It’s long been known that Hard Tech startups rarely attract venture capital. We’ve all heard the explanations from VCs for why this is true — and their reasons are valid.

The other day I read a brilliant piece by DC Palter that approached the “what is the problem with Hard Tech startups” question not from the investor perspective, but from the entrepreneur’s point of view. And sadly this entrepreneur came to the same conclusion that venture capitalists have long believed. 

The primary challenges with raising venture funding for Hard Tech startups as laid out by Palter are:

  1. The capital required to build and scale a Hard Tech startup is orders of magnitude larger than the capital required to, for example, build and scale a SaaS startup.
  2. The time required to build and scale a Hard Tech startup is also much longer than what would be required to build and scale a typical venture-funded software startup.
  3. In fact, the time required to get a Hard Tech startup to an exit is usually longer than the lifetime of a venture fund.
  4. The founders and founding teams of Hard Tech startups tend to over-bias towards scientists — and away from those with business skills.
  5. In the rare cases where there is a founder with business skills, they tend to be sales and marketing skills rather than operational management skills.
  6. Acquisition exit prices for Hard Tech startups are often based on profits rather than revenues — and rarely include any consideration of potential growth.

Looking at these issues, it is clear that venture funds are not set up to do these kinds of deals. But does that fact mean they are bad investments? Does it mean they are bad startups? Or does it create opportunity for someone without the constraints and restrictions baked into the venture model?

Let’s find out. Let’s test a thesis. Let’s conduct a thought experiment.

What happens to these objections if a different kind of entity — one set up differently from venture funds — were to invest in, support, and build these Hard Tech ventures? What would happen to the issues above if large global companies became the default backers of these kinds of ventures?

High Capital Costs

It’s easy to assume that if a venture fund cannot afford the capital costs of an investment neither can a corporation. That is simply not true. The largest venture capital fund in the world has roughly $12B in AUM (assets under management). Apple currently has $202B in cash on hand — and access to sources of capital that could be leveraged to give them something close to $1T. The reality is that the only entities arguably more suited for this kind of capital investment are governments and their related investment vehicles. But government funding comes with implications, requirements, burdens, and constraints that artificially limit venture success. If Hard Tech startups are going to succeed, large corporations are the most suitable funding sources when considering the high capital costs.

Long Timelines

The standard 10-year fund lifetime takes most venture funds out of the running for Hard Tech startups as an exit is likely to come post-fund lifetime. Obviously large corporations do not have this hard constraint and most are familiar with funding products and projects with payoff periods that extend past a decade.

Science-Focused Founders

In many ways, this is where large corporations can not only be most helpful but can actually increase the odds of startup success. Most large corporations are very familiar with the need to pair scientists and engineers with business and operations people. As a result, these companies tend to have business people with extensive experience working with Hard Tech folks in getting products and projects built and launched successfully. Venture funds, as a general rule, have few if any people like this — and those people simply don’t have the time required to work with the startup to create a functional business. This is an area where corporations are significantly advantaged versus venture capitalists.

Profit-Based Exit Prices

This is an interesting one as I, for one, believe that this is in a sense a “second order” problem. I would argue that the lower exit prices for Hard Tech startups are largely driven by the capital constraints they work within, their lack of strong business-focused founders, and the lack of aggressive and growth-oriented investors backing them. I would also argue that exit prices would normalize versus other high-risk investments if these startups had the same access to capital, investor expertise, business networks, and effective business operations leadership that, for example, a venture-funded fintech startup would have.

So in essence it seems like the arguments against investing in Hard Tech startups are all at least mitigated, if not outright eliminated, by having the default source of capital be large corporations rather than venture funds.

And here is where someone points out that just because large corporations could, in theory, do this kind of investment better than venture funds doesn’t mean that they should do these investments. Okay then — let’s consider the question.

Why would large corporations invest in Hard Tech startups?

  1. It’s an opportunity to beat venture capital at its own game.
  2. The lack of venture capital interest artificially depresses valuations and gives corporations increased leverage.
  3. Investing in Hard Tech startups can create opportunities for corporate development and inorganic growth.
  4. While the capital costs are high and timelines are long, the payoffs can be truly massive.

And on top of all of that, in many cases our very future depends on these Hard Tech startups being successful.

Let’s go through each of these one by one.

Beat the VCs

Anyone who is an executive at a large corporation and doesn’t understand that venture capital is coming to take their lunch money is likely to be roadkill. The battle is well underway. VCs will regularly say that they might invest in a startup with the potential for exponential growth — but they will definitely invest in one with both the potential for exponential growth and the destruction of incumbents in the market. This is a chance to change the battlefield to one that is tilted in the corporations’ favor.

Increase Your Leverage

As an investor, one thing I look for is market spaces that have artificially depressed valuations — especially ones with diminished valuations due to lack of VC interest alone. Women’s clothing is an example. As, for that matter, is nearly any startup that sells to customers who do not have similar demographic and psychographic profiles to VCs or software entrepreneurs. Hard Tech startups fall directly into this category. We all know the mantra: Buy Low, Sell High. Hard Tech startups offer the opportunity to Buy Low due to the lack of competition and interest from venture capitalists

Inorganic Growth

The vast majority of startup wins occur through acquisition. Acquirers tend to be exactly the same large corporations who could and arguably should be investing in these same startups they are acquiring. So by funding Hard Tech startups, large corporations not only have the chance to reduce their overall purchase price in the end, they also have the inside track on the acquisitions of these startups. In addition, the odds of an acquisition being successful should increase as there is a pre-existing relationship between the two parties — and there is clear and deep knowledge of the startup.

Massive Wins

The thing about Hard Tech startups is that, when they win, the wins can be massive. I’ll use fusion power generation as an example. Yes, the capital costs are huge (measured in the billions). Yes, the timelines are long (measured in decades). Yes, the risk is high (we’ve been about to achieve fusion power for the last 40 years). But if the fusion company you back ends up being a winner, the size of the win is no longer a “venture”-sized win and instead is more inline with the win from an investment like developing the Prudhoe Bay oil fields. In other words, the returns would be measured in the hundreds of billions of dollars.

A Better Future

The problems we are facing — from climate change to economic disruption to access to power and water to peace and freedom for all — are not going to be solved by another app or an increase of 2% in ad yield. If we want society, humanity, and the environment to exist past the next 100 years we need big solutions to these big problems. And those big solutions tend to largely be the things Hard Tech startups are creating. So somebody out there must invest in making these startups successful. Some investors need to invest in a better future. For all of us. 

Maybe you are the hero of this story?