Milestone Matters - Summer 2001 Newsletter

"Good ideas will always find ready venture money. It would have to be a good idea with a good business plan with products and a future, not just an idea of how to use the Internet to do something.”

--Craig R. Barrett, Chief Executive of Intel
Quoted in "So, Technology Pros, What's After The Fall?"
New York Times, July 29, 2001

Editor's Corner

Dear Friends, Investors and Associates,

Trying to forecast what will happen to the economy is a thankless task. In the short term, we are prepared for a lot more pain. Although the broad economy may be flat, business investment is in a double-digit recession. In 12 to 24 months however, we think it is reasonable to expect that businesses will accelerate the pace of investment in enterprise information technology, the focus of our fund, albeit with more a disciplined and sophisticated ROI focus. Of course the other key factor affecting the returns of our new limited partners will be the timing of the IPO market. As long as the IPO market returns in three or four years, which we don’t think is excessively optimistic, our timing for Milestone Venture Partners II LP, which just had a $10 million first closing, could be unwittingly exquisite, especially considering the more reasonable prices we see in the private equity markets right now.

Of even greater interest to me is whether or not the New York metropolitan area is going to consistently produce high quality early stage enterprise information technology deals. At a venture capital conference I attended recently, my venture capital peers at larger funds routinely scoffed that New York doesn't have any real technology deals, preferring California and Boston. A partner we know and respect at a large, successful firm in Boston, offered what I think is a classic maxim comparing Boston and New York. He said, "Boston has a lot of engineers who are trying to impersonate schmoozers, while New York has a lot of schmoozers trying to impersonate engineers. Where would you rather invest?" When I asked a west coast VC who was originally a New Yorker and still loves the City what he thought of New York deals, he offered that New York deals were "…MBA smart, not tech smart."

I think these anecdotes are funny and revealing--perhaps in ways unintended--but increasingly obsolete. Of course most of the 60+ Internet IPOs New York produced are experiencing a nuclear cold winter. Quietly and on the margins however, New York's software engineering community is coming into its own. Many talented engineers in the back offices of large financial services, telecommunications, healthcare, and publishing/media concerns have learned the hard way why certain consumer/content/e-commerce business models won't work. Software entrepreneurs have gotten the message--VCs want to see old-fashioned deals with rational business plans, low cash burn rates, proprietary IP, deep industry knowledge and relationships, material customer traction, large markets, and reasonable valuations. The new wave of software solutions we are seeing automate and digitize core business processes within and between large companies. When the New York economy turns, we believe the teams we are backing will be well-positioned to close a ton of business in Manhattan, which is dense with potential marquee reference customers.

New York won't shed its tech-lite image overnight. But in the next wave of technology IPOs, we predict New York will establish its share of enduring and profitable software franchises.

Yours truly,

Todd T. Pietri
General Partner
Milestone Venture Partners

Milestone Portfolio News:

We are happy to announce the final investment of MVP I, a $250,000 seed investment (closed 5/10/01) in Content Directions, Inc. CDI provides content management infrastructure solutions for publishers. The Company possesses unique expertise in the implementation and registration of Digital Object Identifiers (DOIs). The DOI is a number which uniquely identifies published objects of any type (online books, music, video, etc.) and thereby facilitates transactions of any kind (sale, copyright protection, rights management, etc.)

David Sidman, the founder and CEO, drove the successful adoption of the DOI within the scientific journal sector of the publishing industry while he was Director of New Publishing Technologies at John Wiley & Sons, Inc. The 70 largest international journal publishers have committed to tagging all of their online journal articles with DOIs, and have already registered over 3 million DOIs to date. Please visit CDI at www.contentdirections.com.

Milestone Adds Intern

Samuel G. Flicki has joined Milestone Venture Partners as an intern. Mr. Flicki is pursuing his MBA at Columbia Business School and will enter his second year in September of 2001. Prior to matriculating at Columbia, Mr. Flicki served as an SAP consultant with PricewaterhouseCoopers LLP.

Sector Trends and Developments

RENEWED INTEREST IN EARLY DEALS AND FUNDS. In the first quarter of 2001, institutional investors signaled their renewed enthusiasm for venture funds focused on early stage investing. They invested $16.6 billion in venture funds during the period of which $5.7 billion--36% was allocated to funds focused on early stage investing. At the portfolio company level, 28.6% of capital was invested in operating companies raising their initial rounds of funding, an 8% increase in that allocation from the fourth calendar quarter of 2000.

THE IPO ROUTE TO LIQUIDITY REMAINS PROBLEMATIC. In the face of a sluggish IPO market, many firms are counseling their portfolio companies to raise money elsewhere and/or postpone their initial public offering plans until the return of a more propitious environment. In the second quarter of 2001, only nine venture-backed companies raised an aggregate of $676.4 million compared with the raising of $4.02 billion by 51 venture-backed companies in the 2000 comparable quarter.

"ADDENDUM FUNDS" EMERGE TO FILL ILLIQUIDITY VACUUM. In a development related, in part, to the difficult IPO environment referenced above and also due to the general reluctance of private equity investors to commit to second and third round financings while having to contend with their own internal portfolio issues, a new product has surfaced. Firms such as Accel Partners, New Enterprise Associates, Battery Ventures and Benchmark Capital, to cite a few, are raising (or have raised) Addendum Funds (aka Annex Funds) from their existing investors. These funds are being established to provide financial support to existing portfolio companies in earlier venture funds also managed by these firms. The VCs argue these funds represent attractive opportunities to invest in promising companies that, in normal times, would attract support from more traditional sources. Some limited partners refer cynically to these new entities as "bailout" funds. In any event, only time will tell how investors fare in these new funds.

MORGAN STANLEY CIO SURVEY. The May 2, 2001 Morgan Stanley survey of 225 CIOs provides interesting insights into the current IT spending situation.

• Outside consulting retained its No. 1 ranking as the area most likely to be cut.

• Security was ranked as the area least likely to be cut.

• 78% of respondents said connecting to customers and suppliers online is still a top priority.

• 59% of respondents said that even though they purchased a significant amount of software and equipment over the last two years, business needs dictate that they continue to purchase technology at a "fairly aggressive rate" or at a "fairly steady rate."

Private Equity Returns as of March 31, 2001 (Net IRRs from 1,400 private equity firms formed since 1969)

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