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Experts also worry that the federal R&D budget has become too skewed toward relatively mature technologies. “A lot of the federal funding has gotten a little more conservative and risk averse. The government needs to put a bigger percentage in radical innovation and more-exploratory research – technology that’s going to be transformational,” says Deborah Wince-Smith, president of the Council on Competitiveness, a group of industry, university, and labor leaders based in Washington, DC. Amar Bose, professor emeritus at MIT and founder of the Bose audio company in Framingham, MA, puts it more bluntly: “Research funding is going downhill, and I don’t see it turning around. We’re going to have trouble.”

The cutbacks in the federal budget are further exacerbated by the continuing trepidation of many venture capitalists. While valuations of later-stage venture-backed startups have begun to bounce back this year, valuations for younger startups have not. In addition, say experts, some venture capitalists are focusing on certain pockets of technology, such as those relevant to homeland security and biodefense, where the focus is more on developing and deploying existing, well-established technologies than on inventing innovative new ones. All of which could have dire consequences for innovative startup companies.

Indeed, the combination of venture capitalists favoring later-stage startups and the continuing trend of large corporations investing less in speculative research is creating an innovation vacuum, according to some experts. “The effects are pretty ghastly,” says Lita Nelsen, director of MIT’s Technology Licensing Office. “Large corporations have become less and less invested in early-stage research. They buy it from little companies. And if there’s nobody to get the little companies started, we’re getting it at both ends.”

Despite these concerns, however, there are encouraging signs that investment in innovative technologies, at least in the private and public markets, began to regain favor last year. In particular, 2004 was a strong year for companies going public; the number of IPOs and the amount of money they raised reached their highest levels since 2000. What’s more, the value of mergers and acquisitions involving venture-backed companies was 76 percent higher than in 2003 – all of which means that venture capitalists once again have the prospect of lucrative exit strategies and the motivation to invest in startup companies. “Despite the disappointments, venture capital is still a way to make enormous riches,” says Josh Lerner, a professor of investment banking at the Harvard Business School.

Technology Review editors Gregory T. Huang, Corie Lok, and David Rotman contributed to this report.

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