ESP Newsletter: Issue 4

ESP Newsletter: Issue 4

12/07/2011

A Message From Early Stage Partners

The start-up phase is over, and we're moving into the growth phase. That's the kind of statement we like to make about portfolio companies, but it can also be applied to the entrepreneurial ecosystems in which we operate, Ohio and Michigan. Over the course of the last decade, as we have been building Early Stage Partners, the ecosystems in which we operate have also been undergoing transformation; from backward-looking Rust Belt economies, to forward-looking technology economies. This has been evident in the creation of accelerators like JumpStart, Ann Arbor Spark, TechColumbus, Automation Alley,BioEnterprise, and many more; in the creation of pools of limited partner capital like the Venture Michigan Fund, the Ohio Capital Fund, and the Ohio Midwest Fund; in the increase of organized angels funds with which we partner; and in an increase in both the quantity and quality of investment opportunities for regional early stage venture capital funds.

The results of this ongoing transformation appear most visibly in the companies in which Early Stage Partners has invested over the last four years. There is a greater diversity of opportunity, an improvement in quality, and better management teams available to us now than when we started Early Stage Partners in 2001...and frankly, we have become better at selecting, nurturing, and managing investments as we have gained experience.

Both Michigan and Ohio are transitioning from the start-up phase to the growth phase. Interestingly enough, both states have former venture capitalists in key leadership positions: Governor Rick Snyder, in Michigan, formerly of Ardesta, and Chief Investment Officer of Jobs Ohio, Mark Kvamme, formerly of Sequoia Capital. These are experienced private sector investors who have chosen to bring their talents and experience in the entrepreneurial community in the private sector to the public sector to tackle the challenge of supporting the emergence of growth companies that generate breakthroughs in job and wealth creation. They both have big ideas and loads of energy.

Nobody can predict which companies will emerge into big winners—that’s partly the point of having an entrepreneurial economy: create lots of companies, and let the experimental nature of market forces nurture the emerging winners. We believe that some of the future big winners reside in the ESP portfolio. Read further to hear about one such company.

Portfolio Company: LineStream Technologies

"You’re hitting the long ball. Don’t sell the company until it’s worth a billion dollars.” That’s what Mark Kvamme, Chief Investment Officer for JobsOhio and a special limited partner at Sequoia Capital, said about LineStream Technologies during a recent visit. Mr. Kvamme knows something about high-value exits, as he led Sequoia Capital’s investment in LinkedIn and, until its recent IPO, served on LinkedIn’s board.

Mr. Kvamme stopped by Linestream, which has taken offices in Cleveland's resurgent "Flats District," on a swing through Cleveland to learn about the city's emerging entrepreneurial economy. The company, which makes software that enhances the performance of automated systems and is a spin-out of Cleveland State University (CSU), is just one of the promising investments in the Early Stage Partners portfolio.

As we previously mentioned on the Early Stage Partners web site, LineStream recently signed a major licensing agreementwith Texas Instruments that will embed the company's software into four chip platforms.

How LineStream's Products Work

LineStream has developed software that dramatically improves control over automated processes, enhancing performance in equipment found everywhere from manufacturing plants to households. This is a multi-billion dollar market opportunity that is currently being served by technology that was developed 80 years ago and is out-of-date. In partnership with leading chip and controller providers, LineStream will deploy its software into products ranging from industrial equipment to washing machines.

LineStream's disruptive control software addresses the biggest challenges in automated product design and performance today. Control algorithms, encoded in software, are implemented to sustain desired operational performance in automated products. The current industry standard control algorithms, used in over 97% of automated processes and products, are based on proportional-integral-derivative controller algorithms, better known as PID controls. This legacy technology makes product design and calibration lengthy; calibration requires imprecise trial-and-error processes. In operation, PID controls are slow to react to errors such as vibration and friction that can cause equipment to move outside specified parameters. This results in downtime as equipment is recalibrated, increased labor costs, and reduced capacity utilization. LineStream's controls slash setup time and proactively cancel errors that cause inefficiency. The benefits include shorter design cycles, sustainable product performance, and dramatic energy savings.

How A Deal Is Constructed

When venture capital investors look for university technologies around which to create companies, they often flock to the "usual suspects:" high profile universities in a few geographies with well-developed technology transfer functions that generate the majority of the country's academic research funding and many of its startups. Yet there are many other universities with top researchers and intriguing technologies that are often overlooked. Finding the gems in these universities is harder; they may not have large or experienced technology transfer functions or even a history of supporting the formation of companies.

