• A company that makes chemicals that enable ceiling paint to light the room
• A company that makes a kidney dialysis system that can be used at home.
• A company that enables people to access the internet over their electric power lines.
These are just some of the startup companies that are currently working to grow their businesses in the Pittsburgh Region. Most of the technologies being used by these companies were developed in the university and corporate R&D labs here in the region.
Although these labs provide good jobs for the region, the full economic development benefit comes from commercializing as many of the new technologies as possible in companies located in the region.
This process, called technology transfer, can benefit the Pittsburgh Region’s economy in two ways:
(1) Some technologies will be licensed to existing firms, to help them improve existing products or processes or to enable them to introduce new products. If the facilities using these technologies are located in the Pittsburgh region, the technologies can help create new jobs or retain existing jobs.
(2) Other technologies will be licensed to entrepreneurs, who create new companies to commercialize the technologies, thereby creating new jobs.
The process of getting new technologies out of the labs and into new businesses located in the region has not been one of the Pittsburgh region’s strengths in the past. Although the Pittsburgh Region ranks in the top 5 nationally in terms of federal research funding, the new company formation rate is only 1/3 of the national average.
But that is starting to change. (See Pittsburgh Post-Gazette article.) For example, the national Association of University Technology Managers announced in December 2005 that the University of Pittsburgh ranked 6th in the nation in the number of start-up companies formed from new technologies developed at the universities. (See University of Pittsburgh press release and Pittsburgh Post-Gazette article.)
A priority for the Pittsburgh Region is to increase the rate at which these new entrepreneurial companies are created and grow successfully. Some of the companies will grow into businesses that employ hundreds of workers, like Industrial Scientific, McKesson Automation, Nomos, ServiceLink, and VoCollect. Some will remain small, but even though each of them may only employ dozens of workers, collectively these small firms will employ hundreds of area residents. Even those firms that are sold to other companies and move out of the region will generate returns to the local investors who supported them, enabling them to invest in additional startup firms.
What does the region need to do to encourage and support entrepreneurship?
The skills and experiences required to invent new technologies are not the same skills needed to successfully turn those new technologies into successful businesses. Inventors who want to be entrepreneurs need advice and assistance to do so.
Fortunately, over the past decade, the Pittsburgh Region has created a strong network of non-profit agencies with a primary mission of helping new technology companies get started and grow successfully. Innovation Works, the Idea Foundry, the Technology Collaborative, Pittsburgh Gateways, and the Life Sciences Greenhouse provide a wide range of services to help startup companies, including entrepreneurial training, mentoring, research and product development financing, office and lab space, talent recruitment, and marketing assistance. All five organizations coordinate their activities as part of the Greater Oakland Keystone Innovation Zone (GO-KIZ).
During 2004-2005, these organizations provided funding or other services to over 200 businesses, and assisted over 30 new companies to get started.
These organizations rely heavily on state funding to support their operations. Most of the funding comes from Pennsylvania’s Ben Franklin Technology Development Authority (BFTDA). Unfortunately, cuts in state funding for BFTDA have led to stagnant or reduced funding for these organizations.
Among the myriad challenges facing a startup company and its entrepreneurs is obtaining the financial capital needed to fuel growth. It generally takes years before most startup companies start to make a profit, and until then, they need investors who will cover the high costs involved with hiring employees, leasing space and equipment, developing product prototypes, finding initial customers, and developing sufficient capacity to deliver their product or service to prospective customers.
There are several distinct stages which companies go through, with different types of capital needed for each. There is a growing consensus that startup companies in the Pittsburgh region face difficulties getting adequate capital during the startup/seed stage and early growth stage of development.
The riskiest investments of all are those made at the earliest stages of company formation and growth, often before any sales are made or a product is even actually functioning. There are two primary mechanisms whereby startup firms obtain initial seed capital – non-profit economic development agencies and angel investors.
Although some venture capital firms make seed capital investments, there has been a trend nationally towards venture capital firms moving away from the earliest stage investments. This trend particularly hurts regions like Pittsburgh that do not have a large number of local venture capital funds. Innovation Works reports that a growing number of companies in the region are waiting many months or years to obtain the venture capital they need to reach the next stage of growth, and it forecasts that the capital gap will exceed $20 million this year.
Innovation Works is the leading economic development agency in the Pittsburgh Region making early stage investments in companies, but the other technology development organizations (Idea Foundry, The Technology Collaborative, and the Life Sciences Greenhouse) also provide some seed funding for startup companies. Continued and expanded state funding for these agencies is critical to insure they can help as many deserving companies as possible get to the next stage of financing.
Angel investors are individuals, or groups of individuals, who make investments in early stage companies. The most likely source of angel investors is individuals who have been successful entrepreneurs – because they have made enough money to invest some of it in risky deals, and because they understand how angel investing works. Although the Pittsburgh Region has a lot of people who have enough money to invest in risky deals, most of them did not make their money as entrepreneurs and so they are unfamiliar with the process of angel investing.
