Investing in Tech Start-Ups

April 2, 2008

The overture can come from anywhereâ€"a patient, colleague, family member, or a mere acquaintance. No doubt you've heard it beforeâ€""Hey Doc, I have a great business opportunity I'd like to discuss with you. This is right up your alley."

“The real problem is not whether machines think but whether men do.”—B.F. Skinner

The overture can come from anywhere—a patient, colleague, family member, or a mere acquaintance. No doubt you’ve heard it before—“Hey Doc, I have a great business opportunity I’d like to discuss with you. This is right up your alley.”

Physicians receive such overtures frequently for two reasons—they have technological insights that many do not possess and they have resources to invest. Moreover, having a medical doctor in the group of investors supporting the launch of a product or firm can, rightly or not, bring some additional credibility and assist with attracting financing. Here are some points to consider.

Just because it’s good or interesting science or technology doesn’t mean it’s necessarily a good basis for a business.

The criteria for success as a product launch or a business initiative are quite different from a development that one finds interesting. The development may be too expensive to produce or may not present a competitive advantage over what is already available.

What’s the importance of the initiative having attracted peer-reviewed funding such as an NIH SBIR grant or state-based program funding?If the product or firm has been successful in competing for peer-reviewed funding from a governmental or other source this can be an important indicator that others knowledgeable in the specialty feel the inventor or promoter is onto an idea with promise. A number of government sponsored programs exist to facilitate commercialization of new scientific and technological ideas. A handful of agencies, including the National Institutes of Health (NIH) and National Science Foundation (NSF), participate in a federal program known as the Small Business Innovation Research (SBIR) program designed to “encourage small businesses to explore their technological potential and provides the incentive to profit from its commercialization.” State-based programs have also been launched in a number of areas to facilitate and support such advancements due to their economic development potential.

The importance of good intellectual property protection.

For many science or technology-based start-ups the principal business assets are intangible—intellectual property (IP) rights in patents or copyrights. Securing this protection can be expensive but at the same time it is essential. Future investors will want to examine the extent and rigor of the IP protection secured to date both as a measure of potential for future growth and as a reflection of the savvy of those leading the enterprise. The same will be true for potential commercialization or merger partners.

Be prepared to have your early stage investment diluted.

Initial investments are often referred to as the “seed round” of funding, coming from friends and family or even from “angel investors”—wealthy individuals interested in seeing the product or firm do well. Contrast this with “venture capital” that comes from professional outside investors. The later an investor joins the undertaking the more likely it is that the newly arrived investor will want to diminish the ownership share of those investors who preceded him.

The inventor may not be the person to lead business development.

Unfortunately, the talents that serve one well in the role of inventor or developer of technology are not necessarily those that position the person to lead development of a business enterprise. As with patients, some inventors will understand and accept this news better than others.

Joseph L. Fink III, BS, Pharm; JD, is Professor of Pharmacy Law and Policy at the University of Kentucky, Lexington, KY. Assisting him with this article was T. Joseph Mattingly II, who is a both a PharmD and MBA student, and Juita-Elena Yusuf, MBA, PhD, a Postdoctoral Research Associate in the Gatton College of Business and Economics at the University of Kentucky, Lexington, KY.