Issue Date: March 31, 2008
ABOUT 500 small-company business plans came through the door last year at BASF Venture Capital, the investment arm of the German chemical giant. After an initial screening, company analysts rejected three-quarters of the plans. BASF then carried out in-depth reviews of less than half of those left and eventually negotiated deals with just a few companies.
"This situation is not unusual for venture capital investors," says BASF Investment Manager Andre Moreira about the low odds for getting funded. "We are very much focused on quality." With a doctorate in physics, Moreira is part of a 13-member team of experts in science or economics who evaluate potential investments.
The BASF investment group tries to open windows on new technologies and generate adequate returns for the risks it takes. With about $190 million to invest, it has purchased stakes in 18 small companies and has put money into five venture capital funds over the past seven years. These investments target technology for current or future BASF businesses, or fall into one of five company "growth clusters."
The nanotechnology cluster is Moreira's focus. Over the past two decades, the field has emerged in large part from academia, moving from university labs into small companies. While nanotechnology offers tremendous promise for a wide range of industries, nascent university research or intellectual property (IP) usually requires significant commercial development before it is of practical use. Today, the academic, business, and investment communities are struggling to translate that basic science into real products.
"Unfortunately, what we see often, especially in nanotechnology, is that someone has a technology that can do wonders in many areas, but they don't know what problems they want to solve," Moreira says. "It's good to have focus to get something done and then move onto the next stage."
To interest investors, small companies with broadly applicable—or platform—technologies, should pursue an initial product with the greatest chance for success, Moreira explains. Additional uses can follow later to expand a business.
BASF may invest anywhere from $1.5 million to $7.5 million in a small company. "Our sweet spot is in the early- and mid-stage companies," Moreira says, "but it can't be too close after the proof of concept for us to feel comfortable investing." (To see a timeline of venture investing in small companies, go to www.cen-online.org.)
Beyond a proof of concept, Moreira, like most investment managers, wants to see a small business meet certain criteria. Typically on investors' lists are a qualified management team, a fully elaborated business plan, promising market prospects, and a strict market and customer focus. Also critical is a strong IP portfolio that ensures the freedom to operate and creates competitive barriers.
Venture investors put an estimated $668 million into small nanotech companies in 2007, a 13% decrease compared with 2006, according to New York City-based Lux Research. Along with the decrease in funding, there has been a trend toward fewer deals being made. Moreover, investment has shifted to more mature companies, says Lux Research Director Michael Holman. "Companies actually starting to do things, like building out manufacturing, are getting later and larger financing rounds."
WHEREAS THIS TREND may simply reflect the maturing of some companies after many years, it may also indicate that investors want to put their money behind companies with products and not just potential. The Nanobusiness Alliance trade group states that nanotech companies face "a significant challenge in the so-called valley of death created by inadequate seed and early-stage capital, insufficient understanding of nanotech in the financial community, and limited commercial transfer between Fortune 500 companies with challenges and emerging businesses with solutions."
Although getting a small business to the stage where it can attract investors takes initiative and perseverance, nanotech start-ups and spin-offs keep appearing. According to Lux, out of about 60 nanotech venture capital deals in a given year, only a third involve new companies getting very early-stage funding. At the same time, only about 10% of existing companies generate a return for investors through a public stock offering or by being acquired, while a slightly higher percentage close down. Not only do few companies become mature enough to consider a stock offering, but financial markets aren't favorable for nanotech stocks.
As of mid-2007, the Woodrow Wilson Center for Scholars' Project on Emerging Nanotechnologies counted at least 300 nanotech companies operating in three main sectors: materials, medicine and health, and tools and instrumentation. And at least 138 universities and government labs were working on some aspect of nanotechnology R&D.
Universities have been a breeding ground for nanotech research and start-up companies. A perusal of technology-transfer office websites at major schools shows an array of nanotech patents available for licensing. The University of California system, Massachusetts Institute of Technology, and Rice University rank among leading nanotech patentees overall and are the top three among universities. Like other schools such as Harvard University, they have spun off several nanotech firms.
