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Special Report: MURKY MISSION: Vague directive dilutes 21st Century Fund's high-tech impact

February 7, 2005

When directors of Indiana's 21st Century Research and Technology Fund convened in May 2003, they'd already doled out $70 million in state grants over three years to fund h i g h - t e c h innovation a n d w e r e preparing to u n l e a s h another $60 million.

But you wouldn't know it after reading minutes from that meeting. They show a rollicking debate broke out over the 21st Century's Fund's mission: Was it to plant seeds that might bolster the Indiana economy for future generations? Or to provide financing to immediately turn promising ideas into new products and businesses?

These were exactly the same questions they'd asked one another in 1999.

Government and business leaders have widely hailed the 21st Century Fund as a key tool to modernize Indiana's flagging economy. But an IBJ analysis of its six-year history found the Legislature never provided a concise vision for the program, and over time ideological divisions on the 11-member board have only widened.

The result, according to IBJ's analysis: The program, which many backers think was thinly funded from the start, has diluted its impact by providing relatively small amounts of funding to a broad range of areas, including just $21.5 million to directly bol- ster startup companies.

"The amount of money available in the state is not going to support both basic research and commercialization," Robert Uffen, a Virginia consultant and former National Science Foundation program director told IBJ. He was hired by the board last spring to evaluate its priorities.

"They're both high-cost initiatives, and it's impossible to say this can do both."

Among the board members sparring on that spring day in 2003 were two friends, Dr. Craig Brater and Dr. Mike Mirro. Brater still believes long-term, openended research offers Indiana its best chance to innovate for the future. Mirro prefers investments whose commercial path to development is clear.

"The research that goes on, particularly in university settings, drives successful technology economies," said Brater, dean of Indiana University's School of Medicine. "You have to invest in that infrastructure."

Mirro, a Fort Wayne cardiologist, shot back:

"The question is whether that will result in commercial opportunities in the near term," he said. "The near term being your lifetime."

Indiana now has invested more than $130 million through the 21st Century Fund, the state's showcase program to spur Hoosiers into the New Economy and create jobs of the future. The money bought pioneering medical research, modernization of rustbelt manufacturers, world-class university expertise, cutting-edge software development, and more.

Thanks to the 21st Century Fund, engineers are researching new forms of rocket propulsion at Purdue University. Steelmakers in northwest Indiana are running their aging blast furnaces more efficiently. And scientists in downtown Indianapolis are closer to unlocking the secrets of the genome.

But IBJ's analysis found less than 17 percent of the 21st Century Fund's money went to true startups.

More than 31 percent supported projects at some of the state's largest firms, such as Zimmer Inc. in Warsaw, and Eli Lilly and Co. and Rolls Royce Corp. in Indianapolis.

More than one-third of its investments fostered manufacturing modernization projects, even though advanced manufacturing made up less than 21 percent of proposals.

And geographically, the largest share by far-$51 million-flowed to West Lafayette, home of Purdue University.

Gov. Mitch Daniels, a Republican who won election largely by touting his economic development plans, has proposed earmarking $75 million for the 21st Century Fund over the next two years, matching what it received over the prior two.

"It's going to be a great tool in the box," Daniels said. "[But] it's very easy for people to play with the taxpayers' money."

He plans to dissolve the fund's current board and fold the program into the new Indiana Economic Development Corp. But its new Republican managers will face the same dilemma as their Democratic predecessors: how to maximize the bang for the state's buck. And transform Indiana's economy in the process.

When it works, the 21st Century Fund is a catalyst, a spark igniting a blaze of innovation. West Lafayette-based Endocyte Inc., for example, credits 21st Century Fund money for helping keep the doors open in its earliest days, when times were tight. The promising cancer research startup has now led Indiana's list of venture capital recipients for two years running.

Money from the 21st Century Fund helped Zimmer research a whole new type of technology for medical devices.

Historically, the orthopedics industry made steel implants, which require risky, painful surgery. With the help of people like University of Notre Dame professor Steven Schmid, Zimmer is moving toward molded plastic implants that allow patients to walk again in mere days.

"The state of Indiana providing this money allowed Zimmer to shake money from the corporate tree," Schmid said. "Without the 21st Century Fund, [the project] would have just died."

But for every project the 21st Century Fund backs, it rejects seven. In frustration, repeatedly rejected applicants look elsewhere for cash. Sometimes they give up entirely on their untested ideas.

