James F. Kenefick - Azafran Capital INSIGHTS Vol. 11

YOUR EYE ON INNOVATIVE MACHINE LEARNING SOLVING REAL WORLD PROBLEMS

Azafran Capital Partners

INSIGHTS What’s It All About, Alpha?

In the VC world Alpha means different things to different funds and managers - following are thoughts & highlights from Azafran’s take on Alpha We think about transformational value 24/7 and want to share our insight here on what it means to generate this value. Often referred to as alpha, so let’s be clear that we are talking about return on capital above a generally accepted return. In this case, we choose the S&P 500 Dividend Reinvested return (Index 1), as the generally acceptable starting point/benchmark.

Therefore to generate alpha we are talking about returns that should exceed Index 1 over the following periods; 2.2x (01/2000-12/2019) or 2.4x (01/2010-12/2019). source: S&P Market timing is generally unpredictable and no investment return discussion is complete without noting that if an investor mistimed just a handful of S&P 500 trading days, returns would be much lower, even negative.

Technology alpha in the US is now well embedded in the big names of the S&P 500 now lead in large part by FAANG/FANG/MAGA and some of the major industrials. These companies have spent 20+ years successfully developing and maturing into platforms of consumer focused technologies around advertising, data, connectivity and networking.

These platform companies are maturing, developing and acquiring in this next wave of technology development in their own search for alpha.

So let’s benchmark the S&P 500 Dividend Reinvested Index in the last 5-years as these technologies and companies continue to mature and this period returns 1.7x (01/2015-12/2019). I think we can all agree the S&P 500 is clearly a great place to be proportionally allocated for the long term and 1.7x forms our base case, Index 1.

We are in the midst of the most rapid acceleration of technology the world has experienced, maybe ever. From health care to industrial automation, entrepreneurs across the globe are developing incredible, groundbreaking solutions and technologies to take advantage of the base layer elements created since the advent of the Internet.

Now we should think about generating alpha outside the public capital markets precisely because these technologies are maturing in an era when technology continues to evolve rapidly. The deep technological evolution taking place is creating the next wave of transformational value. A commonly held thesis is that, a portion of this alpha will likely develop inside of the S&P companies, but the majority of this alpha will flourish in private companies. Many of which are obscure, unknown and early-stage today.

It is our belief that many of these private companies will stay private longer and many will not even make it to IPO as the mature players strategically acquire the earlier stage innovators and challengers to generate their own alpha.

The top tier of VC performance has been close to 2.4x. Overall, though, VC performance has underperformed our S&P Index 1 benchmark. Another crucial consideration in determining alpha is the VC ratio used to measure it. We often see it measured with total value to paid in capital (TVPI) which effectively marks the “book value” of the portfolio, versus distributed value to paid in capital (DVPI), which is more focussed on liquidity by measuring how much capital has been redistributed to LP’s, (even if reinvested in a multi-fund capability). [Continued on Page Two] Azafran INSIGHTS © Azafran Capital Partners 2020 - All Rights Reserved

issue ELEVEN issue eleven FOCUS At Azafran Capital Partners, we are an early stage venture fund investing in companies ($2M to $8M) that are using deep learning and machine learning, emphasizing voice, acoustics and imagery datasets in the health, wellness, IoT / automation and enterprise spaces.

Issue Eleven of INSIGHTS focuses on the Azafran’s definition of Alpha, as seen through the eyes of our General Partners. In addition, we have our ongoing series From the Road as we scour the globe for the best founders and companies that fit our thesis. We also highlight some notable and informative reports out in the past month that help prove out and back up the Azafran investment thesis/Alpha.

Issue Eleven will also be accompanied by our first podcast, Azafran INSIGHTS, which we will be releasing as part of each issue to provide more insight and backdrop to the contents in the issue and highlight the experience and perspective of the Azafran team, our partners and portfolio.