LineStream came to the attention of Early Stage Partners Managing Director Jim Petras when he was judging a business plan competition at NASA. He reviewed a plan for the technology on which LineStream is based, called active disturbance rejection control (ADRC)--the lifelong work of Zhiquiang Gao, Ph.D., Associate Professor and Director of the Center for Advanced Controls Technology at CSU. Based on long experience evaluating manufacturing technologies, Mr. Petras understood the potential of Dr. Gao's work to change industry. He spent the next two years working with Cleveland State to form a company--they had a tech transfer office that was in its infancy and no formal way to hold equity in a company.

"Linestream provided us with an opportunity to commercialize a very promising CSU-based technology, as well as to become a seed investor through the creative use of a research corporation which holds our stake in LineStream. The entire process has highlighted the importance of an effective tech transfer function within a state university such as CSU," said Leonard D. Young, Esq., Associate General Counsel and Director of Technology Transfer at CSU. "Our technology portfolio has grown substantially since we licensed the LineStream technology, and LineStream has played a significant role in the growth of CSU's technology transfer office," he said.

After a series of meetings, it was agreed that Cleveland State University would contribute the technology and Early Stage Partners would commit up to $2 million of seed and early stage capital predicated on the accomplishment of certain commercial milestones. A company was incorporated as ADRC, with Cleveland State’s equity interest being held in a pre-existing University of Akron research foundation. The capital would be used to engage a CEO as well as several consultants to develop a product from the technology, to engage with customers, and to write an initial business plan. An early test with two Parker-Hannifin industrial-based projects, including polymer production lines, provided the validation that was needed to scale the company: energy costs for a series of polymer extruders were reduced by 57%.

Attention then turned to the next steps in building a company: recruitment of a team and the development of a fuller business plan. The search led to Cleveland native Dave Neundorfer, a former Eaton Corporation engineer and manager who was completing his MBA at Stanford University. Mr. Petras had known Mr. Neundorfer for some time, and approached him about the opportunity. After a round of discussions, Mr. Neundorfer agreed to forgo other opportunities he had in Silicon Valley for the chance to be CEO of a start-up. He also introduced the board to Peter Ziebelman, an experienced Silicon Valley entrepreneur and venture capitalist with whom Mr. Neundorfer had formed a mentoring relationship while at Stanford. Mr. Ziebelman agreed to join the LineStream board.

"Jim told me about the opportunity at one of our biannual breakfast catch-ups. Inspired by Jim’s enthusiasm and excited about an opportunity to work with ESP, I soon met Dr. Gao and began learning more about the technology. At Eaton, I was an “intrapreneur”, overseeing continuous improvement projects that improved efficiency by three to five percent with significant process overhauls. Dr. Gao’s technology delivers improvements of thirty to fifty percent with a simple software upgrade. Other opportunities could not compare; I wanted to be part of the team charged with productizing and deploying this industry-shifting technology to the world."

Mr. Ziebelman was equally intrigued about the LineStream opportunity. “The decision to join LineStream’s board was clear to me. I have been closely involved with dozens of start-ups in Silicon Valley, and LineStream was following a pattern I have seen demonstrated by the most successful ones. LineStream laid out their plan to disrupt a very large market with CSU’s proprietary technology. The LineStream team was going to do this by enlisting one of the largest players (TI) to give it the credibility and market presence to ramp customer interest. Most importantly, these guys were having fun as they set their sights on building a word class company.”

An early step for the board and management team was to devise a go-to-market strategy. The LineStream software was powerful, and unique, but it was software—which can be reverse engineered and copied. In addition to the usual steps of filing patents—which Cleveland State University had been doing for years—the company determined that the most effective strategy for protecting its IP would be to deploy the software on chips, rather than as a separate software product that could be more easily decompiled and reverse engineered. A search also was begun for a better name than ADRC, resulting in the company changing its name to LineStream.

As Mr. Neundorfer and the board developed the business plan, serendipity crept in. Mr. Petras served on the board of St. Edward’s, a Cleveland parochial high school which he had attended, along with a senior executive of Texas Instruments. They talked about LineStream, and the Texas Instruments executive was intrigued. Like Mr. Petras, he saw the potential to replace PID technology with something new and more effective, and the opportunity for TI to leap over competitors in the controls market. This initial conversation led to a formal evaluation of the technology by TI. A series of technical and business interactions ensued. Once the TI team understood the potential for the technology, they moved quickly (for a large corporation) to a license agreement to incorporate LineStream’s technology into four chip sets.

The validation provided by Texas Instruments, the commitment they made to market the product lines, and the licensing revenues that are expected to ensue propelled LineStream from being a start-up to being a growth stage company. LineStream has moved to larger office space in anticipation of hiring up to ten people to both fulfill the agreement with Texas Instruments, and to diversify into other high growth channels. Potential channel partners have shown a strong interest in embedding LineStream’s solution into platforms that control many of the world’s manufacturing processes—industrial drives, industrial controllers and embedded processors. A billion dollar long ball indeed!

