Building a Business > Regional initiatives

Nature Biotechnology  17,  BE7-BE8 (February 1999)

The European university as a startup generator

Bernard Witholt is professor at the Institute of Biotechnology, Federal Institute of Technology, Zürich, Switzerland
bw@biotech.biol.ethz.ch.

Universities continue to foster new company formation in Europe's limited venture capital system.

Creating a new company requires an idea, a market, a few people, and enough capital to mold them into a functional whole. Europe has traditionally lagged behind the US in this molding process, at least in part because, while amply available in the US, access to venture capital is more limited in Europe. Perhaps even worse, with an immature venture capital system, there are also fewer experienced venture capitalists in Europe. Other reasons often cited include the past involvement of government (e.g., France, UK, the Netherlands) and banks (e.g., Germany) in major industrial companies, the conservatism of banks and pension funds with respect to investments, fiscal problems in extending equity or stock options to startup management, and the difficulties of realizing gains through IPOs on European exchanges.

Many Europeans seem to believe that if only there were a strong venture capital supply in Europe, healthy companies would develop. However, a look at the US venture financing industry's history shows that experience in company formation and early development are as important to success as the ability to attract capital. Especially in the past two decades, the better venture firms have been able to systematically generate yearly returns exceeding 20% over periods of 5 to 8 years through investments in small, but fast-growing high-technology companies. Early successes occurred mostly in the microelectronics, computer, and software industries, but since the 1980s, there have also been significant successes in biotechnology.

The experience and financial commitment provided by venture partners helps in the selection of able managers and high-quality legal assistance, in the development of markets, and in access to further capital. In the absence of a mature European venture capital industry, universities have taken the lead in nurturing small companies.

Science parks and startups

Several European universities took an early lead in developing new enterprises based on university research and facilities. One of these was Heriot Watt University in Edinburgh, UK, which developed its research park in the early 1970s. By the late 1980s, companies at the park employed more people than the university. Science parks have in general developed more rapidly and extensively in the UK than in continental Europe. A group of about 50 such parks, hosting nearly 1,400 companies and employing about 25,000 people, are united in the UK Science Park Association. Another early entrant was Chalmers University in Goteborg, Sweden, which in 1979 set about to create 15 companies every year. So far, more than 200 companies have been created, employing 3,000 people.

Activities in the Netherlands began in the early 1980s, with the development of science parks around the universities of Twente, Groningen, and Leiden. The focus of these organizations differed: Leiden provided real estate near the university; Twente provided space and incubator facilities; and Groningen formed small companies initially housed in university laboratories to develop a critical mass and profitable operations before moving to premises in the science park. At first supported by national programs, dozens of companies were founded in science parks and university incubators. As these startups gained experience and visibility, venture capitalists and investment companies began to show interest, and it is now relatively easy to raise funds for startup activities in the Netherlands.

The science park movement was also evident in Germany. Many of these parks were not related to universities. However, in the case of biotechnology, public resistance against gene technology discouraged would-be startups. The atmosphere has changed in recent years, in large part due to the commitment of the German Ministry of Research and Education. Strengthened by the BioRegio competition, Germany's major industrial regions are now putting together support structures and resources to generate new biotechnology startups.

In Switzerland, company creation has become an important priority. In particular, there are increasing activities at the Federal Institutes of Technology in Zürich (ETH-Z) and Lausanne (EPF-L), including lecture courses in entrepreneurship, practical courses on small business development, and financially attractive facilities for startups within university buildings, resulting in four to six new startups yearly at ETH-Z, and similar numbers at EPF-L.

A recent European Commission study on the European experience with high-tech startups finds a survival rate of 80–90% after 5 or 6 years, compared to approximately 50% for startups generally. High-tech startups tend to be created by scientists rather than by financial or management specialists. Early growth is considerably faster than for new businesses generally, but the subsequent managed rapid growth with large increases of market capitalization often seen in the US remains rare in Europe.

Significant clustering of such new companies in Europe is seen only in the UK, along the M4 corridor and between Oxford and Cambridge, and around the major German urban centers. Finance is still perceived as a major limitation, with only 6.5% of European venture capital going to early-stage investments, whereas in the US about 27% of available venture capital is invested in early-stage projects. The total available venture capital in the US exceeds that available in Europe by about threefold.

The university's role

Seed financing for the earliest stages of company formation is difficult to raise in Europe. It is here that universities have been able to help by providing facilities including space, equipment, infrastructure, expertise, contacts, and the opportunity to identify adventurous students and interesting research at an early stage. These can be considered university venture facilities, as valuable as the funds and experience provided by effective venture financiers.

However, despite the availability of these resources, the number, size, and value of biotechnology and other high-tech startups generated in Europe has been modest compared to the US. This is due to the small number of committed entrepreneurs in Europe. In fact, although universities have been among the most active organizations in supporting the creation of startups, this positive attitude has generally been confined to a small number of professors and leading members of university administrations.

