A VC explains in painful detail why commercializing research is so hard

Last week I had lunch with Andrew J. Pulkrabek, executive director for 43North. Launched just a few months ago, 43North is a business plan competition that will give out a total of US$5million in funding, along with incubator space and mentoring, to would-be entrepreneurs as long as they’re willing to set up in Buffalo and stay there for at least a year.

Pulkrabek has a background both as an entrepreneur as well as a venture capitalist, so after he walked through the basics of the 43North program I asked him why he thought it was so hard for academics to commercialize their work successfully. His answer was so thorough I thought it worth transcribing and posting in its entirety below:

My alma mater is the University of Minnesota, a top five research institution, and you’d hear that exact same concern addressed there. I don’t think people are ever going to be happy with the amount of technology that gets developed (in academia) and what gets commercialized. 

Part of the challenge with that, if I step back and look at it from my venture capital background and the private equity side of things, is that the technologies coming out of the schools are so very early stage, they’re so high risk, and what’s happened since the financial crisis is that corporate America has gotten risk-averse. They don’t want to go into early-stage deals, and they feel much more comfortable — because a lot of public CEOs live by the (financial) quarter — to keep money on the balance sheet. I’ll pay multiple times over what it’s worth today if it’s de-risked and commercialized in the market than I would if it was five years earlier and had a higher risk profile. As the CEO in that situation, I don’t want to take the risk profile of that failing, because it looks to the market and I could be out of a job in a quarter. So from that standpoint, the strategic capital has gone very far downstream. 

Venture capital has followed suit, because in some cases what you’ve seen over the last 10 years is that VCs start out, they raise $50 million, they invest it, they get the internal rate of return for their limited partners, they come back and say, ‘Well, $50 million was great, but now I want to do a $150 million fund.’ But now they’re collecting two and 20 — a two percent management fee and 20 percent (cut from the gains) — but they have a disincentive to necessarily add more staff to do the due diligence and conduct the deals. They have an incentive to keep their staff at the same levels and put the capital out in the marketplace. Now all of a sudden their internal rate of return drops. It’s a long cycle, a 10, 15-year cycle, and you can raise a lot of capital when you get a 10-year, close-ended fund. You don’t necessarily deliver a return back to your limited partners for six years. So they can tell a lot of story, get a lot of money under management. 

What ends up happening, though, is a bull-whip effect. At the end of it, the limited partners come back and say, ‘You know, we didn’t get the return we were hoping for, and so now we’re not going to go back and invest in these small venture capital firms.’ Because again, they’re higher risk. You’ve got folks that may not have that deep experience in having done the venture investing. Now venture capital says, ‘Okay, I can’t invest now in higher-risk deals, because I could lose, and I won’t be able to raise my next follow-on fund.’ 

So what have they done? They’ve gone right downstream with everybody else. That’s left the academic institutions, which may have some bench-top research done, some maybe interesting IP formed around it, saying, ‘This is something that could address a significant market.’ But you have that major gap between the bench-top research and the ability to get the first significant round of capital to be able to de-risk it and get it to the point where that money can come in.

There are no easy solutions to the problems Pulkrabek has outlined, but anyone hoping to advance what they’ve done in UX design, gamification or interactive display shouldn’t be discouraged. Better to understand the challenges upfront and prepare accordingly. It may mean doing more of the due-diligence before presenting an idea, or connecting with people who can help present it as a safer-sounding bet. Winning a business plan competition is one thing. Whether researchers can win over VCs and the equity markets is the real $5 million question.

photo credit: @Doug88888 via photopin cc