Milestone Matters Newsletter
Summer, 2005

"Our internal estimate is that it is a 300 year problem . . . if we could just get everyone to stop writing books, producing television, doing things digitally and so forth, we could achieve comprehensiveness in about ten years. So, the extra 290 years is really because the rate of production of digital and pseudo-digital artifacts is so quick." Google CEO, Eric Schmidt, speaking at the recent Goldman Sachs Internet conference regarding achieving his firm's goal of encompassing ALL information

Dear Friends, Investors and Associates:

Over the course of the summer, my thoughts have turned to "markets" - a term frequently used and abused, most certainly the latter within the context of venture capital investing. The fundamental hazard that ensnares pundits is that they tend to think of markets as large, stable,  identifiable and static phenomena.  They also favor readily available macro economic statistics to bolster their analyses.  This is not a useful approach when trying to discern the pattern of emerging entrepreneurial behavior and attendant markets and investment opportunities.  In the venture capital context, markets are most appealing when they are invisible - small but offering the promise of explosive growth.

Had Secretary Rumsfeld referred to "Old Europe" within an economic rather than political context, he would have been closer to the mark. As Jean Schmitt, a venture capitalist with the French firm, SOFINOVA, recently observed, none of Europe's largest 100 companies were founded within the past decade while 40% of the largest U.S. companies were established during this period.  This is arguably a reflection of the combination of the U.S.'s historical lead in research, a U.S. entrepreneurial culture, a vibrant private equity community, deep capital markets, (particularly NASDAQ) and the willingness of Americans to accept and in some cases embrace change.  But this broad topic is for another day and venue. Suffice it to say, that in the U.S., particularly within the early stage venture business, it is insufficient and often misleading to assess markets by simply surveying the current landscape.

So our interest at Milestone is focused on immature but rapidly expanding markets, many of which are being created as I write this piece. As the above quote from Google CEO, Eric Schmidt, makes clear, information is growing at an exponential rate, and finding what is useful constitutes a huge market that didn't exist just a few years ago before the Internet was so pervasive and prior to the availability of search engines.  Google alone won't solve the problem, but I believe that dozens of specialized search tools will become available to service a variety of vertical markets in greater depth. Some of these tools will prove to be the foundation of large companies. These search tools are in and of themselves a new "market."

The information age has turned one fundamental paradigm on its head. In 1968, ecologist Garrett Hardin wrote about the "tragedy of the commons," by which phrase he was referring to the degradation of the commonweal reflected by the over crowding of national and city parks, the deterioration of our water supply and the pollution of the air.  He was also dismayed by the strain placed on our shared public infrastructure by an expanding population. However, the Internet, a global shared public resource, invites us to think about "the cornucopia of the commons" because as more people use the Internet and contribute their products and ideas, this aspect of the commonweal is further enriched and of greater utility to all. In this vein, Professor Yochai Benkler of Yale Law School has coined the term, "Commons Based Peer Production" by which he is referring to smart Internet-linked individuals in the "flat world" of Tom Friedman who are using the Internet to create software, get and generate content, make computations, store data and establish connectivity, to cite some applications.

There are many examples of innovative ways people are harnessing the Web and many constitute new markets. For example, in South Korea, a clutch of entrepreneurs founded OhmyNews.  Currently 36,000 volunteer journalists are contributing 200 stories daily. The site attracts over 1 million visitors each day, more than the third ranking TV station in the country. Advertisers are sure to follow.

In one of the great second acts in American business history, Steve Jobs conceived of iTunes.  Since its introduction in 2001, Apple has sold more than 13 million units (more than 5 million in Q2 2005) and customers have downloaded 54 million songs.  Industry observers forecast $9.3 billion in sales for downloaded music products by 2009. This excludes the separate but related market of downloaded book titles of which 17,000 are available from Apple's partner, audible.com.  Incidentally, listening to books is now more common than reading books among the U.S. population.

So, I would urge all those interested in the venture capital marketplace to discount the macroeconomics and the monolithic discussion of commerce that predominates in the business media and keep an eye open for new markets and insurgent companies where growth prospects are dazzling.

With kind regards to all and appreciation for your support.

Edwin A. Goodman
General Partner

MVP I

PlusFunds Recapitalized, Milestone Yields 2.9 Times Return
Milestone recently announced the sale of its investment in PlusFunds Group, Inc.  PlusFunds has an exclusive license to develop investment products based on the S&P Hedge Fund Index.  The firm has grown rapidly in the last two years and has achieved significant profitability.

Milestone sold its position for $450,557 as against its cost of $157,833, a 2.85x multiple of invested capital.

JUXTAPOSITION

"U.S. closes Indonesian embassy due to unspecified terrorist threats. “Indonesia's Lion Mentari Airlines plans to buy 60 Boeing 737s for $3.9 billion."  Wall Street Journal, May 26, 2005

INTERNET VIBRANCY

• To date, 53 million people have contributed content to the Web

• Four hundred thousand people make their living utilizing a commerce platform provided by eBay

• U.S. online ad spending is forecast to increase 28% to $12.3 billion in 2005

• U.S. online purchases now total $73 billion - 5% of the retail equivalent and are expected to reach 10% and $179 billion within 5 years
  
  

I.T. doesn't matter.  The information age is over.  Silicon Valley as we know it is dead, and it's never coming back.  These chilling words by prominent technology industry observers illustrate the uphill battle that entrepreneurs have faced over the past several years.  Whether they are struggling to win over disenchanted I.T. purchasers or convince bubble-burned investors of the potential value of innovative ideas, entrepreneurs have recently endured one of the most discouraging periods in decades for technology development.