That's where the company is today. Stay tuned for updates.

Meet the LineStream Team

Dave Neundorfer, President

Prior to joining LineStream Technologies, Dave was a manufacturing engineer, quality engineer, and plant floor supervisor with Eaton Corporation. Dave has managed multi-million dollar design, industrial automation and continuous improvement projects, and has extensive project management experience. Dave has a B.S. in Mechanical Engineering and an MBA from Stanford’s Graduate School of Business.

Gang Tian, CTO

Gang is a Ph.D. candidate in advanced controls at Cleveland State University, and has been working to develop and disseminate ADRC for the last 5 years. A control luminary, Gang has published work on advanced control algorithms and industrial control applications. His prior experience includes system integration, software product direction, and VP level management experience with two Chinese telecommunications companies.

Matt Zilli, VP of Marketing

Matt brings to LineStream nine years of experience working with startup technology companies. Matt was responsible for Business Development and Product Management at Rovi Corp., working on digital media and entertainment software products. He also spent 6 years at Texas Instruments, where he held various sales, marketing and business development positions. Matt holds a B.S. in Computer Science from Santa Clara University and an MBA from UC Berkeley’s Haas School of Business.

Q:  Dr. Gao, you have dedicated your life to developing and deploying ADRC technology to the world. What role has the city of Cleveland played in this process?

A:  It is quite fitting to see thisgame-changing innovationforindustrial and motor-controlled products come from a region that led the industrial revolution. It is the Cleveland and Northeast Ohio industrial, academic, and investment ecosystem that made this breakthrough possible.

Q:  Could ADRC have been developed and launched at major coastal universities on the coasts?

A:  Honestly, I doubt it. It comes down to which is most important: gaining and retaining prestige (in other words, approval of peers in academia) or seeing and understanding problems in the real world and devoting decades of your life to solving them. It's about the willingness to innovate within the constraints of engineering practice, and recognizing and living by its values: simplicity, transparency, and superior performance. To be sure, I could not have done this all by myself. Having ESP’s commitment to and appreciation for launching disruptive technology undoubtedly accelerated our crossing of the chasm between academia and reality.

Q:  Gang, you worked closely with Dr. Gao, and were one of the driving forces behind bringing this technology from concept to deployment-ready product. What was the biggest challenge throughout this process?

A:  The biggest challenge was proving the technology on manufacturing plant floors. We knew it would work, but it was difficult to find manufacturers willing to test it.

Q:  How did you find early adopters?

A:  Jim and ESP helped remove roadblocks. Soon after beginning to work with ESP, we were in front of VP’s at Fortune 500 companies, and not long thereafter controlling high-temperature extrusion processes in a Parker Hannifin facility.

Q:  And the results were compelling?

A:  We cut their energy consumption by 57% in the first line, and replicated this performance across all of their automated lines. The data and testimonials generated from these tests paved the way to licensing agreements like the one we signed with TI.

Q:  Matt, you turned down offers from hot Silicon Valley start-ups and brand names like Google to move to Cleveland to join LineStream. You’re a California guy; why did you move?

A:  While I was working for TI, I used to be on the other side of the table during negotiations with software companies like LineStream. Dave and I connected through a mutual friend, and I helped with scenario planning and strategy prep for the TI negotiation. When Dave called after it was over, I was blown away by how favorable the unprecedented terms in the license agreement were for LineStream. Clearly, TI was committed to deploying this technology. Soon thereafter, during meetings with Jim and Peter, I realized that not only was TI keen on LineStream, but experienced VC’s were committed to its success and willing to roll up their sleeves to realize it. I joined LineStream because I wanted to come in at the ground floor and help build a company with early momentum, committed investors, and unparalleled growth potential.

Q:  Dave, you have been part of the ESP family for over two years. Where have they added the most value for LineStream?

A:  [Laughing] Jim introduces me to a new potential partner each week! But it goes way beyond match-making. The best example I have was negotiating the license agreement with TI. There we were, a three-employee company negotiating a long-term deal with a Fortune 200 giant. As they beat us up on terms for two days straight, Jim helped us fend off unfavorable terms such as cap limits and provided a firm, calming presence throughout the experience. Having his support this early in the company’s life is helping us to maximize the opportunity. I could give you hundreds of such examples where Jim and the entire ESP team have stepped in to lend a hand. This type of commitment is uncommon, and will certainly pay dividends with LineStream as well as ESP’s other portfolio companies.

Q:  Thank you.

Staff Photo

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For Limited Partners

Investors in either Early Stage Partners I LP or Early Stage Partners II LP can access statements of account, quarterly reports, partnership documents, and other information on the Early Stage Partners Web site (www.esplp.com). For a user name and password, please e-mail Connie Weber at cweber@esplp.com.