By Sarah Kearney, Fiona Murray, & Matthew Nordan
The power of science to change the world should be self-evident. Consider the
immeasurable impact that science and engineering innovation had on social
conditions during the 20th century. The first half of the century produced
the assembly line, the airplane, penicillin, and a vaccine for tuberculosis; the second half
brought the eradication of polio and smallpox. Scientists harnessed the power of the sun
with photo voltaic cells, invented the birth control pill, and sequenced the human genome.
Work done in research laboratories sparked a Green Revolution: In the 1960s, rice yields
in India were about two tons per hectare; by the mid-1990s, they had risen to six. In the
1970s, rice cost about $550 a ton; in 2001, it cost less than $200. By June 2012, more than
one-third of all people on earth had used the Internet—a system built on the backbone of
science and engineering research conducted in the 1960s.1 In each of these cases, the results
of scientific discovery yielded both public goods and private fortunes.
Today, research discoveries languish in ivory towers for lack of entities that are willing,
able, and properly structured to invest the capital necessary to build lasting organizations
that can move those discoveries from the lab to the field.2 People in the university community
lament the growing “idea-to-impact gap” (sometimes known as the “valley of death”).3
Because of this gap, corporate leaders find few promising innovation-driven companies to
acquire. Government agencies in scientifically advanced nations cite this gap as a rationale
for allocating taxpayer funds to domestic commercialization efforts.4
Conventional wisdom holds that venture capital can fill this gap.
But the venture asset class has come to focus on developing varieties
of consumer-oriented digital innovation over short time periods. It’s
optimized to support Instagram, not impact. And its investment criteria
are very narrow: nothing too long-term, nothing too expensive, and
nothing that involves too much technology or market risk. In “What
Happened to the Future?”—a manifesto issued by the Founders Fund,
a Silicon Valley-based investment firm—the author notes, “In the late
1990s, … venture investing shifted away from funding transformational
companies and toward companies that solved incremental problems or
even fake problems.… VC has ceased to be the funder of the future, and
instead become a funder of features, widgets, irrelevances.”5
Over the past three years, we have explored the role that impact
investment by philanthropists can play in funding science. Philanthropists,
we have found, are overlooking the middle ground that lies between
their grantmaking to universities and their investment in venture
funds. This middle ground is precisely where exciting and potentially
life-changing technologies can thrive. Instead of focusing on ways to
“fix” venture capital, we argue that the philanthropy and impact investment
communities can join to create new vehicles that support the
creation, translation, and deployment of socially beneficial innovations.
In this article, we outline the parallel histories of science philanthropy
and venture investing. That dual history, in our view, has
culminated in a bifurcated financial system and has contributed to the idea-to-impact gap. We also propose a solution to that problem:
philanthropic investment, or the use of grantmaking to fund early-stage
technology ventures that hold the promise of achieving significant impact at a large scale.
The Bifurcation of Science Funding
Why, in our own era, has it become so challenging to fund the commercial
development of transformative scientific discoveries? To
answer this question, it is useful to observe the history of investment
in science for social and economic purposes.
The story of financial support for science research and commercialization
in the United States is one of increasing bifurcation. In the
beginning, those who conducted scientific work also funded it. In the
early 19th century, gentleman scholars like Thomas Jefferson worked
at science as they worked at politics, literature, and farming; it was, in
short, an important part of being a gentleman. By the middle of the
century, however, science had emerged as a matter for specialists. This
transformation had implications for funding: Scientists now focused
on securing external patronage for their research.6
Foundation support | After 1880, philanthropists began to organize
their efforts formally, and they introduced a greater degree of
regularity into science funding, particularly by helping to establish
the new research-oriented universities that emerged during that
period. Philanthropic foundations hired professional staff members to engage with the scientific community, and they commanded the
resources necessary to support an increasingly complicated and
expensive search for knowledge.7
In the period after World War I, the visibility and prestige of science
reached new heights. Foundations invested $100 million in science
between the two world wars. Between 1918 and 1925, for example, the
General Education Board (established by John D. Rockefeller in 1903)
invested $20 million in astronomy, physics, chemistry, and biology.
