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There were not one but two very interesting reports in the past 48 hours coming out of Scotland. The first was a particularly harsh critique of Scottish efforts to commercialize IP from its Universities. Robert Hannah, a partner in account firm Grant Thornton’s technology industry group, laid blame for poor performance on a lack of management expertise, particularly in raising investment. He called for improvements in management education, but didn’t stop there. He went so far as to suggest that Scotland should spend “serious money” to “buy in” management experts from the US “who have done it before.” Hannah’s comments came in response to a report from Targeting Innovation which advocated for more concentrated funding in fewer university spin-outs to improve their chances for success.

The second piece of innovation news was an announcement by Perth-based venture investors Braveheart of a 15-year commercialization agreement with Aberdeen University. The deal gives Braveheart first refusal rights to IP in certain areas, and appears to offer at least £5m over 5 years, with a dedicated fund thereafter that will include other investors. Braveheart also has similar deals with the University of Strathclyde and the University of Edinburgh. The stated objective is the fill the proverbial “funding gap” and accelerate Scotland’s success in IP commercialization. This kind of long-term partnership between investors and universities seems to be getting more popular.

I enjoyed Carl Weissman’s recent article on Xconomy (one of my favorite sites!) in which he talks about (among other things) how venture capital has lost it’s taste for investing in “risky” innovation. There is a lot of truth in what he says, “VCs are demanding that these technologies be ‘de-risked’ before they warrant venture investment, and of course they think this should be accomplished using other people’s money.” But, if it’s true - and I very much think it is - then it begs the question as to why. What has changed? Have VC’s collectively lost their nerve?

VCs are Too Big
One problem is that many of today’s funds have simply become too large to invest in innovation. Bets on disruptive ideas or radical new technologies that are unproven tend to be smaller. Remember that being “unproven” is the attribute that both risk and innovation share - by definition. But if you have a billion-dollar fund, it’s impractical to make investments averaging less than $10m each. The sheer number of investments in the portfolio would be overwhelming to try to manage.

Performance
However, there is a more important problem, and that has to do with returns. The fact is that many VC funds of recent vintage did not perform as hoped. Too many investments that were “disruptive”, “radical”, and “game-changing”, simply turned out to be “game-ending” instead. VC’s have largely responded by moving their investments down-stream to the growth phase. Many have commented, and I think it is true, that VC’s have become just another player in the Private Equity world. That means that they invest in growth not innovation.

“De-Risking” Innovation
But the amorphic nature of the word “innovation” never ceases to amaze me, and these PEs in VC clothing continue to wield it liberally in defense of their post-innovation investments. As Weissman insightfully notes, VCs continue to talk big about investing in “innovations” as long as they have been “de-risked”. This simply means that they want to take the “unproven” out of both innovation and risk. Of course, when you do that all that remains is growth. That’s not innovation and it obviously isn’t risk.

The Funding Gap is Real
The interesting thing is that all of this seems to prove that there is a funding gap after all, which Weissman is arguing doesn’t really exist. He says it is merely an “expectations gap”. Although that may be true, that gap exists in a very important place: the minds of the investors. If there is a gap in their expectations, then I would expect that to manifest itself in their investments - which is exactly what a “funding gap” is.

I think what has happened is that the established VCs have sort-of “grown up” with their investments. I look at it as like an elementary school that changes to being a high school and then a university as their students progress, rather than admitting a new crop of kindergarten-ers. Over time, VCs seem to have lost interest in the fresh new faces. Certainly they invest in new companies, but many of them aren’t as “new” as they may appear. They invest in people they know, people that they have invested in before, or people who have a “proven track record of success”. Those are all acceptable things to invest in, but investing in your friends it isn’t the same thing as investing in innovation.

What Is Next?
I think that this has created a situation that is rife for disruption. Investors willing to make smaller investments at earlier stages are likely discover that the higher returns associated with things that are “unproven” are still out there for the taking. In fact, Weissman may be proof of that. To bolster his argument that there is no funding gap, Weissman provides his own company as evidence that VCs still make early stage bets on innovation, while criticizing other VCs for not doing so. So which is it Carl? Have VC’s mostly moved away from risk and innovation, or are they mostly like you? You can’t have it both ways. My own experience is mixed. I have certainly interacted with a lot of VCs that aren’t bashful about their departure from the rough and tumble world of early-stage venturing. But, I have also met several new VCs over the past year that are talking about filling this gap as a core part of their investment strategy. I think that the funding gap is real (as is Weissman’s “expectations gap”), but that innovation is not dead - it’s just hungry.