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A lesson on funding cycles

Brian O'Connell on October 25, 2011 Source: Kauffman Foundation

Venture capital is a fickle, prickly industry.

Like any investor, too many venture funders follow the herd, and place the bulk of their bets on the next “hot market.”

When the expected profits in that market don’t materialize, or materialize and then dry up, venture capitalists snap their checkbooks shut, grab their Armani briefcases, and head for the door.

In other words, venture capitalists are prone to boom-and-bust markets, too.

That’s a good lesson for healthcare entrepreneurs, who may well wonder why they have such a tough time pegging the sentiment – emotional and logical – of funding groups. Such business owners need to anticipate when the interest of professional investors wanes, and figure out what keys, clues and code words venture professionals tend to display just before the circus leaves town.

Fortunately, there’s some good research on the topic. In fact, a big reason for boom-and-bust cycles in the venture sector can be found in just two words: critical mass.

That’s the conclusion drawn by a new study on boom-and-bust cycles in the bio-based materials and chemical industry, which is just coming out of a period where sector companies received $3.1 billion in VC funding since 2004 – about half that time under the strain of a deteriorating economy.

The data was compiled by Lux Research, a Boston-based analytical firm. In a recently released study, “Seeding Investment in the Next Crop of Bio-Based Materials and Chemicals,” researchers conclude that entire industries – the chemical sector, in this case – can actually grow too big for their britches, and drive profit opportunities down for professional investment groups.

“The industry no longer offers daredevil innovators grand challenges that attract risk capital and venture finance,” explains Mark Bunger, lead author of the report. “Its challenges today lie in day-to-day dilemmas of running a mature, mundane business, and the payoffs are more predictable.”

“That doesn’t mean the field is dead; on the contrary, it means it has survived its pre-commercial childhood and is now highly relevant to corporations, regulators and consumers,” he adds.

Note that Bunger doesn’t include venture capital investors in that group. By the time “corporations, regulators and consumers” show up, the window of profit opportunity has started to close – you just can’t get that 300 percent markup, investment-wise, from a company that has shed its training wheels and outgrown its formative years.

Of course, Lux Research doesn’t phrase it that way; it uses the term “rapidly maturing” to describe such companies. But it does imply that the bloom goes off the rose for companies that have been around a while – especially those in the life sciences sector.

“Startups that initially attracted funding with the pledge to attack strategic global problems like peak oil and global warming have narrowed their focus to more mundane issues such as greener consumer products and packaging; they have also solved scientific issues in areas like synthetic biology, and are now just locking in feedstock contracts and negotiating project financing,” says the report.

The study draws other conclusions, too, but they’re geared more toward investors and executives in the chemicals industry. But the one conclusion drawn that should interest healthcare business owners is that the time to strike on the venture front is when opportunity for growth is at its zenith.

After that, you’re on your own.

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