Table of Contents
Summary
The UK’s universities produce world-class technical research, but there is often a “valley of death” between academic research and the dynamic technical ventures that create economic growth and progress.
VC is a limited tool for lucrative, special cases of new business creation. Most areas of R&D and innovation do not have venture capital-sized markets. The UK has the opportunity to facilitate the creation of a large, profitable, and innovative SME ecosystem.
To address this problem, the UK government should fund Venture Creation teams which share facilities with existing Catapult centres. These teams would use industrial R&D contracts as a break-even search function to find problem areas and technological innovations that can be spun into profitable businesses. This would facilitate innovation and venture creation in sectors that are currently neglected by VC due to market size.
Each venture creation team would have 5-15 people, containing systems engineers who would architect new solutions and join the spinouts, and domain specialists who enable the technical development work to happen.
To do this, the government should establish a team in DSIT to recruit venture creation teams and fund a venture creation team working at four catapult centres as a pilot (CPI, CG&T, MTC, AMRC). This would cost £15m per year.
This model has already been validated. Venture creation teams will build industrial R&D contracts in the UK (like the Cambridge consultancies do), use this as a break-even search function (like the MIT Technology Plan often facilitated), and use it to help create a successful SME ecosystem in the UK (like Fraunhofer has done).
Fraunhofer's extensive R&D collaborations with German SMEs (Mittelstand) prove that top technical talent can drive significant economic impact by solving real-world challenges for mid-sized businesses, rather than solely pursuing VC-backed unicorns.
MIT’s Technology Plan showed that working on industrial R&D contracts is an ideal way to facilitate the creation of spinout companies in the industrial sector.
The Cambridge consultancies have shown that industrial R&D contracting can be very successful in the UK.
Challenge and Opportunity
Challenge
UK productivity and growth have mostly stalled since the financial crisis. Successive governments have correctly identified that science and technology innovation could hold the key to growth. However, the UK has struggled to turn its world-class technical and scientific research into consistent economic benefits.
The UK has often looked to venture capital (VC) as the way to boost its startup ecosystem. But VC is not the only model for building impactful businesses. VC funding can be an extremely effective tool for turning academic ideas into commercial products. However, the model is poorly suited for many areas of technical innovation, including chemical engineering and manufacturing. This leads to a “valley of death” between academic research and dynamic technical ventures.
There exists a class of problems that are not being effectively addressed by the current VC model. To better capitalise on progress in technical research, the UK should experiment with using industrial R&D contracts as a break-even search function for developing innovative new startups.
Opportunity
The UK should establish venture creation teams that use industry contracting arrangements to spin out new companies. This model is inspired by the Fraunhofer, MIT, and the Cambridge consultancies in the UK (see case studies below).
Venture creation teams would work as industrial R&D contractors for established British companies (for example, SMEs and bluechip firms), working on their technical challenges, and spinning out new businesses to commercialise the technical solutions created through the contracted R&D work.
This model for scientific and technical venture creation addresses a key market segment which the existing venture capital model does not address: small and mid-sized markets. VCs are not interested in investing in problem areas with small market sizes. The proposed model enables technical research to be funded by industry, up to the point where it can be commercialised, without the need for venture capital funding. This enables businesses to be created without the need for venture capital from day one.
The UK is currently well-placed to implement the described venture creation model by leveraging the facilities and equipment present in the existing Catapult Network. Catapult centres already engage with British companies, supporting them with R&D. However, the Catapults have not successfully turned this industrial engagement into spinouts.
Introducing venture creation teams into the existing Catapult Network through facility and equipment sharing would be a way to magnify the impact of the Catapult Network, leveraging its existing expertise, community, and equipment as a vehicle to create new British businesses.
These venture creation teams can cost-effectively learn an area of research and gain industrial know-how through industry contracts. This allows them to develop key technologies before raising private capital. As technologies arise that are ripe for spinning out, groups can break off from their Catapult hosts and begin to build their business in the market.
Case Studies
Case study #1 - Germany’s Fraunhofer Institutes
Germany’s large and extremely successful Mittelstand (SMEs) demonstrates the range of companies which are key to productivity, growth and employment. However, these companies individually rarely achieve revenues above £50 million.
The Fraunhofer Society runs research institutes across Germany, which provide industrial contract research for German firms of all sizes. Overall, Fraunhofer institutes win over £1 billion per year in research contracts from Mittelstand firms, large companies and the German Government.
There is evidence that Fraunhofer startups are able to navigate the “valley of death” and become profitable companies. This is because each Fraunhofer research contract begins with a clear market need, since it is based on industry demand. Fraunhofer is successful at venture creation despite not actually placing a huge amount of emphasis on entrepreneurship, skills or raising capital. Instead, the emphasis is on providing research that is actually useful to industrial customers. The survival rate of Fraunhofer spin offs is still exceptional; over 90% of Fraunhofer spin-offs are still alive five years after their founding, and over 80% still exist after 10 years.