Kicking things off below with a quote and conclusion of a great article by Nathan Heller in last month’s New Yorker:

A new generation of smaller-scale venture capitalists are indeed focussing resources on startups led by people underrepresented in tech leadership, and, for the first time, Venture World is starting to pay attention to the interests of everyone it serves.“ Is Venture Capital Worth the Risk? New Yorker - Nathan Heller, January 2020

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Azafran Alpha [Continued from Page One] The Azafran team is focussed on DVPI supported by our specific fund thesis, and it’s defined timing to liquidity, as well as the increasing demand and dynamics of secondary private equity/venture capital market for attractive multiples and early liquidity ($100B market and growing at a 38% CAGR). source: Lazard/Preqin The Azafran track record also supports our statement of alpha, across our defined time basis, in the 3.5x to 5.8x range, true alpha.

market PREDICTIONS Buyouts on the Rise ●

2019 Mean Value of M& acquisitions in U.S. Technology Sector was $175M versus $129M in 2018 and $107M in 2017

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PE shops now account for a fifth of all VC exits

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That's a sea change from prior years,when IPOs and acquisitions were the only options

Here is the summary on how Azafran Capital Partners achieve alpha and outperforms: In 2019 our in-house research team tracked $23B of transactions in our defined market, up from $9B in 2018 and $4B in 2017. This highlights the growth dynamics of our market. AI & ML Series A returns are +40%. Between 2x and 3x higher than broader tech sector source: PitchBook also a contributor to alpha. There is a gap in the market between $2M to $8M, due to the fact that most early stage investment is happening below $1M or above $10M.

Source: Aranca, PWC

Azafran invests in that gap and we are one of just 4 Deep Tech Funds, out of a total of 120 Deep Tech Funds globally, between $100-$200M based in the U.S. Northeast. Our geographic focus is away from SFO, from Austin/Denver to eastern edges of Europe.

This is Azafran’s Fund 2, our Fund 1 proved our investment thesis and is performing above 4x. Our multi fund strategy enables LPs to take advantage of performance DVPI, and reload.

We invest in value not volume. And we build value, ask our portfolio companies. Azafran partners are longtime YPO and EO members and leaders with deep technology startup, operations, biz dev, investment experience. We have a passion for entrepreneurs and actively leverage our connections to over 40,000 companies globally, with over $10 Trillion in revenues, to help build and grow our businesses.

Just like timing the S&P, investors need to consider the long-term platform-oriented VC. Our investment in the early stage investment gap and our Team’s real world value to founders, drive above average ownership interests at optimal valuations. The median hi-tech M&A exit EV is $175M (growing at a 28% CAGR - over $23.4B in 2019), source: PitchBook meaning we don’t need ‘Unicorns’ or IPOs to generate our alpha. We focus on greater absolute returns and DVPI. Much of this alpha capability is about careful research, consideration, execution, and we held back a few trade secrets.

Source: Aranca, PWC

NEWSWORTHY… AI and Machine Learning Outperforming Rest of VC Investments The chart to the right and detail below highlights AI/ML trend outperforming all other aspects of the investment landscape: [Pitchbook] “Emerging technologies show robust results compared to broader tech startups. Drilling down to the vertical level, we see impressive VC return metrics from fintech and AI & ML startups, outperforming the overall technology space. Given the nascence of these areas, the natural progression will be for competition to increase and drive down performance, but for now investors have been rewarded.

Evidence mounts for specialization as a differentiator...this is also key for LPs to consider when making allocation decisions.

Next, we looked at the AI & ML vertical, which has seen a precipitous growth in VC investment of over 1,400% from 2013 to 2018. Of those myriad AI & ML businesses that received funding, many achieved impressive exits. The gross and adjusted returns for this segment are the highest of the slices we analyzed in this research, with adjusted annualized returns coming in at 35.6% for Series D at the lowest and ranging up to 50.2% on Series C investments.”

Excerpt from the 2020 report: VC Returns by Series: Part II How sector and vertical breakdowns affect adjusted returns Azafran INSIGHTS © Azafran Capital Partners 2020 - All Rights Reserved

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from the ROAD Highlights from Conferences, Pitch Days, Openings and other Events around the U.S. and World Standard procedure and part of the Azafran team process - we are out on the front lines every week, attending and speaking at conferences, events, pitch days, openings. We are all seasoned entrepreneurs, operators and start up geeks so this part comes easy for us.

