Bridging the Valley: Is lack of funding the reason cars can’t fly yet?

Bridging the Valley is a series recording a shared exploration of the potholes in the road of hardware technology development between lab research and implementation. These obstacles to development often prevent the productization of new technologies, causing a phenomenon called the “Valley of Death.” In this and future articles, the author will dive deeper into the causes of the Valley of Death that we hypothesized in the introduction to the series, and provide more information on various areas of the technology development ecosystem.

If we threw more money at technology development, could we be living in the world that was dreamed up for us in the movie Back to the Future?  It’s possible. The more resources we put toward developing a technology, the more likely it is to succeed. When more resources are available, the environment becomes more forgiving to both technical and business mistakes. It allows a company to pivot from focusing on the wrong customer audience, or iterate further on the technology to make it safer or more reliable.  

Fundamentally, an increase in funding results in an increase in likelihood that a technology could succeed.  There are two major obstacles to increasing funding; the first of these issues is that new technologies, especially hardware technologies, can be extremely expensive and risky. The ratio of cost and risk to potential return on investment is far worse than most software startups, which is why so many venture capitalists (VCs) are focused on software tech companies. The second issue is that deep tech development time spans longer than what many VCs expect and are structured for.  

Why invest in something so expensive and risky? 

This early in the development, there’s still substantial risk, both technical and business-wise. The market for the product might simply not yet exist, or society might reject it, even if it would be viable and helpful.   If you believe the FDA, you might see the anti-vaccine movement or the pushback against GMOs as real-world examples of this. This cost-risk-reward profile is difficult for most funding sources to accept.  Furthermore, because there are so many unknowns, it’s impossible to have high confidence in any prediction of how much development will cost or how long it’ll take. Even if all goes well, the development can take 5 to 10+ years, which adds to the financial uncertainty because it’s simply not possible to predict so far out. This means that any financial plan for a deep tech startup will require a significant margin for error.  

Sell parts of your company or navigate government bureaucracy?

Given these challenges, there are some entities that are willing to provide capital to these startups based on new technologies. Two major sources of funding are venture capital and angel investment. Both provide dilutive forms of investment, where the funded company sells a portion of ownership in return for the funding. In general, these entities will invest in a significant number of startups, with the goal of at least one providing 10–100x return on investment in a 3–5 year time span. This model works well for the high-risk, high-reward nature of startups. However, when the standard VC model is applied to deep tech, it’s not necessarily an ideal match. MIT’s Energy Initiative wrote a paper of how venture capital ended up being a poor fit for the clean technology (“cleantech”) startups, and a number of the issues it identifies can be generalized. 

An alternative form of funding is government grants; the most common at this phase of development for US startups are Small Business Innovation Research grants.  Many other countries have similar grant programs. These are slightly different from the dilutive forms of funding (VCs and angel investors) because their drivers are quite different. Rather than trying to make a direct economic return on investment, the government is trying to stimulate economic growth and enable technological superiority to other countries. Because of this difference in goals, the government can be more suited for funding deep tech research.  

Technological development is beneficial for any government, even if the entity conducting the research doesn’t end up producing a profitable product. It builds technical expertise in the workforce, incrementally explores specific technology areas, and generates IP that may benefit a different product. It’s also important to note that the value of technology to society cannot be measured solely from the profit of the first company that’s founded by the inventors. If a new technology does improve people’s lives, that positive impact will be much more massive than the balance of that company’s finances. Humanity will normally benefit from that technology forever once it’s been developed, and it’ll be adopted by other companies and other uses. Governments are more interested in this than the success of individual companies, so they’re willing to invest more for the sake of technological progress, rather than profit.

However, this funding method has its own difficulties. Like most things in government, the process is slow; it takes a minimum of 6 months between application submission and funding approval. When building a company, this timeline can result in risks to cash flow. Furthermore, grant application is difficult — almost an art unto itself. There are individuals in the job market that specialize in grant writing. The SBIR Phase I and II grants also have a maximum grant size that isn’t large enough to support a company to reach profitability. There’s a Phase III that isn’t technically part of the SBIR program, but it’s poorly defined and only granted on a case-by-case basis, when the company is creating a product that a government agency wants. There are companies that have made it to profitability through government and foundation funding, but it’s uncommon and very difficult.

Getting the funding required to bridge the gap to profitability for a deep tech company isn’t easy, especially for hardware technologies. It looks like there are efforts in the right direction, though. There are VC firms that are specifically created for funding deep tech; they often have partners that have experience founding deep tech companies. This means they have a better understanding of what these technologies need to make it to product, and can better structure the firm’s investment strategy to fit the needs of deep tech startups. Although government grants are generally inadequate on their own, they do help bridge the gap to a technology de-risked enough for dilutive funding.  

There’s quite a bit of scientific literature around the role that funding plays in the Valley of Death [1] [2] [3], which we’ll discuss more in future articles. Moving forward, in future installments of this series, we’ll revisit the topics of the previous articles, but take a much more data-based approach, and finally start drawing conclusions on what the solutions might be. What changes do you think will get us to the flying-car age? Share your thoughts on our Discord

CATEGORY
Bridging the Valley
AUTHOR
Mike Lo
DATE
09.27.23
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