Reached via e-mail in Hyderabad, South India, Arthur Usmani expressed only frustration with the 21st Century Fund. Through his Indianapolis companies ALTEC USA and Usmani Development Co., he submitted proposals for an artificial bone substitute, diabetes monitoring system and more.

With nine proposals, he was the most frequent single applicant. But all his ideas were rejected. Usmani said he burned through $500,000 in the process.

"The fund was a waste for the taxpayers," he wrote.

In their hunt for financial help, promising young companies seldom give up without a fight. If they're thwarted locally, they soon look beyond state lines.

Perhaps even more frustrating than the failed proposals are the rejects that go on to find success elsewhere.

Artificial-kidney startup Renal Solutions Inc. once sought $2 million from the 21st Century Fund. The board actually approved its proposal. But then-Gov. Frank O'Bannon temporarily froze the fund's activity in the face of Indiana's massive budget deficit. Renal Solutions didn't get the money.

Searching for cash, CEO Peter DeComo moved the company from West Lafayette to Pittsburgh in 2003. Since then, it's grown to 43 employees and raised $22.3 million, mostly from East Coast venture capitalists. DeComo expects negotiations for another $12 million infusion to conclude soon.

Renal Solutions is now nearing completion of clinical trials for its product.

"I think the company, based on market size, has the potential to be as big as $500 million" in annual revenue, DeComo said.

Indiana's belt wasn't always so tight. In 1999, the state was sitting on a $2 billion surplus. Legislators were ready to consider major investments in economic development. They established the 21st Century Fund to transform promising science into new products and companies, leverage more research money from the federal government, and promote high-tech entrepreneurship.

Any one of those concepts would be an expensive proposition. And by definition, there are no sure bets in new technology. Even if it were all invested in a single place, $130 million would hardly ensure the next Eli Lilly.

So the General Assembly gave the 21st Century Fund plenty of elbow room. The board, chaired by then-Lt. Gov. Joe Kernan, kept the rules simple. Above all else, it valued good science.

To eliminate the chance of partisan taint, the board delegated proposal review to scientific peers from other states. Based on their recommendations, it prioritized projects and began making grants. Although authorized to direct up to $5 million per proposal, the largest-ever 21st Century Fund grant was under $2.5 million. In all, it approved 100 proposals out of a potential 715.

The money ran out all too quickly.

The board's aim was to mirror Washington, D.C.'s, acceptance ratio of proposals for science grants, about 20 percent to 25 percent. It actually funded less than 14 percent of proposed projects.

To match the 25-percent target, the 21st Century Fund would have needed $223 million-or $93 million more than it received over the last half decade.

"There were literally hundreds of excellent proposals that weren't funded," said board member and venture capitalist Teri Willey, a general partner with Chicagobased ARCH Development Partners LLC. "We had to rank and order them, and cut off when we ran out of money."

Board members worried perpetually about the chilling effect if Indiana continually ignores the pleas of its best and brightest. Minutes from March 2004 show some were particularly concerned about a steady drop in applications from the life sciences sector.

Over five years, Indiana gave $55.6 million to 37 life sciences projects. But applicants in the life sciences had wanted much more. They submitted 309 applications seeking $389 million.

Applicants in advanced manufacturing had a far better rate of success. The state awarded $44 million to 38 applicants in the field, after receiving 115 applications seeking $186 million.

"The 21st Century Fund's birth was predicated on the life sciences," Brater said. "[But in] the distribution of the awards, my personal belief was there wasn't enough going in the life sciences direction."

The General Assembly determines how much money to give the 21st Century Fund. But the board decides how to deploy it. The research vs. development split between Brater and Mirro was its foremost dilemma.

Research advocates pushed for the creation of federal "Centers of Excellence," which require development of research partnerships among top-notch university faculty and their corporate counterparts. Advocates of this approach fish for innovation with the widest net possible. And largely on Uncle Sam's dime. Local research investments can convince federal grantmakers of a project's worth.

Board member Jeffrey Kantor, vice president for graduate studies and research at the University of Notre Dame, pointed out that Indiana ranks 14th in population, but 25 states draw more federal research money. If Indiana got its fair share per capita, Kantor said, its annual $283 million in federal support would more than double.

Thanks to the 21st Century Fund, Indiana now has 29 Centers of Excellence. The $46.7 million spent to create them is responsible for the lion's share of the $268 million in follow-on funding the 21st Century Fund touts it has leveraged from federal and corporate sources. And those centers are now available to support all sorts of university and private-sector projects.

"How do you put value on that?" asked Kantor. "At some point in the future, you'll see increased economic activities."

