Milestone Matters Newsletter
Summer 2007

“That system can hold things up . . .. There’s a bus . . . if you get on the bus, you’re out. If you miss the bus, well the next bus is three years later.” Craig Mundie, Microsoft’s newly appointed Chief Research & Strategy officer, commenting on the challenges attendant to speeding innovation when new applications are generally embedded in Microsoft’s traditional, cyclically-introduced software products. The Wall Street Journal, July 30, 2007
 

Dear Friends, Investors and Associates,

This past weekend, my wife and I enjoyed entertaining some friends of longstanding but failed to think through the chemistry of the occasion. My Boston friend has made a long meandering political journey and could now be characterized as a neo conservative intellectual. In fact, I found him reading Norman Podhoretz’s tome about his own political evolution. Also a guest, was my friend and his wife from New Mexico, who could safely be described as “of the left.” Included among their bona fides are the co-founding of a commune out west in the 60’s, fervent anti-war (Vietnam) activity and pro bono legal work for many a worthy client.

The conversation, sometimes heated, ranged from global warming to AIDS to executive pay, to poverty in the U.S. to healthcare to corporate governance to utopian communities to refugees to romantic relationships, to e-mail and the iPhone. It was enervating fun. I left for work on Monday morning with an intellectual hangover. I recalled my days in the world of educational radio when so many issues were touched upon but none resolved. Perhaps this is endemic to communities that think and discuss, but don’t do.

In any event, it felt comfortable to return to the world of Mammon where the goals are clear and the metrics widely shared and one might even accomplish something concrete and good, i.e. create wealth while solving a problem.

I then took a step back to think about how we have been spending our time at Milestone recently. It has been the busiest month in my recollection and certainly the busiest July I have ever experienced in the VC business. Whatever happened to tranquil summers? Beyond nurturing our brood of twenty-one portfolio companies and working to convince potential investors to add to Milestone III’s capital base, we have been scrutinizing a burgeoning number of prospective investments.

As we sift through these opportunities, we are confronted daily by the pervasive impact of the Internet which continues to reshape the business landscape. I noted recently an article on the Dow Jones VentureWire concerning a young, albeit fast growing, company which provides a micro blogging platform and facilitates short messages among its registrants.

The service is free and to quote one of the VC investors; “The question everyone asks, is what is the business model? To be completely and totally honest, we don’t yet know . . ..” So the question surfaces, will the VCs’ faith in a growing non-paying user base (think, for example YouTube and Skype) be rewarded or otherwise?

Since the business press has a penchant for covering venture-financed companies that are smashing successes (think Google and eBay) and those which soar and are subsequently humbled (recall Boo.com) the many small companies that die in their proverbial cribs go unnoticed and unmourned. The challenge remains to distinguish between fragile early stage companies with no revenues and great potential and those destined for oblivion. There are some pertinent questions that help shape the debate at Milestone.

Is the application more than “cool”? In addition to being captivating, does it offer some heretofore unavailable utility? Is the audience large enough? Is that audience passionate such that it is likely to spread the word to friends and colleagues? Is the application easy to use? Has management had pertinent positive entrepreneurial experience?

Yes answers to the above queries are no assurance of success but good harbingers. If one can attract enthusiastic visitors who find the application easy to use and spread the word, the business can benefit from “viral” marketing and will grow rapidly. If the demographics are appealing, advertisers will follow.

This provides additional grist for our internal decision making with respect to prospective investments. We view the Internet as a wonderful tool to leverage business strategies. While we remain alert to innovative applications enabled by the Internet, we are drawn to revenue-generating companies with proven business models.

In our very small and different way, we hope to emulate Warren Buffet’s success by achieving outsized returns over the long haul and also by tap dancing on our way to work.

With our best wishes for the balance of the summer

Edwin A. Goodman
General Partner
 

SkillSurvey, a MVP portfolio company which offers automated online reference checking solutions concluded a $1.46 million follow-on round of financing. The principal current investors, including Inflection Point Ventures and Milestone were joined by the Delaware Innovation Fund.

