VC R&D Funding Returns to Normal
Venture capital (VC) is the money and resources made available to small businesses
and startup firms that normally would not have access to public or institutional
funding. These investments are traditionally long term and high risk, but have
become an important function in the formation and expansion of high-technology
companies.
In the mid- to late-1990s, rapid technology growth and the misconception that
business patterns and practices were being radically and permanently changed by
some of those technologies, created an environment where venture capitalists invested
in start-up companies without any type of rational judgment. Investors disregarded
the need for sound business plans, market analyses, and competitive situations
and chased companies that focused on technologies like e-commerce, photonics,
and genomics-based biotechnologies. These investors were attracted by the high
gains made through VC investments in the early-1990s and the projected financial
growth in new technology sectors. They seemed unconcerned with the lack of underlying
justifications for the new financial growth predictions.
In 1999 and 2000 (now known as the “bubble years”), for example, start-up
Internet-specific companies involved in online commerce attracted more than 40%
of all VC funds. And in 2000 alone, more than $100 billion in total VC funding
was spent (according to the Money Tree Survey by PricewaterhouseCoopers, Thomson
Venture Economics, and the National Venture Capital Assn.) in a marketplace where
only two years earlier only $20 billion was invested.
When the Internet bubble burst and the economic recession occurred following the
Sept. 11, 2001 terrorist attacks in the U.S., the high level of VC funding saw
equally rapid declines. The artificially high levels of investments made during
the bubble years are now gone and not likely to be even closely approached any
time soon. According to a recent report by the Bioseeker Group in Stockholm, Sweden,
“Guide to the European Life Science VC Market,” the consequences of
the crash of the VC market in 2001 was decreased optimism from investors—in
August 2004 there had been no successful IPOs (initial public offerings) of European
biotech companies for the past 20 months, compared to 39 IPOs in 2000 and five
in 2001. Bankruptcies have become common, and valuations of late-stage companies
are lower than ever before.
Click the image to enlarge
The venture capital “bubble years” of 1999 and 2000 have been
replaced with a more rational growth rate and business model similar to
that in the early-1990s.
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According to the Bioseeker report, “to get over this critical funding crisis
in the European life science area, major consolidation, M&A and increased
b2b-pharma collaborations will be needed.” European life science start-ups
are still continuing, but in order to survive the next generation of entrepreneurs
will have to run real companies with a clear potential to generate profits in
a shorter time frame than in the past—the traditional time frame for life
science IPOs has never been more than five to seven years.
In the U.S. high-tech VC market, after experiencing similar investment reductions
throughout 2001 and 2002, quarterly VC investments ‘bottomed out’
in 2003 and have seen some regrowth patterns in late-2003 and into the first half
of 2004. About $5.6 billion was invested into 761 companies in the second quarter
of 2004, according to the Money Tree Survey. This figure compares to $5 billion
invested in the first quarter of 2004 and $5.4 billion in the fourth quarter of
2003.
“While investment levels are not exuberant, they’re realistic,”
says Tracy Lefteroff, global managing partner of the VC practice at PricewaterhouseCoopers,
Washington, D.C. “We see refined optimism in the U.S. market. There is a
more balanced mix of investing between earlier and later stage companies. And
the IPO window here is open again, though temperate. The pieces are in place for
good years ahead.”
“It’s difficult to revisit the level of investments seen in 1999 to
2000,” says Jim Millar, a General Partner with Battelle Ventures, Princeton,
N.J. “We’re now back to the levels of 1997 to 1998, which was still
five times the levels seen in the early 1990s. We’re also back to looking
at good technologies, with strong business plans, good market edges, and proven
niche sectors.”
Nanotech bubble
Click the image to enlarge
Outside of the still stagnant telecom marketplace, most high-tech industries in the U.S. are seeing increasing VC activity over the past year.
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“One might hope that investors have learned from these experiences [the
bubble technologies] and will be more cautious in the future,” says J.
Malcolm Wilkinson, Managing Director of Technology for Industry, Ltd., Cambridgeshire,
UK, at the Commercialization of Micro and Nano Systems (COMS) Conference this
past August in Edmonton, Alberta. “However, there are signs that once
again investors are engaging in ‘herd’ behavior and chasing the
latest technology fad—nanotechnology.”
Despite its hype, however, nanotech is still at the beginning of a mostly promising
lifecycle. And for now nanotech is still one of the smaller opportunities for
VC investors. The life science sector (biotechnology and medical devices, combined)
continues to dominate other industries for investment capital, as it has for
the past eight consecutive quarters. Investments in life sciences totaled about
$1.4 billion, or 25% of all VC in Q2 2004. Proportionately, life sciences investments
remains near their historical highs.
