Published Online: January 31, 2012
Published in Print: February 1, 2012, as K-12 Marketplace Sees Major Flow of Venture Capital

K-12 Marketplace Sees Major Flow of Venture Capital

The flow of venture capital into the K-12 education market has exploded over the past year, reaching its highest transaction values in a decade in 2011, industry observers say.

They attribute that rise to such factors as a heightened interest in educational technology; the decreasing cost of electronic devices such as tablet computers, laptops, netbooks, and mobile devices; and the movement toward standardization of curriculum through the Common Core State Standards.

"Having been in this space, covering it for more than a decade, I've not seen this level of interest or supply of early-stage K-12 businesses in the last decade by any stretch of the imagination," said Adam J. Newman, a founding and managing partner of Education Growth Advisors, an education business advisory firm in Stamford, Conn.

"What you have right now in K-12 education is an ecosystem of really dynamic entrepreneurs and emergent companies and a very diverse set of organizations that have become interested in the education space," he said.

Betting on Education

The flow of venture capital funds into the K-12 market dropped precipitously in 2001, following two years of huge investments of about $500 million annually before the dot-com bubble burst. Investments leveled off between 2001 and 2006, before rising again, and taking off last year, surpassing venture capital investments in higher education for the first time since 2006.

Venture capital transaction values in the K-12 field, which include both public and private schools, increased from roughly $130 million in 2010 to $334 million last year, according to data from the Chicago-based GSV Advisors.

Precollegiate education historically has not been an easy market for venture capitalists to break into, analysts say, but certain factors are contributing to a higher awareness of this market for investors.

Venture capitalists generally look for "high-growth opportunities" and rely on the ability to scale up new enterprises quickly, said Mr. Newman. So the common standards in English/language arts and math, for instance, which have been adopted by all but four states, are contributing to companies' perception of a potential for fast growth in standards-related ventures across a larger market, he said.

"[The common core] is breaking down some of those state-level barriers that made it challenging for folks [to achieve scale]," said Mr. Newman. (His firm's other founding and managing partner, Christopher L. Curran, is a trustee of Editorial Projects in Education, the nonprofit publisher of Education Week.)

For instance, MasteryConnect is an educational technology startup that aims to help teachers transition to the common-core standards. The platform allows teachers to find, administer, score, and track student data through formative assessments.

Limiting the Risks

At the same time, educators are becoming more open to technology in classrooms, said Tom Vander Ark, a managing partner of Learn-Capital, a San Mateo, Calif.-based venture capital firm focused on funding entrepreneurs working in education. "Now you have digital natives teaching digital natives," he said.

Jennifer Carolan, an associate partner for the San Francisco-based NewSchools Venture Fund, a nonprofit venture-philanthropy firm working in education, said that teachers are not only more open to technology, they are also beginning to expect the same technology tools in schools that they use everywhere else.

"There's an increased demand for the latest technology tools because the teachers are younger, the demographics have shifted, and there's an even greater chasm between what educators are using in their everyday lives and the tools they have available to do their work," Ms. Carolan said. "Technology is an attractive venture deal because it tends to yield a higher profit margin, so it's a natural place for venture capital to play a role in."

In fact, the last large influx of venture capital into K-12 education coincided with the dot-com boom of 1999 and 2000, spiking at $497 million and $521 million, respectively, further establishing the strong link between technology and venture capital. (Numbers have not been adjusted for inflation.)

The NewSchools Venture Fund typically invests in promising for-profit education startups in their early stages, when it may be too much of a risk for venture capitalists, said Ms. Carolan. In fact, the organization recently announced the creation of an educational technology seed fund that will help ed-tech startups find early-stage funding.

"[We] play the role of taking out the risk early on," she said, "and helping these companies until they get to the point where venture capitalists will take a look at them and invest."

For example, three years ago, NewSchools invested in BetterLesson, a company that allows educators to use the Web to share and catalog lesson plans, after recognizing the need for such a tool in the education community. BetterLesson now generates about 120,000 unique hits a month on its site and 250 sign-ups a day, said Ms. Carolan. And although NewSchools continues to contribute funding to BetterLesson, in its latest round of funding in August of 2011, the majority of the funding was from other organizations, including traditional venture capital firms, said Ms. Carolan.

BetterLesson's success is in part a shift toward more social learning, a market within educational technology that is experiencing much growth, Ms. Carolan said. Companies such as Grockit, a test-prep social-networking website based in San Francisco, and the education-focused social-networking site Edmodo, based in San Mateo, Calif., are other examples of successful social-learning startups, she said.

