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Equity Notes: Investment in internally started companies boosts venture creation model
By Jeff Miller, Mass High Tech
September 22, 2003 - It's still too early to tell whether Flagship Ventures' model of "venture creation" will pay off, but one thing is already clear: The investors at Cambridge-based Flagship have convinced plenty of other firms that the companies they've created are for real.
In the past two weeks, two Cambridge companies co-founded by Flagship raised A-round money from outside investors. That makes six such internal Flagship startups that have caught the attention of other investors in the past two years.
"This is something that the venture investment industry has been doing for a long time in a one-off kind of way: an entrepreneur who hangs out with a firm, a technology looking for a management team, something like that," said Noubar Afeyan, senior managing director at Flagship. "We've been doing it in a more systematic and proactive way."
Indeed, most VC firms these days have an entrepreneur-in-residence or six on the payroll in hopes that they'll get a first look at these folks' next creations. And occasionally, traditional firms have founded companies internally. Charles River Ventures did it in 2000 with Chelmsford wireless gear maker WaterCove Networks. That same year, Prism Venture Partners founded Beverly-based Insulet Corp., which is making disposable insulin delivery systems for diabetics.
So don't confuse Flagship with the much hyped Internet incubators of the boom era. Unlike IdeaLab or the earlier incarnation of the Cambridge Incubator, Flagship doesn't offer services and space in exchange for equity. Instead, two teams of 12 people investigate areas of opportunity in life sciences and IT around predetermined themes. Sometimes there's an outside entrepreneur involved, sometimes there's an intriguing technology, other times just a perceived market need with no one filling it. When they find one that looks promising, they raise it to the "project" level - Flagship allocates some capital and team members take a closer look at the market and applicable technologies.
"In the last three years, about one-third of the projects were discontinued before we went out to get money for them," Afeyan said. "These are things we allocated some capital to. Dozens more were just an idea and never went much further."
Two projects have recently emerged as independent companies. IntelliVid Corp. raised $5.5 million from Flagship and two Bay State firms - Egan Managed Capital and DFJ New England - while Genstruct Inc. banked $6.5 million from both Flagship and North Carolina-based A.M. Pappas and Associates.
IntelliVid (which, despite a press release announcing its funding, remains media-shy) is developing technologies to aid in monitoring, searching and analyzing video feeds from closed-circuit television systems.
Genstruct, on the other hand, is using computer models to decipher how drugs, disease and biological systems interact, with an eye toward designing better clinical trials for speedier approval from the Food and Drug Administration.
In addition to the six internally generated companies that have received funding from outside firms, Flagship has acted as the sole backer for two others: EngeneOS, a Waltham-based biomolecular engineering firm, and Affinnova, a Cambridge-based software company that applies an evolutionary genetic model to the aesthetics of consumer products design.
How well are these internally generated companies doing? Hard to say.
Affinnova, for example, has won some large customers, including Proctor & Gamble Co., PepsiCo Inc. and Kraft Foods Inc. On the other hand, Flagship's InfiniBand hardware startup, Marlborough-based InfiniSwitch Corp., merged earlier this year with a Texas InfiniBand software maker called Lane 15 to form a new company, Fabric Networks.
According to published reports, Fabric Networks has ceased operations and is looking for a buyer. Afeyan said that's not entirely correct. "I think it's more accurate to say that we've reduced operations to a core group of people and are looking at some alternate strategies," Afeyan said. "Looking for a buyer is one of them, but with the financing we raised, we can look at the whole fabric computing space, (technologies) such as Ethernet."
Afeyan doesn't expect that all of Flagship's internal startups will succeed.
"If we do our job right, they'll look no worse, but no better than any other company we may have invested in," Afeyan said.
And Flagship isn't putting all its eggs in the internal venture creation basket. The three funds under the Flagship umbrella manage $400 million and have invested in about 40 companies; less than a quarter of these ventures were generated internally.
"You want to take this kind of primary risk only if there isn't a company to invest in," Afeyan said. "It's always easier to invest in an existing company than to create it yourself."
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