On Creating Deeptech Confluences: mobilizing private capital into ventures for humanity (Part 2)

San Francisco Bay Area — A Deeptech Confluence

This is the second of a four part series On Creating Deeptech Confluences. The work is based off my research & masters thesis at the MIT Sloan Sustainability Initiative. This post dives into the investor’s role in deeptech specialization & syndication.

Introduction

This post builds off post 1 where we discussed the deeptech entrepreneur’s role in de-risking team and technology. This second post covers the deeptech investor’s role in successfully financing breakthrough science ventures. Outlined are two strategies commonly used among successful deeptech investors. The strategies are complementary and supplementary to current strategies for investing in capital-intensive startups (e.g. milestone-based financing and term sheet streamlining).

These strategies apply to investors in VC firms, corporate VC firms, family offices, and individual investors. They are especially meant for emerging managers who aspire to invest in deeptech. Finally, these practices should also be seen as a guiding post for entrepreneurs seeking funding from top-tier deeptech investors.

Investors: specializing and syndicating for success

If entrepreneurs are the bedrock of any Deeptech Confluence, investors are the fuel that feeds the fire. It is through their early capital and support that technologies lift off the ground. However, it takes more than just regular venture capital to maximize chances of success in deeptech. Two multi-layered strategies nvestors employ to maximize chances of firm and portfolio success are 1) establishing a superior brand, and 2) using syndication partners. Each are described in depth below.

Brand creation

To be a deeptech investor requires a superior brand. The question is what makes a superior brand? In short: industry specialization, an extensive network, a superior value-add, and a proven track record. This is similar to superior brand creation in regular venture capital. The difference lies in what each of these four components mean when translated to deeptech investing.

First, a specialized deeptech investor focuses on certain kinds of technologies where they have decades of knowledge and experience. Deeptech is hard for a reason. It requires requires experts rather than professionals. Take for example Phoenix Venture Partners (PVP). Their team is full of materials science PhDs with years of experience at places like Applied Materials. They have created a deeptech brand known for material science innovation investing. As a result, PVPs efforts have been materializing into success with their recent fund II announcement. They have a seriously specialized team.

Second, what constitutes an extensive network is much broader in deeptech investing. Deeptech is multifaceted and therefore touches many more stakeholders. Take for example VantagePoint Capital Partners (VPCP). They are an energy technology specialist with a team full of energy-focused PhDs and JDs. They have managed through the 2000 dot-com bubble and ‘08-’10 cleantech bubble by engaging over 80 investors, corporations, banks, research groups, consultants and other support partners for their 150+ company portfolio. Regular IT investing does not typically require such a broad network. However for VPCP, it has been critical to their brand creation and success through recessions.

Third, a deeptech investor has a wider range of value-adds to their portfolio companies. Value-add has a limited definition in traditional IT investing because it is maximizing value for a limited number of stakeholders. In deeptech, value-add extends beyond just founders, employees, customers, and investors. It extends to communities. A perfect example can be seen by Nancy Pfund’s work DBL Partners. Nancy actively writes policy briefs, white papers, and government petitions to shift the regulatory environment in favor of her portfolio companies. Why? Because the companies are solving social and environmental problems that otherwise falls in the realm of government responsibility. The result is DBL Partners has become a leading brand for cleantech ventures seeking funding. Their early investments in Tesla and SolarCity are proof of their superior value-add capabilities.

Fourth, deeptech investors need a proven track record of both deeptech and non-deeptech successes. Every investor must show returns regardless their focus. However in deeptech it is necessary to mix quick and high yielding software investments in each fund. They bolster returns and grant more leeway for the moonshot investments. A good example can be seen by Braemer Energy Ventures (BEV). For their first fund, they invested in multiple solar module, battery, biofuel, and ‘clean coal’ technology companies… basically as capital-intensive as it gets. But their breakthrough came from their investment in software-based demand response company, EnerNOC. After the company IPO’d in 2007, the payout allowed Braemar to immediately raised Fund II the same year. And it wouldn’t be long until they rinsed and repeated to Fund III.

In sum, all four of these components of brand creation are interrelated. They are also sufficient. Without them there is no (continued) investment from limited partners (LPs) and capital markets. The most prominent deeptech investors can be recognized for their efforts in these areas of brand creation.

Strategic syndication

Deeptech ventures are inherently more risky than regular IT ventures. Their hardware-based products and complex science requires longer time-horizons (and more capital) than usually anticipated. Deeptech investors must therefore find ways to chop up and mitigate this risk. Syndication — and more importantly strategic syndication — is how they do this most effectively.

