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Topic 1: Early Stage R&D

Early Stage R&D:
The changing scope and nature of innovation has not been matched by changes in policies encouraging capital allocation for early-stage innovations; controlling the cost of accessing research from government labs and universities; and support for coordinating Federal and state support of basic and applied research in growth sectors that assure job formation.

 

Need:
Early stage companies have always depended upon attainment of seed capital to fund idea development, discover market potential, and build relationships.   Such capital is necessary long before a market can be proven, a successful customer can be cited, or other VC requirements can be met.  Increasingly, as early-stage companies tackle complex multi-system problems, this discover-and-develop stage can last even longer, being required to meet even more stringent demands.  Direct funding and financial incentives are needed to support the critical seed-planting part of the innovation eco-system.

 

Situation:
Current policy assumes that early-stage, seed funding is provided by friends, family, angels and other sources of private capital. The policy also assumes that Federal funding of research and development moves readily into commercial use with limited transfer cost. The reality is that entrepreneurs have experienced major boom and bust cycles of early stage financing, as the venture funding industry has withdrawn from early stage innovation financing, and Federal funding focuses on specific basic research topics, regardless of the cost of transfer and commercialization. While the global capital system is effectively awash in capital, the investment funds demand higher returns similar to speculative activities, creating a de facto shrinkage of funding for early-stage innovation. 

 

Federal Government Role:
The Federal government can re-enliven this system through 1) modification of policies affecting capital formation and allocation to encourage funding of early stage innovation; 2) reducing the cost of the technology transfer from Federal labs and universities; and 3) funding both basic and applied research to avoid leaving the “valley of death gaps” that currently plague such innovation sectors as energy, water, materials and sustainable growing.

1)       Modifying select tax policies could attract investors to compensate for the loss of backing by friends and family.  By treating all investment tax credits and capital gains treatments equally, current policies miss a unique opportunity to motivate investors to back early stage, highly innovative companies.  Existing policies effectively encourage investors to seek low risk investments, devoid of innovation.  R&D tax credit policy can treat early stage startups as a second, separate tier. For example, these tax credits should be made permanent and transferable, acknowledging the reality that early stage companies rarely have enough revenue to need tax credits.  Direct funding supplies can be created in multiple ways including: a seed funding pool for <$500K investments; a redistribution of funding currently concentrated to large prime contractors to being offered to small and micro-companies; and the creation of an early-stage public market, allowing investors large and small to share in the risk and opportunity of supporting innovation.

2)       The existing technology transfer system is an improvement over the 1970’s, but still provides little to no professional, peer review recognition to individual scientists and engineers for technology transfer. Tying Federal funding of laboratories and universities to performance targets that reward commercialization can expand the professional capabilities of the technology transfer system, thereby increasing the attractiveness of providing early stage companies in access to government funded research. 

3)       The long emphasis on Federal funding of basic research has not adjusted to recognize the complexity of converting such research into innovative applications given the existing legacy systems for healthcare, communication, food production, energy and transportation. As a result, entrepreneurs currently must absorb the costs of moving research from lab to full innovation.  A more balanced approach to funding both basic and applied research can alleviate the current “valley of death” in the process that impedes progress.

Finally, the Federal government can reduce the operational costs of start-ups through the provision of lab space, incubators, and by reducing responsibility for ancillary expenses such as health-insurance and regulatory compliance designed for larger businesses.

 

Recommendation Summary:

- create incentives for early stage investment
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reward technology transfer and commercialization
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balance basic and applied research
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reduce responsibility for compliance requirements designed for larger businesses

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