Nanotechnology is hot, but investors are wary. For the adventurous few it will require patience of Brobdingnagian proportions.
By Steven Brull
August 2002
Institutional Investor Magazine
Veteran biotechnology entrepreneur Larry Bock knows his way around the venture capital market. Undeterred by its long odds, he made the rounds last year to finance the launch of his new Palo Alto, Californiabased company, Nanosys.
Bock trotted out the obligatory PowerPoint presentation, quantifying as best he could the futuristic promise of nanotechnology -- the science of creating advanced materials, systems and devices on an unimaginably small, atomic scale. In the process he tried to make the case for Nanosys as an ideal vehicle for investors willing to take a calculated risk on this emerging and highly speculative field. But none of Bock’s images or graphs packed the punch of the 35-year-old film clip that he included with his slides.
It was the classic graduation-party scene in The Graduate, in which one of the guests offers some unsolicited career advice to the young Benjamin Braddock (played by Dustin Hoffman): “I just want to say one word to you . . . just one word. . . .” That word was “plastics,” but Bock inserted “nanotechnology” instead.
“It was a dumb joke, but people got it,” he says.
They also anted up: Bock raised $2 million in seed money last fall and followed that with a $15 million round in February. With contributions from the likes of Arch Venture Partners and Rockefeller family vehicle Venrock Associates, Nanosys is one of the best-funded start-ups in a field that has been hyped as much as plastics was in its day. It is certainly as puzzling to the uninitiated. Nanotechnology, like plastics, is more conceptual than concrete, a broad category of potential developments rather than a simple or single product.
While scientists have been manipulating matter at the submolecular level for years, nanotechnology began to creep into investors’ consciousness just as the Internet bubble was bursting. They may have been hungering for the next big thing, but it soon became apparent that small science, though potentially big, was anything but next -- certainly not next year, and probably further away than the five to seven years that venture capitalists are usually willing to wait before exiting their investments.
Call it the anti-Internet, with paybacks coming not in months but over decades, and with cash-burn rates that have to be managed not over a few quarters but over several market cycles.
Although some nanotechnology innovations are already in the marketplace -- for example, materials that strengthen automotive components or lengthen the lives of batteries -- these tend to be low-margin commodity items. For the windfall returns that early-stage investors customarily shoot for, entrepreneurs like Bock point to blockbuster breakthroughs in bioscience and electronics that are still far from market ready.
Yet Bock, a Nanosys co-founder as well as its president and chief executive officer, has attracted venture money to an intellectual-property proposition: He is assembling and hoping to exploit a portfolio of patents, now numbering about 40, by selling or licensing them to companies trying to commercialize nanotechnology products. Besides being well funded, Nanosys enjoys considerable cachet in Silicon Valley, thanks to the presence on its board of high-tech celebrities like marketing guru Regis McKenna and Ethernet inventor Robert Metcalfe, who is also a partner at Nanosys investor Polaris Venture Partners.
Nanosys represents but a fraction of the gathering interest in nanotechnology. More than $4 billion worldwide will be poured this year into nanotech research and development, estimates Tim Harper, executive director of the European NanoBusiness Association and CEO of Madrid-based market research firm CMP Científica. Of that total, half will be invested by governments in basic research; most of the rest will come from companies like Hewlett-Packard Co., Hitachi, IBM Corp. and NEC Corp., which have sizable R&D departments and a heritage of cutting-edge technology research. Only a small percentage of funding is coming from private investors, but a growing number of true believers expect nanotechnology to take its place alongside microcomputing, genomics and the Internet as one of the seminal technologies of the age.
“This industry can be huge. It’s just a question of timing,” declares Bryan Roberts, a general partner with Venrock Associates. “We’re either early or really, really early.”
Then again, they could be really, really wrong. It took more than a decade for integrated circuits and genetic engineering to spawn significant commercial enterprises and shareholder returns; investors who jumped in too early got hurt. Nanotech may now be hopelessly premature; no one can yet predict when it will be the punch line that “plastics” was in the 1960s.
IT’S ALL TOO EASY TO DISMISS WHAT CAN’T BE seen. Nanotechnology -- derived from nanos, the Greek word for dwarf -- is impossible, literally, to grasp. When engineers talk in nanodimensions, they start with the nanometer, which is one billionth of a meter, approximately the width of three atoms. A human hair is 200,000 nanometers in diameter.
Nanotechnology, however, isn’t only about scale. It’s also about the ability to fabricate materials and devices that are smaller than 100 nanometers. That’s the threshold below which the classical physical laws of Newton give way to quantum physics, where materials take on entirely new properties.
Some theorists believe that quantum science holds the key to future advances in computing by extending the miniaturization of circuitry beyond today’s semiconductor chips. But a practical quantum computer is at least a decade away. Today researchers are turning out a steady stream of incremental nanotechnologies that, for example, increase the corrosion resistance of paints or help the body to more easily absorb drugs. Potentially more momentous products -- including molecular transistors and square-inch storage drives that can hold 6 million pages of text -- have been demonstrated in laboratories.
