Venture Capital and Research Centers: Facilitating Innovation

Venture Capital and Research Centers: Facilitating Innovation

Venture Capital and Research Centers

Facilitating Innovation

Benjamin J Chazen

MIT Washington Office

August 2016

Introduction

Today’s venture capital system is biased towards IT/Software related fields to such an extent that we can no longer rely on it to enable innovation and growth in clean energy, biotech and many other non-software industries. Software has proven to be the most reliable source of profits for venture capital firms; software startups are suited for the venture capital model because they are easy and cheap to scale, likely to be acquired by large tech firms and because venture capitalists have connections and expertise in that field.[1] Evidence shows that the venture capital system is simply not equipped to fund clean energy research and bring viable clean energy solutions to market. That the market fails to price in clean energy’s beneficial environmental impact does not mean that we can simply ignore the challenge of investing in clean energy solutions and bringing them to scale. In order to solve this problem, we ought to turn out attention to private and university sponsored research centers and startup incubators. By examining existing research centers and startup incubators we can understand which features to replicate in MIT’s Innovation Orchards initiative. The first section of this paper will discuss the ways in which our venture capital system discriminates against clean energy. The second section of this paper will present statistics on venture capital investment activity across sectors and regions. The third section of this paper will examine three case studies of successful research centers and startup incubators.

Section I

Thus far, venture capital investments in clean energy have proven extremely unprofitable. From 2006-2011, venture capital firms invested heavily in clean energy firms. There were several important factors that led to a sharp rise in venture capital clean energy investment. Rising gas and electricity prices (gas prices quadrupled from 1998 to 2008), Al Gore’s Inconvenient Truth and energy policy made venture capitalists believe that investment in clean energy would be profitable and socially responsible. The opposite proved to be true. From 2006-2011, less than half of the $25B invested in clean energy found its way back to investors. Ninety percent of clean energy investments failed to return 1x invested capital and in 2008, 2009 and 2011 0% of clean energy investments returned 2x invested capital.[2] As a result of the financial crisis of 2008, a decline in oil and gas prices, an oversupply of solar panels and Congress’ failure to pass emissions-limiting legislation, investment in clean energy declined sharply from 2008 onwards. In the absence of government action to incentivize private actors to invest in clean energy, the laws of economics will largely prevent clean energy from receiving private investment.

Further complicating matters is uncertainty regarding political and economic changes in the clean energy policy environment. The potential for rapid change to the political and economic framework under which clean energy operates is yet another barrier to clean energy investment. Venture capital firms do not know whether conditions favorable to their investments will change or remain the same. If Congress fails to renew clean energy tax subsidies, for example, then investments in clean energy suddenly become much riskier. Lower fossil-fuel energy prices, often a consequence of changes in domestic policy and/or geopolitical shifts, could make clean energy economically unviable without substantial advance notice. In an unpredictable and rapidly changing policy environment firms are unable to trust in the assumption that conditions favorable to their investment will remain as they need to be.

In addition to having to navigate an unpredictable policy environment, venture capital firms avoid clean energy projects because they require massive initial capital investments. Solyndra, a thin-film solar panel manufacturer, required $970M in investments prior to is IPO.[3] It then proceeded to declare bankruptcy and shut down permanently in 2011. Other high-profile cleantech failures include HelioVolt (consuming over $200M in VC funds over 13 years) and Xunlight, a company adept at winning tax credits and government grants but unable to scale. Typically, venture capitalists are comfortable investing up to $40-50M in any given company before its IPO or acquisition.[4] In Q1 2016, VC firms invested a total of $12,140,064,100 in 969 companies, imputing an average investment value of approximately $12.5 million per company.[5] Using the same method to calculate the average value of venture capital investments in the software sector yields a result of $6.37 million per company.[6] For venture capital firms a cheaper initial investment translates to a higher equity stake and therefore also a higher risk tolerance. Most clean energy investments, as evinced by Solyndra and other expensive cleantech failures, are prohibitively expensive and high-risk for venture capitalists.

Another reason venture capital firms do not invest in clean energy isbecause most projects occur on too long of a timeframe for the firm to tolerate. Venture capital firms expect their investments to mature roughly on a 10-year time scale.[7] The first five years involve stages of progressive investment and helping the projects scale and the following five years are when profits begin to return to the venture capital firm. Most endeavors in clean energy take 10-15 years to fully mature.[8] To further complicate matters, there is always the possibility that, after millions of dollars in investment and several years of research, a clean-energy project may prove to be irremediably unprofitable. The expanded timeframe and increased risk of clean energy investments exist because clean energy companies face two essential challenges where companies in most other sectors face only one: first, making technology to serve a specific purpose and second, to scale that technology profitably.[9] It is difficult to know how much time and how many resources are necessary to develop and implement manufacturing techniques that enable cleantech projects to scale profitably.

