High-Risk Investors Eye Education Opportunities

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Venture capitalists, the spark plugs in the growth of emerging high-tech industries and in the booming national economy, are setting their sights on the business of education.

The cutting-edge investors are increasingly scouting opportunities in areas directly related to K-12 education, such as school management firms, after-school tutoring services, and educational publishing. Venture capitalists provide crucial financing for new companies in their early stages, when risks are high but the potential payoff is large.

In an effort to track this burgeoning interest, Education Week and KnowledgeQuest Ventures llc surveyed venture capital firms this summer on a variety of questions related to education. The survey found cautious but growing interest in a broad range of sectors, from child care to educational software to corporate training.

That is significant, experts say, because venture capitalists make money by spotting opportunities early as economic winds shift. The findings may signal that business opportunities in education, long a sidelight to the much larger government investment, are here to stay.

For More Information

For more information on the joint Education Week/Knowledgequest Ventures survey, go to: www.kqventures.com.

"Their interest is an important indicator of the potential future growth of an industry," said Jeffrey A. Fromm, the president of KnowledgeQuest Ventures, a New York City-based firm that provides consulting and financial services to education-related businesses. "There are some big players who are interested in education now."

Eighty percent of the 64 firms responding to the survey said they would consider investing in education enterprises in the next three years. Mr. Fromm said those 51 firms alone now manage more than $4 billion in venture funds.

The survey, mailed to 1,000 firms, sought to identify those with an interest in education and is the first of its kind to focus specifically on that field. Mr. Fromm noted that many firms did not respond because they focus their investments in other areas.

Jeffrey A. Fromm

A Bellwether

Education is a $670 billion annual enterprise in the United States, counting government and private spending for all sectors--preschool, K-12, higher education, adult education, and corporate training. By one estimate, the budding for-profit education sector, which includes private management of public schools, educational services such as after-school tutoring, and educational products, had revenues of $64 billion in 1997.

Where do venture capitalists fit in?

These investors pump money into new or young companies in which they see potential for rapid growth and high rates of return. Unlike banks, which loan money and are repaid with interest, venture capitalists take an equity share in the new business. And their participation comes in the stages before a company is in a position to offer stock to the public.

Venture capitalists' money comes from a variety of sources. Major institutional investors such as pension funds set aside a small amount of their assets for venture capital. Other investors include corporations, endowments, wealthy individuals, and the venture capitalists themselves.

Venture capitalists are "a bellwether of the future trajectory of certain industries," Mr. Fromm said. "They have been the driving force behind the technology industry in the last decade. They were important investors in Internet companies."

K-12 Is Risky

Mr. Fromm will present the results of the survey this week in Chicago at the Education Industry Finance and Investment Institute, a gathering of education entrepreneurs, investment analysts, venture capitalists, and others that is sponsored by New York City-based Fulcrum Information Services Inc.

Among the survey's findings:

  • Most venture capital investment and interest has been in the more mature sectors of the education industry, such as corporate training, adult education and lifelong learning, and for-profit postsecondary, vocational, and technical schools.
  • For-profit K-12 education providers, child-care and prekindergarten companies, and services for at-risk youths are viewed as posing a greater risk for investment.
  • Many of the education-related opportunities venture capitalists come across lack quality business plans, have inadequate business concepts or strategies, or have weak management.

"The shortage of good investment opportunities coming across venture capital firms' desks is what is holding back the education industry," Mr. Fromm said.

Burt Alimansky, the managing director of Alimansky Capital Group, a New York City venture capital firm that participated in the survey, agreed. "I don't see a lot of people beating a path to venture capitalists' doors with well-thought-out business plans" for education start-ups, he said.

Mr. Alimansky is somewhat skeptical, however, that venture capital firms are as enthusiastic about the field as some inside the education policy world. "The education industry is very exciting," he said, "and there will be terrific opportunities, but I think it is early."