Similarly, the Carnegie Corporation and the Rockefeller Foundation
each gave approximately $8 million to the National Research Council,
which served as a trade association for science. The council developed
markets for PhDs in industry, created communication networks, and
encouraged cooperative research projects.8 By 1925, at least a dozen
large foundations sponsored research on a large scale.9
In part because of changes in tax policy, charitable donations of
all kinds—including donations to support science and
engineering—increased steadily throughout the 20th century. In 1955, annual
giving from individuals, foundations, and corporations totaled
$7.7 billion. By 1998, annual giving had risen to $175 billion.10 Scientific
discovery, engineering, and medicine have always received significant
funding from individual givers. Today, philanthropic contributions
account for almost 30 percent of US universities’ funding for
research expenditures.11
Venture capital | In parallel with the expansion of philanthropy to
support fundamental discovery in universities, wealthy individuals
were pioneering the use of for-profit investment vehicles to fund entrepreneurial
start-ups—a practice known today as venture capital.
Consider the case of Venrock, an early-stage venture capital firm
that originated as an investment arm of the Rockefeller family. In 1938,
members of the family invested in Eastern Air Lines, then headed by
CEO (and former World War I flying ace) Eddie Rickenbacker. To make
that investment, Laurance Rockefeller, a grandson of Standard Oil magnate
John D. Rockefeller and an aviation enthusiast, pooled his money
with personal checks from five siblings. In the years that followed, the
Rockefeller group backed dozens more early-stage companies, and
nearly all of them were science- and engineering-driven enterprises in
fields such as aviation (McDonnell Aircraft), imaging (Itek), rocketry
(eReaction Motors), analytical instruments (Thermo Electron), and
power (United Nuclear). In 1946, the Rockefeller family formalized its
ad hoc investing activity into a fund called Rockefeller Brothers Inc.
Other wealthy families followed a similar pattern in their investment
activity. In 1911, for example, Carnegie Steel cofounder Henry
Phipps formed Bessemer Securities. In the 1930s, the financier John
Hay Whitney began investing in high-tech start-ups such as Pioneer
Pictures and Technicolor Corporation. These investors were amateurs,
but they blazed a trail for the venture capital asset class as a whole.
In the late 1960s, the Rockefellers brought in outside managers to
professionalize the firm’s venture investment activity and dubbed the
new entity Venrock. These managers continued to invest family money
on an “evergreen” basis (that is, by re-investing proceeds with no fixed
date of liquidation), and the firm continued to focus on science- and
engineering-driven enterprises, both in established industries such as
electronics and computing (Intel, Apple, and 3Com) and in other categories
marked by rapid technological change—in particular, health care.
In the meantime, a new breed of venture capital partnerships
emerged. Partners in these firms didn’t invest their own cash, but rather drew their funding from foundations, trusts, pension funds,
and other third-party investors. American Research and Development
(ARD), founded in 1946, was the most influential of these
firms. ARD alumni founded other East Coast VC firms, among them
Greylock, Morgan Holland Ventures, and Fidelity Ventures. Similar
operations sprang up on the West Coast—among them Draper and
Johnson Investment Company, Sutter Hill Ventures, Kleiner Perkins
Caufield and Byers, and Sequoia Capital. What distinguished these
newcomers was a financing model that matched the needs of thirdparty
capital providers: Instead of developing “evergreen” funds,
these firms offered “closed-end” funds. Typically, those funds have
a nominal 10-year lifetime that requires portfolio companies to go
from initial investment to acquisition or IPO within a decade.
The rise of the Internet in the 1990s saw two changes in the
venture asset class. First, the amount of money invested in venture
funds grew dramatically, from $8 billion in 1995 to $105 billion in
2000, at the height of the Internet bubble. (More recently, that
figure has stabilized at $25 billion to $30 billion per year). Second,
the investment focus of VCs shifted toward software and Internet
companies that require less capital to scale up and produce faster
returns than science-driven companies. In other words, businesses
like Groupon, Twitter, and Instagram stole the limelight from businesses
like Intel, Genentech, and 3Com.
Inside the Idea-to-Impact Gap
By the early 21st century, the separation of capital along the idea-to-impact continuum was complete. Today, the process of funding
science operates within established legal boundaries that delineate
how investors interact with nonprofit and for-profit organizations.
Nonprofit institutions (including universities) receive grants from
government agencies, corporate donations, and private philanthropy
to conduct basic science and engineering research. When that research
yields ideas (and intellectual property) with commercial potential,
for-profit entities step in to license those ideas and to translate them
into marketable products. This bifurcated system isn’t equipped to
support innovations that have a long time horizon for development.
