Minutes of the Regular Meeting of NMSBIC, October 17, 2011

A regular meeting of the New Mexico Small Business Investment Corporation was called to order on this date at approximately 9:00 a.m. in the conference room of the WESST Enterprise Center, 609 Broadway Boulevard NE, Albuquerque, New Mexico.

A quorum was present:

Members Present:

Mr. Sam Cobb, Acting Chairman

Mr. Joseph Badal

Mr. Alan Fowler

Mr. Lupe Garcia

Ms. Roxanna Meyers

Mr. Clarence L. Smith [designee of Hon. James Lewis, State Treasurer]

Ms. Launa Waller

Members Excused: None

Legal Counsel to Board: Mr. Randall J. McDonald

Financial Advisor to Board: Mr. Paul Goblet

Consulting CFO: Ms. Dee Brescia

Recording Secretary: Ms. Judith Beatty

Guests Present:

Mr. Brad Steward, Pulakos CPAs

Mr. Jake Dopson, Pulakos CPAs

Mr. Moritz Schlenzig, Mesa Ventures

Mr. Les Matthews, Mesa Ventures

Mr. Michael Schafer, NMCC

Ms. Shyla Sheppard, NMCC

Mr. Owen Lopez, McCune Foundation/NMCC Board Member

APPROVAL OF AGENDA

Mr. Fowler moved for approval of the Agenda, as presented. Mr. Badal seconded the motion, which passed unanimously by voice vote.

REVIEW AND ACCEPTANCE OF BOARD MINUTES: September 16, 2011

Ms. Meyers moved approval of the September 16 minutes, as submitted. Mr. Smith seconded the motion, which passed unanimously by voice vote.

AUDIT PRESENTATION: BRAD STEWARD & JAKE DOPSON, PULAKOS

Discussion and Possible Vote on Acceptance of Audit

Mr. Dopson reviewed details of the audit and discussed the following results:

• No instances of fraud or improper activity noted during the audit.
• No audit adjustments.
• No new/changes in accounting policies.
• No management letter issued for 6-30-11. There was no signer authority on the operating cash account (the result of changeover of officers at board level along with changing banks during the transition period), and this is being addressed.
• Full & complete cooperation by NMSBIC representatives.
• Independent auditor’s report:
• Unqualified (clean) opinion
• Opinion on Supplemental Information: Additional detail was provided on activities and transactions in 2010 and 2011. The auditors have the same unqualified opinion on that information.
• Emphasis paragraph – investments in New Mexico entities. Deals with the fact that a substantial piece of the SBIC investments are in equities, in which there is inherent risk.

Mr. Dopson reviewed graphics of investment performance and expenses.

Mr. Goblet said his projections are that the NMSBIC Fund will be at about $44 million in three to four years. He noted that investment management fees continue to decline, and in 2011 fees were reduced by about $100,000 and are at $630,000; and operating expenses, at a projected $252,000, remain essentially unchanged. He said the typical fund J-curve has been significantly compromised by the crushing losses of NM Growth Funds I and 2.

Mr. Goblet noted that Pulakos CPA has lowered their audit fee by about $3,000 for two years in a row.

Acting Chair Cobb said much of that can be attributed to the work of Ms. Brescia and Mr. Goblet.

Ms. Meyers moved approval of the Audit, as presented. Mr. Fowler seconded the motion, which passed unanimously by voice vote.

REVIEW AND ACCEPTANCE OF FINANCIAL REPORT

Ms. Brescia reviewed the September financials.

Mr. Cobb asked Ms. Brescia to double-check the Loan Fund and ACCION activity reports each month to see if there are any trends relative to their nonperforming loans. He suggested creating three additional columns under the schedule of activity to separate out repayments, reclassified loans, and loans moved out of the portfolio altogether.

On the equity side, Ms. Meyers also asked Ms. Brescia to break out capital commitments into capital calls and management fees.

Mr. Badal moved approval of the September financials. Mr. Fowler seconded the motion, which passed unanimously by voice vote.

