Venture capital firms invested heavily in SaaS over the past 10 years. Funding grew in that period by close to 700%, outpacing the growth of overall VC funding by almost six times. Now, however, more and more VCs are turning to deep tech – tech involving tangible engineering innovation or scientific advances.
According to data from Dealroom, European investors poured $17.7 billion into deep tech startups on the continent last year. That was less than the record-breaking $22.8 billion poured into the space in 2021; but it was still a huge jump from the $11.6bn and $11.1bn invested in 2019 and 2020, respectively. The trend is set to continue.
Why is this? Because, for deep tech companies, once you have product-market fit – that is, once you have identified a market need and built a solution customers want to buy – your customer acquisition cost, including advertising, does not have to scale with revenue in the way it must with SaaS. There are some huge deep tech companies that produce something so distinct that their customer acquisition costs remain staggeringly low.
Take the Dutch semiconductor manufacturer ASML and the French aerospace giant Airbus. Both have technical advantages that make them the largest global suppliers of their primary product offerings. (ASML, in fact, is the world’s only supplier of extreme ultraviolet lithography, as well as its largest supplier for the semiconductor industry.)
These companies cannot completely disregard customer acquisition, of course; they do have to keep wooing customers. But since their customer acquisition cost does not come close to scaling with revenue, they are freed to invest chiefly in research and development so they can keep creating, developing and supplying the best products they can. Their R&D investment depends on what they can afford, and their vision for the future of the market. Profitability remains closely tied to product development; the risk is a technical, not a customer acquisition one.
Although on the whole SaaS companies are profitable, their continued profitability is highly dependent on keeping customer churn rates low. This creates risk – one which, from the standpoint of investors, tends to be underestimated. Successful, profitable SaaS businesses also run the risk of spawning copycats, who attempt to duplicate their model. Some business models can create a protective ‘moat’, typically thanks to network effects, whereby the increased number of people improve the value of the service in question. Social media companies such as Facebook are prime examples of beneficiaries of this phenomenon.
The more people that use a platform in an individual’s network, the more likely it is that the individual will use it too. This strongly reduces copycats. But what can be more likely in the case of SaaS companies is that copycats put competitive pressure on the businesses they copy, causing them to bleed customers or reduce their prices.
One of the challenges for deep tech founders is that there are only a small number of venture capital funds that truly understand it. Not only this, but there is only a small number of partners and decision makers within those VC funds who will truly understand a specific industry within deep tech. Genuine industry-specific knowledge is essential both for the VCs, so they invest in the right deep tech companies, and for the companies, who need effective VC support. We are still a long way from establishing the kind of metrics that have been used to assess SaaS through the years – metrics such as annual recurring revenue, customer acquisition cost, and churn. While some investors might see the absence of tried-and-tested standards of measurement as cause for caution, it can make the deep tech game exciting for others.
Cailabs could not have got where we are today without the support of our investors, who at every stage have seen the long-term value of investing in this little-understood – but, we believe, very important – technology. This is because VCs who understand deep tech, cultivate industry-specific knowledge, and exhibit good judgement, stand to benefit hugely from their investments – as do the deep tech companies able to draw on their invaluable support.
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