Many of the potential products expected to come out of current nanotech research
work are still many years away from being commercialized. The recent withdrawal
of Nanosys, Palo Alto, Calif., from its IPO typified the state of the nanotech
industry. “Nanosys had a great technology and a great team, but the products
were still too far away,” says Battelle Ventures’ Millar. “Venture
capitalists look to make money in the five to 10 year timeframe. The 10 to 20
year timeframe is too long a period of time.”
“Nanotech is no different than any other new technology,” continues
Millar. VC investors still want to see a business plan (same as pre-bubble),
a list of management profiles, and a business model that describes their potential
customers, information about their distribution channels, and in-depth analyses
of their competitors.
Where to get the money
Click the image to enlarge
The continuing reaction to the capital collapse in 2001 has most
VC investments going into later stage developments.
Click the image to enlarge
All rounds of VC funding in the U.S. marketplace, and especially
the first round, are seeing increasing levels of activity over those
seen two years ago. |
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Traditional VC is generally made available to an entrepreneurial company from
an organized group of wealthy investors. These individuals invest their shareholders’
money in a company along with providing hands-on assistance in the technology,
management, production, and overall organization. Funding for a start-up company
can also come from an angel investor—an individual who provides capital
to one or more startups. Unlike a business partner, the angel investor is rarely
involved in the management of a company and can usually add value to a company
through their contacts and expertise.
“Angel investment is a simpler relationship, where the investor is often
intrigued by the technology and has a high level of individual confidence in the
entrepreneur,” says Millar. There are all sorts of variations on these investment
types including SEC accredited investors, adventure capitalists, blind pools,
bridge loans, institutional investors, silent partners, and others. A good general
description of many of these variations can be reviewed at www.fundingpost.com/glossary/venture-glossary.asp.
Long-term outlook
“There’s a healthy amount of VC money now available that is looking
for new investments,” says Battelle’s Millar. There are VC groups
available for early, mid- and late-stage funding programs. Battelle Ventures
is one of the groups that funds seed and early stage programs requiring $3 million
or less in annual revenue by the entrepreneurial firm. Most VC firms are not
interested in entrepreneurial firms until there are $3 to $5 million in annual
revenues.
Milton Chang, Managing Director of VC firm Incubic, Mountain View, Calif., agrees
with Millar about the availability of VC funds. “There’s lots of
money out there, probably twice as much invested as there should be,”
he says. His firm’s proactive involvement in their investments has become
the norm in today’s VC marketplace. Today’s successful VC investor
has become well versed in the technologies, legalities, management, and marketing
of the companies they invest in. They transfer the successes they achieved to
attain their own wealth to the companies they now invest in.
And while many new VC investors appeared during the bubble years, some of those
have disappeared. The same consolidation phase seen in high-growth technology
firms was also necessary for the VC investors themselves, many of the newly
established VC investors were simply too small. According to the Swedish business
magazine Veckans Affarer, “more than 100 of the 150 previous VC investors
in Sweden have ceased their business or undergone a merger or acquisition during
2000 and 2001.” In Europe, this trend has forced most VC investments to
move primarily to later stages.
With VC investments, it is always painful to “pull the strings”
of portfolio companies since you have to believe in your portfolio companies
and that investing in them is right, says Hugo Birner, general partner at TVM
Techno Venture Management, a German-American VC firm with offices in Boston.
“Because of this attitude, the VC community is probably not terminating
unsuccessful companies fast enough, but as technology industries mature, investors
have to become tougher.”
There are many contradictory preferences from today’s VC investors. While
new high-tech companies need a long-term focus and novel technologies, the development
time has to be fast and profits need to be generated as quickly as possible.
And while some companies, especially in the life sciences, need a strong focus
and deep knowledge of their product’s target application, it’s still
important for the company to diversify.
As a result, there has been decreased enthusiasm among VC investors for some
very long-range, narrowly targeted technology areas, like stem cells, gene therapy,
and agrobiotechnology. Delivering products in these areas has proven to be more
difficult than was earlier predicted and the shorter times to market demanded
by new VC investors is less likely to be seen in these areas. It’s more
likely that these technology areas will be supported in the future by the large,
independently funded biopharmaceutical companies, than by small startups.
—Tim Studt
Battelle Ventures, 609-921-1456, www.battelleventures.com
Bioseeker Group, 46-8673-1700, www.bioseeker.com
Incubic, 650-960-2383, www.incubic.com
National Venture Capital Assn., 703-524-2549, www.nvca.org
PricewaterhouseCoopers, 646-471-4000, www.pwcmoneytree.com
Technology for Industry, 44-1353-865400, www.tfi-ltd.co.uk
TVM-Techno Venture Management, 617-345-9320, www.tvmvc.com
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