Clean energy firms are less likely to be acquired by established companies because, based on current levels of profitability rather than long-term potential, methods of clean energy production are almost never more cost-effective than current methods. Compared to exit rates of 11.9% and 6.3% for software and medical companies respectively, only 3.8% of clean energy companies were acquired from 2006-2011.[10] Venture capital firms have no interest in funding projects that will not be acquired because expecting an exit within five to ten years is key to venture capital investment strategy. The connection that exists between venture capitalists who fund the initial operations and established industry players who purchase the startups once they reach maturity is very strong in software but practically nonexistent in clean energy. The relationship between venture capital and industry functions only when both venture capitalists and industry players derive profit from their investments. With venture capital firms disinclined to invest, clean energy companies struggle to demonstrate profit potential, get acquired by an industry player and then brought to scale. Clean energy is not given the chance to scale because it is generally the parent company that figures out how to scale the product of the company it buys. The challenge of scaling clean energy has proven extremely difficult; investors are too afraid of not receiving a timely return on capital to invest in clean energy scaling efforts. Clean energy also misses out on the stock market interest that accompanies being acquired by a larger company.[11] Market forces simply do not encourage pursuit and development of scalable clean energy solutions.

The lack of institutional support surrounding clean energy makes progress in the field very slow and unreliable. There must be an institutional framework in place to help clean energy startups move forward from the point at which a project is too advanced to receive more government funding but not yet profitable. The clean energy community refers to this gap between fundability and profitability as ‘the valley of death’.[12] If we are serious about implementing clean energy solutions and avoiding the dire environmental and economic consequences of inaction on this issue we will have to find a solution to the problem of funding and scaling clean energy outside the venture capital model.

Section II

Since 2002, the aggregate of all seed and early-stage funding has risen steadily across all industries. All investment statistics pertain to fiscal year 2015. Across all industries. there were 1513 deals worth a total of $9.325B ($6.16M per company). In biotechnology, there were 122 deals worth a total of $1.84B ($15.1M per company). Investment in biotechnology has outpaced the aggregate of all industries. In software/IT services, there were 717 deals worth a total of $4.183B ($5.83M per company). Software/IT investment has risen faster than average. Industrial/Energy investment has fluctuated very much and has declined since 2011. In Industrial/Energy there were 76 deals worth $466.4M ($6.13M per company). Medical device investment hit a peak in 2009 and has remained steady for the most part since then, decreasing slightly. In medical devices, there were 74 deals worth $347.3M ($4.69M per company). Investment in financial services has risen sharply since 2014. There were 37 deals worth $308.1M ($8.33M per company).[13] Here are recent trends in seed and early stage venture capital investment by region in software/IT and biotechnology: 451 out of 1173 software/IT deals were made in Silicon Valley. 81 out of 331 biotechnology deals occurred in New England, while 83 out of 331 deals occurred in Silicon Valley.[14]

Section III

Case Western: Sears think[box]

Case Western University sponsors a program called Sears think[box] that provides a public space for anyone to ‘tinker and creatively invent’. The White House named think[box] a national leader in university makerspaces. It is located in a 7-story 50,000 square foot facility, soon to expand and undergo renovation. Being a $35M project, Sears think[box] is one of the world’s largest university innovation centers. The State of Ohio granted $1M to think[box], citing it as an economic engine for the region. Sears think[box] receives over 5000 visits each month, making it the third most popular facility on campus, behind the athletics center and the library. During the fall and spring semesters it is open 63 hours a week and during the summer it is open 20 hours a week.

Sears think[box] is equipped with 3D printers, laser cutters, photo tables, sewing machines, CNC routers, vinyl cutters, saw stands, laminators, 3D stereo inspection microscopes, soldering irons, hand tools, all-in-one electronics instruments (multimeter, power supply, oscilloscope, and function generator), 3D scanners, vacuum chambers, drill presses, combination sanders, vertical and horizontal bandsaws, panel saws and software design programs such as Adobe Photoshop and CorelDraw.[15] The facility is a shared space with both group and individual workstations. Upon arrival in the facility, a teaching assistant will greet think[box] users and connect them with the right tools to work on their projects. Staff will not assist users in designing or building; they can only provide basic tutorials. While the center does not allow users to do mass manufacturing on the premises, think[box] will connect users to people and resources to further build their business. All of the services and training users receive from think[box] staff is free. Materials, however, are not free; undergraduates receive a discount while all other users must pay a standard price unless they bring their own materials.