As shown in the figure below, deeptech investors come in a variety of flavors. VCs make up a predominate portion of capital invested in deeptech. However corporate investors, angel investors, family offices, and government / NGOs all contribute to the mix as well. Each investor type plays a specific role in the capital pool allotted to deeptech ventures. Each brings specific value-adds and risk mitigation techniques to the table.

Adding value and reducing risk across the deeptech syndicate

In theory: the more and diverse the syndicate partners, the better. The complementary capabilities are stacked to form a complete and exhaustive value-add. Additionally, the commitment sizes are spread across the group to reduce financial exposure. Although egos and personal politics usually impedes this ideal mix, it is still important for investors to strive for the ideal stack. Capital alone will only go so far.

A prime example of a syndicate at work can be seen in the financing of Bay Area Imprint Energy. The early-stage startup is making thin and flexible batteries for a variety of critical applications. According to Crunchbase and Pitchbook, they have raised seed and series A funding from:

  • Flex Lab IX and Dow Venture Capital (corporates)
  • PVP and AME Cloud Ventures (VC)
  • In-Q-Tel, NSF, and FlexTech Alliance (Gov. / NGO)
  • Plug-and-Play and Summer@Highland (accelerators / VC)
  • Individuals like Farzad Nazem (angels)

You can see everything in this syndicate. It includes corporate strategic support to improve their manufacturing and science. It includes expert financial and advisory support to improve their business model and go-to-market. And it includes government strategic support to provide non-dilutive funding and a bridge to critical applications. Time will tell if the technology is adopted at mass but on the basis of the syndicate alone they have much higher probability of succeeding.

Strategic syndication also has the benefit of blended capital structures. Equity investments are expensive from an economical and control standpoint. It is because they bear tremendous risk. Therefore when possible and applicable, it is wise to add non-dilutive funding from NGOs, Government, venture debt investors, and strategic partners to the mix. This non-equity financing can be a major lifeline to keep teams intact and motivated for the long haul.

A good example can be seen in Manus Biosynthesis. They are a biotech company out of Cambridge using microorganisms to develop resource intensive compounds. Like other pharma-biotech’s they have leveraged potential customers (i.e. strategic partners) to fund their R&D upfront. To date they have raised around $25 million using this method. If that were from traditional equity investment it would have cost the company around two-thirds of their equity (assuming seed, series A, and series B funding). Instead they have been able to retain that value internally to motivate their engineering work. It will materialize into a big win for their strategic partners if they find breakthrough success.

The example implicitly brings up the value of strategic partners, which otherwise may be known as corporate investors. Corporations tend to have many motivations when it comes to venture investing or open innovation. Understanding the gamut of involvement is critical for entrepreneurs and other investors seeking funding: some groups have longer term horizons than others, while some larger budgets and more executive buy-in than others. Digging deep to understand why a corporation invests and where it lies on this risk-reward spectrum is essential for successful deeptech investing.

Manvi Goel, formely at Greentown Labs, created such a framework to evaluate different corporate investor groups. She interviewed dozens of corporate VC groups and their investor attributes to populate the risk-reward spectrum. Her results are distilled in the table below.

Three types of corporate investors — Optimizers, Distributors, Explorers

As an example, we can use the framework to evaluate corporate investors in oil and gas:

First are Shell, Schlumberger, and Chevron. They are typical ‘Optimizers’ because they still dedicate half their venture investments to oil and gas technologies. As such their focus is primarily on incremental innovations. Plus Schlumberger’s group is not publicized externally.

Next are BP and Exxon Mobil. They are ‘Distributors’ because they are driven to meet business needs over the medium term horizon. BP focuses on renewable fuels with the goal of slowly adopting new technology into their business. Exxon doesn’t invest but partners with renewable fuel and energy efficiency companies to bolster their business portfolio.

Last are Statoil and Total. They are ‘Explorers’ because they invest generously in game changing technologies. They have no agenda other than being on the right side of the energy revolution. Their buy-in comes from top management and they been the first to invest in many breakthrough technologies. They are in search of game changing innovations.

These different groups of corporate investors have different why’s and how’s to investing. Understanding them will enable any entrepreneur or partnering investor to form a truly strategic syndicate.

Conclusion

Deeptech investors succeed when they build a superior brand and use strategic syndication to the greatest extent possible. They are an investor’s best tools when it comes to moving the odds into their favor.

The investor’s role in advancing the Deeptech Confluence is much like the match that (re)starts the fire. They breathe economic life into game changing technologies with the hope of starting a big flame. However they cannot succeed alone. Unlike hyper-competitive IT investing, colloboration far outweighs competition when it comes to deeptech venture financing. Therefore policymaker support is needed to ensure the regulatory environment sufficiently creates market pull and technology push. Post 3 will dive into how policymakers keep the maro conditions ideal for deeptech ventures to thrive.