Milestone Matters
- Fall 2002 Newsletter
|
The Half-Empty
View
-
Technology
Led Slowdown
-
Consumer
Reaction Pile-on
-
September
11
-
The War
-
2002 is
History
-
Financings
Unavailable
-
Stay Afloat,
Tread Water, Hunker Down
|
The Half-Full
View
-
Less Competition
-
Time to
Develop Technology
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Focus: Sustainable
Advantage, Value-Add
-
Better Critique,
Better Ventures, Higher Bar
-
Longer Term
View/Horizon
-
Lower Funding
= Lower Risk
Vinod
Khosla, Kleiner Perkins Caufield & Byers
|
Editor's
Corner
Dear
Friends, Investors and Associates:
The Fall is upon us but the political and economic
air is not clear and crisp.
In fact, the clouds of uncertainty persist.
To say that we are receiving mixed signals would be the grossest
understatement. Despite
much fiery rhetoric, Congress adjourned without passing Homeland
Security legislation, and after calling for a beefing up of SEC
enforcement powers, the White House has scaled back its original
budget proposals in support of Wall Street's key regulator.
Perhaps Mr. Spitzer will yet save the day and restore the
credibility of the markets by incarcerating the likes of Messrs.
Waksal and Kozloski and forcing them to surrender some of their
ill-gotten gains.
The stock market has been huffing and puffing
of late and making upward moves but no consensus has emerged that
this is a sustainable trend. A few wags have noted that the acronym,
IPO, for lack of usage, may be lost to the language forever.
The Democrats have tried mightily to change the political
subject from the war on terrorism and the putative war on Iraq to
the economy, but in the absence of some arresting alternative economic
proposals, this has proved impossible.
Our view is that we have entered the silly season
of political rhetoric as we run up to the election and accordingly,
not much that is edifying will be forthcoming from our leading politicians.
All indications are that control of the House and particularly,
the Senate, may turn on a very few too-close-to-call races.
It appears that in these circumstances, both parties are
awaiting a "favorable outcome" leading to definitive control
for the Republicans or greater leverage over the legislative process
for the Democrats. Then,
and only then, within the context of the new political landscape,
will serious debate and perhaps, programs, emerge.
So in the midst of dubious macroeconomic prospects,
a haltingly advancing public market, the threat of war and the pervasiveness
of terror propounded by frustrated political groups and deranged
individuals, we have to shepherd MVP's investment program.
All these issues do, in fact, find their manifestations in
the venture arena where we toil.
We move forward, aware that we cannot control
the many exogenous variables but perhaps mitigate their impact by
choosing our investment targets with great care.
Our preferred companies have the following characteristics:
Paying customer corroboration of the firm's product and service
offerings; Seasoned management teams with realistic valuation expectations;
Business models that offer very compelling economic and operating
benefits to customers; Low capital intensity, which permits the
firm to reach breakeven within 12 to 18 months with $2 to $4 million
dollars; Markets that have customers accustomed to acquiring technology
to maintain a competitive edge, such as the financial services and
pharmaceutical industries; and markets that are characterized by
heightened security concerns and attendant increases in spending.
We continue to implement this strategy and are
pleased to be operating within the small fund, early stage sector
of the private equity market which, historically, has generated
the most attractive long-term returns.
(See box below).
As always, my partners and I remain grateful
for your support and welcome any comments, suggestions or questions
you may have.
Yours truly
Edwin
A. Goodman
General
Partner
MVP Adds New Advisory Board Member
Commencing October 1, 2002, Jonathan Glick has
agreed to become the third member of the MVP II Advisory Board joining
Messrs. Nick Davidge and Gerry Mintz.
Jonathan is the Director and Founder of The Clear
Markets Board, a research firm providing hedge fund investors with
outsourced due diligence services. Jonathan was founder and CEO
of OuterForce Systems, a media workflow software company. Prior
to that, in his capacity as Group Director of Product Development,
Jonathan led all technology and product development for The New
York Times Electronic Media Company, including product management
of the world's top newspaper website, The New York Times on the
Web. Prior to his work
at The Times, Jonathan served as Vice President of Network Development
at iVillage.
Jonathan
was educated at McGill University in Montreal Canada, receiving
his BA, with honors, in Political Science in 1993.
He also did graduate work at Columbia University in Instructional
Technology (Cognitive Science) where his academic focus was the
development of networked applications for communication and education.
Milestone
II Portfolio News
Milestone invested
in Knovel Corporation of Norwich,
NY, on September 17, 2002.
Knovel provides scientific and engineering reference information
to Global 2000 corporations and leading academic and government
institutions via the Internet.
It sells to these
customers on the basis of annual pre-paid subscriptions.
The company aggregates information from different publishers
while enabling its customers to search all the data simultaneously.
It also incorporates software tools which permit manipulation
of the data provided. Since
beginning the service in March 2000, Knovel has signed numerous
high-profile customers, won a number of awards for its product,
and has had a 100 percent renewal rate from its customers to date.
