At a Private Xconomy Dinner, Luminaries Debate the Future of Innovation in San Diego

12/22/10

The importance of diversifying the local economy became obvious in San Diego during the 1980s, as the ebb in defense spending exposed the area’s collective dependence on Atlas rockets and cruise missiles, along with the payroll for the Navy’s Pacific Fleet. But the path forward also was obvious—especially after Ely Lilly acquired San Diego’s Hybritech for $480 million in 1986. San Diego’s biotech cluster was born in a confluence of opportunity and necessity.

Since then, San Diego has prided itself on its innovations in life sciences, wireless communications, and other technology clusters. But these days, there is a pervasive sense that San Diego’s innovation economy is flagging—and might even be faltering. The hometown venture capital firms that helped fuel this area’s extraordinary expansion during the booming 1990s have largely evaporated—and this time the path forward is far from obvious.

So Xconomy asked some of San Diego’s best business minds to participate in an “on the record” dinner discussion on December 8, as a way to generate ideas for boosting San Diego’s innovation economy.

In attendance at the dinner—which was hosted by National University and sponsored by Ernst & Young, Latham & Watkins, and Silicon Valley Bank—were Linden Blue, vice-chairman at General Atomics; Hui Cai, vice president of business development at WuXi AppTec; C.J. Warner, chief operating officer at Sapphire Energy; Erik Bruvold, president of the National University System Institute for Policy Research; Miles Kirby, a senior director of business development at Qualcomm; Andy Pelletier of Silicon Valley Bank; Hiep Pham, CEO of TipCity; Bill Rastetter, a partner at venture firm Venrock; Faye Russell of Latham & Watkins; David Titus of Windward Ventures and the San Diego Regional Economic Development Corp.; Jim Waring, board chairman at Cleantech San Diego; Claudio Arriola, regional president of Canieti Noroeste in Tijuana, Mexico; Doug Regnier, partner at Ernst & Young; Katy Frankel, tax partner at Ernst & Young; and Bob Watkins of R.J. Watkins & Co. Executive Recruiting Consultants (and the San Diego Regional Economic Development Corporation). Xconomy publisher Steve Woit, business development associate Michele Gerus, San Diego editor Bruce V. Bigelow, and San Francisco editor Wade Roush also attended. Our conversation circled several areas of concern:

—Access to capital remains the single biggest issue for seed-stage startups in San Diego. Venture funding is down 67 percent from its peak of $541 million in the first quarter of 2009, descending to $173 million in the third quarter of 2010, according to Bruvold. Innovators and entrepreneurs continue to launch promising startups, but they are wanting for venture capital.

—Hand in hand with the decline in local venture investing has been the shrinking size of the area’s indigenous venture industry. In 1996, according to Titus, there were three general partners with investing authority residing in San Diego. “Then we had this huge explosion so that by 2001, there were roughly 30 general partners who lived and worked in San Diego who had the ability to write checks, so you had this explosion of deals,” said Titus. “That has shrunk back now to where, arguably, there are maybe 10 partners resident in San Diego who can write checks.”

—In Titus’s view, the shortage of local venture partners in San Diego “has a huge impact on how many companies get funded.” But Venrock’s Rastetter disagreed, arguing that big venture firms in technology hubs like San Francisco, Boston, or Seattle don’t see geography as a barrier, and that good ideas win funding wherever they’re born. “I’m pretty agnostic as to where a company is,” Rastetter said. “I’m looking for ideas, and for a strategy that is going to survive in an environment of extreme capital scarcity. I’m looking for people, I’m looking for IP, and I’m looking for a plausible value inflection [that opens] access to more capital. That has nothing to do with where I am.”

Titus rejected that argument. “I’d love to get a look at the last three years of Series A deals in San Diego and see what percentage do not have a local investor in them,” he said. “I’m willing to bet that it’s less than 30 percent.”

—San Diego needs more angel investors with more money. Individual investors in the Bay Area, in particular, seem to work more assiduously and make many more investments. Titus said he’d recently read about a young individual investor in the Bay Area who had decided to stop investing after putting money into 45 companies. “I’d be shocked by anyone in San Diego who’s made even 20″ investments, Titus exclaimed.

—San Diego needs more technology incubators like EvoNexus, operated by the nonprofit industry group CommNexus as a pro-bono, no-strings attached incubator for entrepreneurs who have promising technologies and solid business plans, dinner participants agreed. While profit-minded technology incubators like IdeaEdge (a San Diego incubator based on the model of Waltham, MA-based CMGI) have mostly imploded, incubators are still a powerful platform for launching new companies. Titus predicted that over the next five years, the EvoNexus incubator would produce “several modestly growing, successful companies, and one or two really big stars… I’m not sure who they are going to be yet, but the quality is there.”

“Take a look at Plug and Play Tech Centers in Silicon Valley,” said Waring. “It’s 150,000 square feet of phenomenally dynamic space; it’s just alive. There is a potential to have a Plug and Play in San Diego. It’s not going to be 150,000 square feet, but that raises questions of deal flow. I think we desperately need that.”

