Funding innovation

When Google floated on NASDAQ in 2004, it was worth over US$20bn and its innovative search engine technology swept it to an, as yet, unassailable world leadership in its marketplace. Its rise from garage start-up to global brand is the stuff of Silicon Valley folklore. Richard Willsher asks how

What is less well-known and less well-appreciated is that Google's founders, Larry Page and Sergei Brin, both computer science graduates of California's Stanford University, were supported by US Government funding at an early stage in their progress towards becoming billionaires.

Page received support from Digital Libraries Initiative, which was in turn supported by the National Science Foundation, NASA and the Defense Advanced Research Projects Agency. Brin benefited from a graduate student fellowship from the National Science Foundation. There is probably no better case study of how public sector funding of innovation - in the field of research into page-ranking search technology in this case - can be crucial in spawning massively successful businesses and also altering and advancing human behaviour in a given area of activity and endeavour.

Perhaps Brin and Page would have followed a similar path without such funding, we will never know, but early stage funding, whether in the form of grants, loans or equity investment, is a vital step in enabling innovation to take place. State funding is now a common theme in many governments' support for research and development and, in many cases, for small businesses to start up and flourish. The UK's seven research councils, for example, are 'public bodies charged with investing taxpayers' money in science and research in the UK in order to advance knowledge and generate new ideas which can be used to create wealth and drive improvements in quality of life' (1). They support around 30,000 researchers. The European Union's New Venture Tools aims to 'link technology parks, universities, and technology transfer centres in a European virtual one-stop shop network to provide online services related to innovation management, technology transfer, and spin-off support to European SMEs' (2). Importantly, its finance guide points to a series of sources of finance, of which grants, awards and European Investment Fund loan guarantees and venture funds form a part. Israel's now famous research institutes and incubators for scientists and innovators, especially from the former Soviet Union, have enabled those with few cash resources to make a vital jump from innovation to early-stage commercialisation.

These are some examples of sources of public sector funding, but countries around the world that aspire to use innovation to buy them a place at the globalised economic table have similar schemes. Often, government support runs alongside private sources such as universities, innovators' own funds, those of family and friends and business angels, or other individuals with money to invest, who may bring their own expertise and experience and, in doing so, require an equity stake in the innovation or business they fund.

Obstacle

Up to now obtaining funding from venture capital and private equity firms has tended to be difficult, because they may choose not to invest in early-stage businesses, or they seek reliable cash flows in the companies in which they invest. Often, they have minimum funding requirements that are too large for a fledging, innovative business. The jump from grant or business angel support is often referred to as an equity gap, and for many businesses it has proved a difficult obstacle to overcome.

This gap looks to be narrowing significantly, however. 'I do not believe [the equity gap] is a reality today,' says Laurence Garrett, a partner at 3i, a global private equity investor based in London. 'The truth is that there will always be more projects/companies looking for funding than available funds. It is also true that not all these projects should by any means receive any funding at all... Today, strong entrepreneurs who can demonstrate a compelling growth story will not experience problems in receiving funding to grow their businesses.'

Matt Cohler, Vice President of strategy and business operations at Facebook.com, 'a social utility that connects you with the people around you', speaking at a seminar at Oxford's Said Business School entitled Silicon Valley Comes to Oxford, put it another way. He said that there is still more money than good ideas (3). The emphasis clearly needs to be on 'good', of course.

Against a background of innovation funding from small-scale grants and private investment to rounds of private equity finance, it is arguable that stock markets do not provide early-stage funding for innovation. Rather, they provide an exit route for private funders and business owners who want to cash in their earlier stage investment chips; 'release some of their capital' is the elegant private equity phrase. True, businesses such as Google and many others may not have been able to expand their businesses through acquisition and innovation without funding from a public market. But by the time they can afford a flotation and have developed the credibility to attract investors, they will probably have moved beyond their most innovative, fastest growth phase. By then, they are corporate vehicles with all of the corporate concerns of publicly listed, quarterly-reporting businesses.

That is not to say that public companies do not innovate. This would be an absurd allegation, because many of the world's biggest businesses devote large amounts of their resources, both of cash and kind, to support research and innovation. Microsoft, for example, has research centres in Redmond, Washington State, Cambridge (UK), Beijing in China and Bangalore, India. These churn out new ideas and develop intellectual property for their parent. Other corporate sponsors of R&D and innovation include Shell, IBM, Intel and Unilever, and there are many, many more. Some of their research may be used to reinforce their own products and services; others may be spun off as independent businesses or form the basis for joint ventures. Alongside this, many major drug companies now effectively fund smaller research firms, either directly or through academic research institutions, in order to develop next-generation products.

However, for businesses of all sizes and for all countries, especially those in the Western world, funding innovation is not just a thing that is nice to do. As Thomas L Friedman explains so well in The World is Flat (4), the failure to invest and fund innovation would be a dire mistake for corporations and for countries, when countries like China, India and others are rapidly educating highly skilled technologists and researchers in large numbers. He adds, however, that research has now become borderless. In his flat world, major Western corporations are funding innovation not in their own backyards but where labour, skills and commitment to excel are most available. The risk is that, in the race to innovate, Western economies and their roster of lumbering multinational corporations become ageing heavyweights, defending their titles as world leaders in innovation as larger, more agile opponents learn their skills and perform them so much better. In the end the future belongs to the new, the energetic and innovative, and that is why funding for innovation is so important.

References
(1) See Research Council's UK website, www.rcuk.ac.uk
(2) For more about New Venture Tools, www.newventuretools.net
(3) Silicon Valley Comes to Oxford, Said Business School, www.sbs.ox.ac.uk
(4) The World is Flat by Thomas L Friedman, published by Penguin Books, 2006.

Richard Willsher is a financial and business writer with a background in investment banking.