Venture capital company Harris & Harris Group (Nasdaq: TINY ) specializes in tiny technology. The Fool's Jack Uldrich recently interviewed Charles Harris, CEO of this March 2005 Motley Fool Rule Breakers recommendation, and learned about Harris & Harris' investments in nanotech start-ups, its high-risk, high-reward investment philosophy, the effects of Sarbanes-Oxley, and more.
Jack Uldrich: What is Harris & Harris Group, and how are you different from your peers?
Charles Harris: In most respects, we are a rather conventional venture capital firm. We co-invest with a wide variety of other venture capital firms, as well as industrial companies, in start-up and early-stage companies based on novel technologies. We are, however, different in two respects: Because we are a publicly held company and invest only our own capital, we have permanent capital; and we invest only in companies that are working with what MIT terms "tiny technology," which in our case usually means nanoscale technology.
Permanent capital enables us to be an unusually patient investor. Sometimes we invest in companies at their very early stages of development, and we do not have to sell our shares in companies in our portfolio that go public unless we think the timing is right. Our specialized focus on tiny technology has resulted in our now having some 26 companies in our portfolio that could be considered to be working on products and services at the nanoscale. We are not aware of any other venture capital firm that has as many such nanotech investments. Having so many nanotech investments has also given us the benefits of an unique ecosystem, as each of our portfolio companies has its own technical resources from which we can draw expertise relevant to our work.
Even though our permanent capital enables us to invest at very early stages of development, we also may make our initial investment in a company at later stages of development. For example, we initially invested in one of our current portfolio companies after it already had products on the market and was profitable.
JU: Harris & Harris' investments in nanotech start-ups span a variety of sectors. For instance, Evolved Nanomaterials Science is arguably a pharmaceutical play, Innovalight is a next-generation solar cell company, and Molecular Imprint is a semiconductor company. Do you spread your investments across sectors to achieve a more diversified portfolio?
CH: We have a reasonably diversified portfolio in that no two of our portfolio companies are nose-to-nose competitors, and our portfolio companies are producing and developing products and services for a wide variety of markets. But this diversification is a byproduct of investing on a case-by-case, bottom-up basis; it is not the product of a top-down diversification strategy.
For example, one could conclude that as many as 10 of our portfolio companies are developing so-called cleantech or greentech solutions, but we have not set out deliberately to create a cleantech portfolio. Nor does our portfolio necessarily mirror the profile of overall current nanotechnology commercialization. For example, materials for sale to third parties are of limited interest to us as venture capitalists, because we think that their manufacture is more suited to big companies that can live with eventual commodity pricing. As of March 31 of this year, our largest area of concentration -- some 28% of our portfolio -- was in various aspects of electronics. Other major areas of concentration for us are instrumentation (15%), clean energy and power (14%), health care (13%), and semiconductor (12%).
Sarbanes-Oxley and new approaches
JU: Sarbanes-Oxley has undoubtedly reduced the number of companies that have chosen to go public in recent years. What do you think the impact on Harris & Harris' portfolio has been, and do you think that any of your companies will consider going public abroad -- for instance, on the London Alternative Investment Market?
CH: Economically, Sarbanes-Oxley could be viewed for analytical purposes as a sort of tax on U.S. publicly held companies that falls disproportionately on smaller companies. To be viable as publicly held entities, companies now simply have to be larger to absorb this tax than they had to be before the imposition of this tax. As a result, some companies have been going private, and some have been going public abroad.
Another new possibility for gaining liquidity while escaping Sarbanes-Oxley may be the coming private 144A exchanges, the first of which is Goldman Sachs' TRuE exchange, on which it recently listed Oak Tree Management. Other investment banking firms are purportedly working on similar private 144A exchanges, as is Nasdaq, which is in the process of trying to get regulatory approval for what it calls its Portal exchange. Companies on these exchanges will not be subject to Sarbanes-Oxley, as only institutions with $100 million or more in assets will be allowed to trade on them, and companies listed on them may have no more than 499 shareholders.
It remains to be seen how these private 144A exchanges will develop, but in principle, smaller companies could list on them and, in the absence of the disproportionate Sarbanes-Oxley tax, once again be competitive with larger companies for capital. Obviously, we do not know how quickly or in what directions these new private exchanges will develop, but we are watching them closely on behalf of our portfolio companies. Regrettably, the investing public is excluded from investing directly in companies that go private, or list abroad, or may list on the 144A exchanges, but Harris & Harris Group itself should qualify to buy and sell on the 144A exchanges.
High risks, high rewards
JU: Can you tell our readers a little more about Harris & Harris' investment philosophy? What type of payoff are you looking for from your investments and within what time frame?
CH: Venture capital for start-up and early-stage companies based on novel technologies involves making high-risk investments, in search of high returns when successful. The returns on individual investments tend to be asymmetrical. While there are no guarantees, good overall returns can be made even though a venture capital firm may lose money on the majority of its investments.
