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The case for seed capital

If you've ever started a business, you know that there is a chasm between concept and execution. If it's a service business, or one that involves re-selling rather than developing new products, the launch process can be complex, but it may not be prohibitively capital intensive.

But what if you're doing rocket science -- or life science -- or have an idea for an innovative use for an existing technology? How do you move forward on the daunting task of transforming your idea into reality?

Well, one thing that often differentiates a service or traditional business from a tech firm is the initial financial challenge. It isn't necessarily easy, but neither is it unrealistic for a traditional business to be able to bootstrap or finesse a substantial portion of launch costs. That process may not help you grow quickly, but you may be able to establish an enterprise with your own resources. But if you are planning to take a technology to market, you are likely to need some seed capital.

To use an analogy from childhood, it's sort of like starting to swing. Surely you can sit on a swing, pump your legs and get moving. If you're strong, you might be able to reach great heights. But if you can get a push to get started, there's a much better chance that you can be flying higher much sooner -- going faster with ease. For a tech company, the push may not only be helpful, it may be an absolute necessity.

For the benefit of those who have not experienced the business development cycle of a tech company, it looks somewhat like this:

The tech biz development cycle

This is clearly an oversimplification -- and for a life sciences company many of these steps can take several years, but for a management team with some depth of experience, this is not an impossible mission. Nevertheless, this abbreviated process can be expected to take a minimum of 3 to 5 years. And without cash, even the most brilliant innovations are not likely to ever see a customer, much less generate revenues or profits.

It goes to growth

Although the vast majority of this year's Inc500 companies were not technology firms (of the 58 in California, only 13 were high-tech) the availability of seed capital mapped directly onto growth. "Companies with $100,000 of seed capital or more on average employed 150 people and generated nearly $21 million in sales in 2001... From 1997 through 2001, the companies with the most start-up capital experienced employee growth of 614 percent..." (Inc Magazine, Inc500 Special Edition 2002). According to Growthink Research Inc., of the $45 billion in new funding raised nationally during 2002, 30 percent was in Series A or seed stage rounds.

If we measure new innovations by patent activity, San Diego is above average, according to Sandag's Indicators of Sustainable Competitiveness (May 2002): "In 1999, the most recent year for which data was available, inventors were awarded 1,749 utility patents, ranking the region fourth compared to 20 other U.S. regions," which included Austin, Atlanta, Boston, Portland, San Jose, Denver and other emerging tech communities. Between 1990 and 1999, 4,754 patents were filed, with the majority coming from biotech/biomed, defense, computers and electronics, and communications industries. So the pipeline is in place for continuing innovation.

Why is this important?

One of the greatest sources of San Diego's economic growth over the past decade has been the technology and biotechnology firms. With rich sources of science -- from universities, specialized institutes, corporate spin-offs and the defense industries -- we have, as a region, an amazing array of raw materials from which to fuel continued new business development.

However, with the personal portfolios of the region's angel investors having been dramatically reduced by this protracted bear market, the sources of seed capital are diminishing.

Sources of seed capital

Seed capital is high-risk capital. Generally speaking, the initial funding for an innovative new tech venture is aimed at proving the scientific principles upon which the product will be developed. Following scientific or technical validation, which takes time and money, and the identification of a compelling market to position product development, only then can a company begin to foresee a realistic return on investment. And while a seasoned management team launching a new venture may have the credibility to secure angel or venture capital from the onset, for most start-ups the only seed funds available are those from personal reserves, friends and family or from research grants.

The good news is that grants for research and development are available to support the initial proof-of-concept technologies in a wide range of scientific endeavors. The Small Business Innovation Research (SBIR) program represents a set-aside of federal research dollars to fund the commercialization of innovative technologies of interest to various federal agencies ranging from the Department of Energy to the National Institutes of Health. In a study conducted on behalf of the state of California and the San Diego Regional Technology Alliance by UCSD Extension, federal SBIR funding received in San Diego between 1993 and 1999 totaled $102.9 million (without considering Department of Defense or classified R&D).

But the bad news is, there are very few sources of capital to help grow the business once the technology has passed beyond proof-of-concept or prototype stage. So the chasm between validated science and new business development remains without the capital to add the magic ingredients -- management, marketing and a sound business strategy -- which can turn great science into great business.

Our innovation economy is at risk

The mid-1990s in San Diego saw the re-purposing of defense-developed technologies and the development of a vibrant, creative technology and biotechnology economy. Running parallel with the growth of our technology sector was a program called CalTIP (California Technology Investment Partnership).

Although clearly CalTIP was only one small component in a large mix of factors that contributed to the coming-of-age of San Diego's technology clusters, it did make a contribution -- especially for those companies that found seed capital through this program.

CalTIP, administered in San Diego by the RTA, is a competitive grant program that provides funds of up to $250,000 to California companies seeking to commercialize new and innovative technology products. The program provides essential capital for product development and commercialization -- supplementing federal research grants -- and has helped technology teams transform R&D projects into viable businesses.

Despite its role in fostering seed capital formation, however, state budget constraints are challenging its continued availability.

As sources of seed capital diminish, we have to question the sustainability of our innovation economy. Can we weather the drought? Will this period make the survivors stronger, or will it discourage great discoveries? I'm afraid that only time will tell.

Orion is president and CEO of the San Diego Regional Technology Alliance. He can be reached at tyler.orion@sddt.com.

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