Case study

CacheFlow: A Venture-Capital Deal

by Professor Ian H. Giddy,
New York University


Venture Capitalists 'R' Us
CacheFlow: The Life Cycle
Of a Venture-Capital Deal


1. Birth of CacheFlow Inc.

[CacheFlow 1]

March 13, 1996 - First, an idea. Then, the angels... Everyone wants quicker access to Web pages. Michael Malcolm, former president and CEO of Network Appliance, envisions a new company to do just that. The idea spawns CacheFlow Inc. The key: provide local storage, or "caching" -- hence the company's name -- of frequently used Internet data via an appliance added to customers' computer networks that helps them access most-used Web sites. He and partner Joe Pruskowski raise $1 million in seed capital loans from a dozen "angel" investors in San Francisco and Seattle.

August 1996 - Though CacheFlow has cash, venture firms bang on its door trying to get a piece of the action. Benchmark Capital Partners "were pretty aggressive," Mr. Malcolm recalls.

2. First financing from a venture-capital firm

October 1996 - Benchmark takes the lead in the first venture-capital financing, buying 3.2 million Series A preferred shares at 87.5 cents each. For its $2.8 million, Benchmark gets about 25% of CacheFlow. The angel investors turn their loans into Series A shares at the same price. Together, the founders, angel investors and a handful of employees own the remaining 75% of CacheFlow's shares. The money will be used to hire managers and develop the product.
January 1997 - Stuart Phillips, a senior executive at Cisco Systems, joins the board as an outside director, invited by Mr. Malcolm, who had worked for Mr. Phillips as a consultant in the late 1980s. Six months later, Mr. Phillips leaves Cisco to join U.S. Venture Partners, a VC firm.

June 1997 - Mr. Pruskowski steps down as president and CEO of CacheFlow for personal reasons, but keeps his 58,572 Series A shares. Mr. Malcolm becomes interim CEO.

August 1997 - The company begins getting feedback from users testing its prototype product. But there's still no sign of revenues. A possible initial public offering seems far off.

3. Testing of products

November 1997 - After product tests, CacheFlow seeks cash for marketing. Mr. Phillips convinces his new partners to pitch in some money.

December 1997 - Still no revenue. But U.S. Venture Partners gets 17% of CacheFlow in return for $6 million. Benchmark chips in $1.8 million to maintain its stake at 25%. The Series B shares are priced at $2.26: the company's value is up 158% in 14 months.

May 1998 - Finally, revenue! CacheFlow's sales total $809,000 in the next three months. Its client list grows to include Xerox, Delta Air Lines and Goldman Sachs.

June 1998 - Investment bankers start to woo CacheFlow's board. Objective: an IPO. A successful IPO would mean big fees for bankers -- and big returns for the venture investors.

March 1999 - Mr. Malcolm hires veteran tech executive Brian NeSmith as CEO. In his second week, Mr. NeSmith talks to venture capitalists about more financing. Technology Crossover Ventures pays $4.575 for Series C shares, or $8.7 million for 7% of the firm. Benchmark invests $3.4 million; U.S. Venture Partners $2.1 million. But their stakes are cut to 18% and 12% after stock option grants to CacheFlow executives.

4. Board interviews bankers
[CacheFlow 4]

July 1999 - Before selecting bankers, Mr. NeSmith uses the proceeds to hire new managers. Michael Johnson, another tech company veteran, joins as chief financial officer. "I'd been here three weeks when Brian tells me we're taking it public," Mr. Johnson says.

August 1999 - CacheFlow's directors begin grilling bankers interested in leading their IPO. Goldman Sachs is ruled out early: It has an underwriting commitment to rival Inktomi. By September, the team is chosen: Morgan Stanley Dean Witter will be in charge of the deal (CacheFlow likes its analyst, George Kelly) with Credit Suisse First Boston as co-lead (Mr. Johnson has ties to Frank Quattrone's technology banking group). Dain Rauscher is a co-manager. Left on the sidelines are Merrill Lynch and Robertson Stephens.

September 1999 - The company files a registration statement with the Securities and Exchange Commission for the sale of five million shares, or 15.6% of CacheFlow's stock. It reports that in the year ended April 30, it had revenues of $3.8 million, but a net loss of $13.2 million. For the quarter ended July 30, revenues were $2.2 million but losses reached $6 million. It has about 120 employees.

5. CacheFlow goes public
[CacheFlow 5]

November 1999 - Underwriters say they'll try to get at least $13 a share. Marc Andreesen -- co-founder of Netscape -- joins the board.

The buzz around CacheFlow increases, along with the demand for Internet infrastructure investments. Now, underwriters want $20 a share. The price is finally set still higher, at $24. The IPO is completed Nov. 19. The stock closes at $126.375 a share the first day of trading. That gives Series A investors a 14,342% gain, Series B investors a 5,491% gain and Series C holders a 2,662% return. After the IPO, Benchmark owns 14% of the company; U.S. Venture Partners 9%; and Technology Crossover Ventures -- which bought more shares in the IPO -- 6%.

February 2000 - CacheFlow's stock now trades at $112.875 a share, up 370.3% from the IPO price. The stock for which Benchmark paid $8 million in three stages is now worth $536.9 million. U.S. Venture's total stake, purchased for $8.1 million in total, is now worth $351 million; and Technology Crossover Ventures' $8.7 million investment in the third and thus least-risky financing round, is now worth $213.3 million. Meanwhile, Mr. Malcolm's 5.1 million shares are now worth $575.7 million.

-- By Suzanne McGee, The Wall Street Journal
February 22, 2000 | | | | contact
Copyright ©2005  Ian Giddy. All rights reserved.