Milestone
invested $550,000 as part of a $2,925,000 financing with Himalaya
Capital Management, SAVP and Stonehenge.
Richard Dumler will serve on the Board of Directors.
Stock
Options Brouhaha
"The current
practice (of granting and accounting for stock options) does nothing
but enable greed and encourage CEOs to inflate earnings to drive
up the value of their stock." This quote from the head of an
accounting association pretty much sums up the popular and media
attitudes about stock options and CEOs.
The proponents of this view, together with assorted politicians,
have a cure-all remedy: treat stock options as an expense.
They have a powerful
ally in FASB, the Financial Accounting Standards Board, which is
made up of practicing, corporate, and academic accountants.
The question of accounting for options has led to open warfare
among the various factions, with corporate America against and the
academics for expensing them. An uneasy truce followed, but in the aftermath of the stock
market meltdown and associated scandals, the academics seem ascendant.
It is worth noting, however, that FASB is the group that
gave us mark-to-market accounting, which is what enabled Enron to
create "earnings" out of thin air.
Amidst the clamor
about expensing options, with many venture capitalists predicting
the demise of our entrepreneurial society, if such accounting is
mandated, it is worth examining the basic premises.
Premise #1 is that this change will have the desired effect.
Will expensing options restrain the greedy, self-serving
CEO with a doormat Board of Directors?
There is no reason to think this is the case; indeed the
opposite may be true.
Options depend for
their value, not on the initial level of earnings, but on the trend,
assuming that there is a correlation between rising earnings and
stock price. So if
we expense options, we lower the stock price.
Does our greedy CEO care?
No, why should he?
He's just got his options at a lower price and his earlier
ones are way under water anyway.
He still has the same incentive to manipulate earnings upward,
plus he has an additional tool.
In the later years, he can stop issuing options.
No options, equals no expense, equals an increase in earnings,
which equals a higher stock price, all other factors being the same.
That is unless you believe in the efficient market theory,
in which case, expensing options is unnecessary.
But won't the prospect
of lower earnings and a lower stock price cause even a supine compensation
committee to issue fewer options?
This is entirely possible but then who is most likely to
get them? Asking accounting
principles rather than the Ten Commandments to bring about fairness
and equity is asking rather much.
Premise #2 of the
proponents is that not expensing options is deceptive and fraudulent
accounting, since options are compensation and should be accounted
for as such. Options
most certainly are compensation, no question about it, and they
have a value. Why else give them out?
But, that expensing options will lead to more meaningful
financial statements is a dubious proposition at best and more likely,
simply wrong.
Forget the very real
difficulties in determining an option's fair value, which even proponents
admit. What entries
are necessary to keep a company's books in balance? After all, when
you expense something, there is normally an offset to the balance
sheet, namely cash; even depreciation and amortization generally
begin with the purchase of an asset for cash.
But a stock option
does not cost the issuing company cash; rather it costs its shareholders
potential dilution of their equity interest in the company.
It would seem logical that this is the impact to be made
clear to the stockholder, as is done now.
After all, the dilution from a rights offering is not run
through the income statement. Instead, in their attempt to pander to the investor's obsession
with a single number, EPS, the FASB does him a disservice by promoting
expensing options.
Consider
two companies, N and O, both in the same industry and with the same
fundamental prospects. Expensing options is now the law of the land.
O has a stock option program; N does not.
Both have volatile stock prices, but both prices are now the
same, since both companies reported the same EPS after all charges.
O has 10% of its stock on option, but had a non-cash charge
against earnings because of expensing stock options that equaled 25%
of its earnings. Which
company's stock would Warren Buffet buy? Hmmm… Maybe the world's richest proponent for expensing stock
options is on to something here.
---Richard J. Dumler, General Partner
US
Private Equity Performance
(Investment Horizon Performance as of June 30, 2002)
| Fund Type
|
1 Yr |
3 Yr |
5 Yr |
10 Yr |
20 Yr |
| Early/Seed VC
|
-35.3
|
36.9
|
46.2
|
32.6
|
20.2
|
| Balanced VC
|
-20.8
|
27.7
|
26.2
|
22.4
|
15.0
|
| Later Stage
|
-20.5
|
11.8
|
17.6
|
24.1
|
16.5
|
| All Venture
|
-27.0
|
26.5
|
30.6
|
26.1
|
16.9
|
| All Buyouts
|
-11.4
|
-1.3
|
3.4
|
9.8
|
12.9
|
| Mezzanine
|
-4.4
|
6.0
|
7.8
|
11.6
|
11.4
|
| All Private
Equity |
-16.5
|
5.5
|
10.9
|
16.1
|
15.2
|
| *Numbers
are based on 1400 US venture capital and buyout funds formed
since 1969. Returns are net to investors after fees and
carried interest. |
Source:
Thomson
Venture Economics/NVCA
Milestone
Venture Partners
Investing
in early Stage Enterprise Information Technology Companies in the
New York
Metropolitan
Area
551
Madison Avenue, 7th Floor, New York, NY 10022 V: [212] 223 7400
F: [212] 223 0315
www.milestonevp.com
|
