A VC’s perspective on deep tech fundraising in Q1 2023

Like nearly every other sector, deep tech faced significant headwinds in 2022. As interest rates skyrocketed, deep tech deals, which inherently take more capital than other kinds of software businesses, became less attractive to many VCs and their LPs than lower-risk investments.

For instance, even though quantum computing suddenly became popular in the public markets as D-Wave, Rigetti and IonQ listed in the last year, private investment declined significantly — the sector received just over $600 million in venture capital in 2022, down from $800 million in 2021, according to Crunchbase.

Seasoned investors and operators in different segments of deep tech have been adapting to these changes in real time as the cheap money days dwindle in the rearview. For instance, in this environment, space tech startups would never have been able to raise the kind of money they did in 2021 to be able to deploy the technologies they’re working on today. As Delian Asparouhov, a principal at Founders Fund and the founder of Varda Space Industries, shared last month, it would be impossible to raise the $42 million his startup did in 2021 for its space factory “idea” in today’s market climate.

While some investors will continue to sit on the sidelines as we kick off 2023, it’s important to note that many funds are still sitting on amounts of dry powder like they’ve never had before. That doesn’t mean they or their LPs will be in a rush to deploy that capital, but money will be available to startups that can demonstrate current demand and are realistic about their valuations. As it becomes increasingly difficult to realize big exits in the years ahead, the technologies within deep tech that are transforming entire industries offer some of the only paths to “10x exits.”

These are positive signs for deep tech founders preparing to raise money this year. Another positive note is that some of the logic driving VCs to stay away from deep tech startups in down markets may be unfounded. Our team recently analyzed recent deep tech unicorns to understand how much money it took for them to get to the $1 billion mark. The results reinforced what we knew from experience: Deep tech startups’ capital and time requirements are on par with companies in other sectors. In fact, the median deep tech startup took $115 million and 5.2 years to become a unicorn.

With that as a backdrop, let’s look at a few areas where deep tech will find interest from investors in 2023.

Startups moving beyond launch tech in space

While Delian noted correctly that funding for long-term “moon shots” will be tough to find in the current market, I still believe investors will look for startups that are closer to commercialization in the sector. To date, 99% of the total investment in the space tech market has gone to the satellite and launch industries. Now is the time to focus on moving objects around in space rather than just getting them there.

For instance, investors are increasingly interested in solutions that tackle astrodynamics or propulsion to guide the motion of satellites and other spacecraft — for example, AI startups working on ways to simulate scenarios and generate maneuver plans for operators so they can avoid space collisions. Investors are also interested in future machine learning and neural networks use cases for astrodynamics, such as orbit predictions and spacecraft flight modeling.

Space missions also call for hardened software and hardware. As we look toward edge solutions for space-bound vehicles and objects, startups that can create radiation-safe applications will be in demand. So while the space economy will continue to provide numerous opportunities to invest in atoms, there will also be an opportunity to invest in the bits moving atoms across our skies.

Deep tech riding climate’s regulatory wave

Software alone will never solve the multitude of issues contributing to our climate crisis. Hardware solutions and engineering-led innovations in deep tech are needed to solve our most significant climate challenges.

While VCs were quick to move away from capital-intensive startups when the first clean tech bubble burst in 2008, I don’t think that will be the case this time. In fact, I believe deep tech companies raising capital in the climate space over the next year will see the least pullback from investors. The biggest reason for that is regulatory tailwinds.

The Inflation Reduction Act (IRA), passed in 2022, is the largest investment in climate and energy in American history. In fact, the amount of money intended to accelerate the country’s shift to renewable energy is about 10 times as much as the amount was allocated in 2008 to bring renewables to market.

The IRA has already created a significant opportunity to invest in new battery storage technologies to harness the true power of renewable energy. Funds are looking into the opportunity: VC investment in battery storage increased 290% over the last year.

In addition, state regulations mandating electric vehicles are creating additional opportunities. While it’s clear EVs emit less carbon dioxide into the atmosphere than combustion engine vehicles, the supply of electricity and how that energy is produced will dictate just how much of a positive impact we can make. Electricity needs could be five times the current production as more electric vehicles roll out to our streets.

This is creating significant demand for deep tech innovations that can help power EVs more effectively and cleanly. Startups working on new solutions around battery swapping, grid leakage, and solar and wind efficiency should continue to see strong investor appetite in the year ahead.

Deep tech solutions of interest to VCs could range from advancements in Perovskites to drastically improve solar panels’ output to new use cases for machine learning to automate the optimization of grid power.

Automation powering the next industrial revolution

As of 2021, 77% of all VC funding in the U.S. went to software, e-commerce and cloud companies, while manufacturing and other industries like energy accounted for just 4%. However, pandemic-induced labor shortages and supply chain issues in the manufacturing sector over the last few years have contributed to a new wave of deep tech investment in automation and robotics. Manufacturers and warehouses are also being hit hard by inflation and the energy crisis, making efficiency and cost reduction a top priority.

In 2021, VC-backed robotic startups raised $17 billion, nearly triple from a year earlier. While investment declined a bit in 2022, the sector has weathered the downturn far better than SaaS or B2B software.

Furthermore, industrial robotics costs are expected to drop by 50%-60% over the next few years, according to research by ARK Invest. This dramatic cost reduction and demand for manufacturing efficiency will continue to drive investor interest in startups developing automation solutions.

As manufacturers look to solve a complex labor puzzle in the year ahead, startups working on multipurpose robots are one area VCs have considerable appetite for. This is because, unlike single-purpose robots, multipurpose robots maintain the ability to work alongside humans and can be easily programmed to do different tasks without adding equipment or workflows.

Indeed, the transformative potential of technologies like these should keep investors’ attention in 2023 despite the macro headwinds. There’s increasing demand for deep tech’s capabilities across the space, climate and manufacturing industries, and startups targeting these areas are best positioned for the fundraising trail in the year ahead.