Posted on October 4th, 2010 | No Comments »
We have just finished our 9th Annual NanoBusiness Alliance Conference http://www.nanobusiness2010.com/ in Chicago, IL. On Monday afternoon we had the opportunity to hear a Keynote Speech delivered by Doug Jamison http://www.tinytechvc.com/team.cfm, CEO of Harris & Harris http://www.tinytechvc.com/index.cfm (TINY). Doug’s 10 year analysis of the Nanotechnology market was relevant and pragmatic.
In this interview, we talk to Doug about the state of the venture capital business and how it is impacting the nanotechnology community. We also explore some of the nanotech investments Harris & Harris Group have made over the past decade and discuss the firm’s strategic direction. We hope you enjoy the interview. – Steve Waite
Doug Jamison, Chairman of the Board, Chief Executive Officer and Managing Director, Harris & Harris Group, Inc. Mr. Jamison has served as Chairman and Chief Executive Officer since January 2009; as President and Chief Operating Officer from January 2005 to December 2008; as Treasurer from March 2005 to May 2008; as a Managing Director since January 2004; as Chief Financial Officer from January 2005 to December 2007; and as Vice President from September 2002 to December 2004. He has been a member of the Board of Directors since May 2007. Since January 2009, he has served as Chairman and Chief Executive Officer of Harris & Harris Enterprises, Inc., a wholly owned subsidiary of the Company, since 2005, he has served as a Director; and from January 2005 to December 2008 he served as President. From 1998 to 2002, Mr. Jamison worked as a Senior Technology Manager at the University of Utah Technology Transfer Office, where he managed intellectual property for the University of Utah. This included assessing technologies in both the biological sciences and the physical sciences, working with patent attorneys to develop patent protection, and developing and marketing these technologies with industry. He is a Co-Editor-in-Chief, Journal of Nanotechnology Law & Business and Co-Chair of the Advisory Board, Converging Technology Bar Association and a member of the University of Pennsylvania Nano-Bio Interface Ethics Advisory Board. He was graduated from Dartmouth College (B.A.) and the University of Utah (M.S.).
SW: We are delighted to be able to speak with you today, Doug, and appreciate your time. There is a lot to discuss. Let’s start off talking about the structural changes witnessed in the public capital markets over the past decade and what that means for companies bringing nano-enabled products to market. What are the big changes we’ve seen and how have they impacted the venture capital business and the nano community in particular?
DJ: There have been multiple structural changes in the public markets over the past decade, but the ones we are most concerned about are the changes that have occurred in the market for companies with less than $500 million market capitalizations. David Weild and Edward Kim recently detailed some of these structural changes in an article titled, “Market structure is causing the IPO crisis – and more.” The rise of online brokerage has destroyed the incentive for brokers to discover small capitalization companies and to help these companies communicate their stories to the public markets. Decimal pricing for stocks and options, while making the greater market more liquid has eliminated the incentive for market makers to put their capital at risk, creating less liquidity for the smallest public companies. Regulation Fair Disclosure devalued stock research. Capital markets infrastructure for the smallest public companies has continued to erode. Initial Public Offerings (IPOs) that raise below $50 million have declined precipitously after 2000. IPO candidates now need to be larger and more mature before accessing the public markets. The result of these structural changes has been a steep decline in publicly listed companies on U.S. based exchanges (NYSE, AMEX and Nasdaq). The authors above trace this decline in listings to 22 million potential jobs that have been lost across the economy. For the United States, the problem is compounded by the fact that these changes are happening in an environment in which other countries’ exchanges have been increasing the number of listed companies and the number of public companies listing outside the United States is increasing.
The impact for the U.S. venture capital community is that venture capital as an asset class is now experiencing negative returns. This will result in less capital flowing to venture capital as an asset class which may translate to less capital being made available for small, innovative, high growth companies. Nanotechnology companies, which are naturally capital intensive, will need more capital and need to be more mature than was historically the case before the potential for an exit opportunity emerges. These companies could be required to identify alternative sources of capital than the venture capital community. That said, there are a number of nanotechnology companies that have successfully raised significant amounts of capital which says a lot about the quality of these nanotechnology companies.
SW: Harris and Harris Group (H&H) continues to be laser-focused on nanotechnology despite the lack of activity in the IPO markets to date. Has there been a drop off in the number of U.S.-based venture firms engaged in nanotech financing activities due to these structural changes?
