The Deeptech Series A Chasm - An Insider's perspective and a clarion call for VCs

India’s future lies in unlocking the potential of deeptech. With investments in deeptech startups in India this year crossing over $1B, in a market of $60B with a CAGR of 40%, many VCs are lured, but with the necessary caution of the longer investment cycles and higher R&D burn rates.

There is, however, a Grand Canyon in India's deeptech startup land: on one side there is the young and idealistic startup with plans to change the world, and on the other side is the VC with dry powder for "growth" capital. In the middle lies a deep valley where there are zombies and graveyards.

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The Origins

The story of a deeptech startup is well characterised by the Dunning-Kruger Curve. It maps out how confidence and competence play out over time. Interestingly, there are two peaks of confidence - first at the start (Mount Stupid), and the second after a long time (Mature Confidence). Between the two peaks, is a valley where competence is rising but confidence is falling. Something similar is experienced in a deeptech startup as well.

Imagine this: Deepti is a deeptech founder starting up with huge ambitions to disrupt the industry with a breakthrough innovation. 

She sees a flood of capital going into the early-stage startups - Government grants, angel investments, pre-seed/seed cheques. Checking the boxes of a promising team, a huge market and a good plan to capture it with breakthrough tech, she gets the first external capital in.

The first few months feel great! There's excitement from investors, validation from customers, and the team has shifted to a brand-new office with equipment and tech to make it all happen. They build a prototype/POC to showcase, and it is received well by the audiences. They reach a TRL (Tech Readiness Level) of 6 by the end of the first year. The rapid progress is enabled with using COTS components, additive manufacturing, and an agile development plan.

Fast forward another few months, Deepti notices a change. For some reason, the confident optimism in the team is now replaced with sceptical pessimism. Not without reason - there is progress, but it's not at the pace she had imagined, and projected to the investors. Mired in technical issues with the product, regulatory quicksand, and bureaucratic red tape for some crucial licenses, she is confronted with the reality - this is much harder than she thought. 

The VCs are able to assist her in getting some of the regulatory approvals, and cutting some of the bureaucratic red tape by being vocal about the industry licensing issues at public forums.

While there is progress in those areas, a new crisis emerges - few key people leave the company, demoralised by some of the changes (or lack thereof). But Deepti doesn't quit. She has conviction that she can make it through. She hires new engineers, who can take the product to the maturity level required for commercialisation.

It takes them another six months to get to TRL 7 from TRL6.

Feeling pain from a thousand small cuts, she continues on the path, seeking the light at the end of the tunnel. She tries to sell the product to the early adopters, and is able to deliver, but the product has a few technical issues when deployed in the real environment. Nothing impossible to fix, but solving them would take time and money - things that are in short supply. Her runway is down to a few months, and she has to try hard to secure the next round, while balancing all the other issues.

The ones who put in the first cheques start to doubt Deepti's ability to commercialise what she has built. They also notice that her once bold confidence now seems to have vanished into thin air. When they press her about the delays, Deepti is honest: there are several issues on the table, all of which need time to be resolved.

To make matters worse, the markets are down as well. Dry powder is being rationed, and VCs are hesitant to invest in a startup lacking widescale traction. A few of her advisors urge her to shift their focus towards revenue and profitability instead.

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Analysis

Deepti has now reached the lowest point of the deeptech grind. Every deeptech founder - Elon Musk, Jensen Huang, Peter Thiel, Palmer Luckey - has been here at some stage. At this point, her company’s fate hinges largely on what investors decide to do next.

Will they back Deepti, believing that success is right around the corner, or will they pass, worried that the commercialisation risk is quite high?

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The Indian Way

Here is what I see happening quietly behind the scenes for a lot of deeptech startups in India: Imagine a case where Deepti decides to double down on revenues and focuses on becoming profitable. She cuts down the staff to the bare essentials, focuses on just one product and gets to profitability - not the disruptive unicorn she had imagined, but a good horse. She has now built a sustainable small business - a ‘dhanda’ - and becomes content with a growth of 10-15%, a comfortable family life and a machine that works.

Early-stage funding + focus of profitability in the growth stage = Small business with slower growth. 

I have nothing against small businesses, but I have seen enough examples of the above transition to wonder what could have been, if Deepti had received a vote of confidence and a VC that saw what others couldn't.

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An alternate case

If at the lowest point of her journey, an investor had doubled down on the conviction that Deepti will succeed - helping her raise the next round with concrete revenue and product milestones, unlocking deals within the portfolio companies, and hiring for executive roles that will take the company from 10-100

- She could have built a large-scale business, scaled and captured the market, went for an IPO, and maybe returned 100x to the investors.

For more references, take the following cases:

1. Sequoia invests in struggling Airbnb (2008)

Sequoia backed Airbnb when revenue was collapsing, the founders had maxed out personal credit cards, and the company was literally selling cereal boxes to survive the recession.

2. Accel invests in uncertain DJI (2015)

Accel invested in DJI when the global drone industry was still unproven, regulators were tightening restrictions, and analysts believed consumer drones were a fad with limited commercial use.

3. Founders Fund invests in repeatedly failing SpaceX (2008)

Founders Fund doubled down on SpaceX right after three consecutive Falcon 1 launch failures, when the company had only enough cash for one final attempt before shutting down.

4. Shoichiro Irimajiri invests in a commercially failed Nvidia (1996)

Former Sega COO Shoichiro Irimajiri invested in Nvidia after its first two chips (NV1 and NV2) had failed commercially, and after the company was weeks away from running out of cash.

5. Valor Equity Partners invests in almost-bankrupt Tesla (2008)

Valor Equity backed Tesla when it was nearing bankruptcy, burning over $4M a month, struggling with Roadster delays, and unable to secure bridge financing during the financial crisis.

And we know how those stories ended: with the greatest returns in several generations.

Somewhere in India today, another Deepti is at her lowest point - and the only question is which investor will have the courage to cross the chasm with her.

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A clarion call to Indian VCs

If you’re an early stage investor in a deeptech startup, please understand that deeptech doesn't follow the typical SaaS seven-year cycle, the ride is bumpier and longer, but with strategic patience, it may compound to 100x in 12 years, instead of 10x in 7.

If you're an Indian VC investing in deeptech companies at the growth stage, please understand the nuances of what's really happening behind the scenes of cash crunch, tough times, and low confidence. When ashes fall, your conviction will make the legends rise.