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The Boston Globe

Business

INNOVATION ECONOMY

Investors putting start-ups on diets

PhotOral

Lexington’s PhotOral says it needs $10 million to launch its product.

How much can you accomplish with not much?

That’s the question du jour for every entrepreneur. Investors are obsessed with “capital efficient’’ businesses, and just like a spouse haranguing you to visit the gym more often, they believe that everything could be sleeker and more streamlined.

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“If you’re going out to the investor community saying that you’re going to need $50 million or more to get to commercialization, it’s going to be a tough slog,’’ says Rob Day, a Boston investor who focuses on the energy industry. “There has unquestionably been a shift to more capital efficient companies over the last two or three years.’’

The classic capital efficient start-up, in the eyes of an investor, ought to be able to take a million bucks (or less), build a product that works, and land some early customers. The craze started in the tech sector, where open source software and pay-as-you-go cloud computing services radically reduced the cost to create a Web business. Apple’s iTunes Store and the Android Market also made it far easier to distribute a new mobile app. But now investors in energy, medical device, and biotech industries have started chanting the mantra of capital efficiency.

What impact will that have on Boston’s innovation economy, which is much better at producing new robots, stents, and cancer drugs - hardly inexpensive ventures - than games like Angry Birds?

At the root of the emphasis on doing more with less is shrinkage in the venture capital industry: There are fewer venture capital firms with less money to dole out. The most recent data from the National Venture Capital Association, for the third quarter of 2011, shows that venture firms nationally raised half as much in that quarter as a year earlier.

“Returns just have not been good,’’ says Jeffrey Bussgang, a partner at Flybridge Capital Partners in Boston. The venture capital industry as a whole has lost nearly 5 percent on investments over the past 10 years, according to Cambridge Associates, a local advisory firm that tracks industry performance.

As a result, says entrepreneur Greg Schmergel, “VCs who used to be interested in things like hardware and semiconductors now say they’re more interested in making $250,000 or $500,000 investments. They want the two guys who just got out of MIT and are building a Facebook app.’’

Schmergel has raised just over $30 million for Woburn-based Nantero, which is developing a new memory chip for computers. “It’s unfortunate, because if you look at our competitive advantage relative to Silicon Valley, it probably isn’t in making Facebook apps. It’s in biotech and nanotech and semiconductors,’’ he says.

In biotech, says Mark Benjamin, chief executive of Galenea in Cambridge, “less money is going to change the paradigm. Innovation happens with teams of people that have real resources and can fail a few times. You can’t fund real science for a year or two and expect to see results.’’ Benjamin’s company, which has technology that helps drug developers hunt for new drugs to fight neurodegenerative diseases, is currently raising money. He expects that corporate partners in the pharmaceutical industry, not venture firms, will supply it.

In clean-tech, Day says he has seen several local companies have trouble raising money because they’ll require several million to turn a promising idea into a product. Instead of a new kind of solar cell, investors “are looking for energy efficiency or software plays that don’t require major capital expenditures.’’

“If you want to see breakthrough technical innovations come to market, and VCs aren’t willing to do them, there’s a definite gap there,’’ Day says. “And if the budgets of government research programs see their budgets slashed, well, that would be horrible.’’

Entrepreneurs, however, are adapting. Heather Keith is working to bring to market a device for assessing whether a patient has had a stroke. She’s doing it with a team of contractors and consultants, most of whom are working part time for equity in the company, Strohl Medical.

Keith hopes to raise about $500,000 - enough, she believes, to get the device approved by the Food & Drug Administration and find the first 20 customers. “No doubt, it would be easier with more money in the bank, and office space, and full-time employees,’’ she admits.

Stamatis Astra, chief executive of Lexington-based PhotOral, said his start-up will need about $10 million to successfully launch its product - a device that uses blue light to kill bacteria inside the mouth that cause gum disease and bad breath. But he’s starting off smaller.

“We think we need about $1 million to do a good prototype, and go through the FDA process,’’ he says. He aims to get the company’s product on the market next year.

The big difference in raising money now, Astra says, is “people are talking about milestones and tranches: You may need $10 million, but let’s start with $1 million and give you very specific milestones to hit before you get more.’’

Many predict that 2012 could see a shake-out of capital efficient start-ups, since not all will persuade investors they’re worthy of more money. “If those companies can’t figure out how to get acquired before they need that next $2 million or $4 million in funding, they’re dead,’’ says start-up adviser Brad Harkavy.

I understand the allure of chasing lots of business ideas that can be built and tested with very little cash. But I tend to agree with Schmergel at Nantero, who says that “unless you think that the whole world has changed, and these lightweight mobile and social media apps are the only thing that can succeed, it feels like we shouldn’t take the focus off of our strengths.’’ And one of those strengths, he says, is pursuing “big ideas that may be capital-intensive, not capital efficient.’’

Fast and cheap is great - except for concepts that can’t simply be wrestled into reality that way.

Scott Kirsner can be reached at kirsner@pobox.com. Follow him on Twitter @ScottKirsner.
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