Aug 29, 2007

VCs Go Back To School With New University Funds

Jonathan Matsey

The garage-founded start-up may be a thing of the past after the dot-com bust, but universities and research institutions remain a hotbed of emerging technologies. And a growing number of U.S. schools are working with investors to turn these intellectual properties into viable companies.

As venture capitalists continue moving further downstream, concentrating more on later-stage deals, a shortage of dedicated early-stage VC investors is creating a whole on the tech-transfer side. "The bigger guys don't look at these deals anymore," said Tom Callaway, managing partner at seed-stage firm Georgia Venture Partners. "So the money is flowing from the smaller type funds."

Companies formed around universities usually involve scientifically complex technology in the life sciences, nanotechnology or clean technology spaces. Unlike the information technology companies founded during the bubble nearly a decade ago, these start-ups are typically founded by professors who lack entrepreneurial acumen.

As a result, their financing needs are different, said Caroline Popper, president of BCM Technologies, a firm created in 1983 to fund companies launching out of the Baylor College of Medicine in Houston. "There is particularly little early-stage capital out there for them," she said. "I'm not talking angels and friends and family -- that will always exist -- I'm talking about capital that's informed, that can move them forward to the next round of funding."

Since its founding, BCM, one of the oldest and successful university-affiliated funds in the U.S., has invested in 35 companies, and its alumni include publicly traded Repros Therapeutics Inc. and Lexicon Genetics Inc. as well as Genosys Biotechnologies Inc., acquired by Sigma-Aldrich Corp. in 1998. The firm, which is currently managing a $20 million commitment from 2000, aims to bring both capital and business expertise to budding start-ups. "Many faculty want a commercialization option for their technology," said Popper. "Together, we will do it if a technology is worth value creation."

While the U.S. lags significantly behind the U.K. - where groups like Imperial Innovations Group PLC at Imperial College London and Qubis Ltd. at the Queen's University of Belfast have operated for decades - universities here appear to be catching up. For example, the three biggest funds in Utah -- Wasatch Venture Fund, vSpring Capital and UV Partners -- are partnering with the University of Utah and local angel investors to launch a $10 million fund, currently named 3V, to launch start-ups from the school, people familiar with the fund said.

The University of Utah already has three other in-house funds, the smallest of which makes investments of only $35,000, said Brian A. Cummings, director of the school's technology commercialization office. The funds combine regular equity investing with an incubation program "to get them kicked out the door," Cummings said. The three existing funds cover the life-cycle of a technology from inception to the establishment of a company. The new fund will help to sustain the companies once they have formally left the university, bridging the gap between their "graduation" and their first formal VC round.

But just as important for securing institutional cash for a traditional Series A is proof-of-concept, Cummings said. "We've had to set up our own venture funding devices because the venture firms aren't interested until we're in trials," he said.

It is likely that there will be more of these funds coming on line in the next few years. James M. Golubieski, president of Foundation Venture Capital, said he has already been contacted by foundations affiliated with universities in Connecticut, Michigan and Indiana looking to replicate his firm's model. Foundation Venture is dedicated to financing University of Medicine and Dentistry of New Jersey spin-outs, as well as its sole backer, the New Jersey Health Foundation. The firm launched last year with $5 million to invest sub-$1 million in early-stage UMDNJ companies. To date, the firm has made one investment, providing $500,000 in seed financing to drug developer Snowdon Inc. in March.

There is also a regional aspect to these funds, said Callaway of Georgia Venture Partners, which is backed in part by three Georgia universities. "I think that in communities like Boston, San Francisco, San Diego, the emerging gap is filled by medical device and biotech entrepreneurs, who form a base of sophisticated angels," he said. "In places like Florida, Georgia, Virginia, where there's not been a series of successful exits, these funds serve as gap fillers."

Georgia Venture Partners has done several deals with Emergent Growth Fund of Florida, an angel group in Gainesville, Fla., that has teamed up with the University of Florida to work closely with the school's tech transfer office for its ongoing second fund of up to $7 million, according to Lee May chairman of the fund.

Even as universities allocate money for these funds, the technology transfer offices at many of these schools have been forced to become savvier since they are not often seen as core to the university's mission and can be vulnerable during a budget crunch. "Tech transfer remains a loss-leader kind of business, Cummings said. "It's gotten much bigger, though; every year I go to a tech transfer conference, there are more and more people there."

Despite their recent proliferation, small university-oriented funds have not been without their problems. Many have only a handful of millions of dollars on hand, making significant financing re-ups a challenge. "It's a real problem for the smaller funds, and the later-stage investors may not see them as contributing value anymore," Callaway said.

These firms are particularly vulnerable to substantial dilution or the complete inability to participate in follow-on rounds. "It happens more often than not," he said, declining to provide specific examples.

Overbeck of BCM Technologies acknowledged the concern, but said that the best solution is to push the companies towards a successful exit. "The problem is you never have enough capital," she said. "The only way I know to get around it is to get it to the next valuation point."

As universities launch new funds, and older ones like BCM Technologies and Emergent Technologies Inc., an Austin, Texas, firm with several funds for university spin-outs in the Southwest, are building larger funds, it's possible that some of these firms may grow beyond a small group of colleges. The University of Chicago's ARCH Development Corp., founded in 1986, spun off in 1994 as ARCH Venture Partners, now a large early-stage venture firm in Chicago.

Kent Madsen, managing director at Wasatch in Salt Lake City, said that ultimately university-affiliated funds are about extracting the best of professors' labs and providing them with the assistance to develop a company. "We're trying to identify the hair-brained ideas in the brains of some professors and helping them flesh that out," he said.