The energy sector offers a prime example of a technology field
that suffers from a lack of early-stage investment. Energy is one of
the world’s most important industries, accounting for 10 percent
of global GDP. (By comparison, only about 3 percent of global GDP
derives from commerce on the Internet.) Yet energy has historically
accounted for only 1 percent to 2 percent of venture capital investment.
A burst of VC investment entered the energy field in the second
half of the 2000s, when fossil-fuel prices soared, but by 2013
investment had plummeted back to historical levels.
When we look back at earlier radical energy innovations that
reached broad deployment, we see that the funding sources that enabled their development are essentially gone. Nuclear fission originated
with the Manhattan Project, an unprecedented mobilization
of public money; no comparable stream of government funding exists
today. Photovoltaic cells emerged from AT&T Bell Laboratories,
a corporate R&D institution; Bell Labs—and similar entities like
Xerox PARC—are now just shadows of their former selves.
Recent efforts to reverse this trend have gone only so far. Since
2009, the US Advanced Research Projects Agency-Energy (ARPA-E)
has spent more than $800 million to fund more than 350 breakthrough
energy technology projects. ARPA-E focuses its grantmaking explicitly
on projects with commercial potential. Even so, only a handful of its
awardees have been able to raise institutional risk capital to supplement
their ARPA-E funding.
Most explanations of the science funding gap fail to recognize that
the shortfall has two causes: First, compared with software investments,
many science-driven investments have a relatively unappealing
risk-return profile. Second, and equally important, the financial
interests of investors who participate in the innovation process are
often not in alignment with the social goals of scientist-entrepreneurs.
One venture capitalist, speaking in 2013 at an American Academy of
Arts and Sciences roundtable on energy finance, put it this way: “I will not invest because of climate change. My limited partners expect
financial returns within a certain timeframe.”
For-profit investment vehicles for early-stage companies fail to
account for investors’ charitable objectives or the potential social returns
of such innovations. Conversely, tax-shielded charitable funds
are rarely used to support for-profit technology companies, even when
those companies advance desirable social outcomes. In each case, neither
purely philanthropic motives nor purely profit-based motives are
sufficient to justify investment. As a result, capital to build companies
in areas such as energy, water, and health care remains in short supply.
A New Role for Philanthropy
We believe that a solution to this problem lies in the emergence of a
new breed of philanthropic investors—individuals and institutions
that aim to bridge the divisions that mark the funding of science today.
Consider the Bill & Melinda Gates Foundation. Over the past half-decade,
the Gates Foundation has deployed a considerable amount of
capital to bridge the idea-to-impact gap within the health-care field.
In 2011, for example, the foundation made a $10 million equity investment
in Liquidia Technologies, a for-profit venture that develops
and commercializes vaccines that prevent infectious diseases. The
foundation made this transaction as a
program-related investment (PRI); for
financial and legal purposes, therefore,
it counts as a grant. And in 2013, the
foundation made a PRI in the Global
Health Investment Fund (GHIF), a traditionally
structured venture fund that
supports medical research and development.
That PRI took the form of a loan
guarantee that allowed investors in
GHIF to hedge as much as 60 percent
of their invested capital, and it helped
GHIF raise $108 million.
Following the lead of the Gates
Foundation and other pioneering philanthropists,
we advocate a model
that occupies the space between research
grants and for-profit risk capital.
Of particular interest to us are
impact investment approaches that
blend philanthropic and financial
perspectives. A handful of organizations
are already blazing trails at the
boundary between nonprofit and for-profit
investment in science and engineering,
and they are pursuing a wide
variety of methods. (See “Funding
Lab-to-Field Innovation: Pioneering
Approaches” below.)
The model that we propose will be
compelling to a wide range of philanthropic
asset owners. Here, we will focus
on charitable foundations. The US
Internal Revenue Code requires each
foundation to spend at least 5 percent of its assets annually on efforts to further one or more charitable
purposes. (The advancement of science counts as one such purpose.)
To fulfill the 5 percent mandate, foundations historically have
made grants to public charities without an expectation of receiving
a financial return. In 2011, grant disbursements from foundations
totaled $47 billion.12
Today, however, foundations are increasingly forging impact investment
strategies that involve deploying assets on both sides of
their house—on the 5 percent side, where grantmaking takes place,
and on the 95 percent side, where endowment managers work to
preserve foundation capital.
