My hot kitchen and the spirit of venture capital
The current market dynamic for tech companies (read: dumpster fire) is giving many talking heads an opportunity to draw parallels with the dot com bust. We should recognise that, unlike at the dawn of the new millennium, we are not standing in the foothills of the consumer internet and the cloud. Whatever foothills we are standing in today, they are burning. I wrote this post from my kitchen in London last week while it measured 41 degrees Celsius.
This moment has got me thinking instead about an earlier history: the emergence of venture capital itself. I have been thinking about Arthur Rock, the so-called “Traitorous Eight” and Fairchild Semiconductor.
I shall not go into the whole story — you can read about it in this excellent article in The Generalist — but, in essence, Rock saw talent and a bold idea in need of capital and a home. In brokering a deal, Rock enabled the foundational technology of our digital age to come to life, and he staked his claim to being one of the most influential investors of our time.
I bring this up because I think that an equivalent start-up — a hardware business with outstanding technology risk — would struggle to find venture capital backing today, especially during this market downturn.
Software is just too attractive. It is one of the greatest business models imaginable: zero marginal cost to scale plus high intrinsic margins is one helluva drug. Stacked up against enterprise software, the neo-Fairchilds look like dodgy investments.
“The ongoing capital requirements are too high for us to realise venture-scale returns.”
“The public markets will not value this like a software company.”
“Your margins are <80%.”
“It is too difficult for us to evaluate the science risk.”
If you are the founder of a frontier technology business, you have probably heard one or more of these comments from an investor before.
It is true: hardware is hard. Even though I believe it has never been more difficult to build a generational software company, relatively speaking, building a frontier technology start-up with deep science and / or hardware at the core of its value proposition is tougher.
Yet, on a day like today, at a time like now, with humanity under pressure from converging existential threats, should we be investing in anything other than frontier technology?
A burning earth, rapid deterioration of food supply chains, the rising cost of healthcare; these are problems that cannot be solved by software alone. Problems in the physical world need physical solutions, and VCs must recapture the spirit of the early venture capitalists and invest in them.
Investing in frontier technology companies does not have to be scary. Frontier founders — here are some ways you can “de-risk” your companies in the eyes of prospective investors.
Hardware and science can be the ultimate defensive moats. Think about ASML’s monopoly on advanced photolithography machines, SpaceX’s reusable boosters, and NVIDIA’s GPUs. These products form the backbone of globally important and highly cash generative businesses. NVIDIA is a particularly strong example, since it started life as a pure hardware business and has become a software-like company over time with equivalent margins.
Explain how your start-up’s hardware and science risk will be the foundation of a platform upon which high intrinsic margins can be generated.
Hardware and science based value propositions can scale logarithmically. Think AWS and patented drugs. When science becomes IP, it is capable of exponential growth. And when hardware can be highly leveraged, for example by serving high value customers contemporaneously or becoming de facto tools with significant lock-in effects, scale compounds and margins expand.
Home in on how your start-up can break out from linear returns and deliver exponential returns to scale. Even stronger if you can explain exactly how you will finance this scale with non-dilutive financing.
Frontier talent is often easier to find, motivate, retain and compound. Think about the landscape of nuclear fusion companies. There are only so many, and even fewer when you cut the pack by technological approach, progress and geography. There are only a handful of academic institutions with cutting edge laboratories and serious experimental equipment. The most ambitious fusion physicists and engineers, plus commercial operators who want to work on one of the most important technologies of our time, do not have a ton of options!
Show off your scientific talent, allow investors to visit your team and get a sense for the mission-driven collaboration taking place, and share the limelight with team members who have been with your company for a long time.
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“We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard” — apologies, but I had to shoe-horn JFK’s famous quote in here somewhere.
Hardware and science should not be compared like-for-like with software. They are different kinds of businesses that can be equally, if not more, valuable, when done right.
Frontier tech founders — you have the incredible opportunity before you to build companies that can have both an outsized economic and societal impact. There are many businesses and models that have succeeded before you. Learn from them, and find investors who share your passion for the long but important road ahead.
VCs — it is our role to focus on the longer term arc of progress, which bends beyond the horizon to a place where truly seismic outcomes lie, and to be imaginative about business models beyond software.
At a time like this, one ought to be optimistic about technology and take comfort in the fact that humankind has a habit of overcoming the seemingly impossible.
If any of this resonates, then please get in touch:
wdufton at omersventures dot com // @willjdufton
