Financing Innovation: Report from the AAAI Conference

We keep talking about how it’s not enough to just have good ideas, we have to execute them to turn them into innovations. A lot of good ideas can be tested on a small scale to see if they’ll work, but many ideas need a fair bit of cash to execute. If you work in a big company, there should be some kind of process in place for selecting and executing ideas. If you’re an entrepreneur, you need to find the money yourself. I’ve spend the past three days at the Australian Association of Angel Investors (AAAI) National Conference 2010 in Adelaide, learning about innovation finance from the side of the people with the cash.

As with many important ideas about innovation, Schumpeter was the first to really draw attention to the critical connection between entrepreneurial idea execution and the importance of finance. The importance of that connection has only increased since he first made it in the early 20th century. Angel Investors are a key part of the finance ecosystem as they are the most common providers of seed funding. So the work with people that have great ideas, but often not a whole lot else. The venture capital funding doesn’t usually come into play until the idea is more developed.

Here are some of the things that I’ve learned while listening to talks at the conference:

  • The finance people talk about ‘innovation’ the same way that we talk about ‘invention’ here, and we’re referencing the same thing – an idea that hasn’t been executed. As Dan Mothersill put it: “The net sum value of a killer idea is zero.”
  • The bulk of the Angel investment in the US, Europe and Australia is going into biotechnology, software and medical devices. Cleantech and other energy related ideas have been the fastest growing sector over the past year or so. This is interesting because other stats that were discussed yesterday suggest that most successful start-ups are not reliant on Intellectual Property rights as a key part of their business model, but most of the money is going to industries with strong IP regimes (with the exception of software). I wonder if this reveals a problem in the screening process?
  • Some interesting stats: according to Angelsoft, which compiles data from around the world on over 20,000 idea proposals per year, this is how many of those were evaluated and funded in 2009:

    That’s part of why I’m wondering about the screening process. On the other hand, Angel investors that screen rigourously make a much higher return than those with less process (and the good processes are checklist driven!). The consensus is that about 50% of Angel investments result in all the money being lost, about 40% break even, and the whole game is worthwhile because of the payoffs from the other 10%.

  • The vast majority of Angel investments exit and make money once the start-up is bought out. Initial Public Offerings of stock continue to be pretty much non-existent (13 in the US last year!).
  • There appears to be a strong move towards collaborative investing. AAAI primarily represents Angel networks. They share the effort on evaluating ideas, and if the idea gets through all of the due diligence, then several members of the network will end up putting in money. Related to this, many of the conference participants are reporting that VC funds have been moving away from seed funding in recent years. The Angel networks end up filling this gap. My suspicion is that there is definitely a network analysis story in here. I bet that there are structural differences between the collaborative and investment networks of successful Angel networks compared to those of less successful ones.
  • Sue Preston from CalCEF Clean Energy Angel Fund in the US and Nick McNaughton from Blue Cove Ventures in Australia both said that M&A interest in start-ups increased dramatically in December after over a year of being essentially dead in both countries. Others reported similar observations – this seems to be an interesting signal about the current state of the economy.
  • McNaughton also discussed innovation in China and suggested that Angel investors are not paying enough attention to Asia. On his recent travels there he discovered that there are over 240 companies working on making electric cars in China. This is consistent with research that I’ve done in the area as well – the idea that the Asian economies are primarily driven by imitation rather than innovation is about 10 years out of date. We need to take this more seriously.
  • When Eric Schmidt from Google spoke at TED last week, he gave everyone in the audience a free Nexus One smart phone. When Alan Noble from Google Australia spoke here, he gave all of us a free look at a Nexus One. Unfair!

The conference has been quite interesting, and I’ve learned a lot. I also have some thoughts on how entrepreneurs link their ideas into the economic network, but I’ll save those for another post. In the meantime, I think it’s sufficient to reflect on the critical importance of finance to innovation. It’s an idea that we probably haven’t discussed enough here, but I definitely aim to give it more thought!

Student and teacher of innovation - University of Queensland Business School - links to academic papers, twitter, and so on can be found here.

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