On the endowment side, foundation leaders have begun to apply
positive and negative screens to the investments they make. A recently
launched movement called Divest-Invest Philanthropy, for example,
highlights the power of large foundation endowments to shape social
outcomes.13 Citing both ethical and financial reasons, the movement
calls on foundations to divest their endowments of holdings in fossil-fuel
companies. To date, the dialogue around this movement has focused
on avoiding harmful investment activities (“divest”). But no less important,
in our view, is the need to support helpful activities (“invest”).
The use of direct investment—often called Mission-Related
Investments
(MRI)—allows foundations to put the full weight of
their assets toward the pursuit of philanthropic goals. (In 2011, the
endowments of US foundations were collectively worth an estimated
$600 billion.) With an MRI, a foundation uses endowment funds to support
a business whose products or services align with the foundation’s
mission. As a rule, MRIs promise a market-rate return and therefore
meet “prudent investor” requirements. Endowment managers have
a fiduciary duty to preserve capital over time, and the US tax code
mandates that they refrain from making high-risk investments that
might jeopardize the longevity of their foundation. As we have noted,
however, many early-stage ventures in science and engineering cannot
meet that standard. MRIs offer one tool for philanthropic investors to
deploy, but they will not be sufficient to fill the idea-to-impact gap.
The Promise of Program-Related Investments
There is another side of impact investing that has greater potential
to close the idea-to-impact gap in science and engineering. By its
nature, that gap can be filled only by concessionary investment—by
vehicles in which investors concede, or give up, something that they
would otherwise expect in return for their money.14
Foundations can make such investments in the form of a PRI.
With a PRI, a foundation channels grant funds (that is, money that
comes from the “5 percent” side of its operations) to a for-profit
company that does “program-related” work. Such work is program-related
insofar as it advances a programmatic goal of the foundation.
The US tax code requires a PRI to meet a two-part test: The investment
must “significantly further” the charitable goals of a foundation,
and it must be such that the foundation would not have made
it “except for [its] relationship” to those goals.15
The concessionary nature of a PRI is not based solely on the
magnitude of expected returns. A PRI-making foundation can make
concessions according to various investment criteria—the timeline
for drawing financial returns, for example, or the perceived market,
technology, or regulatory risk of the investment in question. Although
it has become the norm to structure a PRI as low-interest debt, doing so is not a requirement. In any event, the value proposition for philanthropists
is clear: Making a grant in the form of a PRI gives a foundation
a powerful tool for moving critical ideas out of the laboratory
and into the commercial marketplace. Even though PRIs come out of
grant coffers, they offer a foundation the possibility that it will recoup
money that it can redistribute to other charitable causes.
Given this compelling proposition for grantmakers, it is surprising
that the use of PRIs to bridge the idea-to-impact gap is not more
common. According to the best available data, foundations made fewer
than 5,000 PRIs between 1998 and 2010, and together those investments
constituted less than 2 percent of total grantmaking. Among
those PRIs, less than 1 percent—about 35 in all—went to grantees in
science and engineering fields.16 Although few in number, most of
those PRIs went to support technology as it moved from a lab environment
to commercial development. These data lead us to two conclusions:
First, PRIs do have the potential to bridge the idea-to-impact
gap in science and engineering innovation. And second, there are high
barriers that prevent asset holders from using PRIs in this way today.
Some of those barriers are philosophical. Many philanthropists express
concern that PRI-making might cross well-defined boundaries
and violate important institutional norms. Is it inappropriate to direct
grant dollars away from traditional public charities and toward profit-seeking
businesses? How can philanthropists and investors ensure that
PRIs do not duplicate traditional, finance-first investment activities?
In addition, our research suggests that these barriers arise because
of the historic separation of the social logic of philanthropy
from the economic logic of endowment management. These two
areas of practice are organizationally distinct within private foundations:
The grantmaking side of a foundation aims to advance a
charitable mission by funding programs, whereas the endowment
side strives to preserve a corpus of assets. People on each side of the
divide have their own affinity groups, their own governing bodies,
and their own best practices.
Three barriers related to that separation are worth noting.