Key takeaways: Fraunhofer has carried out successful R&D contracts for a vast number of Mittelstand (SMEs) and has a high rate of success when it does spin out companies. This has shown that VC backed unicorns are not the only model for successful, innovative companies. The UK too can have a prosperous, innovative SME ecosystem.
Case study #2 - Massachusetts Institute of Technology (MIT)
MIT offers another example of successfully using research contracts to foster technical ventures. In 1920, MIT was on the verge of bankruptcy, and decided to double down on its commitment to prioritise industrial customers, creating the MIT Technology Plan. This plan made MIT’s staff and facilities available to local industry for contract research.
The Technology Plan was a huge success on multiple fronts. Not only did it bring in revenue for MIT, turning it into one of the world’s leading technical universities, but it also led to the creation of a whole generation of successful technical firms. Soon after the programme began, over 80% of the Applied Chemistry Laboratory’s budget was paid by Technology Plan contracts. The firms that grew out of MIT affiliates in this period include Texas Instruments, Gillette, Raytheon, Arthur D. Little’s chemical consultancy, Koch Industries, McDonnell Douglas, and Rockwell International. These companies are major employers, innovators and engines of growth in the US.
Key takeaways: MIT demonstrated that working as industrial research contractors is an excellent base for building innovative spinouts. Their ‘Technology Plan’ can be replicated by venture creation teams associated with the UK Catapult centres to turn the existing industrial relationships into a venture creation mechanism.
Case study #3 - Cambridge (UK) Engineering Consultancies
The UK already has a major hub for industrial R&D contracting: engineering consultancies in and around Cambridge. Together companies like Cambridge Consultants, TTP, PA Consulting, and Sagentia make hundreds of millions of pounds of revenue a year. By working as a convening point for industrial problems and engineering talent they have spun out many of the most important British startups. Cambridge Consultants alone has created three Billion-Dollar companies (Cambridge Silicon Radio, Domino, Xaar). These consultancies are mainly focused on profiting from industrial research contracts, rather than spinning out IP. Despite not focusing on new venture creation they have shown that industrial R&D contracting can work as a model for new business creation in the UK.
Key takeaways: The success of Cambridge-based consultancies has shown that contracting out industrial R&D can be effective in the UK. These consultancies have played a crucial role in the creation of the 'Silicon Fen,' a tech cluster in the Cambridge area. By intentionally focusing on creating new ventures based on the results of industrial R&D contracts, venture creation teams can bolster the UK technology ecosystem.
Plan of Action
The UK Government has established the Catapult research network. These centres already undertake industry research contracts. The next step would be to incubate venture creation teams that share their equipment and facilities, to aid the process of spinning out new, profitable companies.
To establish these teams, the Government should:
Identify key UK industries which will benefit from a launchpad for creating mid-sized technical ventures, and which Catapult centres are relevant to these industries. The initial proposal is to create venture creation teams that share facilities and equipment with:
Establish a team in DSIT to recruit venture creation teams. Within six months, DIST should hire two or three founding members to lead each team.
Fund venture teams through DSIT. This would lead to an annual programme cost of £15m for four venture creation teams at about £3.5m per team.
Over the next six months, allow these founding members to consult with potential industrial customers, VCs, and existing contract research groups like Fraunhofer or Cambridge Consultants to build their market strategies. As they do this market exploration, these individuals will also hire the rest of their teams.
Each venture creation team would consist of 5-15 individuals — primarily researchers and engineers. Each team should also have at least one systems engineer. These systems engineers will spearhead contract management and undertake the CEO-type work needed to get prospective ventures off the ground when it comes time to spin out.
Budget
The government should ensure that the budget per researcher for these new teams at least equals that of the existing Catapult centre they are using. For a Catapult like the Energy Systems Catapult — whose 2024 award was £59 million for a R&D headcount around 250 — roughly £1.2-3.5 million could minimally cover a staff increase of 5-15. The budget would serve each team in three ways. It serves as:
A financial cushion so their industry contracts do not need to fully cover their costs.
R&D funds to develop technology that allows the team to win new contracts.
A budget to further develop ideas that have the potential to turn into start-ups.
The industrial research contracts will generate revenue that will help sustain the venture creation teams. Whilst engineering consultancies have demonstrated that it is possible to create a profitable business out of industrial R&D contracting this must not be the main aim. The economic payback of the venture creation teams is in the businesses that they spinout. Therefore government funding must be maintained to ensure that the venture creation teams have the freedom to focus on venture building, rather than profiting directly off the industrial R&D contracts.
FAQs
Why should the Government do this and not the private sector?
The Government is uniquely positioned to address a market failure by solving an early-stage coordination problem in the innovation ecosystem. While the UK is renowned for producing cutting-edge research, researchers often lack the necessary capital, commercial skills, and support to bring their innovations to market effectively.