Several universities are increasingly proactive, not only in licensing technology but in trying to develop it to the point where it may be more marketable. Their goal is to attract investors by bridging that valley of death between innovation and commercialization. Some also partner with large corporations to advance research and transfer technologies. And many provide programs and facilities to train and support academic entrepreneurs.
Still, most universities don't go this route. Instead, they rely on traditional means of technology transfer. In the worst case, interested outside parties stumble serendipitously across university IP. The four companies C&EN explores here—Arrowhead Research, Advance Nanotech, Nanosys, and Nano-Terra—are trying to improve the process of commercializing academic nanotech research, although it is not yet clear how successful they will be.
"It's a grossly inefficient process that is reliant on individual entrepreneurs, who may or may not be scientifically literate, to partner up with a professor and start a company, and then hopefully attract some venture investors who can provide guidance," says Christopher Anzalone, who was recently named chief executive officer of Pasadena, Calif.-based Arrowhead Research. With a Ph.D. in biology and a background in venture investing, Anzalone has helped create a handful of nanotech companies, including NanoInk, which came out of Northwestern University.
The traditional process for creating companies isn't good for anybody, Anzalone maintains. "It's not good for the venture capital firms because they don't have the bandwidth to actively manage these companies; it doesn't serve the scientific community because generally many of these companies should not have been started or are run poorly; and it doesn't benefit the university because they end up with illiquid and often worthless stock in these start-ups and royalties that will never come down the pike," Anzalone says.
Seeing opportunities in the nanotech field, Arrowhead has been creating and supporting companies based on university technology for five years. Its access to that technology has come largely by funding research at California Institute of Technology, Stanford University, Duke University, and the University of Florida in return for exclusive commercialization rights.
ARROWHEAD TRIES to be market driven. "We identify attractive market opportunities, look for technologies that can serve those, and then build companies," Anzalone says. More than just an investor, Arrowhead provides an entire management and business development infrastructure in legal, financial, administrative, and regulatory areas. It has five majority-owned subsidiary companies and soon will gain two more by acquiring the Benet Group, a separate firm founded by Anzalone. About a dozen people work for Arrowhead and about 50 are in its subsidiaries.
Anzalone says the company lives and dies by its ability to combine scientific and business capabilities. On the one hand, this involves bringing in senior scientists as advisers. On the other hand, success also hinges on having experienced businesspeople who have created companies in the industries that nanotechnology will impact.
In building companies, Arrowhead usually invests in firms at an earlier stage in their lives than venture capitalists do. It also looks for companies that may have good science but bad business plans, a lack of capital, or investors that want to cash out. "We acquire these and roll them up to bring together all the important pieces of IP in a specific area and, we hope, make a leading company," Anzalone says.
In the long term, Arrowhead may operate one of its subsidiary companies for the cash it generates, or it may spin it off with a stock offering. Many of Arrowhead's subsidiaries are reaching an "inflection point," Anzalone says. "We're in the company-building business, but we're also in the company-selling business." For example, Arrowhead is likely to sell Aonex Technologies, its semiconductor materials subsidiary.
Arrowhead also has decided to combine Calando Pharmaceuticals and Insert Therapeutics, two subsidiaries with drug-delivery technology platforms that came out of Caltech. The consolidation is expected to cut costs and increase efficiency. The goal is to maximize the number of compounds in clinical trials and then license these to large pharmaceutical partners for fees, milestone payments, and royalties, Anzalone explains.
Meanwhile, Anzalone says Arrowhead's Menlo Park, Calif.-based Unidym subsidiary looks good for a public stock offering, if market conditions improve. To create Unidym, Arrowhead rolled up three firms: Unidym, Nanopolaris, and Carbon Nanotechnologies, the latter started by the late Nobel Laureate Richard Smalley. Unidym has licenses from 11 universities covering at least 150 patents and patent applications that support its business in carbon nanotubes.
"The carbon nanotube area was such a muddy space, and no one had been able to control the market because the IP was everywhere," Anzalone says. "It's not a lack of capital that kills companies; it's a lack of focus." Platform technologies such as carbon nanotubes offer a lot of upside potential, but companies need to be built on products that address a market, he adds. To this end, Unidym is initially developing transparent electrodes for touch screens, flat-panel displays, solar cells, and solid-state lighting.