VENTURE CAPITAL BOOT CAMP: LAWRENCE CHAVEZ, PRESIDENT LOTUS LEAF CORP.

Mr. Goblet stated that TVC and the New Mexico Angels held an Angel Boot Camp in Santa Fe recently, which included a presentation by Lawrence Chavez, a former partner in Flywheel Ventures and CEO of Lotus Leaf Coatings, Inc. As Mr. Chavez has been a venture capitalist and is now an entrepreneur, Mr. Goblet thought his perspective on venture capital in New Mexico would be helpful to the NMSBIC Board.

• In 2010, there were 363 idea/seed deals funded with $1.7 billion; 1147 early stage deals funded with $5.3 billion; 1,021 expansion deals funded with $85 billion; and 746 later stage deals funded with $6.3 billion.
• There’s more VC in software than any other industry. It is very capital efficient and one of the hottest places for a VC to go to, including in New Mexico.
• Sources of investors in VC funds: pension funds, 42%; financial/banks & insurance, 25%; endowments & foundations, 21%; corporations (as LPs), 2%; and individuals and family offices, 10%.

Mr. Chavez stated that the true value of a company isn’t the future stream of cash flow discounted for risk; it’s what the company is going to sell for a few years down the road – this is what VCs and angels look at.

Mr. Garcia commented that the SBIC’s role is to provide patient capital to New Mexico companies, and obviously there is risk involved, so it is a challenge.

Mr. Chavez agreed that there is risk, but noted that, according to Cambridge Associates, investments in all types of venture funds have returned an average of 26.5% over 20 years, versus 10.1% for NASDAQ and 8.7% for the S&P 500.

NEW MEXICO COMMUNITY CAPITAL: MICHAEL SCHAFER, SHYLA SHEPPARD, OWEN LOPEZ

Mr. Goblet introduced NMCC Managing Director Michael Schafer and Fund Associate Shyla Sheppard, as well as McCune Foundation Executive Director Owen Lopez.

Ms. Sheppard noted that the NMSBIC and McCune Foundation were both instrumental in helping NMCC become established.

• NMCC is an interesting hybrid organization that provides knowledge and capital to high potential businesses in emerging and underserved markets in New Mexico, and is an advisor and investor and facilitator looking to support the next generation of great New Mexico companies.
• NMCC’s first close was in 2005 at $15 million, focused exclusively on businesses in New Mexico. The investments NMCC Fund I has made have been in the realm of addressing basic needs – water, energy, healthcare, safety/security – in ten portfolio companies.
• NMCC is now raising Fund II, which will also be New Mexico-centric, focusing on four core areas: companies that address issues in water, food and agriculture, energy and healthcare. NMCC is positioned very nicely to address issues in these four areas given the state’s history, institutions and national labs.
• NMCC is the 501(c)3 parent, with two separate divisions: 1) IMPACT-NM, the nonprofit, which provides business advisory services and has been very successful in raising private donations as well as getting state and federal grants. It includes the Tribal Business Initiative, funded with a $750,000 CDFI grant, which leverages some of the advantages that tribally owned business enterprises bring to the table. 2) NMCC management (for profit side).

Mr. Schafer discussed investments and returns in the Fund I portfolio, which currently has a gross multiple of 0.92x and a 2.71x projected multiple in 2015. Current gross IRR is –2.24%, and projected IRR (2015) is 26.83%.

Mr. Badal said the new Board is trying to determine what the NMSBIC’s focus should be going forward; and given that the equity portfolio has sustained a $9 million loss, he would like to understand how the valuation is calculated. For the Board to be able to make some informed decisions during the upcoming strategic planning session, it would be very helpful to go through the evaluation for one company in the portfolio.

Mr. Schafer said he would provide calculations for Mr. Goblet to pass on to the Board.

Acting Chair Cobb stated that New Mexico has created a model that never existed in the state before, and there is value in what this organization does in identifying companies, taking them to the next level, and bringing in management.

