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The view from the VC side

With a PhD in theoretical physics and more than a decade of experience in the investment world, venture capitalist Alexei Andreev has seen his share of innovation successes and failures.

Alexei Andreev

My transition from theoretical physics to the "dark side" of finance began right after my PhD defence. This was in Moscow 20 years ago, and Russian academia was falling apart. Our department head (and future Nobel laureate) Alexei Abrikosov had already departed for the US and, for many of us, going abroad looked like the only viable career option. So I was truly surprised when my thesis co-adviser, Andrei Varlamov, started talking to me not about immigration, but about the world outside academic walls.

"You know, Alexei," he said, "there are two moments in life for a scientist to explore various career options with a safety net in place. The first moment is right now. If you decide to experience the business world for one or two years and you do not like it, academia will take you back as a lost son. But the next window to try yourself outside academia will not open until you are a tenured professor with your own graduate students. Until then, you will have to commit yourself entirely to a chosen field of research, proving every day that you are the best in what you do." After taking a deep breath, he continued. "I am happy to keep working with you, but I think you may enjoy life outside academia. There is something in your personality that most people in my group are missing, something that should make you good in the real world. If you try and you do not like what you see out there, I will welcome you back."

After some thought, I took his advice and joined an investment bank, Renaissance Capital Group, in Russia. I started out as a data-cruncher and to my surprise I learned that complex financial reports could often be reduced to certain key ratios, and that simplified models could be used to predict the health and future potential of a business. These same models, together with industry-specific data, could also be used to estimate the value of a company and its future share price, depending on the management's ability to meet pre-defined milestones. From these simulations and sensitivity analyses, it does not take much to jump to "inverse problems" such as "Which management actions would maximize the value of the company?" and "Which developments can lead to catastrophic failures and how can managers protect the businesses against them?"

Changing directions After a few years, I rose to a position where I was making deals on investing in mature companies across the former Soviet Union. Eventually, though, I became interested not only in observing businesses, but also in affecting how they worked – for example, by making them more valuable and resilient to change. Among mature companies like the ones I was handling, it is difficult for an investor to make much of an impact: once a sizeable business picks up momentum, inertia makes it almost impossible to shift its direction. I soon realized that my real interest lay in early-stage investing, when even a small contribution might have a dramatic impact on a company's future.

By this time, I was also missing physics, the excitement of new discoveries and the intellectual rigour of academic conversations. Silicon Valley – with its influx of cutting-edge technological innovation and unique venture capital (VC) ecosystem – became my new inspirational destination. After earning my MBA degree from Stanford University, I was fortunate enough to work with tech investor Steve Jurvetson (an early financial backer of Hotmail, Tesla Motors and SpaceX, among other firms) in his efforts to bring nanotechnology innovations from research labs to the market. Within three years I moved to my current employer, the VC firm Harris & Harris Group (H&H), and I now lead its West Coast operations.

H&H is unusual among VC firms because for the past 10 years it has focused on investing in innovations that were "born" in the academic world and are just beginning their long route to commercial success. During this time, we have invested in more than 50 companies; for around 80% of them, we were their first institutional backers. All but one of the companies in our current portfolio are spin-offs from research universities or government labs. To evaluate and pursue such opportunities, the investment team at H&H is made up of individuals with diverse scientific backgrounds. My colleagues have PhDs in chemistry, material sciences, biochemical engineering and molecular genetics. They have worked in both academic and industry settings, and have run prototyping and R&D facilities as well as tech-transfer offices.

A start-up's story

Almost every new financing opportunity for VCs begins with a story. For the companies we invest in, this story is usually told by a senior investigator, postdoc or a couple of graduate students who are eager to start their own company based on their academic research. If the innovation they describe is truly unique, can address large unmet needs, has its intellectual property (IP) protected, and can be scaled up in a capital- and time-efficient manner, then VCs will take a serious look at it. If the founders also have one or two driven young scientists eager to change the world and/or an experienced executive who has recognized the idea's potential and wants to help, they have the makings of a promising start-up. At this point, if a mutually acceptable business and financial arrangement can be reached, venture capitalists will invest their money and start working side-by-side with the founding team to build up the company.

