Venture Capital Firm Based Out of Massachusetts Institute of Technology is Bringing Risky Back

Dev Kapadia, ’23, Physical Science, 4/22/20

Figure 1: Venture capital has been an industry that flocks to market tastes and preferences, evident by the  high venture capital investment in Silicon Valley during the dot-com era. Now, the market has grown weary of the unbelievable bull market of recent years and is scrambling to protect losses from the recent crash.

Source: https://commons.wikimedia.org/wiki/File:Venture_capital_by_area_history.png

Anyone can easily acknowledge the severity of major problems in today’s society, but only a fraction of people dedicate time and effort to formulating a plausible solution. Especially given the current pandemic, it is evident that biotechnology needs to be improved to provide quicker responses to infectious diseases that threaten society. Another example would be the media often reporting that the Earth’s average temperature is rising and needs to be controlled to ensure livable conditions for future generations but attempting to solve such complex problems realistically takes time, people, and a lot of money.

Traditionally, the US government and its grants have been an excellent stimulator for much needed innovation. For instance, the Internet started as ARPANET, and it was a project funded by the US Department of Defense to use telephone lines to connect computers at Pentagon-funded research labs.1 Similarly, Google initially started with a total of $4.5 million from grants provided by the National Science Foundation for the idea of PageRank, which would go on to be the foundation of their famed search algorithm we know and love today.2 However, the days of the government apportioning a large amount of capital for ambitious research seem to be coming to an end. The US federal government’s investment in research and development projects relative to the overall economy is at its lowest point in the last sixty years.3

However, venture capital (VC), an industry that specializes in funding early-stage companies with solutions to big problems, can come to the rescue. Since they are investing in a company only a few years after its founding, venture capitalists generally expect many of the companies they fund to fail, but they also expect a few to become massive hits. The profit gained when these “homerun” companies either go public or are sold is intended to make up for the money lost from the other less successful companies.

VC firms are able to invest in these companies by using money from groups and wealthy individuals, who are the limited partners (LPs). When a VC firm wants to start investing in startups, they will raise a fund by securing commitments of funding from LPs for when the startups are identified. The pricing of VC is usually determined by charging 2% of the total value of the fund along with 20% of the final profit. While the 2% on tens of millions or even billion-dollar funds seems like a lot, it is usually just enough to keep the lights on and cover travel expenses. The majority of VC revenue comes from the profits generated when startups in their fund grow and get bought out or go public.

Reputation is also extremely important in the VC industry. With the large amount of capital that they are working with, if VCs invest in too many startups that fail, this will be seen as a failure to the LPs as little to no profit will be generated towards the total fund. When this occurs, VCs can have trouble raising capital for another fund and may be forced to go out of business.

Analysts have been projecting a market crash for a couple years now. The market is usually characterized by boom and bust cycles, and the US economy has had a massive boom period since the 2008 crash. For this reason, VC firm have grown weary about their investments because if they invest in a startup and the market crashes (as it has now), there will be no buyers for their startup, and they will not be able to make a profit. As a result, VCs have been spending their money on less risky startups that do not tackle the big problems of today’s society. This tactic is proving to be a roadblock to startups focused on the climate change, disease prevention, and other areas where success is arguably a lot riskier and more uncertain than for a ride-sharing service that has an identifiable problem and relatively simple solution from a high-level.3

This problem was one of the impetuses for establishing “The Engine,” a VC firm founded in 2016 by the Massachusetts Institute of Technology. It was specifically started to fund the ideas like nanotechnology, quantum computing, and renewable energy—ideas that might seem “too risky” for traditional VC firms to invest in.3

One startup backed by The Engine has taken on a challenge that has stumped scientists for decades: economical and low waste energy. Commonwealth Fusion Systems is attempting to create an almost inexhaustible, carbon-free, economical energy source that produces a lot less radioactive waste than current nuclear energy sources. While this ambitious project seems like something out of a sci-fi movie, chief operating officer Steve Renter claims that the team could produce a working demo as early as 2025.3

Aside from taking on far more risk than the current industry standard, The Engine also differentiates itself by allowing a longer time-length for the startups to grow and build before sale. Traditional VCs are focused on getting the company to sell or go public by year ten of the fund in order to ensure that money gets back to the LPs. The LPs of The Engine, on the other hand, understand that they might not see returns from the fund for at least eighteen years. This allows for startups funded by The Engine to have less pressure to become profitable or even get a working prototype within five years. Furthermore, The Engine provides lab space, mentorship, equipment, and networking for the funded startups.3

Additionally, traditional VC firms are not typically willing to take on a little variability in their team structure. They might grow uneasy if they see a team that has an extremely diverse background, but The Engine welcomes it. They see the diversity as a strength in the form of a variety of perspectives.3

While there are only twenty startups funded by The Engine right now, the VC team is currently revamping an old Polaroid building. Once the renovations are finished, the space is expected to hold 100 companies and 800 entrepreneurs! If more VC firms decide to follow the lead of The Engine, much needed “risky” investment may lead to essential new inventions and solutions to today’s problems.3

 

Bibliography:

[1] Featherly, K. (2016, November 28). ARPANET. Encyclopædia Britannica.       https://www.britannica.com/topic/ARPANET.

[2] Peter L. Singer (2014) Federally Supported Innovations: 22 Examples of Major Technology   Advances That Stem from Federal Research Support. The Information Technology and    Innovation Foundation. http://www2.itif.org/2014-federally-supported-innovations.pdf

[3] Roush, W. (2020, April 1). Who’s Brave Enough to Invest in Saving the Planet? Scientific      American. https://www.scientificamerican.com/article/whos-brave-enough-to-invest-in saving-the-planet/.

 

 

 

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