The Innovation Chain

Stages of Technology Development

Risk Profile

Figure 1

For a concept to be developed – to a point where it attains market entry, there are a number of stages to be followed, from fundamental research to market entry. Although this is a cyclical process, for the sake of illustration, the chain has been shown linearly with the various key steps shown in Figure 1.

The nature of participation is linked to the risks involved. These can be classified into three categories: i) development risk, ii) financial risk, and iii) market risk. Development linked to technology performance uncertainty is most significant in the early research stage, and since the eventual markets are unknown, the markets’ risk is negligible. As the technology moves through its development stages (and the market application becomes clearer), all three categories share an equal weighting. As these demonstrations and scale-ups prove out product capability and the technology moves toward market entry, the other downstream risks dominate, such as market and financial uncertainties (market definition, size, receptivity, uptake rates, etc). Overall, as one nears market entry, all the risk types typically decrease. 

Sources of Funding

Figure 2

There are multiple players in the innovation chain, whose degrees of influence and activity vary along this chain. The illustration is not intended to be comprehensive, nor does it recognize the iterative nature of the innovation chain.  The primary players at the idea-generation and concept development stage (fundamental and applied research, in figure 2) are the universities and colleges (whose major sources of funding are from federal and provincial governments), and industry-based research and development labs. As the technology progresses from bench-scale tests to larger-scale prototype tests and demonstration, funding becomes less certain.

Early private equity — in the form of seed capital or individual (Angel) investors — is a source of financing for fledgling companies prior to the market-ready stage. Formal financing through risk capital typically picks up after the seed capital stage, where products have been prototyped and demonstrated, but are not necessarily manufactured in volume.  And certainly, these companies are not generating revenue. Venture capitalists (VCs) fund individual companies through these stages, and frequently realize their returns (“exit”) once industry, banks and IPO markets invest.

Angel Investors, who are often serial entrepreneurs themselves, will invest in individuals or start-up companies at the pre-seed capital stage, but will generally have an increasingly smaller role to play as the product reaches the market development stages.

Industry, often in the form of manufacturers or major technology users, will invest through all stages, as their individual interests and economic ability allow. However, industry generally focuses on the applied research and market development /market entry stages.

In summary, there is substantial public and private funding for research, which combined are estimated to be at $27.2 billion a year.  On the private sector side (VC funding), the funding levels vary dramatically year by year, with an annual average of $1.8 billion a year as the technology progresses to the product commercialization and market development stages.  This illustrates the bottleneck of where well-funded research that does not obtain sustained funding, and hence does not attain market entry.

Funding Intensity

Figure 3

If we show the Innovation Chain as a function of the funding sources, it becomes more apparent who the major players are at each stage. Government funding supports the initial stages of development where the primary recipients are universities and colleges.

As the technology develops from prototype stage to full demonstration, which is usually where the technology is spun out from academic institutions to private research laboratories, individuals entrepreneurs and SMEs, there is an abrupt drop in funding intensity. In Parallel financial and market risks begin to rise as concern shifts from technology viability to market relevance.

The Funding Intensity line shows the gaps in funding that are the consequence of the lack of maturity of new technologies, the risk aversion of the financial sector, and a profound “disconnectedness” around the key players in Canada. The Funding Intensity line is an illustration of how this lack of integration can allow substantial breaks in the Innovation Chain.

Funding Gaps

Figure 4

As a consequence of the lack of maturity of new technologies and the risk-aversion of the financial sector, there is a structural break in the innovation chain. This occurs in the stage prior to commercialization and market development funding. SDTC classifies this as the “Pre-Commercial Gap”. There is a smaller gap in the chain that occurs prior to standard bank financing. SDTC classifies this as the “Pre-IPO Gap”.

With the general trend toward uncertainty in the financial sector, there has been an even greater withdrawal of capital placements from the pre-commercial stage, as reticent financiers continue to hold portfolios in cash, or simply continue their funding into already funded organizations. This has increased the pre-commercial gap, as money has become more scarce.

In the case of SD technologies, the gap is more severe, as illustrated by the number of deals for the energy and environmental sector registered by Thomson Financial from January 2000 to June 2006. There were 13 deals at the seed stage, 52 at the start-up stage, 61 at other early stage, and 60 at the expansion stage.

For Canada to reap the rewards of its investments in upstream research, it must translate these ideas into technologies that attain market entry. This is true for all sectors of endeavour. Substantiating evidence is provided by the fact that the USA spends 14 times more money on research than does Canada -- not an unreasonable difference considering the relative size of the two economies -- but the USA obtains 49 times more revenue from licensing and royalties that only flow upon successful market entry. Canada may register many patents but if they don’t reach market, return on the investment cannot be achieved.

SDTC Funding

Figure 5

The situation is more severe in the case of SD technologies. These occur in the sectors of energy exploration and production, power generation, energy utilization, transportation, agriculture and forestry, mining, and waste management.  Historically, SD technologies were considered to be more capital-intensive with longer development cycles than other technologies.

Within Canada’s private equity community, $33.76B was expended on all deals between 2000 and 2004. Of this, energy and environment deals were valued at $1.2B, representing about 3.5% of total equity investments (up approximately 1% over 1996-2000).

The recent downturns in the IT and biopharmaceuticals sectors, coupled with an increase in Canada’s commitment to Kyoto and the province’s need for energy infrastructure renewal, have led to an upturn in energy and environment investments within the private Canadian investment community.  Most of the opportunities driving these investments are focused on sustainable activities that are good for the economy, the environment, and society as a whole.

Conclusion

As a result of the breaks in the Innovation Chain and the particular problems faced by SD technologies, promising Canadian companies face extreme difficulty in reaching the market. Hence the benefits of revenues and emission reductions are not realized. Furthermore, there are only a few diverse companies in this space. To develop sufficient critical mass of SD technology developers, manufacturers, and suppliers, there must be a reliable, available, and substantial commitment to funding this sector. SDTC, is beginning to address these problems in this critically important sector.

SDTC aims to bridge the gap in the Innovation Chain by funding promising companies and institutions, who join together to provide solutions for climate change and clean air problems.