Broad investment of small amounts of capital in many startups statistically outperforms concentrated investment in few companies and is a better use of public funding, according to a new study by Kyle Briggs.

Moreover, the long wait time required to realize returns on investment may be incompatible with typical venture capital fund with 10-year lifetimes, his study showed.

The study “puts real data behind the argument that Canada’s long-standing challenges around turning research into impact are structural, and are rooted in risk intolerance,” Briggs said in an email to Research Money.

Canadian public and private sector risk intolerance creates a negative feedback loop, he said. “We only invest in low-risk projects, which guarantees we miss the outliers that create most of the value.”

“This results in low return on public investment, which in turn reinforces the risk intolerance that is actually the cause of the problem.”

The study shows that investing in emerging technology is worth doing even if it fails more 96 percent of the time, since the value of the successful four percent more than offsets the cost of the failed projects, Briggs said.

“It suggests that Canada has to rethink its approach to risk, and understand that risk and failure are the necessary cost of creating value publicly funded research,” he said.

A high failure rate is a positive signal that we are investing widely enough to be sure we are not missing out on valuable technologies, he added.

“The results clearly show that when investing in emerging technologies, the single most important factor in predicting overall performance is the number of investments made, since most of the value is created by a small fraction of technologies.”

The study, Bootstrapping an innovation ecosystem: A self-sustaining framework for investing in emerging technology, was published by SSRN, which publishes preprints of studies that haven’t yet been peer-reviewed.

Briggs is biophysicist and entrepreneur in residence in the Department of Physics at the University of Ottawa, and the owner of the CanInnovate website and substack.

His study examined a dataset comprising the funding history of 9,199 university-affiliated startups in North America and Europe over the last several decades. The study modelled (simulated) the performance of several strategies for investing in early-stage startups attempting to commercialize publicly funded research.

The study found that venture philanthropy, where returns from dilutive investment are recycled to support the subsequent innovations, can be an effective source of capital for bringing emerging technologies to market in ecosystems that are presently limited by risk aversion.

“Our results show that a relatively small amount of initial funding can catalyze an innovation ecosystem that grows exponentially in the long term,” the study said.

“All that matters is that we do not miss the valuable minority, and since it is effectively impossible to predict which technologies will ultimately be valuable, the only winning move is to invest in almost everything.”

Lack of abundant, risk-tolerant private capital leads to “valley of death”

Many innovation ecosystems struggle to translate research from the lab to the market. Unlike the business-to-business (B2B) software-as-a-service (SaaS) venture capital playbook that has

dominated startup investment in recent decades, commercialization attempts based on technologies emerging from publicly funded research (sometimes referred to as “deep tech”) are capital intensive, take longer to mature, and face a high degree of technical risk, according to Briggs’s study. “It is unlikely that a one-size-fits-all approach to fundraising is optimal.”

In ecosystems like Canada and parts of Europe that lack abundant, risk-tolerant private capital, there exists a gap in funding, often called the “valley of death,” for the pre-revenue stages of research commercialization.

While some universities have created dedicated investment funds to bridge this gap, Canada ranks last for the amount of university VC available across North American and Europe, the study noted.

Risk intolerance creates a negative feedback loop in which under-sampling driven by risk aversion leads to subpar returns, which in turn reinforces the risk aversion that is in fact the root cause of the problem, the study said.

Risk intolerance is a self-fulfilling prophecy of underperformance: risk-intolerant investors try to pick winners and as a result make only a few bets, increasing the chances of missing a homerun, Briggs said on his CanInnovate website.

Given the rarity of truly valuable technologies, this under-sampling effectively guarantees that they are missed, which causes their investment portfolios to underperform.

This then becomes the rationale for risk-intolerance in the future, trapping an ecosystem into a negative feedback loop that results in a shallow pool of investment opportunities, he said.

“This is an increasingly urgent problem, since emerging technologies are important elements of technological sovereignty and economic security and often have both dual-use potential and “the potential to address grand societal challenges.”

