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Innovation Ecosystems: The Role of Impact Investing

By Tom Vander Ark — June 11, 2014 6 min read
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By: Matt Greenfield

I am going to approach this topic in an oblique manner; bear with me. In the late eighties I was the youngest employee of ABS Ventures, which at the time
was affiliated with Alex. Brown and Sons, a tech-oriented investment bank now owned by Deutsche Bank. This was before Goldman Sachs and Morgan Stanley came
to dominate technology investment banking, and the valley was ruled by boutique firms. Alex. Brown was one of the four tech IPO leaders. The other three,
Hambrecht and Quist, Montgomery Securities, and Robertson Stephens, were all headquartered in Silicon Valley. Alex. Brown had a San Francisco office, but
its headquarters was in Baltimore. The firm had been founded in 1802 and was in fact the oldest investment bank in America, older than Goldman or Morgan
Stanley. So the firm was a weird hybrid, a centaur that was part Silicon Valley and part old Baltimore. The Baltimore office contained a number of people
who hunted foxes for fun.

There are a lot of interesting things to say about the Baltimore venture ecosystem. The Baltimore/Washington area contains a shockingly high percentage of
the most successful education businesses, including Laureate Education, American Public Education Inc., Blackboard, and 2U (full disclosure: my firm
invested in 2U). This flowering of education businesses can be traced back to Alex. Brown, T. Rowe Price, Legg Mason, and the other venerable finance
businesses in Baltimore, which helped create newer investment firms like New Enterprise Associates, Sterling Partners, Camden Partners, Novak Biddle
Venture Partners, New Markets Venture Partners, and Grotech.

When I lived in Baltimore, I made many trips to the Research Triangle area in North Carolina. The triangle in question was formed by Duke University, North
Carolina State University, and the University of North Carolina at Chapel Hill. Research Triangle contained many substantial corporate research and
development organizations, including key labs for large pharmaceutical industry players like Glaxo and a high percentage of the major communications
equipment companies, including IBM, Northern Telecom, ITT, ATT/Avaya, and Ericsson. This was potentially a rich ground for communications
equipment startups; at the time, Research Triangle had much more serious talent in the sector than Silicon Valley did. I made several efforts to fund
startups in the communications equipment area, but I never got a deal done. I found several exciting opportunities, but none of them ever took venture
funding.

One of those projects was a software development organization formed by a consortium of independent telephone companies. It was similar in structure to
Mastercard and Visa, both of which originally were owned by consortia of banks. The telephony consortium needed to pool resources to build the software to
deliver new features and services. This telephony consortium could have raised a bit of outside capital, started to sell some of its software overseas, and
become a substantial public company. But the employees, who had come from ATT, Northern Telecom, and other large companies, were very happy with their
current lifestyle and did not want to build something huge and fast-growing.

Another of those projects was a spin-out of some test software from ITT. ITT had decided to shut down its very expensive effort to modify its central
office telephone switch for deployment in the US markets. Several employees productized some of the software that ITT was using to simulate a network of
switches signaling to each other. They started selling this test software to other equipment makers as well as to telephone companies. I still remember the
numbers: with no salespeople other than the CEO, the company had $3.75 million in revenue and $2 million of pre-tax profit. I worked very hard on this one,
but in the end the founders decided to sell the company to Tekelec for a total consideration of about $22 million. The founders had both started as
telephone line-men, and neither had ever expected to become wealthy.

There was something missing from the Research Triangle entrepreneurial ecosystem. I have been thinking about what happened for decades now, and I have a
few explanations. The first explanation is that back in the late eighties engineers in Research Triangle could feel relatively secure in their jobs. Those
jobs allowed them to live a pretty nice life and build toward a secure retirement. The second explanation is that there were not a huge number of new job
options: the list of potential employers in the region was not unlimited. One of the greatest strengths of the Silicon Valley corporate ecosystem is that
it continually generates exciting new employment opportunities. The dynamism and diversity of Silicon Valley opportunities makes it a lot easier to take
risks. And the cost of living makes it much more urgent to try for a big win. Moreover, in Silicon Valley staying at one company for a long period can also
be quite risky.

Today, Research Triangle, like much of the country, does have a thriving, innovative entrepreneurial ecosystem. It took a lot of pain and sweat to get
there. Attitudes toward failure, risk, and entrepreneurship have changed across the nation. But making Research Triangle safe for entrepreneurs also
required a long, patient collaboration between local angels and other stakeholders, including real estate owners, lawyers, accountants, university
administrators, and politicians. Research Triangle needed civic boosters willing to make financial investments with multiple non-financial goals. I admire
all of those civic boosters. There were times when their quest must have seemed quixotic. Every region needs similar boosters in order to thrive. And every
industrial sector within an entrepreneurial ecosystem must be nurtured separately. Even if a region has a thriving biotech ecosystem, its software
ecosystem could still be stunted. The Baltimore/Washington area has a uniquely vibrant education ecosystem; many other regions of similar size do not.

In addition to the money of civic boosters, there is also another kind of impact investment that is required to create a thriving regional ecosystem. There
is a key fact I did not mention about those two promising Research Triangle communications software businesses in the late eighties. They were both built
on top of the same platform technology, Signaling System No. 7. SS7 is a set of protocols for communication between telephone switches. It allowed
equipment from different manufacturers to interoperate, much as the TCP/IP protocol makes the internet possible. A single region cannot create a standard
like SS7 or TCP/IP. But without such standards, no regional ecosystem can thrive. Right now, educational innovation could use a few more platforms and
standards. The attack on Inbloom and the Common Core Standards is having a tragic effect. It is difficult for innovators to scale if they have to address
innumerable different state and local standards. I hope that innovation investors like the Gates Foundation will continue to try to create foundations on
top of which innovation can flourish.

The
Smart Cities
blog series catalogs innovations in learning in America’s great cities. We’re writing a book about what we’re learning-
and you can help.

In March 2014, Tom Vander Ark and Matt Greenfield published a co-authored paper,

“Boosting Impact: Why Foundations Should Invest in Venture Funds

.”


Matt Greenfield is a partner at Rethink Education, a venture capital firm focused on innovative technology for learning. His successful investments
include Engrade, 2U, Wireless Generation, Analog Analytics, Wellfleet Communications, and Synernetics.

The opinions expressed in Vander Ark on Innovation are strictly those of the author(s) and do not reflect the opinions or endorsement of Editorial Projects in Education, or any of its publications.

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