Science and TechnologyWritten evidence submitted by The University of Edinburgh

The valley of death can be encountered at various stages of the commercialisation process, but is most often acutely felt in pre and early stage company formations where there are gaps between the early stage/proof of concept nature of the technology and the beginning of increased production and generation of significant revenues. UK universities are significant producers of new companies but in general, these tend to be fairly early-stage propositions that need investment and the involvement of professional management to take them forward and to generate significant revenues. This process takes time as well as money and talent and therefore the perceived risk of such ventures is increased. The general economic situation, the lack of investment funding and the increased aversion to risk by investors, all increase the width and depth of the valley of death, and many otherwise viable propositions will either be stalled or lost completely unless action is taken.

Difficulties in funding the commercialisation of research and how they can be overcome

1. The successful commercialisation of research is only achievable if there is sufficient funding for good quality basic research in key technology areas in the first place. Government should therefore ensure continuing high levels of funding for basic (and applied) research.

2. Universities are significant generators of new technologies and of new companies that are established to exploit some of these technologies. However Universities are not resourced to take all opportunities through the full commercialisation process and, therefore, will often look for partners to co-develop the technologies or take a licence to exploit these technologies. Given the inherent and well-recognised lack of investment in R&D by UK companies, sourcing a UK partner for such work can be challenging. Potential solutions to overcome these problems may include:

(i)Provision of a significant proof-of-concept (PoC) fund to demonstrate the commercial potential of new research discoveries and to bridge the gap between concept and commercialisation. Such funding would also help de-risk projects. Consideration should also be given by Government to co-invest in such PoC schemes alongside established investors.

(ii)Increased funding for joint university/industry research programmes with the companies agreeing to fund 50% of the University’s full research costs (other 50% to be provided by UK Government through the normal mechanisms for funding university research) in return for the right (and obligation) to exploit the results of the programme.The recovery of full costs, and the right to exploit, will provide incentives for all sides.

(iii)Re-establishment of funding for Knowledge transfer Partnership (KTP) schemes to encourage more University/industry partnerships.

(iv)There is a level of stagnation in the Venture Capital industry that is partly due to reduced stock market performance across the globe and reduced opportunities for exits through Initial Public Offerings (IPOs) and trade sales. This stagnation places higher stress, and higher obligations, on the mid-range and Angel investor markets which are not always in a position to respond. Establishment of a co-investment fund, where the Government could directly invest in new companies alongside established investors, would help reduce this stagnation. As well as providing much-needed investment finance, such a fund would also help de-risk the investment proposition for other investors. There is a scheme run by Scottish Enterprise (the Scottish Co-Investment Fund) that is light-touch and widely regarded, that could be used as a model. However, that Fund’s passive nature (it is a “follower”) may need to be looked at, as better results may be delivered if it were to take a lead role.

(v)The introduction of the Enterprise Investment Scheme (EIS) has resulted in a significant increase in the amount of money and private investors participating in the risk capital space. However, it has been apparent for some time that EIS defines the way these private investors invest—through restrictive rules relating to investment models, share classes, etc. EIS has in effect constrained the business angel sector, making it unable to effectively evolve its investment models to react to a changing investment scene. UK business angels now seldom invest alongside VCs and seed investments are made with that aversion in mind. A growing gulf between VC and business angels has effectively broken the funding elevator—making it unlikely for new companies to grow rapidly and to a size where real economic impact is made. Revising EIS to allow the creation of angel funds and to allow the use of derivative share classes, etc would be a step forward.

(vi)Further to the above, removing stamp duty on early stage companies, and/or transfers from early stage investors into “funds” in which they participate, may also go some way to fixing the funding elevator. An unfortunate consequence of a relatively active business angel community, with the current EIS rules, is that small companies often have shareholder registers that run into three figures. This is seen by VCs and other lead investors as a significant challenge—given the need to seek agreement from such a large group. The perceived challenge may be greater than the real one, but it is the perception that informs the decision.

(vii)Enterprise Capital Funds (ECF) have been well supported but few funds promote VC investment and fewer still practice it. An ECF2 programme for VCs with some guidelines on investment models, etc. may encourage more institutional investors and fund managers into that space. Right now, the term VC has to be regarded with scepticism. Most VCs invest at the growth and development stage.

