Support : eNewsletters : Eye on Innovation : Issue 6, August 2010

"The innovation point is the pivotal moment when talented and motivated people seek the opportunity to act on their ideas and dreams."
— W. Arthur Porter

Success Stories — Venture capital makes them come true!

What do the following companies have in common—Genentech, Amazon, Cisco, and eBay? They are all successful, began as small startup companies AND got their funding through venture capital. Throughout its history, venture capital (also known as VC) has developed numerous life-changing innovations into entirely new industries. In the 1970s, VCs helped found the biotechnology industry through their investments in pioneering companies. A decade later, venture funding was growing the software development and semiconductor industries into prime drivers of the U.S. economy. Online retailing followed in the 1990s, and clean technology is poised to extend this legacy today.

Despite the struggling economy, Dialog continues to spot quite a bit of activity in the venture capital industry, underscoring the importance of VC in promoting innovation. In this issue of Eye of Innovation we'll explore business and industry literature, news and market research to:

• find background about the venture capital industry;
• review the latest industries and companies gaining support through venture capital; and
• identify countries where VC is now making a difference.

And, oh yes, read the update on new uses of virtual reality in medicine, the topic in the last issue of Eye on Innovation.

Venture Capital 101

Venture capital as an industry originated in the United States, and American firms have traditionally been the largest participants in venture deals with the bulk of venture capital being deployed in American companies. Much of venture capital's success has come from the entrepreneurial spirit pervasive in the American culture, financial recognition of success, access to good science, and fair and open capital markets. However, increasingly, non-U.S. venture investment is growing—more on that later.

Venture capital firms are professional, institutional managers of risk capital that enables and supports the most innovative and promising companies. By definition, VCs also take a role in managing entrepreneurial companies at an early stage, thus adding skills as well as capital. Because the risk can be high, most venture capital investments are done in a pool format where several investors combine their investments into one large fund that invests in many different startup companies. Thus, investors are spreading out the risk.

Typically, venture capital attracts new companies with limited operating history, too small to raise capital in the public markets or secure a bank loan. To attract venture capital requires a combination of qualities: innovative technology, potential for rapid growth, a well-developed business model and an impressive management team.

Why is VC important?
Venture capital is important to the economy in that it helps grow revenue and increase job opportunities. It is also vital to innovation because the funds finance novel ideas that may otherwise never see the light of day. Frost & Sullivan market research reports from Dialog find that venture- backed companies with a focus on innovative and high-growth potential continue to outperform the overall economy in creating jobs and increasing revenue. In fact, the venture capital industry continues to grow entire new industries nearly from scratch.

Money, money—where is it going?

Investing opportunities in 2010
Tapping Dialog authoritative news and industry sources (Denver Post, San Francisco Chronicle, Washington Post), we find venture capital's traditional powerhouse regions in the U.S. — California, Massachusetts and Texas — lead the way in both revenue and employment by venture-backed companies. After a decline in venture capital investing in early 2009, the first half of 2010 brings some positive changes. Seed, early stage and expansion deals have increased, and smaller deals in the information technology sectors have created a diversity of opportunities. However, investment in later stage deals has remained flat. Market research reports from Dialog forecast investment levels should remain robust for the remainder of 2010.

Catching the venture wave
A Frost & Sullivan report on venture capital funding shows top U.S. sectors in 2010: clean technology, biotechnology, industrial/energy, software and Internet-specific companies. Delving into the top two sectors, we find:

• $1.9 billion in venture capital was invested in 180 clean technology companies in Q1 of 2010 with transportation the top sector by amount invested while energy efficiency attracted the most VC deals. Dollars invested in the clean technology sector doubled in Q2, breaking the quarterly record for the sector. California-based electric vehicle infrastructure company Better Place led the pack with other companies—Fisker Automotive, Vulcan Power, Enerkem, Petra Solar, and Ze-gen—also receiving large venture amounts.

• The life sciences sector (biotech and medical devices) saw a notable increase in VC investing. Companies in the biotechnology, software and industrial/energy industries received the highest level of first-time dollars. For example, some healthy doses of capital went to Pacific Biosciences of California, a DNA sequencing platform developer, OncoMed, specializing in stem-cell cancer research, and Proteolix, Inc. which develops cancer and immune disease therapeutics. Another bright spot is for companies developing vaccines and monoclonals.