Mr. Schafer commented that his biggest fear for New Mexico is that some shortsighted decisions will be made based on where investments are at this point in the J-curve. When the companies in the equity funds start returning capital in the next couple of years, and there are liquidity events, the need for that capital will go up significantly; and because the support won’t be there, it is a foregone conclusion that entrepreneurs will seek capital outside of New Mexico.

Ms. Sheppard said NMCC is targeting $25 million for Fund II. She said the Pueblo of Sandia, which is a significant investor in Fund I, is also potentially a follow-on investor in Fund II and will be watching the NMSBIC to see whether it will be a follow-on investor as well.

Ms. Sheppard said Fund II will be the first multi-tribal venture capital fund, with 80% of the commitments coming from 5-6 tribal entities, both in and out of state. She said the Fund plans to invest in 10-12 portfolio companies in New Mexico. These tribal groups, having become economically successful largely through gaming, have come to understand the importance of diversifying into other areas. With New Mexico’s history and institutions, including the universities and national labs, NMCC has made a strong case about the potential for investing within the four core areas of water, food and agriculture, energy and healthcare.

Mr. Schafer clarified that NMCC is not looking to invest in Indian Country; rather, NMCC will have these tribal entities as limited partners in the same kinds of businesses it is currently invested in now. The LPs can either be acquirers of or can provide competitive advantages for the portfolio companies. Ms. Sheppard added that the tribes are looking for exposure to opportunities that they otherwise wouldn’t be privy to.

Mr. Schafer presented a pie chart of potential and committed investors in Fund II. He said Pueblo of Sandia, which invested $2 million in Fund I, has said it might match the NMSBIC’s investment in Fund II. He stated that McCune Foundation and Merrion Oil & Gas have committed $1.5 million, and letters of intent have been received, or are about to be received, from tribal entities totaling $15 million. A few other tribal entities are considering investments of $5 million each.

Mr. Lopez said McCune Foundation’s mission is to improve the spiritual and physical wellbeing of New Mexicans. He has been with McCune for 18 years, and determined early in the game that poverty is the issue in New Mexico; and McCune sees the NMCC’s strategy as one of the best for addressing that. He said McCune doesn’t lightly commit; they are governed by the Prudent Man Rule and their financial advisors, Slocum and Associates, have looked at all of the potential exits and supports McCune’s investing in the next round. He said he would urge the NMSBIC to do the same.

MEXICO GROWTH FUNDS: MORITZ SCHLENZIG, LES MATTHEWS DISCUSSION AND POSSIBLE VOTE ON NM BROADBAND HOLDING

Mr. Schlenzig and Mr. Matthews presented a chronology of NMGF 1 and ll and a brief detail of each company along with current status and legal issues in connection with some of the companies.

Mr. Schlenzig said that none of the five companies in Fund l, an $8.2 million fund, have lived up to their expectations. All were small businesses that were under-capitalized, with some level of intellectual capital. They were spread across the state, consistent with the NMSBIC’s focus on companies outside of the Rio Grande corridor, and in a cross spectrum of industries across services and manufacturing.

Mr. Schlenzig said that there were tangible and very real effects on at least three of the five companies in from the recessionary environment. The drying up of the debt and equity markets precluded the ability to raise money for the next level of some of the companies. With High Desert Chile, for instance, Mesa Ventures had to take out a high interest loan for a short period of time, which effectively dried up the cash flow of the company and rendered it insolvent.

In looking back, Mr. Schlenzig noted:

• Mesa underestimated the risk inherent in the companies. In each of the portfolio companies, catastrophic events or developments occurred on the operational level that caused significant distress.
• The portfolio companies weren’t ready for professional management. Top talent management was difficult to recruit and even harder to retain.
• The biggest financial crisis since the Great Depression wreaked havoc on the portfolio. The lack of availability of debt and equity capital at reasonable cost tanked the merger between SkyWi and One Connect IP; rendered High Desert Chile insolvent, and almost drove ClingZ into bankruptcy.