Me.dium, a MVP II portfolio company, recently completed its Series B financing in a $15 million round led by Commonwealth Capital of Waltham, MA. Me.dium provides web users the ability to anonymously interact in real-time with other web users based on historical and real-time web search behavior.


 

Health care is very much in the political news these days. It seems no presidential candidate is without a health care plan, but exactly what they plan to do and more importantly, how they plan to pay for it remains murky. Make the drug companies pay seems to be the only common element. So what are the prospects for fundamental change? Not good! In an Oct. 2006 study, Health Affairs found that health care ranked as a second-tier issue behind the war, the economy/jobs, and gas/energy prices. Not much has changed in the last nine months, the movie Sicko not withstanding.

The principal reason is that most Americans are quite satisfied with their health care. In the same survey, while 74% of Americans thought that the U.S. health care system was in crisis (22%) or had major problems (52%), when it came to the care they had received in the last year, 84% said the services or physician care were excellent or good. The Harry and Louise advertisements in 1993 which helped to doom “Hillary care” simply reflected the fact that most Americans then had a good deal and didn’t want any changes. The majority still do, not withstanding the 46 million uninsured.

Americans do object to the rising cost of health care, which they define as their having to pay more out of pocket (higher co-pays etc.). Their solution is to increase government spending; 57% thought the government spends too little on health care. Arguably, more spending is the last thing that a sector of the economy fast approaching 17% of GNP needs, with the federal, state and local governments now picking up an enormous percentage of its costs, directly and indirectly. Some commentators, especially those pushing one-payer (government) health care, argue that government already pays up to two thirds of total health care costs. Their numbers are not entirely fictional if the $225 billion or greater tax subsidy from not taxing health care benefits is counted.

The rapid demise of President Bush’s 2007 plan to reform the tax subsidy gives some indication of the public’s and Congress’ appetite for fundamental reform of the U.S. health care system. Not that it doesn’t need reform; the challenge is where to begin. In my view, the two big structural issues are the least likely to be tackled. First, our system of employer-paid health care through private insurers provides great incentives to insure only the healthy while mostly shielding the consumers of health care from its costs, which is a truly dysfunctional combination. As the study in Health Affairs revealed, the great majority of Americans are content with their own health care. However, they assign low marks to the “system” as a whole. This reflects their concern about the large number of uninsured and their belief that access to quality medical care is a right. It is much less clear that they are willing to pay for their currently uninsured fellow citizens.

Of note in this regard is the Massachusetts experiment with universal health coverage signed into law last year. The underlying idea is perhaps deceptively simple: get a large pool of young and healthy uninsured to subsidize the sicker, older uninsured. By giving the latter group earlier access to medical care, dollars will be saved overall in the system instead of using “free” (but very expensive) emergency care when their aliments become acute. This is a very logical plan except the healthy uninsured aren’t cooperating. As of April 1, 2007 62,979 had signed up for the subsidized plan of which 52,500 paid exactly nothing. The large pool of healthy uninsured have opted not to pay premiums of up to 9.6% of their income but to risk the fines imposed by law under the economically compelling logic that the cost of the fines is less than the cost of the insurance. It is unclear how the shortfall will be made up.

The second big structural problem is that the U.S. health care system is fundamentally revenue-driven not efficiency-driven. The most basic tenet of the system is fee-for-service i.e. the more health care provided the more dollars earned regardless of results. Numerous studies highlight the deficiencies of this system. Does anyone doubt that there would be fewer surgeries if surgeons only earned a salary?

So despite the political rhetoric, unless the politicians believe what they are saying, the short term outlook is for change around the edges, better use of information technology, more of a pay-for-performance attitude, and in all likelihood, more government spending. The long term outlook is unclear but it is likely to be vastly different from what we have today. The transition will not be pretty.
-------Richard J. Dumler, General Partner


Source: Yale University Financial Report 2005-2006


About Milestone Venture Partners

Milestone is an early stage venture capital fund with $65 million under management. We focus on technology-enhanced service businesses in the New York metropolitan area. Companies that we find attractive possess the nucleus of an exceptional management team, an attractive business model, and a compelling market opportunity.

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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