'Moving Target'

The K-12 market has not been the typical destination, however, for traditional venture capitalists, Ms. Carolan said.

"Venture capitalists always look for huge markets, and education is a massive market, but there's been a lot of friction in the past with getting for-profit companies to find profits in schools," she said.

Kim Smith, the co-founder and chief executive officer of Bellwether Education Partners, a nonprofit organization based in Washington that works to improve educational outcomes for low-income students, noted that for-profit companies face opposition in trying to play a significant role in public schools.

"There's never been a huge resistance to the technology," said Ms. Smith, who also co-founded the NewSchools Venture Fund, "but the closer you come to running schools, the more you encounter a very strong ideological aversion to for-profit [companies]."

What's more, Ms. Smith said, the K-12 market is heavily regulated on such matters as what schools can spend money on and how they spend it, rules that can change based on a variety of conditions, including who is occupying the White House.

"If you want to invest, you're being told, 'Here are the rules of the road right now, but in four years, it could be completely different,' " which is not a climate that fosters confidence among venture capitalists, she said.

"There's a constantly moving target for what you should be doing, which is different than most other fields, where there's a little bit more of a consistent knowledge base," Ms. Smith said.

To make matters more complicated, the purchasing decisions of schools do not follow the typical model of most markets, making it hard to predict sales cycles, she said.

"Often, the decisions that are being made about buying things aren't rational," she said. "In education, because there's so much disagreement about what quality looks like and how you can measure it, you can be successful in one place but not necessarily successful in another."

Marguerite Roza, a senior scholar at the Center on Reinventing Public Education, at the University of Washington in Seattle, said another factor that makes the market complex is that the audience for the products companies are marketing—mainly teachers—often doesn't have purchasing power in districts.

"There is no head honcho in education," said Ms. Roza. "The person [who has spending power] are the 60,000 school board members."

Of course, superintendents and other administrators also make purchasing decisions in a district, but regardless, the fragmentation of the market makes it difficult for education companies to achieve efficiencies of scale, she said.

Seeking Social Impact

Meanwhile, as education draws renewed interest from venture capitalists, a new breed of investors is emerging, said Ms. Smith of Bellwether Education.

"There's a small, emerging niche of 'impact' investors," she said, who typically made their money in the corporate sector and now want to reinvest in a good company that will provide profitable returns, but will also have a positive social impact.

"Education is a complicated business, but it hasn't made huge productivity gains, ever, so that's clearly an area ripe for innovation," Ms. Smith said. The productivity gains that technology could achieve in the education market are attracting attention from impact investors as well as traditional venture capitalists, she said.

Robert Lytle, a head of the Boston-based Parthenon Group's Education Center of Excellence, which focuses on for-profit global markets, agreed that impact investing has become a recent trend.

"There are areas of the economy [such as K-12 education] that will not attract venture capital because the business dynamics aren't good enough, but I can invest my money there with a different return profile," he said, keeping in mind that the return will be partly the social impact and partly financial. "It's become more of a movement around the world."

Roy Gilbert, the CEO of Grockit, the website that links social networking with studying, explained the key role of venture capital in building successful startup companies such as his.

Startups often have high initial costs because of the design, development, and engineering it takes to launch a website or product, he said, before a firm can launch the idea and begin to turn a profit.

"There's a significant lag before you're making a ton of revenue," Mr. Gilbert said, and that's where venture capital comes in. Raising seed money is essential to the success of those startups, he said.

"The profile for venture investing is high-risk, big industries where you can take advantage of scale," he said. And while K-12 education has always been a big industry, the opportunity to scale has held back investors, said Mr. Gilbert. However, because of shifting dynamics in the market, that is beginning to change, he said.

"It's a pretty vibrant time," Mr. Newman from Education Growth Advisors said of the current climate for K-12 investment.

"On the flip side is that a lot of these folks won't make it to the other side," he said. "The nature of early-stage investing is that you have a lot of failures along with a number of successes."

With the renewed interest in the K-12 market, Mr. Newman said, "you could run the risk of a lot of these businesses' getting some traction, but not enough" to make a large impact on the industry.

"It will be interesting to see if winners and losers emerge," he said, "and whether we'll have a universe of really interesting, thoughtful ideas."

Vol. 31, Issue 19, Pages 1,10-11

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