WHEN WARRANTED, Arrowhead will halt research programs or shut down businesses. In 2005, Arrowhead management and other shareholders closed microfluidics developer Nanotechnica after determining that it was not progressing satisfactorily toward commercialization and that the market potential was uncertain. Arrowhead received about $3 million in cash and assets from the business and returned the applicable patents to Caltech.
As a publicly traded company itself, Arrowhead is expected to create a return for its shareholders, although it has yet to do so. Since its inception, the company has raised about $79 million. It had revenues of just $1.2 million for the year ending Sept. 30, 2007, and reported a $30 million loss. It spent about $21 million on R&D and had about $24 million in cash.
Advance Nanotech, founded in 2003 in the U.K. and now headquartered in New York City, started life with a business plan very similar to Arrowhead's but is now in the process of abandoning it.
Its founders also believed that the returns from holding majority ownership positions in a portfolio of businesses would outweigh those achievable by venture capital-style investments. And, through that ownership, they figured they would benefit by having decision-making control.
Starting last year, however, Advance has shut down its university partnerships, spun off half of its operations, and is now morphing into one of its own subsidiaries as it jettisons that original business plan. "We've learned an awful lot in the past three years," says Magnus Gittins, an Advance Nanotech founder and its executive chairman. "And the transition we are undergoing reflects that."
THE COMPANY HAD partnerships with the British schools Imperial College London, University of Cambridge, and University of Bristol. But its approach went further than just technology transfer, Gittins says. "We wanted to go beyond the initial IP and find out who had invented the technology and whether there was a desire to continue the work because there was a commercial opportunity." Advance looked for inventors who understood the path to commercialization and the addressable markets.
The company and its partner universities also delineated milestones for success. "Our purpose was to bridge the innovation gap and migrate promising technologies out of universities in the most expeditious and cost-conscious manner," says Gittins, who previously was chief technology officer of a European venture capital fund. "The plan was to keep overhead at the top extremely light and focus management and resources on developing the technologies."
Eventually, Advance hoped, the technologies would mature to the point that either venture capitalists or large corporations would be interested in taking them to market. It succeeded in setting up about 20 programs in electronics, materials, and biopharmaceuticals, and had minority interests in five small operations.
In early 2005, Advance raised $23.5 million in a stock offering to support its programs. It also leveraged some funding from government and industrial sources, as well as the universities' investment in equipment and personnel. "A dollar goes much further in a university setting than it does outside," Gittins says about the advantages of this business model.
Yet Advance managers had to face the challenge of predicting the time and investment that would be required to realize the potential of a given university technology. Although they hoped for great returns, they took on a lot of risk as well. Even projects that came with a prototype device had to pass technical milestones to advance in development; some made it through to the next phase and some didn't.
"What we learned in the process is that it is very hard to do," Gittins says about executing Advance's business plan. "Despite being extremely promising, the technologies still require substantial amounts of capital if their trajectory toward commercialization is to be realized."
In August 2006, faced with the need for financing that would allow it to continue operating, the company realigned about 90% of its portfolio into two divisions: display technologies and sensors.
Advance also discontinued many projects and sold off some minority interests. In early 2007, the company listed its Advance Display Technologies division on the London PLUS stock market. Its remaining operations are being folded into a majority-owned subsidiary, Owlstone Nanotech. Owlstone is an operating company with chemical detection products and several major customers.
"Owlstone is the success story to our model," Gittins maintains. Owlstone's proprietary technology, which came out of Cambridge, matured both technologically and commercially faster than other programs, he says. "The three coinventors originated the concept and proved it within the university lab, and they continue to be the driving force behind commercialization."
INVESTORS HAVE had to pay to get to that point, however. Advance reported last September that its revenues since inception were only $875,000, while during that time it spent $16 million on R&D and lost $33 million. Given the stock market's current skittishness toward companies with uncertain expectations for profitability, Gittins says "it makes complete sense now to focus on Owlstone and for its technology and several related technologies to become our business going forward."