Mr. Schlenzig said the GP’s responses included:

• Substantial efforts to support the portfolio companies in fundraising, restructuring, etc.;
• An early close of additional Fund ll investments.
• Reducing Fund ll management fees in November 2009. Further fee reduction and an earlier termination of Fund ll was considered by the GP and advisory committee in June 2009, but was rejected as not in the best interests of the LPs at that time.
• Management level involvement in Agave and ClingZ.
• GP direct and indirect contributions to portfolio companies and fund activities of $434,000 over and above GP co-investment commitments to funds of $335,000.

Fund prospects:

• Fund ll has potential to recoup some value from asset sales of High Desert Chile and participation in Hatch Valley Farms.
• Recouping value in Fund I hinges on: a) NMBB Holding, LLC and b) remote chance to restructure a value-creating strategic partnership leveraging of Aridien assets.

Mr. Schlenzig stressed that Mesa Ventures has never walked away from any of the companies – for every company, they have rolled up their sleeves and done everything possible to create the best possible outcome.

As background to Mesa’s request for Board action regarding NMBB Holding, LLC, Mr. Matthews presented a summary of the following details:

• NMBB Holding, LLC is the Limited Liability Company formed earlier this year to acquire a 50% interest in Agave Broadband, LLC. Agave was formed in 2009 by Woodside Capital Management as a result of their foreclosure as the senior secured lender of One Connect IP, Inc. Woodside wanted to deploy wireless broadband in New Mexico.
• Mr. Matthews met with Woodside throughout this process and was able to carve out a Series B position for the One Connect shareholders in the new company, Agave. Mesa owns the company 50-50; however, Woodside has a preference on their Series A plus a 25% IRR on their money, after which everything is shared 50-50.
• This was further complicated when SkyWi, the old parent of One Connect, declared bankruptcy in September 2009 and listed One Connect as one of their assets. Mesa had to work with the bankruptcy trustee in Texas, to make sure there was no cloud on the Series B equity. This took a year to clear up. Woodside purchased that equity in October 2010, and turned around and sold that equity (Series B shares) back to Mesa.
• It took Mesa awhile to ensure that the bill of sale language was correct for Mesa. Its intention always was to take the equity and offer it back pari passu to the old One Connect shareholders, of which NM Growth Fund I was about 40% of that equity.
• In August 2011, Mesa did an offering memorandum and circulated it to all of the former shareholders of One Connect and gave them a deadline to either take their fair share or not take it. Always knowing that the NMSBIC would need more time than that, Mesa has essentially waited on that and carved that out in the NMBB operating agreement to allow additional time.
• Agave began building a fully FCC licensed wireless network in the East Mountain areas near Albuquerque in late 2010. By May 2011, the build-out of 6 towers had been completed, and new wireless subscribers began being added. As of October 1, 2011, the company has 385 subscribers.
• On 9/23/11, Agave formed a new subsidiary to acquire the assets of another wireless Internet service with 1,000 subscribers in Albuquerque, Santa Fe, Los Alamos and Grants.
• Also in September, Agave signed a license agreement with MDS America. MDS had previously purchased, at FCC auction, a 12.5 GHz band for approximately 30% of the U.S., including NM. This frequency will allow Agave to begin as early as November to provide up to 50 mbps of wireless service to Albuquerque, then expanding to Santa Fe and Las Cruces. Currently, this interference free, wireless high-speed service isn’t available anywhere in the U.S. MDS has selected Agave and New Mexico as its U.S. test market after previously successfully deploying this technology in the UK and UAE.
• Agave plans on resubmitting its USDA Rural Utility Service loan package as a combined company in November. The loan will be for approximately $12 million and will allow the company to further expand its network to an additional 30 New Mexico towns. This doesn’t affect the equity split Mesa has with Woodside.

Mr. Matthews said Mesa proposes to transfer Fund I’s share of NMBB Holding to the LPs of Fund I in consideration for reimbursement of Mesa’s out-of-pocket costs of acquisition and legal fees. He said the NMSBIC’s share would be 40.16% at a cost of $16,551.43. He noted that Mesa paid Woodside $25,000, which Woodside paid the bankruptcy court. With legal fees, the subscription agreement and other costs, the total amount was about $40,000.