DJ: From the beginning, there hasn’t been nanotechnology-focused venture financing. Venture capitalists have remained focused on industry verticals and end markets applications. This has been beneficial for us, as we have been able to become a leader investing in nanotechnology while being able to partner with some of the best venture firms in their respective industry of expertise. Additionally, in the areas we invest in, such as energy, healthcare, electronics and semiconductors many exciting breakthroughs occur at the nanoscale. As an early stage venture investor, that has led to significant interest in some of the early stage companies we have financed. For instance, in our cleantech portfolio, we are the first institutional investor or a member of the first group of institutional investors in eight of our 12 investments, many of which have raised additional capital from top-tier institutional investors. That said, the active venture capital community is getting smaller, and fewer venture capital firms are making new investments in all markets, not just those enabled by nanotechnology.
SW: You mentioned in a previous conversation that we are seeing a bifurcation in the venture capital sector. What is the significance of this and what are the implications for companies for the nanotech community?
DJ: We are seeing venture capital firms with under $200 million in assets under management becoming more focused on investment opportunities that will require less than $15-30 million in invested capital over their lifetime. This means that these firms may invest less with the larger venture firms and partner with other smaller firms that have the same venture economics. Larger firms with capital to invest are currently in a better position, because these firms can write the large checks required for companies that need to be more mature before reaching an exit opportunity. I think this bifurcation is positive as it is forcing venture funds to find a business model that works for their respective asset sizes.
For the nanotechnology community, this bifurcation means that entrepreneurs need to be knowledgeable of their investors’ assets under management and how much available capital these investors have, what we call “dry powder.” This will dictate the strategy of the investor and the direction the investors will force the company to take. Entrepreneurs will need to make sure their vision of the company, their investment requirements and the time to exit are compatible with their investors. Ultimately, because increases in valuations are more difficult to achieve even for companies that are executing flawlessly against their business plan, entrepreneurs will also need to find ways to grow their companies with greater capital efficiency.
SW: Despite the structural changes and the evaporation of all the nano hype on Wall Street we saw earlier in the previous decade, one gets the sense that nano as an enabling technology is ready for prime time. What’s your assessment?
DJ: By this point in the interview, the reader is probably horrified by the future prospects of venture capital investing. However, even in a very difficult venture investing climate and in a very difficult economy over the past two years, companies enabled by nanotechnology have been maturing. I will focus on our portfolio because I know it well, but the maturing of nanotechnology-enabled companies is occurring across the board.
In our portfolio, we classify our investments into three maturity baskets early stage/technology risk, mid stage/market risk and late stage/expansion risk. We have eight companies in the latter basket. Of these, Solazyme, Xradia, NeoPhotonics, Bridgelux, Molecular Imprints and Metabolon all had record revenue years in both 2008 and 2009. Five of these companies could each generate more than $20 million in revenue in 2010. NeoPhotonics recently reported record second quarter 2010 revenue of over $45 million, and the company was over $2.5 million net income positive in the second quarter alone. In this late stage/expansion risk basket, we also have BioVex, which is in Phase III clinical trials in malignant melanoma.
Even in our mid-stage/market risk basket, these nanotechnology-enabled companies are advancing rapidly. Nanosys recently signed two partnerships, one with LG Innotek and one with Samsung Electronics, both of which will lead to significant growth in revenue in 2011. Innovalight has signed agreements with JA Solar and Yingli Green that will lead to growth in revenue in 2011. Mersana Therapeutics signed a $334 million partnership with Teva Pharmaceuticals for one of its therapeutic programs. Over two thirds of our nanotechnology portfolio has strategic partners and investors, many of which could become potential acquirers of these companies.
Eight years into our focus on nanotechnology, I would say that maturity, defined by product revenue or partnering activity, and not just by capital raised, is in line with our expectations. The number of companies in our portfolio that have a chance at success exceeds our expectations currently. This indicates to us that nanotechnology enables real innovation in the markets where it is focused, and that the impact on these markets is occurring now rather than multiple years from now. The poor economy and the resulting investment climate probably have been helpful in allowing us to discover the companies that won’t succeed earlier, thus permitting us to use our capital for the potential winners.
SW: There is some fascinating research and development going on within the H&H nanotech portfolio. Can you share some of the highlights with us?
