Full-Stack Deep Tech
Why you should sell products, not technology
About the time I started angel investing in 2013, Chris Dixon wrote about “the full-stack startup”, and I was enamored. I saw it as a natural extension of his partner’s “software is eating the world” thesis (2011). If established industries were to be transformed, selling tech to the incumbents wouldn’t be enough. You needed to become the new incumbent. Imagine if Amazon sold white-labeled e-commerce software to Walmart or built server farms for IBM and Cisco, or if Netflix had made tools for Blockbuster and TV networks.
“Suppose you develop a new technology that is valuable to some industry. The old approach was to sell or license your technology to the existing companies in that industry. The new approach is to build a complete, end-to-end product or service that bypasses existing companies.” Chris Dixon, a16z General Partner (2013)
This obviously wasn’t limited to software, though, and we believe it’s even more relevant for deep tech. Would SpaceX be where it is today if they’d settled for selling engines to ULA? What about Tesla if they’d been a contractor for Ford and GM? Anduril is a more recent example. No chance they’d be valued at $8B in a bear market if they were a sub rather than prime defense contractor. Today “deep tech” is trending but hardware innovation isn’t new, nor is the truth that full-stack hardware holds enormous upside. After all, Dixon included Tesla as an example of a full-stack startup in his 2013 essay and four of the ten most valuable companies on the stock market are hardware-centric (Apple, Tesla, TSMC, and Nvidia).
And yet we see so many deep tech startups that aim to sell equipment, components, or services into slow-moving, often thin-margin industries. I don’t blame them. It’s a less intimidating, apparently more capital-efficient path to market. For these reasons I’ve backed a number of these endeavors over the years… but it’s almost always been a mistake. You raise your Seed round and sometimes a Series A on a pilot, LOIs, purchase order, or from strategic investment from a major incumbent. But then they never move as quickly as you and your investors need; they drag out the pilot, move the goalposts, or management changes and you’re forgotten altogether.
I have seen this so many times I’ve lost count, so today we stay away from component/equipment sellers at Cantos. Instead, we look for full-stack deep tech startups. This goes hand in hand with a point from my last post, that in seeking to minimize market risk, nearly everything we invest in today either makes a commodity cheaper (and greener)––or for bio, improves the standard of care. While this post focuses on hardware, we believe the full-stack thesis holds true for TechBio (i.e. use your platform to develop your own drugs).
Implicit in our focus on changing the cost structure and carbon footprint of commodities is the fact that we like to invest in startups that will sell commodities––not equipment. Look at our portfolio: Twelve and Solugen sell chemicals, Mission Barns will sell food, Astranis sells connectivity, Radiant and Arbor will sell energy, Fleetzero will operate their own shipping routes, Earth AI operates its own metals prospecting drill, and Furno will sell cement.
The full-stack approach is intimidating. It is almost always more capital-intensive, which usually makes it harder to fundraise (since not enough VCs have fully embraced what I’m preaching here), but the payoffs are undoubtedly greater. The primary advantages of the full-stack approach are:
- Increased TAM. Though this might trade off gross margins we find that at scale equipment providers’ margins end up getting squeezed, and the industry/product’s overall TAM is usually dramatically larger than that for even a key component therefor.
- Speed & control. We think a lot about rate limiters when we’re considering an investment. As I alluded above, the rate limiter for a horizontal startup is sales cycle––i.e. outside of your control––whereas for a full-stack startup it is funding. The latter might be difficult but it is at least more in your control.
- Customer diversity. Selling an end product vs. equipment typically means you have a more diverse customer base and are less exposed to a few large partners/customers.
- Optionality. When we’re looking at a new startup we like to imagine what future product lines might be layered onto the business at scale. Would Tesla have launched the solar roof, Powerwall, or its own app store if it weren’t full-stack? We don’t think so. While it’s difficult-to-impossible to imagine such product lines at the idea/pre-seed stage, the mere possibility contributes to investor interest and the eventual multiples they’re willing to pay.
At this point you might be thinking we have no upper bound on capital requirements for building full-stack startups, but capital efficiency does matter, especially for a relatively small pre-seed firm like Cantos. You won’t see us invest in giant infrastructure projects like power plants (sorry, grid-scale fusion). When producing commodities I like to think about how low the first rung of the ladder is. For example, while Solugen was selling peroxide by the gallon to local float spas before they closed their Seed round, Twelve will need to build a $100M+ plant to achieve cost parity for their products.
$100–150M is about the max pre-revenue capex we will accept at Cantos––even SpaceX achieved their first successful launch on ~$90M––but we much prefer the first rung to be as low as possible. Not only does revenue speak louder than any story for investors, but selling product early on drives home a culture of customer-centricity, which we view as a key success driver. Even if small scale means low to negative margins in the near-term, building the sales motion early on forces founders to learn the industry intimately and minimizes surprises when you’re ready for scale.
Once you have revenue with strong gross margins (we look for >50%) then capital becomes more abundant. It’s the relative speed/autonomy of the full-stack approach with respect to first revenue that can unlock the billions of dollars often required to transform the world’s most critical industries. Though full-stack startups may initially be more capital intensive we believe that they are ultimately more capital efficient.
If you’re building a full-stack deep tech startup (at pre-seed or seed) with the ambition to transform a critical industry and become an incumbent then we’d love to hear from you. Shoot DMs to me, Andrew (for hardware), or Amee (for bio) on Twitter. If you’re aiming to sell equipment/components/services to help incumbents then look elsewhere––or better yet, reconsider.
