Download September 15, 2012 - Milestone Venture Partners

25339 Milestone Summer2012.qxp:Layout 1
Issue 49
9/5/12
9:37 PM
Page 1
Milestone Matters
Summer 2012
“We have met the enemy . . . and he is us.” Ewing Marion Kauffman Foundation Report on venture capital investing, May 2012.
Editor’s Corner
Dear Friends, Investors and Associates,
The humid doldrums of summer have been exacerbated for venture capitalists by an authoritative resuscitation of the troubles buffeting the industry. This time
they emanate from the prestigious Ewing Marion
Kauffman Foundation which recently issued a comprehensive fifty-one page funereal report. The foundation
was established in the mid-1960s with the goal of
encouraging entrepreneurial activity in the U.S. and
improving educational opportunities. In due course, in
addition to research and grant making, it entered the
investment business on its own behalf. As of February
29, 2012, the foundation had an endowment of $1.83 billion invested in a globally diversified portfolio including
$249 million committed to an assortment of venture capital and growth equity funds. The portfolio includes
investments in more than 100 venture funds managed by
more than sixty General Partner teams and these, reportedly, include some of the “Top Tier Funds.” The foundation’s findings are of particular interest because the
statistics are drawn from their own portfolio from which
they receive detailed and accurate reports rather than via
third party sources which rely on VC management selfreporting and therefore, the report argues, are suspect.
The report is a mea culpa. The foundation’s investment portfolio has done poorly as illustrated by a few
select admissions: (1) Of 100 venture fund investments,
only 20 beat their respective public market equivalent
benchmarks by the standard annual 3 percent or more;
(2) Of 30 funds larger than $400 million, only 4 delivered returns better than a publicly traded small cap index;
(3) Of funds which raised more than $500 million, none,
net of fees, returned capital equal or greater than 2X the
initial capitalization.
The Kauffman report claims that many major sophisticated VC investors have also done poorly including the
sample below which shows returns as a multiple of
invested capital: Kauffman Foundation VC Portfolio 1.3X; Washington State Investment Board - 1.4X;
Oregon Public Employee Retirement Fund - 1.5X; New
York State Retirement Fund - 1.04X.
The report closes by stating that Kauffman plans to
reshape their VC investment portfolio by shrinking the
number of VC partnerships in which they invest to “only
five or ten,” a winnowing from the current 100. This
raises the issue of risk management which is, in part,
achieved through diversity, but that discussion must
await another letter. Suffice it to say that Kauffman’s
plan to reduce the amount of money allocated to venture funds and to severely limit the number of General
Partner team relationships, is very much in line with
institutional investor thinking that we encounter as we
expand our conversations in an effort to raise capital for
MVP IV.
Now a wag might argue that the obvious conclusion
is that the Kauffman investment team is not very
astute. Perhaps the fault lies with their selection rather
than the ills they attribute to the industry? But if one
concluded the discussion with just that riposte, the
opportunity to learn from the data would be lost, so it
is best to assume that it is representative of the whole
and therefore entertain the questions, where does the
venture community go from here and what are the
implications for Milestone?
Let’s begin this exercise with a brief summary of
the five Kauffman recommendations to their peer
institutional investors: (1) Abolish VC investment
mandates normally expressed as a minimum percentage of assets to be allocated to VC funds; (2) When
assessing potential VC fund investments, be very
skeptical that the inevitability of the “J Curve” will
lead to solid VC fund returns; (3) Require transparency with respect to the economics of the General
Partner and the Management Company of VC funds;
(4)Abandon the standard 2% and 20% fee structure in
favor of fund management budgets and 20% profits
interest only to be collected after LPs have received
100% of their capital back plus a preferred return; (5)
Measure VC performance against a Public Market
Equivalent (PME) benchmark. In addition, Kauffman
wants VC fund managers to invest at least 5% of the
total in lieu of the industry standard 1%.
If these recommendations are widely adopted, the
VC industry will shrink. Venture funds for several
years (including the 2012 pace) have raised about $20
billion per annum. This total is likely to revert to about
$5 billion per year which was typical during the early
90s prior to the build-up and bubble culminating in the
$100 billion raised in 2000 and the debacle immediately following. The shrinkage will occur because there
will be less capital available but also because many
VCs will abandon the field reasoning that the most
lucrative days for General Partners are behind them.
If one credits the report’s overarching findings, very
large funds will cease to attract investment and smaller ones will flourish. The further implication is that
large institutional investors will not be able to
CONTINUED ON PAGE 2
Milestone Portfolio News
In July 2012, MVP III, MVP III NY,
and MVP IV invested a total of
$400,000 in Grovo Learning, Inc.
NYC-based Grovo is an online
education and training platform that
helps people find and use sites, and
helps sites reach and educate users.
Grovo produces free and premium
business video tutorials that cover the
Web's most popular and useful sites as
well as essential cloud services in
social media, productivity, and online
marketing. Applications include
Facebook Profile, Advertising, and
Pages, Google Analytics and Apps,
Twitter, Yelp, Basecamp, and
LinkedIn. The videos are delivered
through the Company’s proprietary
education and training platform, which
includes the lesson, pre-written notes,
quizzes, and glossary terms.
Grovo will use the capital raised to
increase its library of video tutorials
and to expand its marketing efforts.
Morgan Rodd serves on the board
of directors of Grovo.
MVP II portfolio company Octagon
Research Solutions has entered into an
agreement to be acquired by Accenture
Inc. (NYSE: ACN) a global management consulting, technology services
and outsourcing company.
Milestone originally invested in
Octagon in 2002 and again in 2005 for a
total of $800,000. The total exit proceeds after the transaction clears regulatory approval will equate to a 5.5x multiple of invested capital and a 32% IRR.