But others aren't willing to be so patient. Indiana needs a kick-start, they argue, and it can't afford to wait on results that could take a generation or more. It should angle where it knows the fish are biting. And only trawl with proven lures.

"There's no question there's an impact of bringing federal money to Indiana. That said, there's no clear path to devel- opment," Mirro said. "We struggle with that all the time. Some board members feel strongly [attracting federal money] is the most important activity we could be involved with. Others, like myself, say we ought to be funding startup companies that have great science."

To find the answer to such thorny questions, last June the board enlisted Uffen, the Virginia consultant and NSF director.

Uffen's findings, which he plans to present to the board this spring, are unambiguous: The 21st Century Fund, with its broad focus, was trying to do too much, undermining its effectiveness accomplishing any of its goals.

"For a centers grant at NSF, you're competing with 50 states and some of them are real powerhouses that can wipe you off the map," he said. "The recommendation is for the fund to skew toward commercialization, because that's where the payoff for the tax dollar is going to be."

But board member Charles Rutledge, interim vice provost for research at Purdue University, fears such short-sighted thinking.

"If all you do is pick the low-hanging fruit, you won't build the ladders to pick the higher-hanging fruit," he said. "And, then, that's the end of it."

Nearly half of the 21st Century Fund's more than $130 million has gone to projects to commercialize products. But much of that money went to big Indiana businesses. IBJ's analysis shows just $21.5 million went to true startups. According to the 21st Century Fund, 20 small companies were formed as a direct result of its awards.

The fund has funneled millions of dollars into modernizing Old Economy mainstays. For example, Chenn Zhou, a professor of mechanical engineering at Purdue Calumet, used a grant to help create efficiency software that allows steelmakers to increase the output of a blast furnace 20 percent and extend its useful life five years.

"The 21st Century Fund money is the foundation to get your project started. And the impact is huge," she said. "Think about it. Even industry people, they don't have that much money to get started and they don't want to invest. Without this money, we couldn't do anything."

But some business leaders say large corporations already have the resources to underwrite research. They argue that the state, with limited dollars to spend, should assist those who need help most.

"Why are we funding the R&D of major companies? It's true that it's leading toward commercialization, but they'd be funding it with or without our money," contended Donald F. Kuratko, executive director of the Johnson Center for Entrepreneurship and Innovation at Indiana University.

"These major companies have their own R&D budgets. Then all of a sudden they come to the trough and say, 'We should get our fair share.' How entrepreneurial is that?"

Day-to-day managers of the 21st Century Fund rattle off a wealth of data they say show the effectiveness of their program. But they also say it's having a huge impact in a less tangible way-encouraging partnerships among top academic minds and among top researchers in the private sector, all aimed at strengthening the state's economy.

"The legacy is going to be the relationships we've created that weren't around before, not only between industry and academia, but between the schools themselves," said 21st Century Fund Director Tony Armstrong. "Those relationships are going to continue long after I'm gone."

But one university clearly outpaced the rest. IBJ research shows that projects whose primary investigator was affiliated with Purdue received $51 million, or nearly 40 percent, of the 21st Century Fund's investments.

As an institution, Purdue may simply be more geared toward the 21st Century Fund's mission.

"The success they've had with this fund speaks well to how Purdue has taken up the issue of technology-driven economic development," said Notre Dame's Kantor. "And more power to them."

Legislators don't appear poised to sharpen the focus of the 21st Century Fund during this session. Republican Sen. David Ford, chairman of the Economic Development and Technology Committee, said he thinks the fund is "run well and professionally."

Elected officials recognize they can't micromanage high-tech economic development, said state Rep. Jeffrey Espich, RUniondale and chairman of the House Ways and Means Committee.

Daniels so far has been tight-lipped about his plans. When asked how the money should best be spent, his response was short: "Carefully."

But Robert Eisenstein, a National Science Foundation division director while Daniels served as White House budget director, doubts Daniels will put up with research for research's sake.

In Washington, Eisenstein said, Daniels wanted research money to finance projects whose outcomes were clear and measurable.

Legislators in Washington face the same dilemma as those in Indiana, he said.

"The very best dollar the federal government spends is in the research area. And where is it on the budget totem pole? It's a tiny fraction, 2 percent of our GDP. It ought to be 10 times that," said Eisenstein, now president of the Santa Fe Institute.

"The problem is, you're asking people to have a very long view. You're asking them to invest, not for themselves, but for their children and maybe even their grandchildren."
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