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Jan. 3, 2005 – We at Harris & Harris Group, Inc. (Nasdaq: TINY) are more confident than ever that nanotechnology will spawn some great new companies. But we and other venture capitalists are not paying — and should not pay — premium valuations for nanotechnology-enabled companies.
Quite simply, there is no scarcity of nanotech-enabled startups in which to invest. Our firm specializes in investing in tiny technology, particularly nanotechnology. We have more than 750 tiny technology-enabled separate investment opportunities in our database or inbox, the vast majority of which are operating at the nanoscale. (“Tiny technology” encompasses the same things — nanotechnology, microsystems and MEMS — that Small Times refers to as “small technology.”)
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We and other venture capitalists will fund, and in certain circumstances pay a premium for, companies with first-rate management teams that are approaching large, existing markets with a clearly superior product based on propriety technology. Increasingly, as nanotechnology becomes more commercially ubiquitous, such companies are enabled by nanotechnology.
But economic considerations will not allow us to pay a premium for nanotechnology per se.
We have been fortunate enough to co-invest alongside a wide variety of other venture capital firms in many of the more prominent nanotech deals. In addition to our general experience in venture capital, we try to bring to the table our expertise in nanotechnology, intellectual property and technology transfer.
But otherwise, our approaches to due diligence, valuation, syndication, documentation, company building, corporate governance and exit strategies conform to conventional venture capital practice.
Usually, our co-investors in a given nanotech deal are not thinking of it as a special case because it happens to be enabled by nanotechnology. In fact, we may be the only venture capital firm in the deal that was attracted to it initially because it was enabled by nanotechnology.
The others are not likely to pay a premium because of the technology. We are not interested in paying a premium for the deal just because of its technology, either.
A good example of an investor syndicate coming together around a nanotech deal is the case of NanoGram Devices Corp.
NanoGram Devices was founded with investments from six venture capital firms, including ours, in January of 2003, to develop and sell batteries for implantable medical devices. The differentiating technology was the ability to make and employ nanoparticles of silver vanadium oxide in the batteries’ cathodes.
It would be presumptuous of me to ascribe motivations to the other five venture capital firms that invested in NanoGram Devices. But Harris & Harris Group was initially attracted by the application of nanotechnology, one of the other firms was represented by a partner who has strong expertise in medical devices, and two of the other firms have made a specialty of investing in energy.
NanoGram Devices was sold, for 3.4 times what we had paid for it, to a publicly held company, Wilson Greatbatch Technologies Inc., in March of 2004.
It is unlikely that Wilson Greatbatch paid a premium for NanoGram Devices because of its nanotechnology classification. Thus, if we venture capitalists had paid a premium for NanoGram Devices’ nano-enabled technology, we would not have made such a high internal rate of return on our investment.
So how do venture capitalists value a technology-based startup, whether or not the technology is classified as nanotechnology? As a rough rule of thumb, the first professional venture capital money in a startup might purchase 30-60 percent of the fully diluted equity.
At the startup stage, financial projections, discounted cash flow calculations and the like — the stuff many of us learned in business school — are not very relevant. In later rounds of financing, as the new company takes shape, its valuation will be based increasingly on the company’s unique attributes and its ability to meet milestones.
Early-stage venture capitalists such as us are like manufacturers. We identify and assemble, at wholesale costs, the parts. Then we add value to them, package them, and sell the finished product — a going concern — at a retail valuation, either in an IPO or in a merger-and-acquisition transaction.
Once these going concerns are converted by us to an IPO, they are likely to be valued in the marketplace on their economic characteristics, not their enabling technology.
In summary, nanotechnology is developing even faster and proving to be even more commercially important than we had hoped. But it does not follow that a venture capitalist can afford to pay a premium for a deal just because it is enabled by nanotechnology.