Changes in Venture Capital & Science Funding: A Perfect Storm

[An edited excerpt of this was posted in The Times Science Blog on 8 October 2010.]

Today’s economic climate and the austerity measures that are being introduced by the government both have their sources, in part, in the global financial crisis and both have triggered significant, potentially unprecedented change both in the funding of the science sector and in venture capital. This period of simultaneous change has additional consequences in the manner in which funding in the science sector and venture capital interact with, and affect, one another. These changes in the funding of the science sector and in venture capital have created a perfect storm.

The science sector

The whole spectrum of sciences, including vitally important areas such as cleantech, life sciences and biotech, and engineering, is facing extreme upheaval, particularly related to the funding of scientific research. An overall difficult economic situation, cuts by government in the area of blue-skies research and less funding available from corporates have created an environment in the UK in which the funding of science that is not immediately of commercial value is seen as unnecessary, imprudent, and wasteful.

At the same time, scientific advancement has been very rapid, and tremendous progress has been made in all areas of science. But this has come at a price, quite literally: scientific research is expensive, it takes place at a very high level of complexity, and some of it is speculative with often long and rarely direct routes from idea to commercialisation.

The venture capital funding environment

Venture capitalists in turn are also facing a difficult economic situation, albeit from a different position compared to scientists. Their responses have been externally constrained, but are also self-constraining. They are constrained by the limited partners who invest in venture capital funds and have an ever-decreasing appetite for risk. Yet, the funds themselves are also less likely to invest in early-stage scientific ventures, partly because of limited partner’s reluctance to do so, but partly also because venture capitalists may not be fully ready and able to rise to the challenges of untangling the intricacy that investing in scientific ventures in their notional, blue-skies stage of development brings with it today.

The complexity of ideas that underlies current scientific exploration has grown exponentially over the last few years. These potential investments require a new level of sophisticated scientific expertise for investors to be able to make informed and prudent decisions, and most venture funds are not well equipped to do this. As a consequence, they seek the comfort and greater certainty of later-stage investment that comes with a proven idea and income stream on its side.

The consequences of a troubled relationship

The pressure, from government, limited partners and venture funds, in the current economic climate to seek safe returns on any investment of public or private funds combined with the complexity of scientific developments and the expertise to judge their future commercial value has led to an ever-increasing gap in the market for the funding of complex blue-skies innovative thinking that solves problems for people and planet. Yet, it is this early stage blue-skies work that the rest of the chain for economic growth in the scientific sector is predicated upon. This raises three questions in relation to research that could have enormous positive impact: who funds it, who decides what gets funded, and what happens to things that are not funded?

To start with the last of these questions, the problem for the UK as a leader in scientific research is this: there is an increasing amount of money available to fund blue-skies research, not just in the US and elsewhere in Europe, but also in China and India. As it proves ever more difficult to raise funds in the UK, the possible consequences are an ideas and brain drain from the UK. At the moment, and especially in relation to China and India, this flight of early-stage ideas is offset by their return to the UK at the point of testing because of the better protection of intellectual property rights here. But eventually and inevitably, China and India will address their shortcomings in this respect and then they will also retain the commercial benefits of the blue-skies research they are investing in.

If retaining its position as a world leader in scientific exploration and its commercialisation is vital to the economy, what needs to be done and are we willing to do it? The gap that needs to be covered is between the origin of an idea and that stage in its development where its successful commercialisation is more likely than not. Early-stage investment funds can play a vital role in bridging this gap: they pick up where notional research leaves off but well before the commercial value of a discovery has been completely verified. These funds need to bring together experts who understand the complex science behind the idea right at the point of due diligence and help funds to judge its potential with venture capitalists who have the business acumen to vet business plans, fund them, and guide their implementation.

Early-stage investment funds do not in themselves resolve the problem of who invests in blue-skies research, but they can make it a more promising and less daunting venture by helping to contribute to a faster and more reliable idea-to-market process. In other words, they can contribute to creating an environment in which traditional investors in notional ideas, such as large corporates, governments and charitable trusts in partnership with universities and dedicated research centres, can be assured that proven ideas will be picked up by next-stage investors who invest in testing an idea and developing it for commercial exploitation. This is the role taken on by early-stage investors, whose lasting and active interest in the success of the entrepreneurs they fund, also provide them with the credibility needed for later-stage investments by larger venture funds, thus performing the vital function of a feeder fund and contributing to the long-term success of their own initial investments and a justification for the investment of private and public funds at the first stage of blue-skies research.

Lucy P. Marcus is the non-executive chair of the Mobius Life Sciences Fund, non-executive director and chair of the board audit committee of BioCity Nottingham, CEO of Marcus Venture Consulting, and a Fellow at University of Cambridge’s Judge Business School. She can be found on Twitter via @lucymarcus

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10 October 2010

The Times Science Blog: Eureka Daily

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