Responding to Mr. Badal, Mr. Schlenzig said Woodside would get all their money back first plus a 25% kicker before any of the other investors could collect their share. Given that Woodside has put $2.5 million into this, they would have to get 125% of that – this accrues over time, so their return is based on a 25% IRR per year.

Mr. Matthews noted that the company Mesa is acquiring does about $1 million annually in revenue with $400,000 of EBITDA. Mesa is giving them 20% equity in the combined entity and they are taking a seller note for about $960,000 over five years at 6%.

Mr. Badal asked how much a sale of this company would have to generate in order for the NMSBIC to recoup its investment, and Mr. Matthews responded that the exit would have to be $10-$11 million. He said the market right now on subscribers ranges from $1,000 to $1,500 per subscriber. He said they would need about 11,000 subscribers.

Acting Chair Cobb noted that, by putting another $16,551.43 into this deal, the NMSBIC would have a 34% share of the combined entity.

Responding to Ms. Waller, Mr. Matthews said the advantage of the 12.5 GHz license is that no one else in New Mexico will have it – they have been offered this download speed because there is no interference on it at all.

Acting Chair Cobb asked Mr. Matthews how confident they are that they will get the USDA loan, and Mr. Matthews responded that they are “pretty confident.”

Responding to Ms. Waller, Mr. Matthews said they will also be offering voice over VOIP service.

Mr. Schlenzig and the Board discussed three options for the NMSBIC in the proposal.

Option 1: Fund l, which expires in November, could be purchased by the LPs outside the Fund after it expires.

Option 2: Set up a holding company in Fund l to acquire the NMBB Holding equity.

Option 3: Restructure Fund l into a holding company and leave the assets in there.

Acting Chair Cobb said it was his understanding that Mesa was offering this to the NMSBIC as an opportunity for it to recoup some of its losses – something that Mesa has no obligation to do under the current operating agreement. Mr. Matthews said that was correct.

Messrs. Schlenzig and Matthews excused themselves from the proceedings.

The Board discussed possible action on the proposal from Mesa.

Ms. Waller noted that this is a heavily regulated industry, and it is a very intricate network. To say that they are not going to rely on any other telecom carrier is somewhat misleading because everyone is interconnected, even with their competitors. She commented that it is difficult to succeed in this industry, and she was not sure about the wisdom of going into this without being in partnership with someone already established in the industry.

Following discussion, Mr. McDonald said he and Mr. Goblet would draw up a series of possible proposals and bring them forward for review in November.

REVIEW, DISCUSSION AND POSSIBLE VOTE ON CONTRACTS:RANDY MCDONALD, DEE BRESCIA, JUDITH BEATTY

Mr. Badal moved to renew Ms. Brescia’s contract, as presented, to 6/30/12; and Ms. Beatty’s contract, as presented, to 6/30/13. Ms. Meyers seconded the motion, which passed unanimously by voice vote.

Mr. McDonald stated that there were no changes to his contract.

Mr. Badal moved to renew Mr. McDonald’s contract to 6/30/12. Mr. Garcia seconded the motion, which passed unanimously by voice vote.

FINANCE NEW MEXICO ANNUAL REPORT

[Postponed to November meeting.]

ANNUAL MEETING MATTERS

Election of Officers

[Postponed to November meeting.]

Open Meetings Act Resolution

Mr. McDonald said boards subject to the Open Meetings Act are required to adopt the Open Meetings Act resolution annually.

Mr. Fowler moved approval of the Resolution. Ms. Waller seconded the motion, which passed unanimously by voice vote.

Annual Report to Governor

[To be approved in final form at the November meeting.]

ADVISOR’S REPORT

Review of Conflict of Interest Memo re: Productive Practice Discussion Regarding Verge Fund’s Approval Process

The Board reviewed a Conflict of Interest Committee memorandum dated October 11, 2011, prepared by Tom Stephenson and David Franklin of Verge.

Mr. Goblet stated that Verge invested in 16 companies in Fund l, and cross-invested in 6 of those companies in Fund 2, and now are about to make the third new investment. About half of the companies were started by the principals of Verge Fund and are managed on a day-to-day basis by the principals.

