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With nanotech, VCs are playing it safe

Venture capitalists are in a quandary: Nanotechnology is promising, but memories of the dot-com bust are still fresh. Can the science of small produce big profits?

    NEW YORK--Kevin McGovern blanched when he was introduced at the Nanobusiness Spring 2002 conference here as a man who has made several investments in profitable nanotechnology companies.

    "Actually, we've made two investments, and only one company is profitable," explained the chairman of McGovern Capital, a Greenwich, Conn.-based venture capital firm.

    The exaggerated introduction and McGovern's backpedaling illustrate the quandary many venture capitalists face as they consider fledgling nanotech companies. Already burned by the dot-com bust, VCs are using considerable caution with this science of building things on a small scale.

    Although nanotech is considered very promising, some critics warn that it is being oversold as the next transformative technology.

    "Mentions of the word 'nanotech' are about the same as the word 'Internet' in 1992 and 1993," said Josh Wolfe, managing partner at VC firm Lux Capital. In many cases, it's just swapped in to replace what was once called "molecular."

    But investors are showing some interest in nanotechnology. The science is being used in everything from IBM making transistors out of carbon nanotubes that outperform silicon transistors to manipulating silicon crystals to produce phosphorescent colors for use in electronic billboard technology. At a more basic level, companies have created "NanoTitanium" fishing rods that use nano-particle titanium combined with carbon fiber, and General Motors is using nanotech to develop stronger materials for cars.

    Private capital investments in nanotech are expected to reach $1 billion this year, up from $100 million in 1999, according to New York-based NanoBusiness Alliance, which organized the conference this week. Even so, many investors admit to being slow to invest in early stage nanotech companies.

    "You have to understand the macro picture--the market is just recovering from the dot-com disaster," said McGovern, who added that he has only been looking at companies that can generate revenue in two years to three years.

    A hard science
    The complicated nature of nanotech means VCs have to do their homework, a far cry from the go-go days when investors lavished cash on companies with vague business plans and no actual products.

    Most VCs in the nanotech field have a science background. Daniel Leff, a senior associate at VC firm Sevin Rosen Funds, has a doctorate in chemistry. Leff studied under renowned nanotechnologist James Heath at UCLA, and even had his own failed nanotech start-up in the early 1990s.

    Wolfe said his firm does not have any science doctorates on staff but relies on a team of 40 advisers. A quick return on nanotech investing is unlikely, he said, because it is still too early to know what the revolutionary technologies will be. His firm's main activity these days is just trying to keep up with the wealth of information and sort through the hype, he said.

    That skepticism and the general backlash is just as big a problem as the hype itself, Leff and other speakers said.

    It is "like saying electricity was greatly exaggerated in the 1890s," keynote speaker Newt Gingrich said. The former speaker of the House is now chief executive of management consulting firm The Gingrich Group.

    VCs can also be put off by the fundamental mystery of nanotechnology--of building devices one molecule at a time, often with surprising and unexpected results.

    "We don't understand the underlying science on a quantum level," said Gingrich, comparing the research to Benjamin Franklin's famous kite experiment. "He knew it was there, but he didn't know what it was, and it was a long way off from when we could use it in a telegraph or a light bulb."

    Instead, venture capitalists should get over their dot-com flashbacks and focus on the unique challenges nanotech actually presents, he said.

    The patent problems
    Patenting has become a major issue, with the recent rush described as an "Oklahoma land rush." There are conflicts between companies and university labs that co-develop technologies, disputes over intellectual property, and questions over whether basic molecular information can even be patented.

    And some companies say there are so many technologies they want to patent that they don't have enough resources to apply for them. Eric Sun, chief executive of New York-based Nanocs, said he doesn't have the money or time to file for all the patents the company could claim, relying instead on trustworthy employees to keep scientific secrets.

    Nanotechnology's birth in the lab can also create problems like the one faced by Hewlett-Packard, which worked with UCLA to develop a technology and had equal rights to the intellectual property. But UCLA sold the rights to Nanosys, a start-up, effectively creating a competitor for HP.

    One option is to invest in companies that don't make products, but simply license out their technology to partners, said Benjamin Savage, an associate at Wasserstein Ventures, the VC arm of Wasserstein & Co. But most VCs say that kind of plan can only take a company so far.

    "Look at what happened with the genomic companies like Celera and Incyte. They've exhausted their potential as IP licensing companies. They now have to morph their business models and become drug discovery companies," Leff said.

    Culture clash
    Meanwhile, the white coats in the lab do not always mix so easily with the suits in the boardroom. The gulf yawns between doctorate holders that are disinterested in actually running a company and business school graduates who don't have the scientific know-how to run a company based on an in-depth knowledge of chemistry, engineering and biology.

    "I'm hugely skeptical of such a science-focused business," said Savage, describing companies that still act like a lab and are "groping for a business model."

    But there are success stories such as Luxtera, which makes nanophotonic integrated circuits and got $200,000 in funding from Sevin Rosen, the VC firm. The big benefit: Chief Executive Alex Dickinson, a founder of the company, has a doctorate in electrical engineering, a Columbia business degree, and years of research at Bell Labs.

    "If we learned anything from the dot-com era, we learned that we have to apply classical analyses to these companies--what are the barriers to entry, who will the customers be?" said Ross Goldstein, managing partner at VC fund Draper Fisher Jurvetson Gotham.