What this means in practice differs from person to person, but investors often have a say in early recruitment decisions, strategic directions, product marketing and -business-development efforts. As the company matures, VCs will start pulling back from operational matters, focusing instead on making the company bigger and more profitable. And because VCs are professional investors who must generate income from their portfolios to stay in business, at some point they will also work on exit strategies, such as selling the company or floating it in an initial public offering (IPO).

Early-stage venture capitalists like me often have between eight and 10 companies in their portfolios, and managing them is a bit like running a large scientific centre that pursues multiple areas of research at once. Both inside and outside academia, success requires proper financing and a flow of demonstrable results. Factors such as societal or financial impact, time to discovery or time to product launch regularly separate fundable from non-fundable projects. And of course, both academic endeavours and start-ups are subject to the "valley of death" problem, where the process of transforming a prototype into a viable product fails owing to a shortage of funds.

In my experience, there is no universal law for avoiding the "valley of death" altogether. However, several factors correlate negatively with the severity of the chasm. One rule is that fast and capital-efficient efforts directed at substantial opportunities rarely fail. Such enterprises are seen as "no brainers" by both public and private funding agencies because of their small upfront risks. This rule explains why social-media companies are much easier to fund than semiconductor or biotech start-ups. Another rule is that projects that can engage large corporations or government agencies as their future customers or users tend to be more viable. And last but not least, "big names" matter; having a Nobel laureate as a scientific founder or principal investigator makes the "valley of death" crossable in most cases (see Success story: Xradia below).

The truth, though, is that most venture-funded projects will eventually fail, whether because of the "valley of death", or deficiencies in execution, technology or market acceptance. Only a small fraction will win the Darwinian race. When that happens, it is a major, life-changing event for the company's founders and employees. For the VC, however, it is just one more tactical victory and a clear signal that it is time to add another company or two to the portfolio.

A physicist's contributions Many physicists-turned-businesspeople attribute their success to the fact that they trained to deal with real-life experiments and observable phenomena, but have also acquired a sophisticated mathematical apparatus that enables them to analyse problems from general principles. This combination is very powerful, providing a solid background for generalizations and detailed activities alike.

No matter what you decide to do in your life, physics will serve you well. Nevertheless, I encourage everyone who feels intrigued by the world outside the "ivory tower" to take a chance and look around. While the number of permanent academic positions is shrinking, private industry is increasingly hungry for people with deep quantitative and analytical backgrounds. Often, recruiters are chasing recent PhD graduates with hands-on knowledge of data analysis for both established businesses and start-ups. For top talent, this translates into good compensation and job security, but also a chance to turn dreams into reality. Don't forget about that part – it is fun!

Success story: Xradia One of the best ways for a technology spin-off to cross the "valley of death" is for it to secure future customers early on, preferably when the technology still resides in a university or a research lab. Harris & Harris has spun off many companies in situations like this, where there is a proven demand for a particular solution or technology that cannot be satisfied within a university setting, but one that really stands out in my memory is Xradia.

Xradia was founded by a scientist, Wenbing Yun, in 2007 after he had developed and managed X-ray microscopy programmes at the US's Lawrence Berkeley and Argonne national laboratories. When Yun booked his first revenues (from the largest semiconductor company in the world), he did it on the basis of a single-page description of what his X-ray imaging tool would do. At the time, the tool did not even exist in blueprints, yet Yun managed to convince the prospective customer that he knew what he was doing based on his reputation alone – and he asked for 50% of the money upfront. That was the beginning of a period of successful growth, profitability and scaling-up, and in 2013 Xradia was acquired by the Carl Zeiss group in a deal worth more than $100m. H&H was the only institutional investor in Xradia, and we truly enjoyed partnering with Yun and his entrepreneurial crew.

Alexei Andreev is currently an active investor in nine private companies, including D-Wave Systems (adiabatic quantum computers), Adesto (next-generation non-volatile computer memory), Cambrios (conductive silver nanowires for touchscreen displays) and Bridgelux (GaN-on-Si light-emitting diodes), www.linkedin.com/pub/alexei-andreev/0/9/8a9



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