Octagon alone returns 34% of Milestone
Venture Partners II. Todd T. Pietri served
on the board of directors as an observer.
Pennsylvania-based Octagon is a
leader in clinical and regulatory information management solutions to the
life sciences industry with 380
employees. The Octagon exit further
strengthens Milestone's long term successful track record in the Digital
Health sector, which includes one IPO
and four profitable sales to strategic
acquirers.
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EDITOR’S LETTER CONT’D FROM PAGE 1
fruitfully invest meaningful amounts of
capital and will move on to other asset
classes while wealthy individuals and
sophisticated family offices will reassert
themselves as key funders of the industry. If this occurs, it will be a return to the
venture capital ecosystem which prevailed prior to the ERISA ruling of 1974
(implemented in 1979) which enabled the
huge U.S. pension fund capital base to
embark on VC fund investing.
As to whither Milestone? We can
abide by all the Kauffman Foundation
recommendations some of which are
simply not relevant to our business
model. We are small and have formally
capped our new fund at $125 million.
By far, we are the largest investors in the
funds we manage. We are not fee driven. We have enjoyed strong performance
relative to many criteria including
PMEs. We are backed predominantly by
wealthy individuals, family offices and
small endowments. Frequently, we
receive institutional responses along
these lines, “we like your performance
and strategy but you are too small for us
to consider because we have to put large
amounts of capital to work.”
So we look forward to new conversations with nimble investors who agree
with Kauffman that small is beautiful.
With best wishes for the balance of the
summer,
9:37 PM
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Digital Healthcare Initiatives
Page Two
MapMyFitness, which helps consumers record and
track their fitness activities such as running, cycling, walking and hiking, is also enjoying increased demand from
health plans as a result of health reform. As health plans
make the shift to a more consumer-focused business model,
MapMyFitness, which has 11 million registered users , is an
attractive advertising vehicle for health plans as they try to
sell policies to members who exercise. In addition, health
plans, in an effort to improve their digital offerings for consumers, are utilizing the MapMyFitness mobile and web
solutions.
eHGT also stands to benefit from the increase in health
insurance coverage. eHGT enables a hospital to gather the
disparate medical records of a newly referred patient so that
it may properly diagnose and, if required, admit the patient.
The more people who have health insurance, the greater the
number of patients who will be channeled through the standard cycle of care (primary care doctors making referrals to
specialists and hospitals) as opposed to accessing care initially through the emergency room.
Halfpenny also benefits from a greater number of
patients moving through the standard cycle of care.
Specifically, Halfpenny helps hospitals with significant laboratory operations communicate with referring physicians.
Physicians can electronically place an order for a battery of
lab tests through their Electronic Health Record (EHR) system and have that order routed to one or more hospital laboratories. When the lab has completed the tests, it can send
the test result data directly through Halfpenny’s hub into the
referring physician’s EHR. The greater the number of doctors with EHRs, the larger the market is for Halfpenny’s
services.
Personally, I feel the U.S. could have improved access to
care, the quality of care and the national health technology
infrastructure with a smaller investment and a greater focus
on consumer incentives than what was passed as law. That
said, I do like the payment reform elements (paying for the
quality of care rather than the volume of care) in the ACA.
Payment reform is generating a new wave of innovation in
care coordination, mobile health applications and big data
analytics. Milestone intends to make investments in these
areas and feels it is well positioned to continue to prosper
from a rapidly changing U.S. healthcare industry.
Digital Health companies provide software and data
services to pharmaceutical companies, hospitals, doctors,
health insurance companies, self-insured employers and
consumers. We have invested over 40% of our capital in
the digital health sector since 2001. Medidata Solutions
(Nasdaq:MDSO), Octagon Research (recently acquired by
Accenture), MedPage Today (acquired by Everyday
Health), Premise (acquired by Allscripts), and CareGain
(acquired by FiServ) have delivered high realized returns
for our limited partners. Several of the Digital Health companies that remain in our portfolio, such as Vitals.com,
Halfpenny Technologies, eHealth Global Technologies
(eHGT), Skill Survey, Integrichain and MapMyFitness are
attacking attractive markets, generating top line growth and
are well-positioned to deliver superior returns.
The recent Supreme Court decision which essentially
upheld the Affordable Care Act (ACA) has important consequences for four of these portfolio companies:
Vitals.com, MapMyFitness, eHGT, and Halfpenny.
Because as many as 30 million additional people will
obtain health insurance, Vitals.com will see increased
demand for its offerings. Vitals.com helps consumers find
and evaluate doctors. Because the supply of doctors will
not grow as fast as the demand for doctors from the newly
insured, consumers will need better web services to find the
doctor with the right expertise, the capacity to see new
patients, and the willingness to accept their insurance
(Vitals knows which insurance policies doctors accept). In
addition, health plans will see a big shift in their mix of
business once the state-based exchanges begin to sell
health insurance directly to consumers and employers
choose to terminate their policies in favor of paying the
proscribed fines. One large plan estimates the percentage
of its revenues coming directly from consumers will
increase from 6% to over 20%. As such, health plans will
choose to advertise on Vitals to reach this segment, given
that Vitals has a growing base of 10 million monthly visitors. In addition, plans will need to offer better data and
software than they currently possess to attract and retain
new retail customers. Vitals is therefore experiencing significant demand for its cost transparency solutions which
help tell a health plan member what their out of pocket
expenses will be for a contemplated medical procedure
---------Todd Pietri, General Partner
with a given doctor.
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
Edwin A. Goodman
General Partner
9/5/12