Walking Through the Valley of Death with the SBA

By |2017-09-14T11:21:26-07:00June 21st, 2012|

A well-known term in the venture industry, “Valley of Death,” can be a financial nightmare for early-stage startups, especially for those that depend on large amounts of funding to bring products to the market.  Companies highly invested in developing innovative technology and products are those that tend to suffer the consequences of this “Valley of Death.”  So, what is this canyon of eternal rest? How can businesses keep from falling into its trap?

The Valley of Death

To keep from falling into this valley, you must first understand what it means.  Think of it as the Grand Canyon, the farther down you venture the riskier it is.  Hiking the Grand Canyon is physically and mentally challenging, requiring the hiker to be extremely patient, well prepared, and to have acceptance of the obstacles they will face.  The Valley of Death is no different.

The farther a start-up travels to bring their product/service to the market, the more financial risk it incurs, which is what the Valley of Death refers to.  According to Andrew Hargadon, author of Into the Valley of Death, “The dip of the valley refers to the debt—the negative balance sheets—that companies experience as they invest money now in hopes of making it back upon success.”

This Valley of Death is more prevalent in start-ups who are trying to invent the next technological advancement or that breakthrough pharmaceutical product that cures a disease.  In general, start-ups who require a lot of capital for research and development purposes are more likely to fall into this valley.

In November 2011, the Breakthrough Institute published a study, titled Bridging the Clean Energy Valleys of Death 

[pdf], which described two types of valleys.  These technological and commercialization Valleys of Death were explained in terms of the clean energy industry, but can be used in others as well.

The first Valley of Death occurs early in development of a technology, as breakthrough research and technological concepts aim to achieve commercial proof-of-concept.  At this stage, innovators and entrepreneurs conducting basic and applied research need further capital to undergo a process of developing, testing, and refining their technologies in order to prove to private funders that these technologies will be viable in markets beyond initial success in the laboratory.

Breakthrough Institute, Bridging the Clean Energy Valleys of Death

This Technological Valley of Death requires large sums of money, but investors are reluctant to offer the financing needed to bring the products to fruition.  At this stage, start-ups have done research and are taking the next steps to building prototypes and possibly starting to form a team of people; all of which require capital.

The Commercialization Valley of Death plagues technologies that have already demonstrated proof of concept, but still require large capital infusions to demonstrate that their design and manufacturing processes can be brought to full commercial scale.  To move a technology from the pilot/demonstration stage to the commercialization stage, the central challenge is accumulating enough capital for the commercialization, production, and manufacturing processes associated with demonstration and market launch.

Breakthrough Institute, Bridging the Clean Energy Valleys of Death

While investors are more willing to offer financing to companies in the commercialization stage, they are still looking for those that will be able to render a return in a short amount of time.  Not only will a  venture capital firm offer funding based on the return time frame, but also based on capital requirements.  If the firm had to choose between two tech companies, they would choose the less capital-intensive company.

Many companies who can possibly bring the next energy-saving technology or the cure for cancer to the market are unable to because they cannot survive the Valley of Death.  There may not be a solution to eliminating this Valley of Death, but there are organizations that are trying to make the journey a bit easier.  The Small Business Administration (SBA),  through their Small Business Investment Company Program, are working to address the shortage of capital to early-stage start-ups.

Small Business Investment Company Program (SBIC)

This program will allocate $1 billion over five years to participating SBIC, privately owned and managed, investment funds so they can invest in early-stage start-ups.  Russ Garland, author of An Older, Wiser SBA Makes New Run at Early-Stage VC, explains that “selected venture funds can obtain leverage of up to $50 million from the SBA to match commitments from private investors. These ‘early-stage innovation funds’ must deploy at least 50% of their capital into early-stage small businesses”.

SBICs invest in particular industries varying from one firm to another and they also vary in terms of when to invest; some may invest during the start-up stage or the expansion stage.  The goal of this SBIC program is to alleviate the shortage of capital to emerging companies who need $1 million to $4 million in order to bring their products/services to the market.  With this program, it might be possible to help emerging companies travel through the Valley of Death unscathed and hopefully more will make it to the other side.

Is your business funded through an SBIC? Tell us about it in the comments.