Chrysalis Insights: Year in Review by David Jones, Jr.

LOUISVILLE, KY (March 12, 2009) – The past six months have challenged most sectors of the economy—including the venture capital industry. Money is tight. Venture capital is hard to raise for both fund managers and entrepreneurs. Venture capital investments in Q4 08 were down 26% from Q3, and this decline was spread across most industries and stages of development. Debt financing is harder to come by, less dependable and more expensive. Tight money is limiting exit opportunities and depressing valuations. In sum, venture capital is not immune to the financial market crisis.

So – should we abandon the entrepreneurial economy in these tough times? My answer is an emphatic “NO!” Innovation will be essential to pulling us out of this mess; simply doing tomorrow what we did yesterday won’t solve our problems. The good news is that big problems that go far beyond the financial sector also offer handsome rewards to those who can conceive, design and implement urgently needed solutions.

Let me give two examples, each a theme behind which Chrysalis is actively investing today. First, in healthcare the nation is embarking on a great debate about how both to cover the uninsured and control costs. This is interesting and important–but the debate has so far largely ignored long-term, disturbing trends in population health that will render its outcome obsolete.

Diseases that result from obesity and smoking now account for an estimated 70% of U.S. healthcare spending. Although rates of smoking seem finally to be responding to high taxes and a dramatic shift in cultural acceptance, obesity rates are still rising, and cultural norms still seem to be moving toward more acceptance and accommodation. The future costs of this trend, in dollars, in workforce and military weakness, and in human suffering, are terrifying. No reform of how we pay for medical care or who we cover can succeed if half of our children contract Type 2 diabetes, or most adults receive heart surgery.

We believe innovation can help avert this looming disaster – not through some magic pill that keeps us thin, but through advances in communication and information technologies that focus behavior change on the actual causes of our conditions: what we eat, how we move, how we live. Chrysalis portfolio company HealthMedia, recently acquired by Johnson & Johnson, proved that free-at-the-margin elements of the Internet can deliver weight loss and persistency equivalent to that achieved by Weight Watcher’s group therapy, but for about 5% of the cost. Johnson & Johnson told the Wall Street Journal that they plan to build a $20 billion wellness coaching business around this innovative platform! We foresee opportunities like this to use information services and other developing technologies all across the healthcare spectrum. Entrepreneurs, for example, are now working on returning a much-needed element of personal contact to physician-patient communications through social networking tools.

This healthcare technology revolution will require both innovations in software, hardware, and communications networks, and new business models that knit these together in sustainable, scalable ways.

This brings me to my second example of an industry in need of ongoing innovation: media and communications. Chrysalis has had great success over the years in building telecommunications infrastructure (think High Speed Access Corp., now the backbone of Charter Communications’ broadband business, and Tritel, now part of ATT Wireless) and specialized information services that could not exist apart from advances in network and IT infrastructure (e.g. Genscape, Appriss, TechRepublic, and CELS, in addition to HealthMedia).

We’re still at it, most recently in Open Kernel Labs. This company supplies software to developers of intelligent mobile phones and broadband devices, allowing them to integrate their offerings across multiple platforms, more securely and faster. We have also invested in Digitalsmiths, which provides technology services that enable video content owners to index and catalogue their libraries for use in targeted advertising. Two high-profile web sites, theWB.com and TMZ.com, are now using DigitalSmiths to index and play video.

In both the media & communications and the healthcare sectors, the emerging combination of digital media and ubiquitous broadband is enabling richer, more personalized delivery of content. We believe that laying the pipes that support delivery, and connecting people with personalized, actionable information, will improve infrastructure, services, and decision making. This thesis underlies our investment philosophy across sectors.

The economy is in a tough place right now, and innovation is only one part of the solution. Renewal of timeless values like thrift, discipline and diligence would also help. But Chrysalis believes strongly that our role in these times is to invest with discipline behind the entrepreneurs with the courage and vision to solve today’s problems–that is, to help them build great companies and deliver great returns to our investors. Plus ça change…