Nano financiers aim to reinvent seed funds
01/01/2006
Can a pair of innovators get ahead of the angels and VCs?
By David Forman
Private funding works a certain way. Entrepreneurs bootstrap their moonlight tinkerings into small startups. They raise early financing from friends, family and angel investors. They go to venture capitalists. But a couple of companies actively funding nanotech are not so certain that’s the best way after all.
Instead, they are breaking the rules and raising money on public markets to sponsor university-level research in hopes of spinning out nano startups. These early stakes, they claim, will help them and their investors profit the most if they strike pay dirt.
However, they also share a set of challenges: holding the long-term attention of investors seeking quarterly results, justifying a stock price without a revenue stream, and rolling nascent technologies into revenue-producing companies fast enough to avoid having to give away lots of equity or pour money into years of expensive product development.
The basic business models of both Arrowhead Research (Nasdaq: ARWR) and Advance Nanotech (OTC.BB: AVNA) are strikingly similar. Both companies are sponsoring research at the university level in exchange for rights to commercialize the intellectual property that results. When the technologies are ready to leave the lab, say the executives in charge of the firms, they will form operating subsidiaries or spin off startups and then provide additional financing and support services and, if necessary, organize a broader investor syndicate for a follow-on round.
“A lot of corporations used to do their own research,” said Bruce Stewart, chairman and chief executive officer of Pasadena, Calif.-based Arrowhead. “What they’re doing now is saying, ‘Let the entrepreneurs do it.’ ... The real research today is in universities.”
Stewart said he can secure exclusive rights to leading-edge university research for between $200,000 and $250,000 per year - a price he considers a bargain. Arrowhead has three operating subsidiary companies and three sponsored research efforts. The company is also building a firm, NanoPolaris, that is attempting to aggregate intellectual property in the field of carbon nanotubes.
 “There’s a lot of people who want to get in early and try to make a big hit,” says Arrowhead Research CEO Bruce Stewart. Photo courtesy of Arrowhead Research. |
Magnus Gittins, president and CEO of New York-based Advance Nanotech, sees the opportunity similarly: In his company’s case, he said it costs about $300,000 per year. One Advance Nanotech subsidiary, Cambridge, England-based Owlstone Nanotech, recently emerged and Gittins said two others are being prepared to be unveiled over the next year. Advance Nanotech claims 15 separate technology partnerships with University of Cambridge and Imperial College London as well as a minority interest in Singular ID Pte. of Singapore.
Arrowhead’s Stewart recently hired Virginia Dadey, a former investment bank sales executive, as vice president of investor relations in order to address the first problem: Shore up an institutional base to better maintain investor interest over the long haul.
Dadey said Arrowhead is being proactive about presenting at industry conferences and is trying to communicate the company’s message to the stock analyst community. And, of course, she is speaking with the institutional investors, hedge funds and other funds that she wants to recruit as investors in the firm.
By December, the company had managed to attract 11 institutional investors, accounting for 10.8 percent of the outstanding shares, according to the Nasdaq market. However, most of that - 9.2 percent - was held by one company. By contrast, the stock of Harris & Harris Group (Nasdaq: TINY), a publicly traded venture capital firm that specializes in nanotechnology, MEMS and microsystems, had 58 institutional investors in early December, representing more than 26 percent of its outstanding shares and a much more stable base of investors.
“It’s not for everybody,” Dadey acknowledged, but said she expects the initial resistance to give way as nanotech companies make more quantifiable achievements. Meanwhile, Stewart said he is beginning to receive inquiries from hedge funds and other large investors.
Advance Nanotech has been slower out of the gate. By early December it had no institutional investors, according to the Nasdaq. CEO Gittins said he spends upwards of two days per week with investment firms. “I believe we have been able to craft a quite unique message,” he said.
He agreed with Dadey that communication is a crucial part of the necessary strategy. “When you’re listed on a junior exchange and you’re a micro cap company you have to really get out and tell the story,” Gittins said. In the last year, he added, “there is more of an appetite for listening to stories about disruptive technologies that will enable new markets.”
And he thinks the job will be easier once portfolio companies prove their mettle. “Once we monetize the Owlstone asset it will provide credibility to me and my management team,” he said.
And, by reference, the stock. Without revenues, profits or other quarterly metrics by which to measure their progress, it will be difficult for investors to justify a certain price, and likewise a challenge for analysts who might be interested in following the companies to set price targets.
However, both Stewart and Gittins acknowledge that moving technologies out of the lab and into product companies will likely be their biggest challenge. What began as a bargain becomes an expensive proposition once they create and staff companies around the technologies, they said.
Already, Arrowhead faced such a situation. After realizing that one of its initial subsidiaries, Nanotechnica, was going to take longer to develop its technology than originally anticipated, Arrowhead shut it down last summer rather than pony up the $16 million it had contemplated investing.
“We pulled Nanotechnica out of the lab and into the market prematurely,” Stewart said. “Now we leave (the technology) in the university for as long as we can.”
In response, Dadey said Arrowhead has tweaked its model to fund only what she characterized as “late stage investments” - that is, university technologies that are almost at a prototype stage. She said that might mean 12 to 24 months to develop a research product and another year for a commercial one.
Gittins said his company also intends to keep technologies in the university setting as long as possible to keep costs down. And, he has hired a trio of industry experts with real-world experience commercializing products in the materials, electronics and life science sectors.
Doubtless such expertise will help. And if they are successful in getting past the so-called valley of death between prototypes and revenues it will be that much more of an accomplishment - because it’s not just any old rule that these companies are breaking, but rather one of the cardinal rules of private equity: Don’t fund science projects.