Shares of life sciences and technology incubator Allied Minds (LSE: ALM) are down over 15% in early trading after it announced it was cutting funding to seven of the 21 start-ups it has provided funding to. This will be a costly process for the company, which is 28% owned by Neil Woodford, and will result in a $146m writedown to the firm's adjusted value.
But does this represent a stellar opportunity for investors to begin a position?
The bullish case
Cutting ties to a full third of the businesses it supports wasn't an easy or, judging by the market reaction, popular decision to make. Yet, there is reason to be optimistic as it shows incoming CEO Jill Smith is taking to heart her remit to concentrate on commercialising the business lines with the most potential.
It was clearly time that the company shifted its focus to commercialisation as to date it has invested over $239m into portfolio businesses yet realised only $1.3m in revenue in H1 2016.
The bearish case
Allied Minds has sold itself to investors as a smart way to go through potential start-ups to find businesses that are worth investing in. But today's admission that sevrn of these businesses aren't panning out does not engender much confidence that the business plan is working.
With a huge write-off on the way, actual sales close to nil and a constant need to tap shareholders for further cash, would-be investors have plenty of reason to be wary. Investing in start-ups is exciting but Allied Minds' plunging share price shows just how volatile a business model it is. Neil Woodford's backing lends a great deal of credence to the company's claims but it is simply too opaque and risky an investment for me.
A profitable path forward?
But not all funds looking to commercialise intellectual property fail to pan out completely. Another of Woodford's big bets is on Touchstone Innovations (LSE: IVO), the company formerly known as Imperial Innovations, in which his funds hold a 23% stake.
While the firm's shares are down around 33% from their 2015 peak it has at least shown it can successfully back and profit from its investments over a long period of time.
Two of its portfolio companies have recently signed licensing agreements with major pharma players Takeda and Bristol-Myers Squibb that could total $790m and $936m over time. These eye-wateringly high payments are far from assured as they're based on reaching ambitious development, clinical, regulatory and sales milestones over many, many years. But the agreements are still a step in the right direction.
But the risks of this business model don't end once a product is commercialised. For evidence of this we have to look no further than Touchstone's spin-off, Circassia Pharmaceuticals, which it still owns a 9.3% stake in. Shares of the popular biotech firm plunged by two-thirds in June after its flagship cat allergy treatments turned out to be no more effective than a placebo in clinical trials.
What does this mean for potential investors? Small-scale tech and pharma firms are risky and even experts in these fields have a tough time picking long-term winners. That shares of Touchstone are sitting below their 2006 IPO price despite successful spin-offs tells me all I need to know about why small shareholders should avoid this volatile and opaque sector.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.