Matthew Mandel

Something exciting about investing in deep tech startups is that the playbooks are still unwritten. It’s still a fairly small world with people trying a diversity of strategies that will be tested by the market and refined in the coming years. One thing I’ve found basically every investor agrees on, however, is that deep tech is “capital intensive”. As much heterogeneity as there is, everyone seems to accept this axiom. And all of the agreement makes me suspicious, so I wanted to think through it a bit.

Why is it that everyone seems to think it’s true? There’s not a good definition of deep tech, but one essential condition of any definition would be that deep tech companies have some technical moat, which is to say that they make things that are hard to make. They might be hard to make because they require lots of R&D or the construction of an innovative manufacturing facility. Because these things are usually more expensive to do than creating software products, deep tech companies are usually more capital intensive.

One distinction the argument doesn’t capture is the cost to develop a product vs the cost of scaling a business. Deep tech companies take more technical risk than market risk, and so they might just frontload their spending on product development, while software companies have to spend more at later stages on sales and marketing and similar functions. A further nuance here is that even if this is true, deep tech investing might still be more difficult because of the nature of the fundraising risk. A deep tech company that can’t finance its first-of-a-kind facility might just die because it has no product/sales to fall back on, whereas a software company that can’t finance increased distribution/growth might be able to cut costs and subsist on income from its existing product.

Another important distinction is differentiating between capital intensity and equity intensity. People will sometimes talk as if deep tech’s capital intensity means that early-stage investors should expect extra dilution. But, deep tech companies are especially good at attracting non-dilutive sources of capital. Climate startups in particular might be able to access multiple times the amount of equity they raise in grants, effectively supercharging instead of diluting an investment. And though R&D not subsidized with grants might require equity dollars, building facilities can usually be done with debt made cheaper by things like collateral and offtake agreements.

Finally, because it’s so early in this wave of deep tech startups, the landscape is going to change a lot in the coming years. I mentioned the traditional sources of non-dilutive funding that deep tech companies can take advantage of, but the increasing demand for capital from deep tech startups will create opportunities for innovative financing partners to find new ways to work with deep tech startups. And then on the product development side, we shouldn’t take the costs of building in the hardware world as constant. Hardware startups are now taking advantage of increasingly powerful simulation tools that are driving down the cost and time required to develop physical products, making deep tech R&D look more like software development.

Ultimately, it’s probably right to say that deep tech is on average more capital intensive, but it’s worth questioning what exactly follows from that. And in identifying the nuances that complicate the story, you might also find the differentiating factors that make a deep tech startup great.