—Increased federal funding over the past two years has buoyed San Diego’s research and development community, especially grants from the National Institutes of Health for biomedical research at the Salk Institute, the Sanford-Burnham Medical Research Institute, The Scripps Research Institute, and UC San Diego. But funding is unlikely to continue at such levels, posing a tough problem for the region in terms of findingalternative sources of funding. “Is what’s fueled the growth in the last two years sustainable?” asked Bruvold. “If not, what replaces it?”

—As an innovation community, San Diego’s startups tend to follow a “build and sell” business model. It’s rare when a San Diego startup grows to become a Fortune 500 company like Qualcomm, and the innovation economy would benefit if Motorola’s spinout Motorola Mobility and other big technology and life sciences companies established their headquarters here.

While Qualcomm may rank as San Diego’s greatest technology triumph, the company’s presence tends to work against innovation and entrepreneurship by recruiting the available engineering talent in the region. Watkins said it’s hard to recruit engineering talent to San Diego because potential recruits ask themselves, “If I don’t make it at Qualcomm, what am I going to do?” That problem is absent in Silicon Valley, because there are so many tech companies and job opportunities in the region.

Kirby acknowledged that Qualcomm itself has been forced to look elsewhere for talent. “I’m in corporate research and development, and we recently started a group in the Bay Area doing R&D,” Kirby said. “Part of it was to attract new talent that we couldn’t get in San Diego. We felt that in San Diego there were a lot of folks who were very good at wireless, but in adjacent areas there was less diversity.”

—It’s important that companies have either the cash or the access to new investment they’ll need to start over if their first technology idea doesn’t work, both Blue and Rastetter commented. “The majority of biotechs succeed in doing something different from what they set out to do,” Rastetter said, speaking from experience as the former head of Idec Pharmaceuticals. “I think biology is so complex that we are just cutting the surface of understanding systems biology, the epigenome, the entire genome. It’s going to take 50, 100, 120 years before ideas are easier to come by than capital. Biology ideas remain the limiting factor in biotech startups today.”

—Watkins and others commented that there is a perception that San Diego’s geographic and cultural attractions tend to work against the needs of the region’s life sciences and technology ecosystems. San Diego’s innovation community prides itself on its reputation for collegiality and of collaboration, but the region also has existed as a corporate cul de sac, constrained to the east by the desert, to the west by the ocean, and to the south by the international border with Mexico. Housing costs are high, and the inadequacies of San Diego’s airport and rail connections to the East only compound the problem.

—Along with its unique problems, San Diego has unique strengths. “It’s important to understand we are not a small Silicon Valley,” Titus argued. “There’s a different culture here. You look at companies in EvoNexus—they are different than the companies at a Plug and Play in the Bay Area. Rightly or wrongly, on the tech side we do hard things. We don’t do 100 different consumer Web apps—we do mini-cameras, we do 3D imaging.”

“What really makes San Diego strong is innovation, and its spirit of collaboration,” said Hui Cai of WuXi AppTec, the wildly successful clinical research organization based in Shanghai, China. She points to the synergies that come when mixed disciplines combine forces to develop “convergence” technologies, such as computational genomics and mobile health, that have the potential to create new fields and open new commercial markets.

Bruce Bigelow is San Diego Editor of Xconomy. Wade Roush is Chief Correspondent and San Francisco Editor. Follow @

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  • June

    Maybe its time San Diego grows up and starts playing in the big game. The build and sell, begging for money cycle is no longer functioning effectively. Time for a more sustainable company economy, so talent does start to feel good about coming to and staying in San Diego. Otherwise, what’s the point of moving to a region, buying an expensive home etc., losing your job and having to leave because there’s no great senior level roles to replace it?

  • http://www.ascertain-ment.com Lou Volpano

    I live and operate in OC and come to SD frequently to explore, and network. Start up capitals never a problem, but the start up attitude is. With all the academics, and ‘institutes’ ready to pontificate, are there any that produce productivity? Coming up with a great idea can be done by a high school drop out. In short – “TALENT” is organic, not manufactured…. and most have not learned – in their hallowed MBA programs – how to even WORK in company, much less form one.

  • http://www.techcoastangels.com Steve Flaim

    Regarding the comment about individual angel investors, I think the critical issue is how many deals are actually done by angels in Southern California, not how many deals an individual angel actually invests in. Tech Coast Angels, located in Southern California, is the largest organized angel investor group in the country. We started operations in 1997 and are now nearly 300 members strong organized into 5 networks (Orange County, Las Angeles, Westlake/Santa Barbara, Inland Empire, and San Diego). We have funded over 150 startup companies with over $150M of our own funds. These companies have gone on to raise over $1B in follow-on funding. We believe that we have made a significant difference in Southern California and it is the aggregate effect that counts rather than any one individual’s investment performance.

  • Cliff

    Great comments and I think talent is one of the biggest issues at hand. Funding aside, the team needs to be able to execute and finding a proven team is now (IMHO) the biggest challenge in SD. The ambitious and passionate leave for greener pastures where they team up with thought leaders.