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An Assessment of the Small Business Innovation Research Program http://www.nap.edu/catalog/11989.html Figure 1-3 The Valley of Death Cash Flow 0 Typical Primary Investors Technology Creation Federal Agencies, Universities, States PREPUBLICATION COPY Technology Development Cash Flow Valley of Death SBIR & ATP Entreprene ur & Seed/Angel Investors Venture Capitalists UNEDITED PROOFS Early Com m ercialization Unsuccessful Successful Copyright © National Academy of Sciences. All rights reserved. IPO Moderately Successful Unsuccessful Source: Adapted from: L.M. Murphy & P. L. Edwards, Bridging the Valley of Death—Transitioning from Public to Private Sector Financing, Golden CO: National Renewable Energy Laboratory, May 2003. This means that inherent technological value does not lead inevitably to commercialization; many good ideas perish on the way to the market. This reality belies a widespread myth that U.S. venture capital markets are so broad and deep that they are invariably able to identify promising entrepreneurial ideas and finance their transition to market. In reality, angel investors and venture capitalists often have quite limited information on new firms. These potential investors are also often focused on a given geographic area. And, as the recent dotcom boom and bust illustrates, venture capital is also prone to herding tendencies, often following market “fads” for particular sectors or technologies. 60 o The Limits of Angel Investment Angel investors are typically affluent individuals who provide capital for a business start-up, usually in exchange for equity. Increasingly, they have been organizing themselves into angel networks or angel groups to share research and pool their own investment capital. The U.S. National Science Policy, A Report to Congress by the House Committee on Science, Washington, D.C.: Government Printing Office, 1998. Accessed at . For an academic analysis of the Valley of Death phenomenon, see Lewis Branscomb and Philip Auerswald, “Valleys of Death and Darwinian Seas: Financing the Invention to Innovation Transition in the United States,” The Journal of Technology Transfer 28 (3-4) August, 2003. 60 See Tom Jacobs, “Biotech follows dot.com boom and bust,” Nature, Volume 20 Number 10, October 2002 p 973. For an analytical perspective, see Devenow, Andrea, and Ivo Welch. 1996. Rational herding in financial economics. European Economic Review 40 (April): 603–15. Devenow and Welch find that when investment managers are assessed on the basis of their performance relative to their peers (rather than against some absolute benchmark), they may end up making investments similar to each other. Time 27
An Assessment of the Small Business Innovation Research Program http://www.nap.edu/catalog/11989.html 28 PREPUBLICATION COPY angel investment market accounted for over $25.6 billion in the United States in 2006. 61 It is a source of start-up capital for many new firms. Yet, the angel market is dispersed and relatively unstructured, with wide variation in investor sophistication, few industry standards and tools, and limited data on performance. 62 In addition, most angel investors are highly localized, preferring to invest in new companies that are within driving distance. 63 This geographic concentration, lack of technological focus, and the privacy concerns of many angel investors, make angel capital difficult to obtain for many high-technology start-ups, particularly those seeking to provide goods and services to the federal government. o The Limits of Venture Capital Like angels, venture capital in the United States is concentrated geographically in the country’s high technology regions. This clustering pattern creates large gaps in the availability of venture capital in rural areas and other regions that do not have high technology clusters served by concentrations of venture investors. Venture capitalists are different from angel investors, however, in that they typically manage the pooled money of others in a professionally-managed fund. Given their obligations to their investors, venture capital firms tend not to invest upstream in the higher-risk, earlystages of technology commercialization, and have increasingly moving further downstream in recent years. (See Figure 1-4.) In 2005, venture capitalists in the United States invested $21.7 billion over the course of 2,939 deals. However, 82 percent of venture capital in the United States was directed to firms in the later stages of development, with the remaining 18 percent directed to seed and early-stage firms. 64 Typically, venture capitalists are also interested in larger investments that are easier to manage than is appropriate for many small innovative technology firms. 65 Large venture capital funds are deterred by the costs of meeting due diligence requirements to permit involvement in managing many small investments with remote and uncertain payoffs. The size of the average venture capital deal was $8.3 million in 2006, whereas the average SBIR Phase III project requires $400,000 to $1 million in funds. Venture capital deal size has also been rising over the past decade. 66 This trend is accelerating. 61 See 2006 Angel Market Analysis, Center for Venture Research at the University of New Hampshire, March 19, 2007. 62 James Geshwiler, John May, and Marianne Hudson, “State of Angel Groups,” Kansas City, MO: Kauffman Foundation, April 27, 2006. 63 See Jeffrey Sohl, John Freear, and William Wetzel, Jr., “Angles on Angels: Financing Technology-based Ventures—A Historical Perspective, Venture Capital, 4(4):275-287, 2002. The authors note that angel investors tend to invest close to home, “typically within a day’s drive.” 64 Ibid. 65 As Joshua Lerner notes, “Because each firm in his portfolio must be closely scrutinized, the typical venture capitalist is typically responsible for no more than a dozen investments. Venture organizations are consequently unwilling to invest in very young firms that require only small capital infusions.” See Joshua Lerner, ““Public Venture Capital”: Rationales and Evaluation” in National Research Council, SBIR: Challenges and Opportunities, op. cit., pp. 115-128. 66 PriceWaterhouseCoopers/Venture Economics/National Venture Capital Association Money Tree Survey, 2005. UNEDITED PROOFS Copyright © National Academy of Sciences. All rights reserved.
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