DJ: Many of our more mature companies have been quite public with announcements over the past six months. You can access their announcements and view their progress on our web site at http://www.hhvc.com/releases.cfm?Year=&ReleasesType=&PageNum=1. We have one young company that is beginning to gain traction in the 3-D cinema market, which is an area that has gained a lot of press recently.
Laser Light Engines (LLE) develops solid state light sources for digital cinema and large venue projection display. The founding technology is based on two important nanotechnology-enabled innovations: 1) the ability to use the combination of inexpensive laser materials and amplification to reach high brightness levels and 2) the ability to convert infrared light into red, green and blue light, separately. The company will manufacture a light source module that can be incorporated in a standard digital cinema projector used by theaters for 2D and 3D movies. LLE recently announced an agreement with IMAX Corporation whereby LLE will develop a custom version of its laser light technology for use in IMAX digital projection systems.
SW: From your vantage point, what key industries in the U.S. are intensively engaged in nanotechnology research and development?
DJ: As I mentioned previously, because many of the advances in science and technology are occurring on the nanoscale, many industries are actively involved with nanotechnology research and development (R&D). In healthcare, the areas of drug delivery, vaccines, personalized medicine and molecular diagnostics are actively engaged in nanotechnology R&D. The semiconductor and electronics industries have been actively engaged in this type of R&D for the past decade. Specifically, next generation chip technology, printable electronics, new transparent conductors and thermal management technologies are developing rapidly. In cleantech, the areas of solar, batteries, power management, biofuels and LEDs are all very active.
SW: H&H currently has 31 private companies in its portfolio. Do you expect any of them to come public within the next 6-12 months and if so, which ones?
DJ: I cannot provide you with many of the names, but currently, NeoPhotonics has filed an S-1 for an IPO. We have two other companies that have engaged bankers for potential sales of their company over the coming 12 months. If the investment climate and the economy are able to stabilize, we believe we may have at least two or three more opportunities for exit events over the coming 18 months. That said, there can be no assurance that these events will occur and a variety of factors, including stock market and general business conditions, could lead any or all of these events to be postponed or not to occur at all.
SW: What is the environment for mergers and acquisitions in nanotechnology today? Do you expect to see more nanotech M&A activity in the future?
DJ: We expect merger and acquisition (M&A) activity to increase over the next few years. Companies have record levels of cash on their balance sheets. These same companies have been forced by the economy and their shareholders to reduce spending and cut costs. In an environment of very slow economic growth over the coming years, these companies will still be asked to deliver profit growth. Now that expenses have been cut and pipelines depleted, these companies will need to turn to innovative growth companies. In the area of energy, healthcare, electronics and semiconductors, we believe that rapidly maturing nanotechnolgy enabled companies, some of which are even generating positive cash flows now, are beginning to be viewed as likely candidates for M&A activity.
SW: You recently wrote a letter to your shareholders that marks a change in strategy at H&H. Tell us about the shift and why you are excited about it.
DJ: We believe some of the structural changes in the market place for both private and public investing have created opportunities for us to expand our strategy. We will remain focused on providing venture capital for nanotechnology enabled companies, but in addition to private venture capital investments, we will also make public venture capital investments and engage in providing debt to nanotechnology enabled companies.
Our public venture capital investments will be focused on the smallest market capitalization, typically companies below $100 million with a sweet-spot in the $50 million market capitalization range. Currently, when compared to equivalent private companies, we believe these public companies are undervalued. We also believe these companies provide us with an opportunity to realize more frequent returns as we believe our time from investment to exit will be 12-24 months rather than 7-10 years for some of our private investments. We believe these companies have the potential to offer venture capital returns in this shorter period of time.
Additionally, credit remains extremely expensive or unavailable for even the strongest small private companies. We have an opportunity to secure favorable terms on debt we provide for companies we know well or work with through our venture investing activities. In addition to fees and monthly principle and interest payments, we may receive warrants in these investments. Many nanotechnology enabled companies are currently producing revenue and some have positive net income. We believe providing venture debt permits us to generate near-term cash flow with a defined period for return on our investment.
SW: When you make an investment in publicly traded nano cap companies, what are some of the characteristics you look for in the company? Would you ever consider taking them private at some point?
