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Capital idea

Venturing into venture capital

money

It might be one of the most repeated mantras in the business world: “You have to spend money to make money.”

In recent years, more and more of the money used to develop, launch and grow companies has come from venture capital funds — investment firms that have the expertise and patience to nurture high-risk startup businesses to profitability over the long haul. Venture capital success stories include some of the most innovative companies in the country, such as Facebook, FedEx, Microsoft and Starbucks.

A 2008 study by consulting firm IHS Global Insight looked at how venture capital affects the U.S. economy. Companies backed by venture capital investors accounted for 12 million jobs — 11 percent of private sector employment — and generated $3 trillion in revenue, or 21 percent of the country’s gross domestic product. Investments such as those are vital for emerging high-tech industries that transform the knowledge created in U.S. research universities into new products for the marketplace.

“The University of Missouri is the state’s university,” says Rob Duncan, MU’s vice chancellor for research. “Major research universities like Mizzou are powerhouses in the development of states’ engines of economic advancement around the country. That’s more important than ever today because we’re obviously in a deep recession. States’ support for higher education won’t improve until their tax rolls improve, and those tax rolls won’t improve until the states’ economies do. So, we have both a responsibility as educators and an enlightened self-interest in seeing the economic conditions of the states advance.”

But some analysts are concerned that Missouri and other Midwestern states are at the back of the line when it comes to venture capital investment. Because most U.S. venture firms are located on the East and West coasts, those areas attract more startup companies.

For instance, the average per capita spending on venture capital investments in Missouri from 2007 to 2009 was $11.11. In Massachusetts it was $439, in California it was $337, and in New York it was $191.

“In Missouri, we need to be appealing to a wide range of venture capital firms, including firms on the coasts,” says Tom Melzer, managing director and co-founder of RiverVest Venture Partners, a St. Louis-based firm that invests in medical devices and biopharmaceuticals.

Melzer, a former economist and president of the St. Louis Federal Reserve Bank, says there are three keys to developing a thriving environment for startup companies. “One key ingredient is intellectual property, and there’s no shortage of that across Missouri.”

Access to capital is another key, Melzer says, and successful startups also require managers with entrepreneurial expertise. “Perhaps the biggest shortage here is a pool of really experienced entrepreneurial talent — people who have been in venture-backed technology businesses, who understand that game and have a track record of doing it successfully,” he says.

Developing a self-sustaining environment can take 25 years or more, Melzer says, and that environment is still evolving in Missouri. “Eventually, when a critical mass of this activity is achieved, the success stories that started here, grew here and got big here start spinning off people with managerial and entrepreneurial experience who want to go around the track again,” he says.

Universities such as Mizzou can play a big role in attracting investment interest from outside the region, he says. For instance, Melzer spoke at a regional life sciences summit that MU helped sponsor in Kansas City, Mo., in March 2010. The two-day event brought together education and business leaders to identify innovations that will lead to private sector investments, job creation and further technological discoveries.

Conferences such as that one are an important way to bring venture capital firms to Missouri for a look at the technological innovations here, he says. “The University of Missouri System, because of its footprint across the state, is the ideal institution to do that sort of thing. I applaud them.”

Rob Duncan, MU’s research head, agrees. He points out that 11 universities that attended the Kansas City life sciences summit are starting to work together in a collaboration called the Midwest Bio-Innovation Belt.

“We are looking to see if there are new economies of scale in high-end computing, for example, to serve the whole region — universities as well as businesses. And also to see if we can share core research facilities across universities and make those research facilities available to startup businesses,” he says.

“If we can do that on a full cost-recovery basis, then we will remain good stewards of public monies, and we will also help ease capital barriers for small companies to get access to state-of-the-art facilities.”

Melzer cautions that the recent economic meltdown has caused a big change in the way venture capital firms invest. Venture funds attract investors because they generate a higher than normal return when the companies they finance and mentor are sold. Those in the business call that an “exit.”

Because of the economic meltdown and international credit crisis, “It’s been a very sluggish environment in terms of achieving exits,” Melzer says. “Not much capital has been returned to investors in recent years, and that’s what keeps the machine going.”

In past years, venture firms were willing to take bigger risks on startup businesses early in their development. Because less capital is available, venture firms now time their investments later in the startup’s life. They might wait until the company begins to show a cash flow or receives regulatory approval of a drug or medical device.

Shying away from early-stage opportunities makes it even tougher to develop technology coming out of universities, Melzer says. “The gap is getting closed by universities figuring out ways to take a company farther along under their umbrella and foster early-stage companies.”

Mizzou has been trying to do just that, Duncan says. He points to the Life Science Business Incubator at Monsanto Place, which MU opened last year in conjunction with the Missouri Innovation Center and Regional Economic Development Inc. That business incubator is nearly filled with startup companies, including several international firms that have relocated to Columbia.

In the past, Duncan says, pharmaceutical firms might invest in a potential new drug very early in the process, well before clinical trials.

“Now they’re all interested in developing closer relationships with universities to encourage the advancement of basic science, but they’re not looking at making an actual investment or a contractual arrangement until much later in the game than they did before,” he says.

Duncan, a physics professor who spent 10 years working at prestigious national laboratories and another decade as a principal investigator in NASA’s program for fundamental physics in space, knows the territory. He has earned five patents for his research and started three companies, and that’s not out of the ordinary for MU’s faculty. During the 2010 fiscal year, the university earned more than $10 million by licensing innovations developed in MU laboratories. That’s a good start — nearly double the $6 million earned in 2008. A number of top research universities earn more than $100 million in licensing revenue each year.

“If you’re planning on a bioscience startup, you should really come to the Midwest Bio-Innovation Belt with your company because this dedication of the area’s public and private universities to advance infrastructure for bioscience will relieve entry barriers for startup companies,” Duncan says.

“As we start to think less parochially and more about the bio-innovation belt as a region, we’ll become far more attractive to both coastal and international investment. So don’t think Rust Belt anymore, think Midwest Bio-Innovation Belt.”

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