(viii)The valley of death is often considered to be a fault in the funding space but clearly a range of other issues at the very least contribute. A number of local initiatives for instance seek to fund the appointment of experienced executives into new companies or pre-companies. However, the capacity of such initiatives is very limited. Perhaps a national programme may be considered providing a percentage of the employment costs and allowing the employing companies to negotiate terms on the remaining percentage with some flexibility.

Sectors where it is particularly difficult to commercialise research

Unless a technology is ready to commercialise, and importantly, generate early revenues, as soon as it leaves the research laboratory, then there can be difficulties in securing the investment the proposition may need. Web-based and software applications tend to be closer to market and tend to require less investment, but otherwise there are challenges.

New technologies can be a particular challenge as there can be an increased requirement to prove the benefits and (significant) revenue-generating potential of such technologies. Cleantech propositions are finding it difficult to raise finance partly due to the unproven nature of their technology offerings and the requirement of potential investors for more data and results before they will consider investing. For example, a wind power company may have proven technology at the lab scale, but the venture capital community may want results at a megawatt scale before they consider investing. This would require a large-scale demonstrator to be built, which in turn requires high levels of expenditure, which in turn may require higher levels of investment than friends, family and angel investors could provide. Thus, the opportunity remains unproven due to a lack of suitable venture finance. This is a general issue for new companies—not just those in the cleantech space.

The life science market has long been recognised as a particular problem area due to the longer term nature of getting new technologies to the market. New company propositions often find it difficult to raise sufficient levels of investment funding to enable them to generate sufficient results to pass required regulatory hurdles and can often run out of cash.

Examples of UK-based research having to be transferred outside UK for commercialisation

Tens of thousands of sites worldwide have contamination of soil, groundwater and surface water by hazardous industrial chemicals. These chemicals, such as fuels and solvents, pose a serious and long-term threat to soils and water quality. With funding from Scottish Enterprise’s Proof of Concept programme, researchers at the University of Edinburgh developed novel remediation technology for the removal of hazardous subsurface contamination (known as “STAR”). When no UK licensing partner could be established, the technology was eventually licensed to a Canadian company and is under-going successful trials in the USA.

Evidence that Government and TSB initiatives have improved the commercialisation of research

There are useful lessons to be learned from the Scottish Enterprise Proof of Concept programme, which used to be highly regarded and its funding led to several successful new company formations in key technology areas. The University of Edinburgh’s biggest success was MTEM Ltd, which was established in 2004 and was the largest ever spinout from a Scottish university after raising initial funding of £7.4 million.

Pre-company incorporation, the project team secured £200K from the Scottish Enterprise Proof of Concept award to support the commercial development of the patented multi transient electromagnetic (MTEM) survey technology, technology that could potentially save the oil industry billions of dollars per year. The PoC award was very helpful in proving the technology and directly led to the record initial fund raising.

When MTEM was funded, the PoC programme regulation was relatively light-touch. Now however, over-regulation of the programme stifles interest from potential entrepreneurs and there are potentially good prospects that are either now looking elsewhere for funding or potentially not being pursued. The Scottish Enterprise Proof of Concept programme is both evidence of a very good government intervention, but also one that is now devalued because of over-regulation.

Knowledge Transfer Partnerships (KTPs) are an additional example of a good Government initiative.

Impact of the Government’s innovation, research and growth strategies on bridging the valley of death

Government Innovation and growth strategies should be adapted to meet the needs of the market in the difficult conditions that affect the global economy, and also to create impact. The establishment of a co-investment fund (as outlined above), perhaps targeted initially at key industry sectors, would immediately increase the capital available for investment in innovative companies, as well as helping to de-risk these investments for private industry. It would provide an economic stimulus that would help bridge the valley of death. Unless the Government provides such a stimulus, the valley will remain deeper and wider for most companies and opportunities will be lost and many will fail due to lack of investment.

It should also be recognised that University inventions may not be sufficiently broad to merit the creation of a spin-out company, but Universities can face considerable challenges when seeking to license these to UK based companies. With a few notable exceptions many UK firms continue to invest a lower proportion of turnover in R&D than their key overseas competitors. This is not only a problem in itself, since these inventions can require further development before they are market ready, but also has a secondary effect of leaving these firms poorly positioned to understand the outputs of University research, and hence many do not have the “absorptive capacity” to appreciate the potential of these outputs, or to assimilate them into their own activities.

Should the UK seek more private equity investment in science and engineering sectors?

See above.

February 2012