The Sears think[box] prioritizes safety above all else. No food, drinks or open toe shoes are allowed in the facility. To verify that a user is qualified to use equipment think[box] makes use of an ability badge system. One gains access to restricted machines upon receiving an ability badge from think[box] staff. It is expected that people use pieces of equipment only after consulting the instructional website and/or a teaching assistant. In order to gain access to the metal or wood shops one must participate in a brief safety orientation. There are five levels of machine access, ranging from level 1 with no restrictions to level 5 that requires training and the completion of a liability form. The think[box] program also has a system in place for the disposal of hazardous waste materials. Below is a diagram of the floor layout, containing both individual and group working spaces:

A think[box] Student Project Fund exists to further support CWRU undergraduate and graduate students in their experimental endeavors. The sponsors of the fund are the George W. Codrington Charitable Foundation, Fran and Jules Belkin and Brandon Palmer (CWR Class of 2000). Funding is more likely to go to teams with diverse makeups in terms of ethnicity and course of study. Academic course related projects are not eligible for funding; the fund primarily targets extra-curricular activities and considers competition-based projects on a case-by-case basis. Many think[box] users participate in engineering contests such as the Saint Gobain Design Competition and the Ohio Clean Energy Challenge. Any single project can receive a maximum of $2500 from the fund. In order to apply and qualify for funding, those seeking funding must complete an online application, submit a two page interim progress report by September 1, 2016 and a three page final report by December 31, 2016. Proposals will be judged according to technical and monetary feasibility as well as utility and creativity. All intellectual property that results from a project’s completion belongs to the students, not the university or any of the program’s other sponsors.

To reiterate, think[box] doors are open to all people, though there are restrictions based on age and special procedures required to register large groups for time in the think[box] facility. While think[box] is not a place for startups in the marketing and expansion phase, think[box] staff are prepared to connect startups in that stage with resources outside the university to assist them in building their businesses. On their website is a full list of informal company partners under the services section.[16] Eligibility for funding from the Student Project Fund is restricted to current undergraduate and graduate students attending Case Western. Award recipients will receive 50% of funding before starting their project and the remaining 50% once they submit their interim report. In the space itself, there are 4 open project bays available on a first-come-first-serve basis and 3 bays reserved for long-term projects that a team must fill out an application to reserve. Sears think[box] staffs its facility with undergraduate and graduate students from Case Western, Cleveland Institute of Art and Cleveland Institute of Music. Student employees are responsible for training users, monitoring safety, keeping the facility clean and organized, and giving group tours. Wages begin at $10/hour.

Invent@NMU

Invent@NMU specializes in the creation and marketing of simple hardware products. They describe themselves as a creative and highly energetic contract design and commercialization house. Unlike most other makerspaces their clients do not have access to any equipment. When the program started in October 2014 the student team consisted of just four members, but now there are three professional mentors who guide a team of 13 part-time student employees. The student employees are the ones who work with manufacturing equipment. There are three main student positions: projects managers, mechanical engineers and industrial product designers. Other staff roles include public relations, graphic design, videography, photography and welding. Equipment available to student employees includes laser engravers, vacuum formers, CNC table routers, drill presses, a wood shop, a metal studio, a sound studio, a ceramics studio, a cinema, letterpresses, screenpresses, a photography studio, lathes, plasma cutters and bandsaws. Clients pay the program $30 for each hour the students spend working on prototyping and refining their products. There are no restrictions on clients; the program serves everyone from students and university staff to independent inventors with no NMU affiliation.

The students’ objective is to develop a product, not necessarily a business. Invent@NMU welcomes ideas at any stage of development but they tend to favor smaller projects for reasons related to cost and production capacity. Invent@NMU will generally take on projects that require less than $100,000 in capital and less than a year to go from ‘napkin to market’. Since October 16, 2014, the program has processed 169 distinct ideas. NMU has funded the program experimentally with $300k annually for three years. Continuation of the program depends on an assessment of its achievements at the end of this three-year period; it is the university’s hope that after three years the program will be able to fund itself using revenue generated from fees charged to clients. After clients have exhausted the resources Invent@NMU has to offer program managers are prepared to connect them with other business development programs to handle such matters as sourcing debt, crafting a business plan and handling long-term operations. Although it is the students who work on projects for clients, the clients retain all rights and intellectual property associated with the final product.