But finding promising venture investments can seem as challenging as the technology itself, which is far more complex and amorphous than the Internet market structure that high-tech investors became familiar with in the 1990s. Steve Jurvetson, a managing director of Redwood City, Californiabased venture firm Draper Fisher Jurvetson, points out that for all the Internet’s problems, its subsectors were pretty straightforward: enterprise software, business-to-consumer commerce, business-to-business commerce, infrastructure equipment and communications. Nano-technology is not so neatly subdivided. As it gets applied in a multitude of industries -- from medicine and electronics to energy, chemicals and structural materials -- each industry will spawn its own set of products, evolving in different directions and at varying paces.
In addition, an understanding of the nanotech landscape requires knowledge of more than one, and perhaps all, of the key theoretical disciplines: materials science, biology, chemistry, optics and quantum physics. “It’s very difficult for venture capitalists to get their heads around nanotechnology,” says CMP Científica’s Harper.
Nanotech’s biggest holdup, however, is the inability to forecast significant product releases. “There are possibly companies springing up now that could be the Intels of the future,” says R. Stanley Williams, director of Hewlett-Packard’s Quantum Science Research lab in Palo Alto. “The problem is we’re not even going to know who they are for another ten years.”
Corporations like HP can be more patient than mainstream venture capitalists; hence nanotech research is a growing, though relatively small, part of their R&D. “It causes one to pause and ask if large companies are going to play a larger role in this industry than they did with the Internet,” notes Jurvetson, one of Silicon Valley’s more unabashed nanotech optimists.
For all the investing drawbacks, however, nanotechnology isn’t an entirely unknown quantity. And although its future may be hazy, history suggests that it’s not completely unpredictable.
The idea of manipulating matter at the nanoscale first came up in a 1959 lecture by the late California Institute of Technology professor and Nobel laureate Richard Feynman. But it was not until the 1980s that science began to catch up to Feynman’s vision, thanks to IBM’s scanning tunneling microscope and atomic force microscope, which enabled engineers to see and manipulate individual atoms. That led to nanoscience’s highest-profile achievement: Rice University professor Richard Smalley’s 1985 discovery of fullerenes. Named for science visionary R. Buckminster Fuller, they were the third form of carbon to be discovered, following graphite and diamonds, and for that Smalley earned the 1996 Nobel Prize in chemistry.
As scientists moved into the quantum realm below 100 nanometers, they found that matter behaved in bizarre ways. Aluminum ground into 30-nanometer particles, for example, combusts like rocket fuel when exposed to air. Strands of carbon called nanotubes have 100 times the tensile strength of steel, and semiconductors can emit the colors of the rainbow.
Scientists refer to these nanoscale experiments as bottom-up materials design; the theoretical results sound like science fiction: molecules that target and kill cancer cells, microchips more powerful than the human brain and computers that consume a billion times less energy than today’s.
Right now all of that really is hype, much of it stoked by none other than the U.S. government. The National Science Foundation, which itself has an annual nanotechnology budget exceeding $200 million, expects the U.S. market for nanotech-based products and services to reach $1 trillion within ten years. For the current fiscal year, the U.S. government allocated $604 million for nanotech research, which would rise to $710 million in President George Bush’s proposed budget for fiscal 2003. CMP Científica estimates that corporations -- through both venture capital and internal R&D -- will be spending $1 billion.
CMP Científica’s Harper adds that the European Union estimates E1.3 billion ($1.31 billion) in nanotech spending this year, while in Asia, combined expeditures by China, Japan, South Korea and Taiwan will exceed $1 billion.
For all the government money flowing into the sector, no more than a few dozen venture capital firms have actually written checks to start-ups. But people active in the market don’t let that get them down. “The hype doesn’t exist except in the minds of a few reporters,” says Charles Harris, chairman and CEO of Harris & Harris Group, a publicly traded investment company that plans to change its name later this year to Tiny Technology Venture Capital. “Nobody’s talking about new business models. There are no IPOs or outrageous valuations.”
There may just be a need for some basic investor education -- starting with a coherent definition of nanotechnology. To purists, it’s not just the manipulation of matter at or below 100 nanometers. The materials have to be designed to take on specific properties or to achieve specific engineering goals.
That latter part is key. After all, humans have been manipulating molecules for centuries. Chinese potters during the Ming Dynasty (13681644) made glazes with nanoparticles without fully understanding the science. The width of circuit lines on today’s microchips are as small as 130 nanometers, with the next generation poised to shrink to 90. That’s nanoscale, but the application doesn’t fit the strict definition of nanotech.
What General Motors is up to does. Using nanoparticles to reinforce the steps on trucks, GM has quietly become one of the biggest nanomaterials producers. Nanophase Technologies Corp., a Romeoville, Illinoisbased spin-off of Argonne National Laboratory, produces nanosize zinc oxide particles that make sunscreen transparent.
