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News - November, 2021

The Attraction and Intricacies of Growth Investments in Deep Tech Startups

The merits of investments in Deep Tech startups are significant, yet the challenges posed to investors navigating the space are also considerable. Cipio Partners breaks down the rules of the space for growth investors.

The Attraction and Intricacies of Growth Investments in Deep Tech Startups

What makes Deep Tech Startups Unique?

Deep Tech startups apply truly novel technology and, as a result, take significantly longer to develop a market ready, scalable product. Lower tech startups apply well proven technologies and can start selling earlier, offering faster early-stage growth. However, there still is great promise for the growth path of Deep Tech products in the long run: once product-market fit and go-to-market fit have been found, consistently high growth rates can be maintained, with the company still being profitable or near-profitable. These benefits owe to the unique features of Deep Tech products: Extensive R&D ensures the product is difficult for competitors to copy in the short term, and hence, hard for customers to substitute. This results in high gross margins and rapid growth with limited marketing budgets. Deep tech start-ups may scale later, but when they do, there is no stopping them.

The investment stages of Deep Tech investing may be divided into an early, pre-product stage and a growth stage, in which companies have a market-ready product. 

Much has been written on early-stage Deep Tech investments, with their high risk but high potential for exceptional returns. Successful investors need to have the patience and financial power to keep investing until success sets in. This said, an early-stage investor can somewhat hedge the technological risk of the long and potentially costly development process, since the tech basis has an intrinsic value after a certain development threshold, which can make even an early, pre-product sale a reasonable exit. 

However, much less has been written on growth investments in Deep Tech startups, perhaps because to do so would seem trivial. If the product has gone to market and sells, then the hard part is surely over. But this can’t be the whole story. If it’s so simple, why aren’t all growth investors piling into Deep Tech?


The Challenges for Growth Investment in Deep Tech 

Deep Tech startups differ from normal growth investments in several crucial ways implying a somewhat different approach of finding and evaluating them, e.g., number of targets, timing of investments or shareholder structure. 

Indeed, Deep Tech startups are rare per se, but Deep Tech startups in the growth stage are even rarer for a host of reasons: 

a) many firms never make it to market. Either they go bankrupt or are sold before reaching the product stage;

b) they are still struggling to find product-market-fit in at least one vertical, maybe because their technology has too many possible use cases with very different customer groups;

c) they already have a product, but this does not scale as reaching scalability might still need very high investments or the organization still depends on highly trained (and hard to find) sales or tech personal in order to sell the product.

Moreover, timing is of the essence for growth investors in the Deep Tech space: too early and invested money may flow into tech development with no guarantee of reaching product-market-fit. Too late, with a scalable product out in the market or a design-in, and the investor faces high competition from other investors, raising the valuation significantly. 

Alternatively, with a scalable product out in the market or a design-in, managers and investors may no longer be interested in equity investments, intending to avoid further dilution of their shares. In such cases, the startup is likely to be managed to reach profitability as investors don’t fear competition, or it is even sold entirely. 

This reveals another set of challenges of Deep Tech startups: the dynamics of their shareholder structure. Deep Tech startups are often relatively old in startup terms. In fact, the deeper the tech, the longer before it can reach a certain scale. As a result, shareholder structures of Deep Tech startups in which founders and early investors are tired of share dilution are common. 

This often leads to internal shareholder discussions about the best strategy: either going ahead with further investments in order to become a product company with inherent product-related risks and indirect risks (i.e. changing company culture, shift of power from engineering to sales etc.), or rather selling the company early in a technology sale. Deep Tech growth investors must be able to understand and navigate such dynamics and be able to offer liquidity options to early investors and founders.

In these discussions, corporate investors have a unique position. They are often shareholders of Deep Tech startups as their lower IRR requirements fit very well to Deep Tech investments at an early stage, if the strategic impact for the corporate is given. However, if they are not buying the business, corporate investors may be disincentivized to scale the startup, as this may widen access to the technology beyond their parent company and impair their advantage. 


What skills does a growth stage Deep Tech investor need?

The assessment of where a Deep Tech company truly is, cannot be reduced to the reading of a handful of KPIs. It requires the Deep Tech growth investor to have a fairly unique skill set.

Alike to early-stage Deep Tech investors, most important of all is an understanding of the underlying tech at hand. The investor must understand the quality of the startup’s published and unpublished intellectual property within the context of industry developments. If there’s potential for other tech trends to disrupt the space and contest the startups’ target market, the investor needs to be aware of this. Moreover, the investor needs to have a profound understanding of the scaling challenges such as manufacturability at scale, quality and certification requirements as well as procurement requirements from large customers.

Additionally, technology and market size are highly interdependent in Deep Tech. The investor needs to evaluate the addressable market which often depends on the product’s technical specifications. Moreover, he must be able to predict how much value increase the target customers of the startup will have, how that is correlated to the unique features of the startup’s tech, and hence, how inelastic and sticky demand is likely to be. A detailed understanding of these factors is essential in modelling future revenues.   



To conclude, Deep Tech investments are a highly interesting and attractive segment for early-stage as well as growth investors. However, they require a very different set of skills and experiences which make the space inaccessible for many firms. Cipio Partners has profound knowledge and experiences in the field through many years of investing in deep tech startups and the necessary technical background of its investment team.