By establishing Catapult centres and venture creation teams, the Government can bridge this gap and provide a structured pathway for promising research to be commercialised. This approach is inspired by Germany's successful Fraunhofer institutes, which are publicly owned but primarily funded through research contracts. This model ensures that the institutes remain market-driven and focused on industry-relevant applications.
Bringing these innovations to market also offers significant public benefits. In mid-20th century America, the social utility of institutions like Bell Labs, MIT, GE Research, and BBN conducting groundbreaking research to integrate into their own products or those of their industrial clients was widely recognised. However, as attitudes towards the management of engineering enterprises changed in the later-1900s, many in industry began to feel this work did not have sufficient ROI to account for the inherent risks.
Many would now argue that may have been inaccurate. Regardless, in certain corporate environments—like America’s in the 1970s and 1980s—these types of views can take hold. A government that believes in the social utility of this work is less susceptible to these types of management fads and down business cycles.
Who would fund these start-ups once they have spun out from their host centre?
Venture creation teams develop technical ideas with demonstrated market potential until businesses are ready to spin off in private markets through the following financial channels:
Raising venture capital after having “de-risked” a technical idea
Raising debt financing through traditional financial channels
Spinning up as an immediately break-even or profitable firm
Why would VCs fund some Catapult start-ups only after a Catapult venture team worked on them, not before?
Many VCs pass on investing in businesses because of (1) market risks, and (2) technical risks.
Market risks occur when there is insufficient demand for a new product, technology, or service.
Technical risks refer to scientific or engineering challenges that prevent a product from being profitable.
Before a Catapult team works on an idea, there might be substantial market or technical risks that deter VC investment – even if the business could generate significant revenue if the risks were overcome. The Catapult team's work can prove technical feasibility and establish customer demand, making the venture more attractive for VC funding.
Market risks and technical risks can be avoided—or at least substantially reduced—through industry contracts, which demonstrate the customer base for a product, allow engineers to solve any technical problems, and build business experience. The likelihood of VC funding after these contracts can therefore be higher.
Will the Government take equity stakes in the startups?
The success of the plan does not depend on government equity stakes. However, if the Government chooses to take an equity stake, it should:
Be in line with private market standards for seed stage investors, likely not exceeding 10%
Remain a passive owner and not require ongoing approval for vital business decisions
Who should be in a venture creation team?
The team composition should enable the venture to fulfil research contracts from day one while building the foundation for a successful spinout company.
The Catapult centres are well-positioned to identify the necessary skills and talent to staff venture teams. This is because the kinds of people necessary to ensure success will differ depending on the project being pursued; for example:
A solar panel research team might include a founding system engineer, a founding material scientist, two electrical engineers, a mechanical engineer, a process manufacturing engineer, a chemist, and a project management assistant to help with procurement.
An applied computational biology team might need a founding system engineer with a biology and coding background, a founding protein chemist, two staff software engineers, and two lab technicians to test the outcomes of the team’s software models.
What is the role of systems engineers?
Systems engineers should possess technical expertise, practical experience, and an entrepreneurial mindset. They do not have to be leading researchers on the frontier of their field. Key skills include:
Sufficient understanding of the product/research to help commercialise it
People management, strategy, and problem-solving capabilities
Potential to become the CEO of a spinout
Evidence from other successful spin-outs—such as the US’s Bell Labs—illustrates the importance of systems engineers being able to perform a wide range of tasks. These individuals will be expected to understand when the time is ripe for an idea to spin off and how to do so.
To ensure the right people are hired for this critical role, the Government should collaborate with local VC firms that have extensive experience identifying and recruiting such talent. Furthermore, the Government should engage with members of Fraunhofer's business teams to provide training for the systems engineers on managing engineering research contracts effectively.
What are other examples of the contract research approach leading to successful engineering ventures?
Contract research fueling successful company formation was common among industrial firms spun out of American land-grant universities before the 1960s. Engineering departments focused heavily on industry-sponsored or state-funded research aimed at near-term applications.
In the 1920s and 1930s, the University of Michigan professors engaged in a typical research contracting arrangement. They utilised the school's wind tunnel to conduct critical analyses for train companies and aircraft manufacturers who sought their expertise. Among the young research assistants working on these contracts was Kelly Johnson, who would later establish Lockheed's renowned Skunk Works.
Johnson's experience with the wind tunnel contracts proved invaluable, enabling him to develop exceptional skills and effectiveness at a rapid pace. A prime example of his capabilities was when, at just 28 years old, he single-handedly redesigned the Lockheed Hudson in a weekend following a meeting with the UK Air Ministry. The UK government went on to purchase hundreds of these aircraft as part of their war effort.
Eric Gilliam is a Fellow at the Good Science Project. His primary roles there are twofold. As a researcher, he writes the FreakTakes Substack. FreakTakes provides detailed operational histories of all-time great science and engineering teams and funders. As an advisor, he works with those who run and fund scientific teams to help them incorporate the lessons of history's best labs and funders. Before starting the FreakTakes Substack, he worked at Steve Levitt's Center for Radical Innovation for Social Change at the University of Chicago.