Looking back, Gittins says he now appreciates that entrepreneurial determination and strong commercial skills are just as important as extraordinary technology. "Although we had a very strong, technology-rich portfolio, it could only be realized if we also invested in the right people," he says, "especially as the challenges evolved from those that were scientific to ones associated with commercializing a product."
The need to combine entrepreneurial spirit, top university research, and business experience was not lost on the founders of Palo Alto, Calif.-based Nanosys. The founding team included Lawrence Bock, a successful biotech venture capitalist; Stephen Empedocles, a Ph.D. chemist from MIT who had worked at two nanotech start-ups; and Calvin Chow, founder of two device-oriented technology companies.
"The company wasn't started based on the work of a single scientist or body of research," says Empedocles, who is vice president for business development. Instead, when they created Nanosys in 2001, the founders were acting on the belief that "nanotechnology had matured to a level where it was possible to start a real nanotech products company," he says.
For Nanosys, this means inorganic materials, and specifically the fabrication and integration of nanostructures into products. To build this platform, the team met with hundreds of university labs. It eventually brought together 10 scientific founders and licensed several hundred patents from the likes of Harvard, MIT, Caltech, Columbia University, and the University of California. "We wanted to find the tool set to make nanotechnology products successful, and no one source had everything that we needed," Empedocles says.
The company's IP portfolio, which has expanded further over the past six years through internal development work, now covers everything from compositions of matter and different nanostructures through assembly techniques, specific applications, device integration, and manufacturing methods. "The combined technology we are developing today has expanded and matured and looks very different from any of the individual technologies originally licensed from our academic founders," Empedocles says.
Nanosys added experienced product-development people and focused initially on solar cells and biosensors. Those initial applications have since evolved into other areas, while its platform technology has been extended to other applications. "We always look for a definable timeline, requiring as few leaps of faith as possible, and a real market where nanotechnology can add quantifiable value," Empedocles says.
To develop products, Nanosys is working with partners such as Sharp, Rockwell Collins, DuPont, NTT DoCoMo, Intel, and various U.S. government agencies. Applications include flat-panel displays, nonvolatile memory, fuel cells, solid-state lighting, and other devices. Applications are selected "by how well our tool kit solves a particular problem and what alternatives exist. If our technology doesn't provide a unique and high value, we don't go after it," Empedocles says. "We want to enable our partners to make new products that are based on our technology and that really differentiate them within their market."
The partner handles end-product manufacturing, while Nanosys focuses on the nanotech side. "Our goal is to supply our partners with a component that can be integrated easily into their existing manufacturing," he says. These "nanomodules" and the interface with a product will differ to meet each partner's needs. Nanosys, however, employs the same core capabilities both to design and manufacture specific nanostructures and to assemble the nanomodules.
Its commercial involvement continues in manufacturing the nanomodules. From the beginning, Empedocles says, Nanosys established a scalable manufacturing infrastructure. Although its target applications require only small quantities of materials, reliable and reproducible production is critical. To execute its plan, Nanosys has about 80 full-time staff.
TO SUPPORT ITSELF, Nanosys gets revenue from joint development funding and from the sale of components to its partners. Material and IP costs are folded into one "value added" price, Empedocles explains, without any additional ongoing royalties. "If we selectively develop an application, the partner gets substantially higher value, and we get paid based on the value we provide, not just the materials' cost," he says.
Since its inception, Nanosys has raised just over $100 million in four rounds of venture capital financing. As a private company, Nanosys doesn't disclose revenues or profits, but Empedocles says the combination of financing, development funding, and product sales allows it to look at new opportunities. As part of its business model, however, the company doesn't generally pursue an area until it has a committed partner that knows the targeted market.
Investors in Nanosys are no doubt interested in getting a return on their investment. In 2004, the company filed for an initial stock offering but didn't proceed when market conditions deteriorated. Because the company is fiscally strong, Empedocles maintains that Nanosys can be "opportunistic" about future financing moves.
