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A Perfect Storm: Global Shifts in Venture Capital and Science Funding

Partly a consequence of the global financial crisis, unprecedented change in venture capital and the science sector is on the cards. And it has additional consequences too.
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A potentially unprecedented change in venture capital and in the funding of the science sector is on the cards as a consequence of today's economic climate and the austerity measures that are being introduced by many governments around the world, including the G7. Partly a consequence of the global financial crisis, 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 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. In an overall difficult economic situation, cuts by governments in the area of blue-skies research and less funding available from corporates have created an environment 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 commercialization.

The venture capital funding environment

Venture capitalists in turn are also facing a difficult economic situation, albeit in a different way than 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.

The complexity of ideas that underlies current scientific exploration has grown exponentially over the last few years. Informed and prudent investment decisions thus require a new level of sophisticated scientific expertise, 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 needed 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 many developed countries that were previously among the undisputed leaders in scientific research is this: there is an increasing amount of money available to fund blue-skies research among the so-called 'rising powers', especially in China and India. As it proves ever more difficult to raise funds, the possible consequences are an ideas and brain drain. At the moment this flight of early-stage ideas is offset by their return to countries such as the US and 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. Moreover, and as seen in the case of Evergreen Solar moving its operations from the US to China, "the draw of Chinese state-owned banks and municipal governments... offering unbeatable assistance" is an indicator of an increasingly competitive market place where countries other than the G7 offer better conditions for funding long-term development and commercialization of new technology.

If retaining their positions as world leaders in scientific exploration and its commercialization is vital to the G7 economies, 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 commercialization 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. Early-stage investment funds thus provide the answer to the question of who decides what gets funded because they bring together scientific experts with venture capitalists -- those who understand the complex science behind the idea right at the point of due diligence and those who have the business acumen to vet business plans, fund them, and guide their implementation.

Early-stage investment funds, however, do not in themselves answer the question 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 centers, 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 who, by taking a 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.

Still, governments must not abdicate their responsibility and will need to decide if they are willing and able to step up and commit to creating an environment where blue-skies thinking is supported -- with direct investment and concrete incentives for the private sector to invest in notional work before its commercial value is fully tested. In other words, governments need to decide whether to make a strategic investment in blue-skies research and in their own futures as countries where science that is about people and planet can flourish.

Note: An edited version of this was published by The Times and on the Marcus Ventures website