But while much attention has been given to technology industry difficulties, there is a bright spot for entrepreneurs that has gone largely unnoticed by the general public:  start-up costs for I.T.-enabled businesses have declined significantly.  According to Joe Kraus, co-founder of Excite.com and CEO of JotSpot, "There's never been a better time to be an entrepreneur because it's never been cheaper to be one."  The capital required to launch JotSpot in 2004 was dramatically lower than the amount needed for Excite.com a decade earlier.  "Excite.com took $3,000,000 to get from idea to launch," says Kraus. "JotSpot took $100,000."

How can an entrepreneur like Kraus experience a 97% reduction in start-up costs for his companies during the past decade?  While some of the decrease is attributable to differences between the two firms, much of the savings relates to a better environment for entrepreneurs.  Several positive secular trends that are supporting the incubation of I.T.-enabled service businesses include:

1. Globally-sourced, low-cost labor.  Advancements in collaborative business processes, the emergence of virtually free telecommunications services, and the economic liberalization of skilled foreign workers have converged to provide U.S. companies a low-cost means of increasing manpower. Elance Online and RentACoder.com are two websites that illustrate just how easy it has become to access inexpensive global labor.

2. Open Source Software.  Robust functionality has driven adoption of open source software into the mainstream of commercial use.  Numerous penny pinching companies are downloading Linux, MySQL and SugarCRM at little or no cost, instead of purchasing similar but more expensive products from Microsoft, Oracle and Siebel.

3. Cheap Hardware.  Improvements in computer processing and memory storage continue to shrink the size and cost of hardware.

4. Enhanced Platform Capabilities of the Web.   Entrepreneurs are capitalizing on the openness of large websites.  Yahoo Merchant Solutions, for example, provides customers the necessary technologies to launch e-commerce businesses, saving companies from the burdensome costs of developing their own commerce engines.  And HousingMaps.com demonstrates the ability of one person to build a popular real estate service by simply writing an application that combines craigslist.com's extensive real estate data with Google Maps' rich graphical interface.

5. Effective Marketing Tools.  Advertising over the Internet is proving to be an effective, cost-efficient means of reaching potential customers, as evidenced by an estimated 28% increase in U.S. online advertising spending in 2005.   In a matter of minutes, start-up companies can launch highly targeted advertising campaigns using Google AdWords and other online advertising programs. 

6. Software-as-a-Service (SAAS).  As software vendors loosen their grip on upfront license revenue models and entertain alternative payment schedules, fledgling companies can pursue arrangements that mitigate the risk of poor purchase decisions and enhance the flexibility to change usage commitments.

The reduction of start-up costs for IT-enabled service businesses creates a number of benefits to entrepreneurs.  First, it opens new opportunities to address niche markets.  Entrepreneurs with low cost structures can build very successful companies even if their businesses are not large category killers.  Next, entrepreneurs can launch and grow service offerings on small amounts of capital infusion from outside investors.  Consequently, they can retain greater ownership in their companies.  Finally, companies can leverage low cost structures to achieve high profit margins, assuming that low barriers to entry have not invited excessive competition.  For these and other reasons, we agree with Joe Kraus' assertion that "it's a great time to be an entrepreneur."

The spillover benefits to Milestone are very exciting.  We are assessing numerous young companies that have already achieved impressive sales momentum on relatively small amounts of capital investment.  While talking with us, the founders of these firms are under less pressure to negotiate a high valuation for their companies.  We are also seeing a number of promising firms actually turn down oversized investments being offered by very large venture capital firms.  It was rare that one heard an entrepreneur in 1999 say, "Thank you for your interest in funding five million dollars, but I only need two million."  But these kinds of comments are indeed being made today.  They are being expressed by capital-efficient companies addressing large market opportunities. We believe this trend is a very good indication that it's a great time to be an entrepreneur, and it's a great time to be an investor.
-----------Alan S. Kelley, Strategy & Research Consultant

US Business Review, Playing The Odds, by Todd Pietri, July, 2005.
Excerpt: "The venture capital industry needs to return to rational exuberance, but it has a long way yet to go. In fact, if the early stage venture industry doesn't change the way it operates, returns for all of the stakeholders – limited partners, venture capitalists and entrepreneurs – will fall well short of the impressive returns the industry has achieved historically, which have been 19 percent compounded for the last 20 years."


About Milestone Venture Partners

Milestone is a traditional venture capital partnership. We focus on early stage, technology-based service companies in the New York metropolitan area. The Fund targets companies that possess the nucleus of an exceptional management team, a compelling business model, and a large market opportunity.

"Investing in Early Stage Technology-Enhanced Service Companies in the New York Metropolitan Area"


Milestone Venture Partners
551 Madison Avenue, 7th Floor
New York, NY 10022 
V: [212] 223 7400
F: [212] 223 0315
www.milestonevp.com

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