Milestone Group Quarterly: April 2005

Articles

• Face to Face: Kim Polese, CEO of Spikesource
• Investment Viewpoint: Stephen J. Harrick, Managing Director & General Partner, Institutional Venture Partners (IVP)
• By Invitation: John Seely Brown & John Hagel, III - IT Platforms for Business Innovation
• Milestone POV: Kathleen Gilligan on Aligning Sales Vision and Process

Investment Viewpoint:

Stephen J. Harrick, Managing Director & General Partner, Institutional Venture Partners (IVP)

Milestone: Are you long or short on Microsoft today, and why?

Harrick: That’s a difficult question for me to answer. In terms of our public market investing at IVP, we focus exclusively on companies with under $1 billion dollar market cap. Microsoft certainly exceeded that mark a long time ago. Microsoft is a company that is to be watched carefully in every new market that they enter. I am most interested in some of their efforts related to web conferencing, especially as it pertains to the smaller players in the space -- but Microsoft is a juggernaut that is not to be underestimated, whenever you fund a young company.

Milestone: IVP is more of a late stage investor; tell us about your investment thesis?

Harrick: Our investment thesis is focused on the expansion-stage for a few reasons. One, it’s about 80% of the dollars that are invested in the venture capital industry in a given year and two, it's what we are good at. The large number of expansion-stage financings equates to healthy deal flow for IVP. It allows us compare apples to apples, meaning companies that are at a similar stage of development. We also actively compare valuations on the private side to valuations in the public market. This gives us some good grounding in the fundamentals and it makes sure that we keep valuation discipline as we take positions in these businesses. IVP is always an active investor. We take board seats; we work to help our portfolio companies with their strategy, prepare them for a public offering, help with M&A and with repositioning product offerings, as appropriate. So, expansion stage fits the skill set of the partnership and it also addresses where we believe there to be great opportunity in the marketplace today.

Milestone: IVP are active investors in the security space, including ArcSight, Tripwire, MarkMonitor and Teros. What opportunities do you see that Symantec, McAfee and others can’t get to first?

Harrick: Well, security in particular is an interesting space because it’s one area, as you look at the IT spending surveys, that has not declined at all over the last three years, it has actually increased year over year. It is also by its nature, a distributed problem which means that there isn’t one vendor that is able to offer an encompassing solution. So we believe that great management teams with innovative products can continue to grow effectively quarter over quarter and reach profitability in the security world. Both Tripwire and ArcSight are already profitable and MarkMonitor is getting pretty close. In the companies that we fund we tend to look for businesses that are best in class, because the occupational hazard in the security world is that there are quickly five or six competitors for each company funded in a given market segment. So in security, our expansion-stage positioning has served us well because we are able to evaluate each market segment as a whole, compare the companies that are out there and then work to invest in the market leader.

Milestone: What’s your take on Symantec acquiring Veritas? Is the strategy sound and can they successfully integrate all the pieces into a cohesive story?

Harrick: I think an integration of a merger that size is difficult for anybody. I think the Symantec management team is a strong one and the pitch is really to be the first company that will have a substantial presence on the server side as well as the desktop side and the resulting synergies that will happen because of that presence. I believe they are going to be challenged to roll out some of their new services and that it will take a while before those businesses catch up with the cash flow that is generated from the anti-virus business. That said, I believe they are a valuable partner for a number of our companies, Teros in particular. I think that, as with any large partner that can help you with distribution, they are one to complement, rather than compete against, where you can.

Milestone: You’ve also been active in the real time communications space, including investments in Webex and Raindance. What’s your take on Microsoft acquiring Groove? Do they walk away with the real time collaboration category now? Also, IVP has invested in Vonage, so how does voIP fit into all this?

Harrick: Microsoft is a serious competitor in the collaboration space because of the eventual embedded nature of their offerings. The original acquisition for Microsoft in this space was Placeware, which to my understanding was primarily a Java application they had to effectively rewrite. The launch of the Placeware service around NetMeeting has been slower to gain traction than the market anticipated. Groove takes Microsoft into the next level of collaboration and I think that when Longhorn finally comes out they are going to be a very serious player in that space. Webex is a classic example of a company that has marketed its offerings exceptionally well and has taken the market leadership position in real time conferencing and collaboration. That is a public position that we took and have since exited and realized a gain. Raindance is one that we are continuing to hold. They have got some very compelling technology with their new SwitchTower platform and they have got a launch of a Web Seminar edition that will take place in the middle of this year. A lot of the customer spend in web conferencing is going toward seminars -- one to many type broadcasts. That is where Centra was originally positioned and it’s a space that is still pretty wide open. Raindance is still a small player in the overall web conferencing space. We believe the current equity of the company is under valued. Raindance also has a substantial audio conferencing business that compliments their web-based offering. In this business, they are currently about 8th or 9th in terms of US market share. Together, the company offers customers a compelling integrated audio and web conferencing product. We look to this year as a very important growth year for Raindance. The company needs to increase the number of seats for their web conferencing products while continuing to drive minutes on the audio side. Overall, they are clearly the number 4 or 5 player in combined web and audio market.

Milestone: What about Vonage, voIP, web conferencing, how does that all play out?