It also is crucial to delivering on the Azafran investment thesis, one more way we are staying on top of the latest companies, partners, and tech that is hitting the street, and most importantly, helping us to find the best companies that fit our thesis.

Upcoming Events and More From the Road Team Azafran will be on hand for the CTO/CIO Edition of the BCI Tech Summit in NYC this March 6th and 7th. The event is focused on the disruptive technology space through the lens of Fortune 500 CTOs & CIOs. We are excited to be moderating a panel the first day, Disruption Through Digital Transformation.

Downtown Redwood City transformed into a startup mecca with the historic Fox Theatre at the center

We’ll also be at SXSW, focusing our energies on the Innovation/ Enterprise Track but of course taking in as much of the cultural zeitgeist as time permits. We’ll also be meeting with some of the local incubators/accelerators in Austin, including the Capital Factory, looking to expand the Azafran ecosystem.

As always, please let us know if you would like to schedule a meetup as we are constantly criss-crossing the U.S. and Europe and it won’t be long before we’re in your corner.

Startup Grind Global 2020 - Silicon Valley

Please email us at insights@azafranpartners.com to setup a call or meeting.

Redwood City, CA Add nonstop panels, pitches and hundreds of startups exhibiting their wares, add in a sprinkle of perfect Bay Area weather, a scene built for the Azafran team.

Global 2020 is an important event for startups, tech leaders, and big brands at the forefront of innovation. Over 10,000 people from around the globe converged on Silicon Valley for 2 days of nonstop education, inspiration, and invaluable networking spanning 10 stages, 100+ sessions, and social events.

It’s really a one-of-a-kind experience and from the hundreds of startups there we spoke with dozens in the ballpark of our thesis and deep conversations with a number of them who we will be adding to our watchlist.

Overall, the event was a smash and one we’ll have on our annual list to visit. The invited startups are carefully curated and almost across the board were in position for a late seed or early A round investment, with revenues or meaningful pilots in action.

Azafran INSIGHTS © Azafran Capital Partners 2020 - All Rights Reserved

The SG Pitch Stage was in action almost the entire 2-day conference, with hundreds of founders and companies pitching their special sauce

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AI and Security [VentureBeat] Great new series from VentureBeat focusing on AI and Security, lots of depth and perspective following is an excerpt from the editor’s notes and a link to the series is below: “Both AI and cybersecurity are nearly omnipresent in our daily lives, and the intersection of the two is of increasing importance as our world becomes more connected, more “intelligent,” and more reliant on online or automated systems. AI technology can impact existing problems in cybersecurity, national security, physical safety, and even media consumption.

The threats are sometimes more sophisticated than ever — but often not. As attack and defense systems evolve, the need for human expertise becomes more imperative — not less. And some of the seemingly most onerous threats, like deepfakes and the increasing presence of AI-powered cameras, have practical and political solutions.

The technology is evolving, and so are the threats; the threats are evolving, and so is the technology.”

Link to the series here.

IN THE KNOW Artificial Intelligence Investment Segment Outperforms “The AI & ML vertical has seen a precipitous growth in VC investment of over 1,400% from 2013 to 2018. Of those myriad AI & ML businesses that received funding, many achieved impressive exits. The gross and adjusted returns for this segment are the highest of the slices we analyzed in this research.”

Source: Pitchbook

Number of Published Papers More Than Doubles “In 2019, the number of published papers related to AI and machine learning was nearly 25,000 in the U.S. alone, up from roughly 10,000 in 2015.

And NeurIPS 2019, one of the world’s largest machine learning and computational neuroscience conferences, featured close to 2,000 accepted papers from thousands of attendees.

There’s no question that the momentum reflects an uptick in publicity and funding – and correspondingly, competition – within the AI research community. But some academics suggest the relentless push for progress might be causing more harm than good.”

Source: VentureBeat AI Weekly

voice-acoustics-imagery & AI/ML Industry Snapshot At a Glance: Top 5 Markets & Global

413 West 14th St. - Suite 200, New York, NY 10014 p: +1.212.913.0700 insights@azafranpartners.com AzafranCapitalPartners.com Azafran INSIGHTS © Azafran Capital Partners 2020 - All Rights Reserved

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