Investment in Edison

As the idea of an education "industry" has emerged in the past few years, more venture capitalists are attending conferences devoted to investment opportunities in the field.

"When you have venture capitalists showing up at education forums, that indicates they are taking a serious interest," Mr. Alimansky said.

Firms typically take a role in managing the companies in which they invest, often by taking a seat on its board of directors. By their nature, these investments are risky, and many of them lose money. But they offer similarly high opportunities for big returns.

Venture capitalists are usually involved in an emerging company for a few years before helping it either to go public by issuing stock or be acquired by a larger company. They take their profits and move on to the next investment.

There are several prominent examples of venture capital investment in key K-12 education businesses in recent years.

The Edison Project, the school management company started by onetime media entrepreneur Christopher Whittle, would never have opened its first school without venture capital from the Sprout Group. The New York City venture capital firm put up $12 million in financing of Edison in 1995 when the project was teetering on the brink of dissolution. Since then, Edison has received investments from other venture capital firms in its efforts to manage charter schools and other public schools.

More recently, Advantage Schools Inc., a Boston-based manager of charter schools, received $10 million from a group led by Fidelity Ventures, a venture capital firm affiliated with mutual-fund giant Fidelity Investments Inc., and Kleiner Perkins Caufield & Byers, a Menlo Park, Calif., firm.

'Big Changes'

John Doerr, a partner in Kleiner Perkins, is a leading Silicon Valley venture capitalist and a well-known supporter of President Clinton. Beginning in the 1980s, he led his firm to invest in such emerging technology companies as Compaq Computer Corp., Sun Microsystems Inc., and Netscape Communications Corp.

Mr. Doerr could not be reached for comment last week, but he is clearly devoting more attention to education.

"The new economy, we're discovering, isn't a strange phenomenon that flourishes exclusively in Silicon Valley," he wrote last year in Red Herring, a monthly magazine that covers the technology industry. "It can happen anywhere and benefit everyone. But if that's going to happen, big changes in education are necessary."

Toward that goal, Mr. Doerr has established the New Schools Fund, which he has described as a nonprofit venture capital fund that will help new education companies. Any returns are to be plowed back into the fund instead of being distributed as profits, as in a commercial venture capital fund.

Profit Motive First

While the interest in improving education may be a motivating factor for some venture capitalists, the survey shows it is not their top incentive.

In the Education Week/KnowledgeQuest Ventures survey, firms were asked to rank factors contributing to their interest in investing in education.

The responses showed the firms squarely focused on the bottom line: Potential return on investment ranked at the top of the list, tied with the size and growth rate of the industry. Their concern about the state of U.S. education ranked last.

"Venture capitalists say business is business," Mr. Fromm said. "They may well have an interest in improving education, but that is not part of their business objective."

One respondent, Steven R. Rabago, the chief executive officer of National Corporate Finance Inc. of Newport Beach, Calif., said venture capitalists see themselves as contributing to social good by helping new businesses succeed and thus "creating value for people."

"But I think there is some altruism there" in looking for education investment opportunities, added Mr. Rabago, who is also a school board member in Laguna Beach, Calif.

Venture firms responding to the survey found lower risks in more established sectors such as corporate training and for-profit postsecondary schools. Unfortunately, said Mr. Fromm, the areas perceived by many as needing innovation the most, such as K-12 schools and at-risk-youth services, are also as the sectors that the venture capitalists say are the most chancy.

Mr. Fromm said he hopes the survey will help education entrepreneurs realize what potential investors are looking for. In the survey, venture capitalists cited inadequate business plans and strategies and weak business management as factors holding back the creation of more deals.

For example, Mr. Fromm suggested, venture capitalists would probably like to see more experienced business managers at the helm of new education businesses. "When it comes to finance and profitability," he said, "an education business is more like a business than it is like another educational institution."

Vol. 18, Issue 3, Pages 1, 12-13

Published in Print: September 23, 1998, as High-Risk Investors Eye Education Opportunities
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