Venture capital investment in nanotech rises - but it's still small

Single zig-zag chain of caesium atoms (red) on a gallium arsenide surface. Picture courtesy NIST.

While countries like France and Japan are ripe with nanotech innovation, very little domestic venture capital is available to commercialise those advances. But US venture capitalists are unlikely to look internationally for the next nanotech idea, because they already are being challenged to sort the wheat from the chaff in the United States.

Institutional venture capitalists worldwide put $480 million into nanotech start-ups in 2005, up from a bit less than $400 million in 2004. The report says the total investment by institutional venture capitalists since 1995 is $2 billion. Most of the deals went to US companies, with Europe lagging.

"Venture capital investment for nanotechnology rose strongly in 2005 due to large, late-stage funding rounds for firms like Aspen Aerogels, Nanomix and Nanosys," said Matthew Nordan, vice president of research for Lux. "But venture capital still remains a drop in the bucket of total nanotech investment, outstripped by corporate R&D spending and government by a factor of 19 times."

Nanotech is a far riskier investment than typical VC deals says Lux, citing five key reasons:

• Start-ups need extensible platform technologies to justify big valuations, but must focus them on specific near-term applications to reach exits.
• Most nanotech start-ups require multidisciplinary skill sets to an extent not found in other fields.
• Most nanotech start-ups can't know in advance how buyers will value their products, which causes uncertain pricing outcomes and revenue projections.
• Most nanotech start-ups depend on scientific innovation that doesn't follow a timeline.
• There are few established yardsticks for valuating nanotechs, so start-ups struggle to make exits before large-scale sales, which differs from IT and biotech.

As a result there are longer timeframes from investment to exit, and a higher rate of business failures than other investments.

Where’s the exit?

Only 9 per cent of the 143 venture-backed nanotech start-ups to date have achieved exits with either an acquisition or initial public offering (IPO). Four of the IPOs occurred since the beginning of 2004. And most of the venture money has been concentrated: the top 10 per cent of venture-backed start-ups account for 43 per cent of the investment total.

The report covered 258 deals with 143 individual nanotech start-ups across 13 countries. US nanotechs dominated the deals, with 165 out of the total, followed by 20 in Germany, 20 in Israel and 17 in the United Kingdom. The remainder were primarily in other European countries, said Ted Sullivan, an analyst with Lux. The report surveyed 28 venture capitalists in the United States, Japan, Israel, Britain and Germany.

A few venture capitalists may set up affiliate networks designed to source deals and exert operating control in other territories. But innovators for the most part will come to venture capitalists rather than the other way around. Lux said start-ups seeking investment might do well to learn from firms like Israel's ApNano Materials and set up tiny US management offices to put line-of-business decision makers in close proximity to US venture capitalists, at the same time keeping R&D abroad.

The four most attractive sectors for venture capital investment are: nanotools, manufacturing and materials, healthcare and life sciences, and electronics and information technology (IT) (see chart below). Key investment areas in nanotools include inspection and fabrication tools, as well as molecular modeling software and services.

In healthcare and life sciences, drug delivery methods, novel therapeutics and diagnostics drew funding. Optical components, solar cells, memory chips, displays and lighting were hot items in electronics and IT. And money went into nanoparticles, nanotubes, nanoporous materials and other nanomaterials, in addition to coatings and composites based on them, in the manufacturing and materials sector.

Venture capital will never dominate nanotech funding, Nordan said, but instead will keep playing a limited role of taking highly selective, well-developed, and generally university-sourced IP from laboratory demonstrations to product manufacturing.

He predicts there will be some consolidation among nanotech start-ups this year, because investors in second-tier start-ups will push their portfolio companies more aggressively toward exit strategies. More acquisitions than IPOs will occur. Lux expects no more than 10 percent of exits to be IPOs, about half the number in other investment fields.