Are you good enough to cross the valley?

Taken from the September 2021 issue of Physics World, where it appeared under the headline “Crossing the valley”. Members of the Institute of Physics can enjoy the full issue via the Physics World app.

In his third article on funding hi-tech firms, James McKenzie looks at recent initiatives to help them jump over the “valley of death”

Risky business Hi-tech firms can face a big gap from start-up funding to having a successful product. (Courtesy: iStock/PrettyVectors)

If you’ve never heard of the “valley of death” before, it’s quite simple. It’s a metaphor to describe what happens after a new company has raised seed money or early-stage funding to develop a product – but before it has started to generate revenue from that product. In crossing the valley of death, the firm can find it hard to raise additional funds since its business model has not yet been proven. And because developing a new product is so unpredictable, it can be hard to know when (or even if) a company will have a real product that customers can buy.

The fundamental difficulty for physics-based and other “deep-tech” businesses hoping to cross the valley is that it can take years to commercialize their products. And you often can’t just get those products ready faster by throwing more money at the problem. You don’t even know when your product will win any acclaim from customers, when it’ll have passed any business or environmental regulations, or how many improvements you’ll still have to make to ensure it sells in big enough numbers.

Rival firms are trying to get better, cheaper versions of your product to market faster

What’s more, all companies operate in a commercial market, where rival firms are constantly trying to get better, cheaper versions of your product to market faster. It’s therefore crucial you keep an eye on your competitors who will be moving the commercial goal posts too. However, if a start-up company does eventually survive “death valley”, it’s a big achievement, signalling to investors that the business has a commercial future with customers that want its products or services.

No illusions

In crossing the valley, it helps to have developed a properly validated business model with predictable revenue streams, which will make later-stage investors more willing to fund your firm. Another option is to take on a debt, such as a loan or invoice financing, to fund this stage. Generally speaking, however, the longer it takes a firm to earn any income, the more likely it’ll be to fail.

Trouble is, most founders are under the illusion that the first funding round will be the hardest and that, once they secure that cash, life afterwards will get easier. But the reality is that there are far more early-stage and “angel” investors willing to take a punt on a new firm than there are late-stage investors ready to sign fat cheques to fund the handful of successful companies that are now making money. Between those extremes lies the valley of death where it’s hard to call the winners and the risks are high.

Thankfully, venture capitalists – people who invest in firms in return for a stake in the business – are well aware of these pitfalls. They generally have the financial and sector experience to help you navigate the valley of death. Nevertheless, it’s still a risky business: very few companies are like Dropbox and Instagram, which quickly made handsome profits and offered investors a massive return on investment in a very short period of time.

Deep-tech businesses are crucial to society as they are often working on important problems, such as “net-zero” carbon-emission goals.

Deep-tech businesses are usually not like that, taking generally 2–10 years to reach the market and with more investment needed to get there. However, such firms are crucial to society as they are often working on important problems, such as helping us to achieve “net-zero” carbon-emission goals. The only way to make these longer-term investments attractive to investors is to offer incentives.

Help at hand

Here in the UK, the government thankfully has its finger on the pulse, with its announcement in July of a scheme known as Future Fund: Breakthrough. It will see the UK commit £375m of funding to fast-growing firms looking to raise at least £30m of investment provided they have previously raised at least £5m. Private investors will have to demonstrate they have secured 70% of the funding, with the lead investor making the connection between the business and the Breakthrough fund.

This scheme comes as a follow-up to the UK government’s previous Future Fund initiative, which was unveiled in March 2020 to support businesses during the pandemic. That scheme, which is now closed, provided more than £1bn of convertible loans to almost 1200 firms.

The new Breakthrough scheme, which is designed to speed up the deployment of innovations that could solve some of society’s greatest challenges, will cover everything from quantum computing and clean technology to the life sciences. This is vital investment given that even a 1% growth in these highly innovative firms could, according to the UK government, grow the UK economy by £38bn.

Rishi Sunak, the UK chancellor, is a key supporter of the scheme. “Our Future Fund: Breakthrough scheme,” he said, “will enable innovative businesses in every corner of the UK to access the finance they need to scale up and bring their transformational technologies to market – all while creating high-skilled jobs and boosting the economy.”

It will be administered by the British Business Bank’s subsidiary, British Patient Capital, whose chief executive Judith Hartley thinks that the UK is “fertile ground” for creating high-growth companies based on cutting-edge technologies, thanks to its many top universities and strong track record in science and research. “Through the commercialization of R&D,” she says, “these transformative companies will help accelerate the deployment of innovative breakthrough technologies that can transform major industries, develop new medicines, support the transition to a net-zero economy and strengthen the UK’s position as a science superpower.”

The schemes are good news, especially as the UK government’s spending on R&D is expected to reach £14.9bn in 2021. That’s the highest level in four decades and part of the UK’s attempts to increase investment in innovation to 2.4% of economic output by 2027. In helping firms cross the valley of death, I hope the new scheme will ensure the UK quickly gets over the economic impact of the COVID-19 pandemic.

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