential payouts made under the call option are primarily based on the success of Nuova Systems' products sold through Cisco, with a minimum potential payout of $10 million and a maximum total payout of $578 million.

I like this model for Corporate Venture Capital. It makes a lot more sense than the usual Corporate VC approach. This is a clearly strategic move for Cisco. And, for the entrepreneurs, it takes a huge piece of the risk out of the equation and allows them to focus on the business.

This is similar, but different, to what happened with Andiamo and Cisco. With Andiamo, Cisco put in about $84M to build the business, then bought it for about $750M. With Nuova, Cisco has put in $50M, could put in $42M more, and has capped the purchase price at $578M. Those numbers make more sense to Cisco than what we saw with Andiamo.

Now, this also limits the upside potential for the Nuova Systems employees. If Cisco owns 80% of the business (post) on the $50M that they invested, that means that the post-money valuation would be $62.5M. That's a pretty high post-money, given the stage that the company is in, to be sure. But what about the subsequent $42M more of investment money? Would that dilute the employee's 20% or just fall into Cisco's 80%. I'll side with the employees on that point and assume that the employee pool will be 20% ownership at the time that Cisco buys them completely back (late 2008 or early 2009).

Result: Worse-case scenario for the employees would be sharing $10M. Best-case would be sharing $578M. So, if the $578M represents 20% of the company valuation in 2009, then the actual company valuation would be something like $2.89B. A number that big is not very likely to happen that soon for this company. But, they could credibly do a $100M payout which would be a $500M valuation by then.

However, what's great about this model is that there will be a spin-in event in the not-too-distant future for those folks. The more progress they make, the better the valuation will be. There will absolutely be cash to share. All are motivated, appropriately, to win.

I like it.

Other Related Articles:

One could see Cisco's spin-in strategy as a creative and rather intelligent way of running its business. We can't think of any major IT players that use this spin-in method as effectively. So, perhaps it's a competitive advantage.


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