Spin-off poser for Cambridge

The University of Cambridge is considering whether to make more cash available to invest in campus spin-off companies.

The university's two seed-investing funds, which started in the 1990s with capital of £6.4 million, are among the most-watched in European academia – and have helped to launch several of Britain's hottest tech and bio companies. But the funds' managers project they will need more cash next year if they are to continue their current investing pace, and the university has begun weighing the matter.

"The university is considering whether or not it should put more money into seed funding," said Bill Matthews, fund manager for Cambridge Enterprise's seed funds. Besides seeking continued funding, the funds would also like to double the maximum size of their investments in any one company to £1 million.

The existing capital has come largely from charitable organisations, the university, and the funds’ own investment returns, with a small contribution from central government. With the government unlikely to spend more, any new cash would be most likely to come from charitable foundations or the university. A decision is not expected until well into 2006.

A European debate

The discussion at Cambridge is just beginning, but it marks a milestone in Europe in thinking about the best way to get ideas out of the lab and into the marketplace.

Over the past decade, a growing number of universities and public research institutions – especially in Britain - have started investing in spin-off companies formed by their staff or students. The aim, encouraged by politicians, has been to keep at home more of the economic benefits of discovery, and also to lure more private investment into R&D. But the initiatives remain controversial, with many academics arguing that universities should be about research and education, not investing and profits.

The competence of university managers has come in for criticism, too. A government-commissioned study led by former Financial Times editor Sir Richard Lambert found the quality of university spin-off companies patchy. They typically get less capital than purely commercial start-ups - and so have a harder time advancing. Licensing, rather than spin-off, would be a better route to market, his review argued.

Similarly, the British Venture Capital Association has been arguing that universities are forming spin-offs too early in the life of an idea. More work, the BVCA says, funded by grant rather than equity, should go into researching an idea’s commercial potential before forming a company around it.

"Some of these [university companies] are spun out as projects, rather than proper businesses," says Jo Taylor, chairman of the BVCA’s technology committee and head of ventures at 3i Group, a big British VC fund. Often, he argues, the companies rush to get funding before they have finished investigating the market or forming their management. Better to stay on campus doing more homework, before spinning out.

"We are very keen for universities to spin things out,” Taylor says. “But it’s just going to be better for those companies if as much investigation of the market as possible is done prior to spinout." [Read more in our inteview, here]

A growth industry

But the spin-off rush is strong. In Britain over the past five years, the number of technology transfer offices at universities has surged to 126, and there are currently about 435 spin-off companies formed from the top 36 universities. Many have received money from government-subsidised University Challenge Funds, begun in 1999, which make small, early-stage investments in companies formed to commercialise campus discoveries.

And lately, some of the tech transfer offices themselves have been growing. This summer Imperial College London raised £20 million in private investment for its tech transfer arm. A few private investment companies, such as exchange-listed IP2IPO, have sprung up to commercialise research at several universities at once.

On the Continent, the action has been slower - but that's changing. Earlier this year Karolinska Institutet, the Stockholm-based medical university that names the Nobel Prize in medicine every year, launched its second spin-off investment fund. And Europe’s biggest industrial research body, Fraunhofer Gesellschaft in Germany, is pushing to close its first, €20 million spin-off round.

For the research institutions, the motivation is stark. Unlike in the US, where university spin-offs have been a part of the investing landscape for decades, in Europe there simply isn’t much private capital available for risky, science-based start-ups.

Over the past 25 years, according to a study for the BVCA by PriceWaterhouseCoopers, £3 billion of the total £32.9 billion invested by private capital funds in Britain went into early-stage investments - and of that, an even smaller fraction went to university spin-offs.

The reason is also clear from the same study: investing in start-ups is a good way to lose money. From inception of each fund until December 2004, the annual internal rate of return for the 55 UK funds that do early-stage investing averaged a loss of 2.9%, compared with an average gain of 13% for all types of funds. And that’s the long-term picture: the more recent record is even worse, with three-year returns averaging a loss of 13.2%.

With numbers like that, Cambridge’s Matthews acknowledges, it's fair to ask, "Why does anybody invest in the early stage? You can't make any money out of it. And a lot of VCs have decided this." That makes the university funds all the more important, he argues. The Cambridge funds' surveys show that a majority of its spin-offs feel they would never have got going without the initial university help. Since then, many have gone on to get additional capital from conventional venture capitalists.

The Cambridge investment record

What happens to the Cambridge funds will be influential in the small world of European tech transfer. Cambridge, with a reputation as the biggest tech-incubator in Europe, was one of the first universities to try systematising its spin-off investment. That means they have a longer track record than most. The older of the two Cambridge seed funds has doubled its money over a decade. That’s a lot better than the average early-stage investment fund in Britain, which racked up annual 6.5% losses over the past decade. But it’s about half as good as the VC industry overall, according to the BVCA.

Cambridge's formal record in seed investing began in 1994, when £2.4 million in university profits from British water-privatisation stocks were poured into creating a University Venture Capital Fund. That fund invested in 23 start-ups, of which four were write-offs, four paid back combined net profits of £2.8 million for the fund, and the rest are still under management. Four companies in the portfolio have floated on the stock exchange, including Cambridge Display Technologies, a leader in the emerging field of flexible, plastic computer screens.

Partly on the strength of that first Cambridge fund, the British government decided to get in the game, as well. It contributed an eighth of the initial £4 million capital for Cambridge to participate in a new programme to create what are called University Challenge Funds. (The rest of the Cambridge money came from charitable foundations and the older Venture Capital Fund.)

Since then, the Cambridge Challenge Fund has invested in 18 companies, and has had one payback - a £625,000 net profit on a stake in Smart Holograms, a Cambridge spin-off using hologram technology to create a new generation of chemical and biological sensors. In Matthews' view, four of the other companies are "quite promising" and two "we will more or less write off". The problem: there wasn't an obvious market for the proposed products, he says.

The funds' structure is straightforward. They are owned 100% by the university, and are managed by a staff of four and overseen by a board of directors with university and non-university representatives. The operating costs for the newer, Challenge Fund have been high, at 3.3% of funds under management - but Matthews, a member of the Institute of Chartered Accountants and before his university days a corporate finance director, says that's not unusual for funds specialising in new companies, with individual investments starting at £50,000. The Challenge Fund currently gets an average of 30 funding proposals a year, which are screened by the staff for decision by the board.

As of last July 31, the two funds had about £1.4 million in cash available for further investment - but without additional funding, the free cash for investment is expected to have shrunk to £300,000 next summer.