Traditional VC models are ineffective for the pre-revenue stages of research commercialization since the long times required (median value 10 years) to bring emerging technology to market are incompatible with the 10-year lifespan and profit-driven nature of typical VC funds, according to the study.

This impatience on the part of private capital effectively leads to a market failure where emerging technologies have no way to get out of the lab and into the market, the study said.

“This leaves a significant opportunity for a competitively-minded and risk-tolerant public sector to correct this failure through a patient investment strategy,” according to the study.

The only way out of this cycle is to embrace risk and accept that a majority failure rate is a positive indicator that we are investing broadly enough to make sure we are not missing the valuable opportunities, Briggs said. “Risk and failure are key elements of strategy, rather than things to be minimized.”

His study found that private investment treats all emerging technology alike.

University spinouts, which are created at a variety of technological readiness levels, usually still face significant uncertainty and require further research.

Non-dilutive funding sources are often available in this stage, which may delay the need for dilutive funding, while traditional dilutive capital sources may be reluctant to get involved in the pre-revenue stage in some ecosystems, requiring spinout to demonstrate viability before a dilutive raise is possible.

A typical Canadian university produces only a few companies each year, and with a handful of exceptions, few consistently produce a large enough number of companies to be confident of breaking even in a reasonable timeframe alone.

All of these combine to create conditions in which the time to raise a first dilutive funding round may be several years.

This data makes clear that once a dilutive round has been raised, the spinout is likely to continue raising another round of dilutive funding every 18 to 24 months, consistent with previous data on the subject.

The complete lack of correlation between the timing of dilutive rounds reinforces this idea. Given the variety of technology sectors represented in the study’s dataset, this suggests that once they have taken dilutive funding, spinouts follow into a consistent pattern of dilutive raising that may be disconnected from the underlying technology.

The number of investments that must be made to cut through the noise of high failure rates is beyond the startup creation capacity of most universities by themselves, Briggs noted.

Typical VC investment may not fit the requirements of all startups

The study noted that while the analysis cannot rule out the possibility that the fundraising timelines with typical VC are just a consequence of “strangely consistent” burn rates, the variety of technologies, jurisdictions, and historical market conditions represented in the data – combined with the stark difference between the time between founding and the first instance of dilutive funding – “make this unlikely.”

“Rather, this observation suggests that once a startup has raised a dilutive round, it then conforms to a fundraising process optimized for their investors,” the study said.

This may not reflect the requirements of all startups commercializing emerging technologies given the mismatch between typical 10-year VC fund lifetimes and emerging technology commercialization timelines.

“This further reinforces the need for funding sources that are tolerant of the realities of the technologies in which they invest, rather than the other way around.”

There is strong evidence that the early stage is where public investment can have the most impact, the study said.

In Europe, shifting the same amount of public support for innovation earlier in the pipeline produced the same economic uplift as doubling the investment, and the American SBIR program, which until recently funded the same early stage of research commercialization, is estimated to create $22 to $33 of economic value for every $1 invested.

Venture philanthropy, seeded with public funding, is positioned precisely to maximize the economic impact of every dollar while bridging the gap between publicly funded research and the point at which it makes sense for for-profit private capital to get involved, according to the study.

From the perspective of the public sector, which is concerned with economic growth more broadly, the value created by this approach goes beyond profits, and includes positive spillovers such as enhanced economic security and sovereignty through retention of intellectual property and entrepreneurial talent and creation of a more robust domestic economy based on the economic activity by scaleups that would not otherwise exist, the study said.

Even startups that are ultimately unsuccessful have value in this model, since they create jobs, provide valuable training opportunities for Canadian entrepreneurs, and incentivize domestic retention and development of both intellectual property and talent.

“This work supports the argument that public sector funding is necessary in the early stages of emerging technology commercialization, and that high failure tolerance is required for securing value from public investment in research,” the study said.

“We find that, provided a large enough number of investments are made, this strategy can be self-sustaining, making it an efficient use of taxpayer dollars to support innovation.”

The study validates the thesis that investing in emerging technologies is primarily a numbers game, and that attempting to pick winners actively drives underperformance, Briggs said.

