US Venture capitalists adopt new strategies in 2011

Setting up in-house incubators for startups, expanding overseas, moving to a more distributed management, and funding venture research to solve specific problems, are amongst the strategies for moving the sector forward discussed at a meeting of venture capitalists at MIT last month.

“You have to proactively identify visionary entrepreneurs and their companies, be a value-add and build the management team, and establish the culture of the organisation,” Henry McCance, chairman emeritus of Greylock Partners told delegates at the event, which was held to celebrate the 65th anniversary of the US venture capital industry.

McCance described turning these ideas into reality when he embarked on a personal mission after his wife was diagnosed with Alzheimer’s disease 10 years ago. He soon found there are no effective treatments. “Quite frankly, I was appalled,” he said. “The disease affects 5.5 million Americans, and it was discovered 100 years ago. Why is the research so ineffective?"

The advent of venture research

The financial model for funding academic medical research was insufficient, inefficient, and ineffective, McCance concluded. And so he co-founded his own organisation to tackle the disease, the Cure Alzheimer’s Fund, which is a venture research non-profit company.

McCance hopes this concept of venture research will catch on. “It can get to cures faster. It’s a new venture capital-like movement that is changing the research paradigm for cures,” he said.

The idea is to formally apply venture capital principles and proactively recruit visionary researchers in the field. The Cure Alzheimer’s fund has assembled a network of a dozen top researchers, including Rudy Tanzi, director of the Genetics and Ageing Research Unit at the Massachusetts General Hospital Institute for Neurodegenerative Diseases. The fund requires only two-page proposals for projects, and responds within a few weeks as opposed to the year it can take for other types of scientific funding.

“The network of researchers is a virtual dream team,” McCance claimed. There are regular webinars and face-to-face meetings are held once a year. “We challenge researchers to dare to be great.”

After five years in existence, the fund has provided $13 million to 18 institutions, helping to identify 100 genes with a link to Alzheimer’s disease.

Proactive investing

Proactive investing also is showing up within the traditional venture capital community. “There is a change in venture investing from a passive to an active model,” according to Jason Mendelson, co-founder and managing director of Foundry Group, of Boulder, CO. “Venture capitalists are going out, founding companies, and setting up incubators. They are proactively finding investments and seeing things before the rest of industry.”

Ed Roberts, professor at MIT Sloan School of Management said that as a result venture capitalists will need to relate more and more to the earliest start ups, in ways they haven’t done in the past.

The need for new ways of communicating applies to entrepreneurs in general, especially the youngest ones. “I see a whole new generation embracing entrepreneurship,” said Theresia Gouw Ranzetta, partner in Accel Partners in Palo Alto, CA. “The 20-somethings are a generation of creators. Their first thought is to be entrepreneurs.”

Noubar Afeyan, managing partner and CEO of Flagship Ventures in Cambridge, MA agreed, saying that in the next 15 years people will increasingly see being an entrepreneur as a career option. “We’re seeing the professionalisation of entrepreneurship,” he said. “And we need to figure out how to improve the odds [of success].”

A winning formula

In a partnership spanning 18 years and almost as many start up companies, Robert Langer, serial entrepreneur and MIT institute professor, and Terry McGuire, general partner at Polaris Venture Partners in Waltham, MA, have devised a formula that improves the chances of an idea becoming the basis of a venture-funded company.

“The formula we’re worked out has been repeated successfully many times,” McGuire said.

Langer listed the ingredients: 1) platform technology, 2) products, 3) a paper published in Science or Nature, 4) patents, ideally blocking patents, 5) in vivo data, and 6) a company created around students, post docs, and collaborators. He pointed to several companies that followed this formula and succeeded, and even spawned their own serial entrepreneurs.

Advanced Inhalation Research Inc. of Cambridge, MA, the first Langer-McGuire collaboration, was acquired by Alkermes Inc. of Waltham, MA, in 1999. Its co-founder David Edwards, one of Langer’s students, went on to start several other companies. A paper on Advanced Inhalation’s technology appeared in Science in 1997. Similarly, MicroCHIPS Inc. of Bedford, MA, co-founded by Langer’s student John Santini, in February started a clinical trial in Europe to deliver a parathyroid hormone. The paper on the MicroCHIPS technology appeared in Nature in 1999.

Spreading out

This kind of one-on-one relationship between entrepreneur and venture capitalist may soon change. Scott Kupor, managing partner at Andreessen Horowitz in Menlo Park, CA, said his firm is trying a new management structure, in which entrepreneurs will interact with a team rather than just one person. “The general partners aren’t interacting one-on-one with the portfolio company, but instead have access to all the resources of the firm, which has niches of expertise,” he said. The approach is similar to that of Creative Arts Agency, which now dominates Hollywood and replaced the former one-on-one interactions between an artist and an agent, he said.

Another trend venture capitalists pointed to is internationalisation, especially investing in Latin America and other under explored areas.

“The talent isn’t just in India and China,” said Linda Rottenberg, CEO and co-founder of Endeavor Global in New York. “We must be prepared for good ideas we can bring back [to the United States]. We’re not yet prepared for great things to be homegrown in these markets [Latin America and the Middle East] and brought back here. That’s the next phase.”

Venture capital investment becalmed

These changes in venture capitalist strategies come at a time when the amount of venture investment dollars is increasing only modestly, while the number of deals declined in the first quarter of 2011.

Venture capitalists invested $5.9 billion in 736 deals in the first quarter, according to the MoneyTree Report from PricewaterhouseCoopers and the National Venture Capital Association, based on data from Thomson Reuters. Quarterly investment activity increased 5 per cent in terms of dollars, but fell 11 per cent in number of deals compared to the fourth quarter of 2010, when $5.6 billion was invested in 827 deals. The bright spots were clean tech, where investments topped $1 billion, and later stage investments, which surged 54 percent over the fourth quarter of 2010.

"The first quarter investment total is setting us on a path for a solid level of investing in 2011.

While we did see a drop in deal volume, the dollars invested remains strong,” said Tracy Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers. There is an increase in average deal size, which hit $8 million at the start of 2011 for the first time since the first quarter of 2007. Lefteroff added that in the first quarter, 14 companies closed funding rounds of $50 million or more, with four of those deals worth more than $100 million.

“Despite recent hype about both funding gaps and bubbles within the venture capital industry, the first quarter demonstrates an investment pace that is reasonable, rational and relevant to the long term nature of our business,” said Mark Heesen, president of the National Venture Capital Association.McGuire of Polaris agrees, and says that the start up area has returned to the status quo of before the financial crisis.

“We’ve returned to a normal, appropriate pace, especially on the life sciences side,” he said, adding that IPOs and M&A also are returning to normal.