Harrick: Well, voIP is here to stay and we believe that Vonage is in front of a very large parade. Vonage is an exceptional company growing at a very impressive rate. Accordingly, they will attract a lot of attention and competition from large vendors and have to navigate the regulatory landscape effectively as they roll out their services. As far as voIP and web conferencing, it will be an important part of the infrastructure. We are hearing that wholesale traffic can be bought at such a low rate that there isn't a real cost advantage today for some of the large conferencing vendors to deploy voIP broadly today. The quality is there and I think it will be a realistic option for people going forward but it isn’t top of mind right now from an infrastructure deployment perspective. For consumers and for businesses, it makes a lot of sense and I think you are going to continue to see exceptional growth there.

Milestone: What’s the future of the software industry as you see it? Will it become commoditized? Where will value migrate to?

Harrick: Truly differentiated intellectual property never becomes commoditized. That is one of the fundamental tenets of the venture business. Software is simply the codification of intellectual property. What we believe is that the software industry, like any high tech industry, continues to change. And the change in that industry has been particularly dramatic because of the nature of competition. We believe that hosted applications and functionality on-demand is a trend that will continue over the next several years. We tend to favor technology-enabled services or software delivered on a subscription based business model over large enterprise software deals. Our new deal pipeline is currently reflecting a number of interesting companies employing those types of models.

Milestone: How can a startup find a space that's large enough to attract venture capital, but not large enough to attract strong competition early from the big players in the space?

Harrick: I believe that is a staged question. I think initially when a start up gets going the most important thing is a stable of early customers that embrace the offering, pay for it, are happy and are referenceable. As a start up selects its market I think it is important for the company to pick a market that’s large enough to support a standalone business and get to a reasonable run rate and profitability. Generally we look for a pathway to an annualized revenue level in excess of $20-$25 million. Beyond that, we look for companies addressing markets that are approaching a billion dollars in size -- but we are careful with analyst growth estimates, as a number of them have been wildly off the mark in the past. Any company that gets into a large market where they are making headway and growing quickly invites competition and there is no way to avoid that. Start ups that innovate, build upon a customer base that is referenceable and continue to hire the best management and partner effectively certainly can be successful.

Milestone: If you could spend your time differently as a VC, aside from working less, what one thing would you change in the demands for your time and why can't you already do this?

Harrick: That’s an interesting question. I think if I had a surplus of time, I would certainly be involved more in community improvement efforts and political efforts, given some of the changes that are going on in the economy and in the country as a whole. I like what Warren Hellman said at a commemoration dinner that I attended where he said "Don’t treat philanthropies as a play thing. Take the same business acumen and judgment that you use everyday and apply it to non-for-profits and philanthropies." I thought that was sound advice. I think there are a number of organizations around the Bay Area that are doing great work and there are several that I would like to become more involved with in the future.

Milestone: If you were an LP and had $10M to invest in a competitors fund, who would it be and why?

Harrick: That is an especially intriguing question given the current market landscape. Everybody in the Venture community has gone through substantial change coming out of the downturn and new funds have begun, some with experienced venture professionals with decent track records. I would evaluate the new funds and favor those that can articulate exactly what business they are in, because I do believe the venture industry has become more institutionalized over time. There are plenty of ways to specialize. It can be based upon your target market, it can be based upon stage, it can be based upon relationships and a network that you and your Partners have built that helps your fund to launch companies into vertical markets where you have specific expertise. I would look for that type of clarity in order to be comfortable with the bounds of the opportunity for a new firm and specialization that will allow them to pick good investments. Rather than endorsing any one particular firm, that is the way I would approach the problem.

Milestone: What was the most intriguing "out of the box" technology-enabled deal you actually have been pitched in the last year?

Harrick: I think the most "out of the box" deal that I remember being pitched was a company called Hydropoint. Hydropoint was in fact funded and it is an interesting business model and value proposition. Hydropoint sells automated sprinkler systems. They take GPS locator technology and deliver climate condition data within a very small geographical radius, dialing up or down the amount of water a sprinkler emits based on the weather patterns in that area. It’s a huge problem, as over-watering causes excessive silt in rivers, pollution and waste, especially throughout the Southwest during dry years. When you have got a sprinkler that adjusts its settings manually or according to data from a broad area, you can over-water to a substantial degree. A lot of municipalities and housing development associations have taken a look at the Hydropoint technology and have started to deploy it. The service, and it is a technology-enabled service, pushes data down to each controller and updates each controller based upon these granular changes in the weather patterns. As a result, you end up with a much more efficient watering process that saves each customer a lot of money.

Steve Harrick is Managing Director & General Partner at IVP.

Steve joined IVP in October 2001. He focuses on expansion stage venture capital investments within the software, Internet, and communications sectors. Mr. Harrick led IVP's investments in Business.com, MarkMonitor, Motion Computing, Teros, Tripwire and WebEx Communications (WEBX) and has been actively involved in IVP's investments in ArcSight and Danger. Mr. Harrick currently serves on the Board of Directors of Business.com, MarkMonitor and Teros.

Prior to joining IVP, Mr. Harrick worked for ICG in San Francisco. As Vice President of Acquisitions, his responsibilities included identifying and executing strategic acquisitions, generating partner company liquidity and providing operational advice to partner company management teams. Before ICG, Mr. Harrick worked for Highland Capital Partners in Boston. His focus on enterprise software and Internet technologies led to investments in ChemConnect, Digital Market, Gamesville.com, Raindance Communications (RNDC), RoweCom (ROWE), and WebLine Communications. Before entering the venture capital industry, Mr. Harrick worked in new business development for Netscape Communications and in mergers and acquisitions for Morgan Stanley.

Mr. Harrick earned a B.A. in History from Yale University and an M.B.A. from Harvard Business School.