Most investors aren’t -- and don’t need to be -- sticklers about what is or isn’t nanotechnology. Many lump microelectromechanical systems under the nanotech rubric. But MEMS are a relatively mature, multibillion-dollar industry, the best-known application being their use as the actuators of automobile air bags. More to the point, MEMS work at the micron level, or one millionth of a meter, which is 1,000 nanometers.
“The micro-nano distinction is kind of silly,” says Rick Snyder, CEO of Ardesta, an Ann Arbor, Michiganbased company. “We call it the ‘small-tech field,’ because as a practical matter there are lots of overlaps and linkages between MEMS and nano. The end user in the real world doesn’t care.”
By CMP Científica’s count, nearly 500 companies worldwide -- about half of them in North America -- are bona fide nanotechnology players, 271 major universities are engaging in nanotech research, and 125 investment companies (including corporate venture capital arms) have made nanotech deals.
THERE ARE, TO BE SURE, PRECIOUS FEW WAYS FOR the investing public to place a bet on nanotechnology. But that hasn’t prevented analysts like Steven Milunovich, Merrill Lynch & Co. global technology strategist, from taking stock of the opportunities. Milunovich and others divide the field into five categories, two of which -- instrumentation (tools and modeling software) and materials (including high-strength steels) -- they consider closest to commercial viability. The other categories are physical (computer chips, drives and optical devices), biological (DNA testing and drug development) and futuristic (fanciful ideas that may never come to pass, like elevators rising from points on the equator to satellites in geosynchronous orbit -- said to be theoretically possible with carbon nanotube construction).
Of the few publicly traded nanotech plays, most are unprofitable and not rated by analysts. These companies include the sunscreen enhancer Nanophase Technologies and Woodbury, New Yorkbased Veeco Instruments, which makes atomic force microscopes but gets a majority of its revenues -- which totaled $449 million last year -- from nonnanotech semiconductor equipment operations.
Veeco, with a market capitalization of roughly $400 million, touts its diversified revenue stream as an advantage that should be attractive to investors, in contrast to New Yorkbased Harris & Harris, which plans to make all future investments in tiny technology. That firm, which made its first investment in 1994, in Nanophase Technologies, and exited it last year, has a market valuation of $19 million and a handful of holdings, including San Franciscobased Optiva, which develops optical nanomaterials for use in flat-panel display screens.
Experts don’t see much upside even in the instrumentation and materials segments. “Materials may help the efficiency of big chemical producers such as Dow, DuPont and BASF, but these companies would be helped more than the producers of the new materials,” says Josh Wolfe, a 24-year-old former Salomon Smith Barney banker who co-founded Lux Capital, an early-stage New York venture firm focusing on nanotech.
Ardesta’s Snyder, besides espousing his big-tent view of “small technology,” raises his sights beyond young, private companies like Nanosys or Optiva. “This is the time to plant the seeds to work with researchers and universities who may not have fully commercial products for some years,” recommends Snyder, a former president and chief operating officer of Gateway, who raised an initial $100 million fund in 2000. He hopes to raise another $100 million this year and to take Ardesta public in 2005.
“The opportunities we’ve found require more time and attention and nurturing than a typical VC fund would be able to give,” Snyder explains. Meanwhile, Ardesta is getting a different kind of traction by publishing a bimonthly magazine and news Web site under the name Small Times. “We want to do what Ziff Davis did with personal computers, promoting the industry and benefiting from different titles,” says Snyder.
Among the more established venture capital firms dipping their toes in are Draper Fisher Jurvetson and Venrock, both known for their early-stage orientations. Says Venrock’s Roberts: “A significant risk in nanotechnology is that because so many little companies are being started, the intellectual property base will become very fragmented.” That’s why Nanosys, as an aggregator of patents that are initially being applied in the sensor and photovoltaic areas, interested Venrock.
Nanotechnology may, in the end, play out much like the integrated circuit business did. Fairchild Semiconductor commercialized IC production in 1959, but it took until 1968 for a group of Fairchild scientists to break away and form Intel Corp., which took several more years to morph into an industry giant. Similarly, in biotechnology, Stanley Cohen of Stanford University and Herbert Boyer of the University of California, San Francisco, applied for a patent on recombinant DNA technology in 1974, but not until 1980 did Genentech, the company that Boyer founded with venture capitalist Robert Swanson, go public. Many investors got burned along the way.
That said, some venture capitalists stuck with their early microelectronics and biotech investments and profited handsomely, and those experiences encourage the nanotechnology fans. “Nanotech could be the next great technology wave,” says Jurvetson. Two to three years from now, he says, as much as 40 percent of his firm’s new investments could be in this sector. “I’m having more fun and learning more than I did two years ago, when making money almost became formulaic,” Jurvetson adds.
Still, nanotechnology could do with a little more formula and a little less blind faith.