Mr. Goblet stated that the Verge Conflict of Interest Committee met last Thursday, prior to their annual meeting, to discuss Productive Practice. Mr. Goblet said he attended the meeting but did not vote because the NMSBIC Board had not seen the documents.

Mr. Goblet said Bill Bice is a founder in Productive Practice, which will do a first round of financing of $950,000, of which $250,000 will come from the principals, and $750,000 from Verge 2.

Ms. Meyers said it wasn’t clear to her how much of a percentage of the company Verge would own versus the NMSBIC.

Acting Chair Cobb said the NMSBIC does not have any rights in terms of directing the fund manager to determine allocation of capital.

Mr. McDonald added that, under the agreements, the GP (Verge and Mr. Bice, in this case) is prohibited from making investments in portfolio companies without approval of the Conflict of Interest Committee – so the idea is to require disclosure of any conflicts of interest and to manage them at the committee level. He said these provisions are in all of the LP agreements of the various equity funds.

Mr. McDonald added that, in addition to the LP agreement, the NMSBIC always enters into a side letter with the general manager in the fund. It covers a number of things, including that their investment in any one company cannot be more than 49% ownership when combined with other investments. The NMSBIC also requires that it get a seat on the conflict of interest committee.

Ms. Meyers spoke to the potential difficulties involved in this kind of arrangement – Mr. Bice is putting $100,000 into this company and getting $750,000 from others, and he not only is paid to run the fund, but he is also managing it.

Mr. Badal said he had no problems with the idea of someone putting their own money into a deal – in fact, that is a plus, in his mind — provided they are getting an interest pari passu. He said he also had no problem with the fund getting a carried interest for bringing the deal to the NMSBIC.

Mr. Badal stated that he was uncomfortable with them getting a fee for doing this because it is their own idea and their own startup – it could be interpreted as a vehicle for the purpose of getting fees out of it. He said disclosure of this conflict does not reduce his level of discomfort.

Mr. Goblet suggested that the real issue here is not their management fee or putting capital in pari passu; the real issue is that they are the founder and get a founding interest in the stock.

Mr. Badal said Mr. Bice and his partners are very competent and honorable people, and he personally wouldn’t object to putting his own money into a deal like this – but this is taxpayers’ money.

Acting Chair Cobb said it was important to understand that, when Verge was first formed, there were not enough entrepreneurs in the state, Verge’s idea was to create this model.

Ms. Meyers stated that she felt all of the members of conflict of interest committees should review the pro formas of all investments to get as much detail as possible before voting; otherwise, it is a rubberstamp.

Mr. Goblet responded that this is the role of the general partners, who are paid to perform that function. He pointed out that all of the Conflict of Interest Committee members in this case have substantial investments and it would not be in their best interest to rubberstamp approvals. Mr. Goblet said he looks at the structure of a company, the cap table, how they arrived at the cap table and the conflicts – not the viability of the company.

Acting Chair Cobb expressed concern about the NMSBIC’s ability to find general partners who are willing to operate without that type of latitude, and Ms. Meyers responded that she thought it would not be a problem.

Mr. Badal commended Mr. Goblet for having reflected the tenor of the September NMSBIC meeting. He suggested having a philosophical discussion about this at the November strategic planning meeting.

Mr. Badal asked Mr. Goblet to provide details on how the $950,000 is to be spent.

OTHER BUSINESS

Mr. Goblet summarized information on the equity funds.

Mr. Badal and Ms. Meyers reported on their meeting with State Investment Officer Steve Moise and SIC member Peter Frank.

Mr. Garcia reported on his visit to Verge headquarters during their annual meeting.

LEGAL UPDATE AND COMMENTS

None.

NEXT MEETING: Monday, November 21, 2011: Office of Ms. Meyers

Acting Chair Cobb stated that a facilitator, David Goldsmith, has been hired for the November strategic planning session for a $1,500 fee.

ADJOURNMENT

Its business completed, the NMSBIC Board adjourned the meeting at approximately 3:40 p.m.