In our own case, we have sold 44 of our venture capital investments over the years, for total proceeds of $143,694,382 on invested capital of $51,229,202. But we lost money on 26 -- nearly 60% of these 44 investments!
The cornerstones of our risk-management strategy include maintaining a strong balance sheet and diversification. Currently, no single investment in our portfolio at cost constitutes more than 5% of our gross assets.
As mentioned earlier, we are patient investors, but there is no question that venture capital-backed IPOs in the U.S. are taking longer to develop in the current regulatory and capital-markets environment. In 2006, the 56 venture-backed companies in the U.S. that went public were approximately 8 years old on average when they completed their IPOs. In 1999, the 250 such IPOs were approximately 3 years old, on average.
Portfolio companies can be acquired much earlier in their life cycle. As an extreme example, one of our early nanotech investments, Nanogram Devices, was purchased 13 months after it was founded for 3.4 times our and the other investors' cost.
And of course, we do not yet know if companies will be able to list on the private 144A exchanges earlier than they currently are listing on the public U.S. exchanges.
JU: In the past few months, Harris & Harris has made several new investments, including in Ancora Pharmaceuticals and Xradia. What do you like about these companies?
CH: Ancora Pharmaceuticals is a spinout of MIT from the lab of professor Peter Seeberger that was founded to commercialize his approach for making complex short-chain carbohydrate molecules using automated, solid-phase techniques. Carbohydrate molecules are inherently difficult to synthesize, and thus few pharmaceutical companies have made significant progress toward bringing carbohydrate-based therapeutics to market. Ancora is using this platform to develop unique carbohydrate-based therapeutics to treat cardiovascular and metabolic disease. Ancora also works with pharmaceutical and industrial partners to provide customized carbohydrate material.
Xradia designs and manufactures a suite of ultra-high-resolution 3-D X-ray microscopes and fluorescence imaging systems for non-destructive imaging of embedded internal structures. These tools are available commercially and are being used by customers for applications including semiconductor packaging inspection, analysis of advanced materials, and imaging of biological specimens ranging from single cells to small animals. Xradia's tools are enabled by the company's ability to design and fabricate high-quality, zone-plate optics made of high-aspect-ratio metallic structures with lateral dimensions of less than 50 nanometers.
JU: Some of your investments have established relationships with large corporations. For example, Nanosys is working with Intel (Nasdaq: INTC ) , Nantero is reported to be testing its technology with a leading semiconductor manufacturer, and Molecular Imprints has sold equipment to Motorola (NYSE: MOT ) and Hewlett-Packard (NYSE: HPQ ) . Do you believe any of these companies might be acquired?
CH: We are not permitted to comment on specific portfolio companies' financing plans. But historically, many more venture capital-backed companies are acquired than go public. In our own case, seven of our former portfolio companies were profitable M&A exits, and seven were profitable IPO exits. Another four were successful private investments in public equities.
JU: In February, D-Wave System, a Canadian start-up, claimed to have demonstrated the first real-time simulation of a quantum computer. Company officials claimed that they might have an even more powerful quantum computer by the end of the year. Can you provide our readers any updates on D-Wave's progress and speculate on how its technology might play out in the commercial marketplace?
CH: D-Wave Systems announced that the company had successfully built a 16-qubit [quantum bit] quantum computer and showed examples of it being used for pattern matching in a database search. The company is continuing development of more complex systems that employ significantly larger numbers of qubits to solve complex problems.
Quantum computers are of specific interest and potential use to solve what are known as NP-hard problems. These are the problems where the sheer volume of complex data and variables prevent digital computers from achieving results in a reasonable amount of time. Such problems are associated with life sciences, biometrics, logistics, parametric database search, and quantitative finance, among many other commercial and scientific areas. The potential application of the technology in the commercial marketplace, therefore, may be very diverse and widespread.
JU: Cambrios is another very interesting investment -- can you tell our readers a little more about the company and what prompted your investment in it?
CH: Cambrios was originally founded to commercialize technology developed in the laboratory of professor Angela Belcher of MIT. Belcher developed methods of using biological organisms to synthesize commercially relevant inorganic materials such as silicon nanowires and inorganic quantum dots and organize these materials into complex structures. This unique and potentially powerful technology was complemented by a highly qualified management team led by Michael Knapp, a founder of Caliper, and a syndicate of blue-chip investors including ARCH Venture Partners, Alloy Ventures, and Oxford Bioscience Partners. This combination of technology, talent and financing attracted us to this investment opportunity.
JU: Harris & Harris is sitting on a good deal of cash. Can investors expect more new investments in the coming months, or are you considering additional investments in any of your holdings?
CH: We are fortunate enough to enjoy a strong deal flow. This year alone, we have seen over 120 new investment opportunities. We also have preemptive rights to invest in any future rounds of financing in almost all of our existing portfolio companies. So we are steadily employing our capital in new and existing portfolio companies. We are determined to try to remain in the forefront with respect to venture capital for tiny technology.
Jack owns shares of Harris & Harris and Intel. The Fool's disclosure policy looms large.