Mismatch of expertise | PRIs, by construction, require the expertise
of both grantmakers and for-profit investors. But these groups do not
have a common language or a common body of expertise. Sourcing
deals, conducting due diligence, structuring investment terms, and
making board-level strategic decisions for technology start-ups are
not activities that grantmakers are trained to do. Money managers,
for their part, have little expertise in analyzing the social impact of
an investment or the concessionary nature of a financial vehicle. On
the contrary, they are trained to focus on financial returns and to
follow prudent investing practices.
Legal uncertainty | Another formidable barrier—one that is
grounded both in regulatory reality and in the risk-averse culture of
the legal community—involves the legal consequences of accepting
investment risk. Attorneys are systemically inclined to discourage
PRI-making in order to protect their clients, and few attorneys today
have experience in advising clients on transactions of this kind.
Policy-driven inertia | Many foundation administrators shy away
from making grants to recipients other than public charities. After
the Tax Reform Act of 1969, which tightened the tax rules that apply
to the philanthropic sector, US foundations began to avoid risktaking
behavior and settled into a routine in which the easiest grant
to make is a general-purpose grant to a public charity.17
Given the urgent nature of global problems like climate change,
water scarcity, and poverty—and given the need for science- and
technology-based solutions to those problems—we believe that
taking action to break down these barriers is imperative.
An Agenda for Philanthropic Investment
The idea-to-impact gap should matter a great deal to the individuals,
families, corporations, and foundations that have already invested in
science, engineering, and medicine. It should matter to any investor
who yearns for real-world results. And it should matter to the billions
of people affected by a lack of electricity, an absence of clean
water, a changing climate, an inefficient manufacturing sector, and
the persistence of diseases like cancer and dementia.
As scientists, funders, and other stakeholders explore various
forms of philanthropic investment, some parts of their journey will
be straightforward. Within the university-philanthropy complex,
structures already exist to find good ideas in university labs, to create
entrepreneurial start-ups, and to partner with government agencies
and large corporations in supporting those young companies.
But the work of expanding access to much-needed risk capital will
be more complex. That is where pioneering needs to happen. Our
hope is that leaders will emerge who have the courage to explore
this new territory where impact investing overlaps with funding for
science. Here, we offer an initial agenda for those leaders to follow.
Entrepreneurs need to educate themselves about the decision-making
processes and legal constraints that are unique to philanthropic
asset owners. Appealing to that group of funders
requires a different approach from the one that they use in
pitching to traditional venture capital firms.
Asset owners need to collaborate with each other in order to
aggregate funds at a sufficient scale. Collaboration at this level
is especially crucial in domains that have certain common elements:
large charitable goals, a misalignment with the structure
of traditional venture capital, and the potential for market
adoption of commercial products. PRIME Coalition, an
entity that we are helping to lead, is one such effort. It is a network
of philanthropists who share an interest in market-based
solutions to climate change. That model, we believe, holds
promise not only in the climate field, but also in other areas
that depend on advances in science and engineering.
Scholars need to refine the vocabulary of impact investment so
that investors and other stakeholders can untangle the various
policy, tax, and accounting issues that affect this emerging field.18
Investment managers need to be willing to move from one compensation
structure (in which they receive management fees
and carried interest) to another (in which they receive budget-based
salaries and impact-based bonuses). Likewise, grantmakers
need to be willing to pay top salaries for high-quality talent.
Impact investment intermediaries need to acknowledge the
importance of science and engineering. They need to build
impact measurement regimes around projects that fall between
the traditional categories of charity and investment.
And they need to expand their focus from the deployment of
proven technologies to the development of technologies that
are unproven but highly promising.
In 2013, Sir Ronald Cohen and William A. Sahlman put forth a
striking claim: “Social Impact Investing Will Be the New Venture
Capital.” They called on impact investors to find the same courage
that the early institutional backers of the venture capital industry
displayed, and they offered a vision of how investors could enable
progress on social issues while also delivering financial returns.19
Our proposal is a concrete response to that broad agenda. Also in
2013, Peter Buffett issued a bold call to his fellow philanthropists.
He urged them to “[try] out concepts that shatter current structures
and systems.”20 Although Buffett made no mention of science and
engineering innovation, we believe that building a philanthropic
bridge between the ivory tower and traditional capital markets
would meet the standard that he set. In that spirit, we encourage
philanthropists of all stripes to pioneer new forms of philanthropic
investment—new approaches that support the kind of innovation
that the world desperately needs.