Source: Frost and Sullivan, Inc.

March towards globalization

While the venture phenomenon has been uniquely American for some time, other countries are beginning to tap into the possibilities that venture-backed companies can offer. Today, countries around the world have begun to emulate the U.S. model by adjusting their tax and regulatory policies and by strengthening intellectual property protection. This will inevitably lead to more innovation worldwide — but also to increased competition for venture capital dollars and the benefits they produce. Because the world has gone global in venture capital, firms are adapting their strategies accordingly.

Who is leading the race for dollars?
Why is there so much interest in China and India? Is East Asia's leadership in patent filings related to cleantech an early indicator? Is the doubling of private R&D in China a sign of things to come? Look at the $200 billion stimulus commitment from China aimed at cleantech or the package from South Korea that represents 81 percent of its GDP. Dialog news reports (AP News, Times of London) and global industry trade journals (Chemistry & Industry, Biopharm International) tell the tale:

• Asia's rising clean technology tigers—China, Japan, and South Korea—have already passed the United States in the production of virtually all clean energy technologies, and over the next five years governments of these nations are predicted to out-invest the United States three-to-one in these sectors. Q1 of 2010 saw the highest funding going to Wuhan HC SemiTek, an LED lighting company, and Prudent Energy, a developer of vanadium redox flow batteries for large scale energy storage. Other Chinese companies to watch in global cleantech are Broad Air, Chery Auto, Himin Solar and NVC Lighting.
• Biotech companies worldwide are also receiving mega-funding. For example, Scottish marine biotech company, Aquapharm Biodiscovery will further develop its portfolio to build a marine- derived compound library containing small molecule and peptide compounds with the size and characteristics of potential new drugs; Mitra Biotech Ltd. in India received funds to focus on personalized treatment of cancer; Ubiquigent, a new UK-listed biotech company based in Scotland, studying a key cell signaling system with significant drug discovery potential and Taiwan plans a venture capital fund eyeing the biotech and green-energy markets.

Biotech Industry: Attractive Companies in Different Stages Worldwide

Winners and losers
U.S. venture capitalists see China as a favorite followed by the U.S., India, Brazil and Russia. Venture capitalists from the Americas (excluding the U.S.) look to Brazil while some see China as a clear winner, followed by Canada, India and the U.S. Asia Pacific VCs are enthusiastic about China, but a portion look at India as a big gainer, followed by Japan and the U.S. European VCs (excluding the UK) predict that China has the most to gain, with potential from India and the U.S., followed by Brazil and France. Finally, UK venture capitalists eye China as the winner, with India following.

Sources: Frost & Sullivan, Inc.; India Business Insight

Conclusions and what's next?

A search of Dialog authoritative trade journals notes that venture capitalists in the United States expect their industry to contract while those in emerging markets, including China, India and Brazil, view expansion over the next five years. Venture capitalists in Europe and Canada also forecast an industry contraction in their respective countries though to a lesser extent than in the U.S.

However, key questions remain:

• Where to invest?
• Who's investing — government? corporate? investment banks? commercial banks, etc?
• Which countries do other countries want to invest in?
• What are viewed as the top government actions to foster innovation?
  • Most significant — government implementation of favorable tax policies for venture development
  • Increased government support for entrepreneurial activity such as research grants, small business investment corporations and increased training programs for entrepreneurs

Future challenges
Top challenges vary in countries around the globe with the exit market being cited the most in the United Kingdom, Canada, India and Israel. Brazil worries about unfavorable tax policies being a hindrance. An unstable regulatory environment is the most common factor mentioned for France and China.

Despite the challenges, U.S. venture investors remain upbeat regarding the quality of the opportunities in the U.S., with most predicting a stable or improving environment for valuations and deal flow. An optimistic forecast is particularly strong from China, Brazil and India.

The deployment of venture capital in other countries is gated by a country's or region's cultural fit, tolerance for failure, services infrastructure that supports developing companies, intellectual property protection, efficient capital markets and the willingness of big business to purchase from small companies. No matter what countries win, venture capital will continue to foster innovation worldwide.

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