Revisiting Incubators: Back To School –

The academic world presents a host of benefits to the venture investor, but having a relationship with a major research university and commercializing its intellectual property is not always easy. And VCs and university officials alike are not in agreement as to which structures and policies are best for commercializing university IP.

One of the chief advantages of university incubators is that they are tightly integrated with research in advanced technology fields. They are structured to encourage experimentation and exploration. The academic world of a major research university is uniquely built to benefit parties on both ends of the incubation cycle. “When you couple the intellectual capability with a business incubator and provide the enabling mechanisms, it’s a wonderful combination,” says John Aplin, managing general partner of CID Equity Partners in Indianapolis. Before becoming a VC, Aplin spent 10 years at Indiana University as a business professor.

VCs are attracted to university incubators for a number of reasons, including lower burn rates and less risk due to investment and vetting by groups familiar with technology. Universities enjoy the special advantages of being on the cutting edge of technology, conducting research in top-notch laboratories by experts in their field. A university-backed incubator also has access to an educated employee base.

University incubators already account for the largest portion of the incubation universe-about 25% of the total-according to the National Business Incubation Association. Proponents of the model expect to see more schools get in the game, creating more opportunities for VCs. Steve Derezinski, director of the Georgia Tech Venture Lab at Georgia Tech University, says that some may view commercialization efforts like his to be anti-academic, but “you’re going to find over the next five years a lot more universities figuring out this model and going after the startups.”

How Purdue Does It

VCs need incubator management that is familiar with the venture capital industry and the greater business world. Being able to differentiate a piece of technology that might make a nice product from a technology platform that could form the foundation of a stand-alone company is essential. Quality, licensed technology is the determining factor in a university incubator company. “You have to distinguish between companies that have licensed technology from a university and companies that just end up in an incubator,” says Ron Ellis, president and CEO Endocyte, which came out of Purdue University’s incubator, the Purdue Gateways Program.

Endocyte, based in West Lafayette, Ind., develops drugs for cancer and immune system diseases, has raised about $47 million in venture capital funding since 2001. Its backers include Burrill & Co., CID Equity Partners, Sanderling Ventures and Triathlon Medical Ventures. Other success stories from Gateways include Arxan Technologies, a San Francisco-based developer of software protection products. It has raised more than $12 million from EDF Ventures, Paladin Capital Management, Solstice Capital and Trident Capital.

Purdue has different groups within Gateways that help its portfolio companies. “I work with young startups but I have almost nothing to do with the IP side,” says Samuel Florance, director of Gateways. “Nor do I manage any of the real estate. We have specialists that address each of those areas. We tend to focus on those things that are our respective strengths.”

Gateways works alongside Purdue’s Research Park and the Office of Technology Commercialization. All three offices exist within the Purdue Research Foundation. Each group contributes to create a network of specialists that can flow into whichever point of need exists. The university does not tightly filter which groups go into the program, but can weed out the weak by ordering companies to vacate their incubator with six month’s notice.

Purdue’s incubator has a good reputation among venture capital firms, and wants to attract VCs that get involved early. “I have an affection for those (VCs) that get in and get their fingernails dirty early rather than later,” Florance says.

Another aspect that VCs look for in university incubators-beyond standard business services-is the ability to access research capital from grants and other sources. Opening the doors to that capital will create a portfolio of stronger companies, particularly in an investing climate that has been punishing to early and seed-stage ideas over the past few years.

The University of Colorado has a decentralized system of incubation, but one that relies on partnering with state and local governments. The university operates four different incubators at four different campuses throughout the state. For the university it’s more about the business network than it is about office space. “The real key is the incubator being a robust business network that can help the university assess the potential of the intellectual property it’s creating and help pull it out of the university by providing advisors initially and access to serial entrepreneurs and early stage capital,” says David Allen, associate VP for technology transfer University of Colorado system.

Many universities, like Stanford, MIT, Purdue and the University of Colorado, follow models that emphasize technology transfer and company independence over a long stay in an incubator. “It’s harder to see the lines of demarcation,” says Aplin of CID Equity Partners. “The lines have blurred over the last few years as university incubators have become more aggressive and more successful.”

“The most successful groups are going to be those who marry the technology transfer function with the incubation function with the acceleration function,” says John Rice, a managing partner with Triathlon Medical Ventures.

Other VCs say universities should forget about incubation and focus solely on tech transfer. “Typically when you have an incubator you’re going to put more resources into that than tech transfer,” says Chad Brownstein, a managing partner with ITU Ventures, which specializes in spinning out university technology. “If I were to open a university today, I would put all my money in a tech transfer office. … University researchers are not experts on company creation.”

Watch Your Step

VCs should be aware of potential pitfalls in working with university incubators. For one, you should make sure that the particular university is committed to commercialization. “You see a lot of what I call pure faculty research being done when the likelihood or interest in commercialization of that research is relatively modest,” says one VC who has invested in several university-incubated companies.

Adds John Rice, a managing partner Triathlon Medical Ventures, “Sometimes when incubators are purely university backed, they lose perspective on what they’re trying to achieve because they’re trying to prolong the project and not build a project. It’s this contact with the real world that will help give these incubators an edge in staying business focused.”

Another problem to watch out for: Some startups say that universities hit them with unrealistic royalty rates. This is a difficult hurdle, particularly when those startups may have to renegotiate with a larger, established company in order to bring technology to market.

And then there is the problem of the incubator thinking of itself as a business-rather than as an entity to help spin out technology. Allen says that having the University of Colorado not own any of its own incubators is a key in helping it avoid a major pitfall of the university incubator: the inherent conflict that applies when an incubator acts as a landlord to companies it needs to help leave its facilities. “There’s a need for facilities to pay rent so they’re not continually relying on subsidies,” he says. “There’s a notion that the incubator should be self-sustaining in some point and if you don’t have enough ways to write down those costs that can be very difficult.” One solution, he says, is to have local governments and economic development groups provide space so that a university doesn’t have to be a landlord.

Incubators Revisited Part 3

In this final installment of a three-part series, VCJ examines incubators sponsored by or closely affiliated with universities. Having an incubator and/or a technology transfer office is the easiest way for the academic world to capitalize on abundant technology and bridge the gulf between the academic world and the real world. But not all incubator structures perform equally, and some VCs question if schools should be in the incubation game at all. VCs and universities alike need to know how best to go about bringing technology from the lab to the market without getting tangled in difficult licensing negotiations or falling back on the incubation policies of yesteryear.

Email: matthew.sheahan@thomson.com