Nanosys doesn't do any fundamental research, so it still looks to the academic community for research advances, Empedocles says. But the company is often mistakenly viewed as one that only licenses technology to others. "The seeds of those 10 academic groups have grown within this product development environment into a very solid platform technology for developing and manufacturing products," he says.
In contrast to Nanosys, three-year-old Nano-Terra was founded around the work of one university laboratory, namely George Whitesides' lab at Harvard. In June 2007, Harvard granted Nano-Terra a license to a portfolio of more than 50 issued and pending patents, which cover nano- and microscale molecular fabrication methods for advanced materials and devices. In return, Harvard received equity in the firm and the right to royalties.
Nano-Terra's business plan is to leverage this IP through codevelopment agreements with large organizations. It already has announced deals with 3M, Merck KGaA, Nestec (part of Nestlé), and the Department of Defense. Simply put, "we want to use our technology and expertise to help companies make better products," says Carmichael Roberts, one of Nano-Terra's founders and now its vice chairman. He expects the first products to roll out within three years.
To execute its business plan, Nano-Terra has a staff of about 30 people and labs in Cambridge, Mass. But it also taps into a global network of academic and industrial collaborators, some of whom are coinventors of Nano-Terra's IP. "There's a whole group of us fortunate enough to have worked either directly or indirectly with George Whitesides who are hugely supportive and excited about the concept behind Nano-Terra," says Roberts, who has a Ph.D. in chemistry and was a postdoctoral fellow in Whitesides' lab. "Many of us are chipping in a little to a lot of time to make it happen."
One reason Nano-Terra was created was simply to increase access to the technology and thinking coming out of the Whitesides lab. The number of requests for Whitesides' time and input on solving problems is "enormous," Roberts says. "Nano-Terra is the embodiment of the commercial solution to serving this unmet need."
Initial capital for Nano-Terra has come from the founders, employees, and others in the collaborative network and was quickly augmented by development funding from the first few partnerships. To expand operations, the company may in the future look for outside financing, but Roberts doesn't anticipate turning to venture capital investors.
THE COMPANY'S VISION is different from that of a small, venture capital-financed company, which must focus on a particular application or product, notes Roberts, who in his career as an entrepreneur has set up other companies with Whitesides. "Another way to focus is to pick a core set of technologies for which the embodiment is very closely related and be wedded to that, never bending from the discipline of developing the technology in collaboration with companies that will be responsible for actually making a product," he explains about Nano-Terra's approach.
"We don't see Nano-Terra manufacturing something and selling it." Roberts adds. "At the same time, we don't see ourselves taking a technology and throwing it over the fence and having someone else develop it, because we know that's a recipe for failure." Nano-Terra's business model is to partner, he adds, and take a role in advancing and developing others' products and manufacturing capabilities.
The value of this offering can be measured in Nano-Terra's ability to attract leading companies as partners. And its success will be measured through a partner's success and the revenues it yields. "Integrating our technology into a manufacturing process that produces a product is critical," Roberts says. "The value we create is in the output of a product being sold that would never have been made if it wasn't for Nano-Terra's technology, capability, and people."
Although people, technology, and business approaches may differ, small nanotech companies are all reaching for the brass ring. "There is a lot of innovation going on broadly, but adoption of new technologies is going to be a tricky part," says John M. A. Roy, senior executive director at the technology-focused investment firm Global Crown Capital in San Francisco. "You see a lot of nanotech companies with a very nice product, but it may be for an industry not used to consuming new technology, and that creates a big barrier."
Other hurdles arise when actually trying to get a product out the door. "I see a lot of university research going into companies that get to a first prototype and then stall out," Roy says. "It's not getting the first prototype or even signing up the first partner, but getting that first scaled product to market that matters." Product development can languish for years at this stage for technical and business reasons.
A company with a technology that works may develop a product only to find that it fails under the actual conditions of use. Others may discover too late that the cost of manufacture is prohibitively high or that scaling up is too difficult. And unless the need for a new technology is urgent, it may be difficult to keep the attention of a large partner that simply has higher priorities.
"These are bugaboos you just don't see in the beginning," Roy says, "but they tend to happen more often than you would think."
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