Editor's Chair: How to get more spin-outs

Universities are funding more campus companies. Richard L. Hudson on the rules of a very risky game.

Seed investing is a risky business. Start-up companies have a way of dying young. And if they don’t, their seed investors have a way of getting diluted out of a profit. Of course, some seed investments make up for all the rest: Microsoft, anyone?

But given the odds, it’s little wonder so few play the seed game. Most VCs stay away. They can read, after all: a recent report from the British Venture Capital Association (BVCA) found the average annual return for early-stage investment funds over the past three years was minus 13.2 percent.

At that rate, the VCs could go broke before the companies they fund. (For more on VCs, see our Investing column by Mary Lisbeth D'Amico.) Of course, angels go where funds fear to tread – but in Europe, some studies suggest, they number no more than 30 individuals per million residents; that’s less than a tenth the ratio in the US.

So what is to be done? Without seed investing, there can be no start-ups – at least not in tech or bio, which need more capital to get going than does a new clothing store or a pizzeria. And no start-ups means a dead economy.

Enter the university seed funds. As some of the stories in this fortnightly edition of Science|Business make clear, there’s a decade-old trend for European research institutions to invest in their own campus companies. Charity begins at home, after all. Another BVCA study, conducted by Cambridge research firm Library House, found 126 technology transfer offices have sprung up at British universities; and the top 36 universities have created 435 spin-offs.

The British government encouraged that development, with support for University Challenge Funds in the late 1990s and an ever-growing portfolio of related programmes now. And the movement is spreading to the Continent – at Karolinska, Fraunhofer and other great names in European science and technology.

But before it goes too far, take a deep breath.

Based on the UK experience, which is longer and broader than anywhere else in Europe, seed investing isn't a good way for a university – most universities, anyway – to win a bit of mad money for a new lab. The payback, if it ever comes, is a long way away – certainly, not until the next rectoral administration takes office. It's not a good way to make professors happy; only a fraction of their spin-offs will succeed, and in the meantime the process provides just one more source of envy or scorn in the faculty lounge. And it isn't necessarily a good way to get an idea out of the lab and into the marketplace: licensing or contract research can be faster and more effective.

That said, for lack of anybody else to do the seed financing, universities should try it in moderation. For any considering the plunge, here are a few recommendations:

1. Ignore the British model. To the extent university seed funds have worked in Britain, it's because the country also has among the deepest financial markets and lowest tax rates in the world. Every country is different, and in each one the universities must experiment with their own investment criteria, fund governance and political systems.
2. Keep it local. This is not a new area for action in Brussels. As just mentioned, every country and university must find its own formula. That can't be achieved by adding a seed-funding plank to the 7th Framework Programme, the big EU science and technology initiative now on the drawing board. Instead, the EU should focus on more-conventional forms of R&D support, and on switching some of its farm-policy billions into more productive sectors, like technology.
3. Look before you leap. Universities should be tough about who they fund and when. They have to filter out the weak sooner, sorting out a prospective spin-out’s market research, business plan and management before incorporation or investment. Academic entrepreneurs have one extraordinary luxury the rest of the world lacks: a steady pay packet that gives them time to plan their new business before launching it. And that planning may show licensing or contract research is a better way than incorporation to develop their idea. (See the Viewpoint from Jo Taylor of 3i Group, for more on this.)
4. Get government help, not cash. The universities aren't going to get rich at this game, and most VCs won't touch it. But it is in the public interest that a country develop a vibrant undergrowth of little tech and bio companies. That requires a public role – but not necessarily a public hand-out. Better, change the rules for investing, taxation and employment so the game gets more attractive for private investors. In countries with high capital gains taxes, exempt profits from university start-ups. Where labour laws hinder lay-offs or require steep social-security payments, exempt start-ups in the first two years. Encourage small-company stock exchanges. Change the investment climate – if not for everybody, then at least for the start-ups.

Of course, Science|Business can be accused of partiality here. It is a start-up, too – and one with quite a few university friends, at that. But as the saying goes, if you really want to understand a man’s problems, try walking a mile in his shoes.