Making the Impossible, Possible: Investing in Frontier Technologies
By Linus Liang, Kevin Wu, Signia Venture Partners
I co-teach a class at Stanford on Frontier Technologies and I am often asked how investors evaluate these ideas. While we don’t focus on deep tech investing at Signia, we recently had a panel of investors that do: Baris Aksoy, General Partner at AV8 Ventures and formerly investor at Intel Capital, Julia Moore, General Partner at Breakout Ventures, and Patrick Sagisi, Director at Acario Innovation and formerly investor at DBL Partners. Here are some of the high level thoughts from that discussion.
What is Frontier Technology?
Frontier technologies allow society to question the status quo and explore the boundaries of possibility, often bringing advanced scientific research to scale in new markets. These technologies are typically unproven, and thus the engineers and founders who work with them bear greater intellectual property risk. Translated into a company, frontier technologies are also a riskier-than-average bet for investors, requiring large upfront capital outlays for products that can be years, if not decades, away from commercialization. But for early believers in a technology, the ultimate economic and social returns can be tremendous — in fact, solar and wind power were all frontier technologies at one point. Today, advancements in autonomous trucking, space systems, biotech, and more promise imminent step change in the way we live.
Elements of Investment Decision-Making
For frontier technology investors, diligence extends far beyond the typical commercial issues that traditional venture capital investors are accustomed to, as the validity and potential of the underlying technology must first be assessed. For most investors, this means tapping a network of domain experts who can translate between sound science and real market potential. These experts are not only helpful as advisors, but also as early team members who can round out the skillsets of a founding team. Of course, it’s important that multiple perspectives are brought into a room; veteran technical experts may be overly pessimistic when interfacing with unfamiliar technologies, while seasoned product-builders may be overly optimistic in recognizing customer demand before a technology has truly been validated.
Nevertheless, these product-builders are practical to focus on product-market fit. Market timing — ensuring that a technology isn’t ‘ahead of its time’ — is the biggest challenge that both founders and investors face when building frontier technology companies. And for investors who sense that they may have invested in a technology too early, they must grapple with the age-old question of whether to gamble and pour in follow-on funding, or to cut their losses and slowly wind down their investment. There is no easy answer, as it’s dependent on the risk profile of a particular fund. Funds specifically raised to back frontier technology companies (i.e. Founders Fund) can often ride out bumpy periods (in other words, the J-Curve), while funds with shorter investment horizons or stricter financial criteria may be forced to cut the cord even if they do not wish to do so. Regardless, the signals of a premature technology or market are never clear, and frontier technology investors must rely on years of pattern recognition and a deep bench of experts to build conviction.
Unsurprisingly, the valuation of frontier technology startups — often years away from seeing revenue or even a product — is always more art than science. Though investors can develop objective measures of technical risk, market size, exit potential, and more, any company’s valuation is ultimately most dependent on the quality of the team behind it. In the world of frontier technology, investors must share the hopes and dreams of the founders they back, and be partners they can turn to through thick and thin.
Challenges in Company-Building
Frontier technology companies often face regulatory hurdles that investors must be comfortable with — and overcome if they choose to invest. This rings particularly true for markets where regulatory compliance is table stakes to operate, such as autonomous trucking or energy infrastructure. With much ambiguity around the pace of technological advancement and the corresponding government response, investors must analyze downside scenarios and believe that companies still have the potential to capture strong returns regardless.
Of course, the silver lining is that regulatory approval can often be a strategic advantage for new companies, particularly those that understand approval processes and own strong government relationships. This is particularly advantageous in many sectors such as biotech, where the primary regulator (the FDA) has established a transparent, well-known approval process for decades that is predictable for founders to navigate.
Beyond regulatory moats, it is difficult to find key milestones of success for many frontier technology startups, but investors have found a few signals helpful. Most obviously, letters of intent (LOIs) or forward-looking contracts with customers are clear signs that point to greater commercial traction. Even evidence of a strong, built-out product — coupled with a great team — can mean that a company is on the right trajectory. Regardless, any outcomes that can help frontier technology companies continue to raise follow-on rounds of financing can be considered successful.
Exiting Frontier Technology Investments
Once a frontier technology company has scaled successfully, it has many options by which to exit and provide early investors liquidity — but the framework in which they must be evaluated is unique.
First, most frontier technology companies, with a higher risk profile than most investors can stomach, will not go public through a traditional IPO and will exit through M&A. However, a recent wave of SPACs (Special Purpose Acquisition Companies) have provided founders and investors an additional option, but they come with key risks that should not be taken lightly. For most frontier technology companies that are pre-revenue or require a long runway to profitability, SPACs are a poor choice; if the company would not otherwise have been successful through a traditional public offering, a SPAC would serve it no better. Even in the broader technology ecosystem, many companies going public via SPAC today are trading at frothy revenue multiples, and with a market contraction, their prospects may look much bleaker than today.
On the other hand, for management teams insistent on going public, a SPAC can allow them to retain greater control of their company and afford them a far less grueling process than a traditional IPO roadshow. Most importantly, SPACs allow some companies access to capital previously inaccessible in the private markets (i.e. expensive infrastructure for EV charging stations).
Exit decisions are tough judgment calls for even the most seasoned founders, but the right investors in their corner can help them navigate the choppiest of waters. Understanding the frontier technology landscape from these very investors helps Signia continuously improve in our ability to identify and champion the world’s most ambitious founders and companies.
Linus Liang is a Partner at Signia Venture Partners, an early-stage venture capital fund in Silicon Valley and Los Angeles. He serves as a Lecturer at Stanford University, where he co-teaches courses on technology and entrepreneurship in the GSB and School of Engineering.