Most professors are not interested in being involved with or in supporting startups. The interaction between a startup and its host laboratory, even when well thought-out and carefully formulated, can be complicated. Pressure on available equipment and resources increases. The confidentiality that is essential to the work of a startup is often counter to the openness expected in an academic laboratory. The perspectives of individuals working within a single laboratory or department—some as university staff, and others as company employees and perhaps shareholders—begin to differentiate significantly, and so on. These are valid reasons for opposing university involvement in startup formation, and such concerns must be addressed carefully. Clearly, the involvement of universities in company formation should not be allowed to lead to the deterioration of the major and traditional tasks of the university, namely teaching and independent research.

Teaching entrepreneurship

Skeptics observe that entrepreneurs are born, not made. However, a well thought-out teaching, research, and practical training program in entrepreneurship will help those who are unlikely to develop their embryonic talents in Europe without some support. The evolution of a successful academic and practical program in entrepreneurship does not differ from that of well-established programs in medicine, music, or research in the natural sciences—all of these recognize the need for formal training, lots of practical work, and a first-class infrastructure.

Thus, universities might explicitly add the creation and development of organizations and companies to their list of major tasks. Universities could complement the provision of venture facilities with teaching, study, and training. As such teaching develops, practical work in multidisciplinary settings is added, for instance in the form of marketing studies, technical and financial feasibility studies, and business plan development. Such partial or extended projects are carried out by groups of several senior students from different disciplines, under university staff supervision and with the help of external mentors from the industrial, commercial, and financial sectors. A university with a solid program, such as that of the Department of Innovation Engineering and Management at Chalmers University, will have no difficulties identifying venture fund managers interested in evaluating such business plans for possible participation.

Recovering investment

How can a university recover its input in such teaching and practical startup support activities? First, the university can regard startups as third-party industrial companies, no different from any other company with which it has contracts, charging the startups for facilities and services at a prearranged rate. This approach works when a startup has sufficient venture capital or operating income. However, it precludes the creation of startups with limited funds. Since those that can attract significant initial support can equally easily locate outside the university, the contribution of the university will be limited if this approach is followed.

Second, the university might provide startups with loans equivalent to its charges for a prearranged period. Such loans are basically in conflict with the notion of venture financing, however, since a stringent and early repayment schedule will hobble the startup and prevent its rapid development, unless these loans are subordinated to other short and long-term commercial loans, with repayments beginning after 3 or 5 years.

Third, the university might participate in startup equity by taking shares equivalent to the value of facilities and services made available to the startup, in effect providing university venture facilities. Holding shares rather than receiving payment for services provided is more in line with the goal of developing rapidly growing startups. However, equity participation of universities in startups is fraught with cons, as well as pros. One of these is that in most European countries, public universities are not permitted to hold shares.

A solution is the creation of a foundation that holds startup shares on behalf of the university. Shareholding can be useful in that the university has an interest in supporting the optimal development of startups in which it holds shares. In the long term, however, conflicts between the primary goals of teaching and independent research and secondary university interests in the development of specific startups can lead to tensions within departments and faculties. Such conflicts can be minimized if the foundation is sufficiently independent of the university.

Fourth, the startup and the university can agree on some indirect form of long-term repayment for venture resources via "company alumnus" status for the startup. A company alumnus is a company that originates within a university, in the same sense that a former student is an alumnus. A company alumnus might subsequently contribute 0.2–1% of its yearly revenues to an "alumni foundation" in recognition of the role of the university in helping the company during its startup phase. The precise percentage to be contributed is negotiated early on, based on the extent and time of university support in establishing the startup. Although a contribution of 1% of total yearly sales to an alumni foundation might seem a large sum, it simply represents a fair return for a risky investment of university resources.

The creation of company alumni foundations will yield results only after a decade or more. If properly set up, their positive features should be obvious to both faculties and startups. Present support for company development with the use of university facilities will yield long-term benefits to the university, and need not be restricted to the departments or institutes where the companies have originated. Such future funds are best disbursed by a distinguished foundation board related only partially to formal university structures.

If European universities continue to play a major role in startup formation in the next decade, many future high-tech companies will have originated in universities. If these companies contribute 0.2–1% of their sales to their respective alma maters, we might reach a stage at which 20–50% of the costs of the more effective universities could be covered by such contributions. If this happens, these universities will become more independent of government funding. The US educational model indicates that this benefits the quality of education and research.

Conclusions

Looking to the future, it will likely remain easier to use university venture facilities for company formation in Europe than in the US. Given a promising concept, a good business plan, and support from a European university and perhaps from a commercial or industrial partner, a driven European bioentrepreneur should be able to develop a small company in a relatively protected environment for the first three years. The availability of early university support can then be used to attract additional partners and venture capital. Thus, although it is perhaps more difficult to raise venture capital in Europe than in the US, it is not particularly difficult to create favorable conditions for the development of new ventures without major capital investment, and here European universities have shown the willingness and the ability to take the lead.