Without more angels, it’s hard to have more successful entrepreneurs, but without more successful entrepreneurs, it’s hard to have more angels. How can the region break out of this vicious cycle?
One approach is to have more people join angel networks, like Blue Tree Allied Angels. In an angel network, a group of individuals interesting in investing in startup companies come together. Staff for the network investigate a startup company to determine whether it would be attractive as an investment. The staff are helped by individual members of the angel network who have expertise in the technology or industry or markets that the particular company is dealing with. (Oftentimes, an earlier investment from one of the non-profit economic development agencies like Innovation Works gets the company far enough along that it can be considered by private angel investors.) Then each member of the network individually decides whether they want to invest in the company. If enough members decide to invest that it’s worthwhile for the company and the network to do a deal, then the network staff handle the paperwork for the investment.
To adequately fill the capital gap in the startup/seed stage, angel networks need more angels! There may also be a need for one or more seed/angel investment funds – these funds could be attractive to individuals interested in making money on early stage companies but without the time or interest in engaging directly in an angel network. They could also be attractive to institutions who want to help fill the early-stage capital gap as a civic investment in the region's future.
Many companies that get adequate seed and angel funding will reach a point where they need significant capital to take their product or service to the full market they can potentially reach. This capital is ordinarily provided by venture capitalists. For companies like this, venture capital is critical to success – without adequate capital, the company may not be able to reach profitability or will fail to reach its true potential. But it is also critical to insuring an adequate supply of seed and angel funding, because unless the company reaches a point where the seed and angel investors can cash out their investments, those seed and angel investors will not have new money to invest in new companies.
Innovation Works forecasts that there will be a need for more than $120 million in early stage venture capital over the coming three years just for the companies that are in its current portfolio. If the region cannot help these companies obtain the venture capital they need, there will be several serious negative consequences:
(1) the companies may stagnate and fail, or move to another region where capital can be obtained;
(2) the agencies and individuals providing seed capital to these firms will not recoup their money, thereby reducing the amount of capital available for seed capital to future companies;
(3) the region will not be seen as an environment conducive to starting new firms, discouraging entrepreneurs from even trying to commercialize new technologies here.
Lack of Capital or Lack of Deals?
Not everyone agrees that there is a lack of capital – some people say that the problem is a lack of good deals in the region, and that capital will come when the deal flow exists. This kind of “chicken-or-the-egg” debate is counter-productive. While in the long run a higher rate of company formation will likely attract more capital, the challenge to the region is insuring that there is adequate capital in the short run, i.e., now. Companies that cannot get adequate capital investment when they need it will either fail or they will move to other regions where adequate capital does exist. It is well-known that early stage investors are unlikely to invest in firms located a long distance away. A startup company with only one or two employees is far more mobile than an angel investor or venture capital firm, so in the short run, inadequate seed and venture capital in the Pittsburgh Region likely means that companies will move to where the capital is.
The Pittsburgh Region needs to insure that the pipeline from startup to success stays full of both capital and companies at every stage. Capital gaps at any stage will “pinch” the pipeline, causing shortages of capital to back up to earlier and earlier stages, creating a vicious cycle that will slow company formation and growth.
There are two approaches to filling the early stage venture capital gap in the region:
(1) Create a new early stage venture fund in the Pittsburgh Region.
Although the fund should not be restricted to making investments in the region (otherwise it will have difficulty attracting investors), its location here will increase the probability that local firms will receive the investments.
(2) Strengthen the linkages between the Pittsburgh Region and out-of- town venture capital funds.
The more local investment there is in venture capital funds, the more leverage there will be in getting the principals of those firms to come to Pittsburgh to look at the potential deals here.
Finally, the Pittsburgh Region needs to see itself as a region of entrepreneurs. The big firms that are here today were started by entrepreneurs, but it goes without saying that the region can’t count on those same big firms to be the big employers of the future – in fact, many of them have already downsized significantly from the past. The Pittsburgh Region needs more and more entrepreneurs to create more and more companies that will hire more and more people if it is to achieve the job growth it needs.
When was the last time that you saw an entrepreneur profiled in the major newspapers?
When was the last time you saw headlines about a startup company’s success on the front page of the newspaper?
When was the last time you saw a story about entrepreneurs or startup companies on the television news?
How many parents and guidance counselors convey to children that true success is “getting a job with a big company” rather than “starting your own business?”
In addition, success in most businesses is about building relationships. Entrepreneurs need to be part of the business and social networks in the Pittsburgh Region in order to succeed, rather than waiting until they succeed to be invited in. To get a sense of how entrepreneurs feel about their status in Pittsburgh, read (and join in) the HELP weblog and Forging Innovation weblog.
If the region wants more entrepreneurs, it needs to show it – by celebrating entrepreneurs (even when they fail), welcoming them into clubs and associations, and making it clear that they are a central part of the region’s economic success.
Comments? Suggestions for changes or additions?
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