DJ: In publicly traded nano capitalization companies we look for the following: companies bringing exciting nanotechnology enabled products to market; public companies that are undervalued in comparison to equivalent private companies; opportunities where additional capital is the primary requirement for the company to execute on its strategy and where the company raises enough capital to remove the financing risk; companies with a defined pathway to increased trading liquidity in their stock; and companies that attract long term investors rather than quick “flipping” hedge funds. We currently don’t have plans to take companies private, but it is certainly within our mandate to do so if the right investment opportunity were to arise.
SW: What has been the response of publicly traded companies you have invested in thus far? One would assume that they are delighted to have H&H on board, especially given all the experience and resources you can bring to table.
DJ: The publicly traded companies we have spoken with are interested in attracting long-term, fundamental investors that understand their business. This describes us well as venture investors. Additionally, these companies appear interested in the 15,000 plus shareholders in TINY that will be introduced to their company through our investment.
SW: I would imagine with 31 private investments that analysts and investors on Wall Street find it difficult to value H&H’s stock. What kinds of things do you do to help educate and enlighten analysts and investors on your business?
DJ: Valuing Harris & Harris Group has always created difficulties for Wall Street. It is very difficult for investors and analysts to completely understand all 31 companies because these companies are private and may not choose to provide information on them. However in venture capital investing, historically, a small percentage of the investments create the great majority of the return for a venture capital fund. Historically, for Harris & Harris Group, less than 40 percent of our investments have created all of the returns for the company.
Therefore, we think it is important for investors to focus on three areas. First, we believe investors should focus on the 4-5 companies that appear to be maturing and that offer the greatest potential return. In our public filings, we break out our investments into three baskets as defined earlier to permit investors to focus on those companies that have the best near term return potential. Second, we believe investors should focus on our pipeline of investments. Are there enough exciting opportunities moving through our pipeline to provide the next generation of returns following our first 4-5 opportunities? Third, we believe investors should focus on the markets our nanotechnology enabled companies are addressing. Are these markets the exciting markets of tomorrow where new companies will be able to extract a premium valuation? In our public filings, we also provide a series of slides that inform our investors about the existing and emerging markets our companies are addressing.
SW: Turning to Washington for a moment, do you think most U.S. policymakers understand the importance of nanotechnology and its role in fostering future innovations, competitiveness and higher living standards?
DJ: Currently, I think there is a dislocation in Washington. When asked about nanotechnology, I think policymakers understand that it is important for U.S. competitiveness and that it could be a great driver of future innovation and productivity for the U.S. economy. I credit the NanoBusiness Alliance and a handful of individuals and organizations for effectively communicating that message. However, I think Washington’s focus on the small businesses and the ecosystem that creates the innovations that are so important in retaining U.S. competitiveness in a more competitive global world has been lost in the government’s response to the credit crisis and the recession. This is unfortunate, because now more than ever, I believe it is these small businesses that drive innovation that offer our country’s best hope for the competitive future ahead of us.
SW: You are involved in editing and publishing The Nanotechnology Law and Business Review, which we’ve always enjoyed reading. How is the publication doing these days and how do interested NanoBusiness Alliance members find out more about it?
DJ: The Journal continues to provide peer reviewed articles on topics that are important to the nanotechnology community. I would recommend going to the web site for Nanotechnology Law & Business to subscribe or to access an article on line. The web site is http://www.nanolabweb.com/.
SW: One last question for you today, Doug. If you were speaking to a group of entrepreneurs who wanted to venture into nanotechnology today, what are three of the most valuable business lessons you would share with them?
DJ: My mentor and the founder of Harris & Harris Group, Charles Harris, has a series of Wall Street adages gathered over 42 years in business that I have found very helpful in guiding me. Four of them are as follows. First, survive to thrive – try to anticipate and prepare for the hard times as they are a normal part of the business cycle and life. Remain in the game and when conditions start to improve, you will be on the ground floor, and it is amazing how quickly you will prosper. Second, give talented, hungry young people a chance to move forward in their careers, even if others think they are not ready. Third, only enter a field in which your company can reasonably expect to become a leader. Finally, pessimists are usually right, but optimists change the world. The art of venture capital is to help the optimists while being aware of the worries of the pessimists.
SW: Thanks again for your time, Doug. We really enjoyed speaking with you and wish you and your colleagues at H&H all the best in the future.