He said his study also shows that:

• emerging technologies follow an extremely skewed distribution of value in which a minority of technologies produce a majority of the return.
• it is practically impossible to predict which technologies will ultimately be in the valuable minority in the early stages.
• the value of the small number of successes more than offsets the cost of the majority of failures.

What is abundantly clear is that this strategy is worth the risk, and that there is room to optimize further, his study said. Even the worst performing portfolios eventually show return, the study said.

“In other words, a ‘Blind Squirrel’ could have made money investing in research startups over the last several decades, provided they had high tolerance for failure, sufficient capital to survive the period before breaking even, and the patience to see their investments through to their conclusion.”

For universities and other philanthropic organizations seeking to contribute to a resilient Canadian economy, this suggests that a nationally coordinated effort is needed to effectively invest in emerging technologies, Briggs said.

Venture philanthropic investing pays off in the long run

In venture philanthropic investing, a risk-tolerant organization, usually a not-for-profit with charitable status, makes dilutive investments of patient capital into early-stage (usually, pre-revenue or idea-stage) startups, Briggs’s study said.

Any returns from the fund are recycled into the fund to support the next generation of technologies. “Because there is no profit sharing, there is no time pressure to realize returns, allowing these investments to be truly patient capital.”

Because returns are reinvested, the model can be self-sustaining in the long term, requiring only an initial public investment to kickstart the process.

Because the fund is a charitable organization, it can continuously augment its funding by soliciting donations from private donors.

If the organization is a charity, private sector contributors enjoy both tax benefits, and regardless of charitable status enjoy long-term economic growth and a higher quantity and quality of investable opportunities, at this early stage or later, that may otherwise not have existed, according to the study.

If seeded with public funds that are then augmented with private donations, venture philanthropy shares the risk of emerging technology investment between the public and private sectors, accepting a high rate of failure, long timelines, and sub-market profits that neither the public nor private sectors would tolerate alone.

“Because the goal is not profit beyond the need to be self-sustaining and operationally solvent, venture philanthropy measures success in terms of talent and IP retention, training first-time founders, company and job creation, and advancement toward societal goals (the United Nations’ Sustainable Development Goals for example).”

Venture philanthropy has been used successfully in several capital-constrained ecosystems, including South Africa and the U.K., according to the study.

The UK Innovation & Science Seed Fund is credited as being responsible for the existence of 78 percent of the companies in which it invested, and claims £29 of follow-on private investment in its portfolio companies for every £1 invested by the fund.

“This approach can be adapted to any ecosystem that is presently limited by risk aversion [including Canada’s],” the study noted.

To create a simulation model specific to Canada, more Canadian data is needed on the founding date, the complete fundraising history, dilution taken in each round, and the eventual outcome (if it has been resolved), of Canadian startups that set out to commercialize publicly funded research, Briggs said.

However, his study showed that venture philanthropy can be self-sustaining in the long term, making it well-suited to a capital-constrained ecosystem like that of Canada.

Briggs said the team behind the public-private-philanthropic  Simple Agreement for Innovation Licensing (SAIL) is working to put venture philanthropy into practice at a national level. Inspired by a model that was highly successful in the U.K., the team is working to adapt venture philanthropy to the Canadian context.

One alternative could be to aggregate the outputs of many research institutions, allowing for a venture philanthropic fund with a national scope to achieve the scale required to cut through the noise without needing to accurately predict which emerging technologies will create long-term value in the early stages, according to his study.

Such a fund would complement existing public sector grant programs by providing its portfolio companies with the funds so often required to match public sector contributions, enabling early startups to receive support from existing federal innovation support programs that would otherwise be excluded by matching requirements.

“In short, a venture philanthropy strategy represents an efficient use of taxpayer dollars to support the commercialization of research, provided it occurs at an appropriate scale.”

to support startups commercializing emerging technologies across the country.

The work that went into Briggs’s paper was funded by Intellectual Property Ontario and Innovation Support Services at the University of Ottawa, with input from Sasha Rogers van Katwyk, Vincent Tabard-Cossa, David Durand, and TJ Misra. 

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