From Hype to Hard Science: An investor’s guide to understanding new frontiers in European Deeptech investing

Raphaëlle d'Ornano
10 min readMay 4, 2023

When the investment mood turns sour and fearful, it’s easy to lose sight of the fact that we live in extraordinarily innovative times. It takes just one panel at Milken to be convinced of that named “What will blow your mind in 2023?”. And what did the three companies on stage — Generate Biomedicines, Koniku and Proximie — have in common? They were mixing Science and Technology in a unique way, in this case all in the field of Healthcare.

In France, my home-country, we see companies giving rise to the economy of 2030: Exotec is using robots to build the automated warehouse of tomorrow, Ÿnsect has developed insect-based protein that enable a healthier and more sustainable food chain, The Exploration Co. is democratizing access to space with its modular and reusable space capsule.

These and other companies across Europe are leveraging hard science and research to develop products that can fundamentally disrupt — and improve — our daily lives. The acceleration of these Deeptech startups represents a major opportunity for investors to back companies that have the potential to deliver massive returns.

But seizing those prospects requires investors to change their mindsets. We are moving away from an era centered around asset-light investments like SaaS platforms to an age of asset-heavy startups that manage factories and have large capital costs. Tech is not what it used to be, and that means business models won’t offer the same predictability of recurring revenue and cash flow as founders wrestle with new forms of technological risks (on top of well-known execution risks at Late-stage). Thus investors can’t necessarily use their classic playbooks to breakdown these companies.

On the surface, this makes Deeptech investing seem intimidating. But it doesn’t have to be.

We’ve performed due diligence on a growing number of these asset-heavy companies. So, let’s breakdown some of the key elements for investors to understand so they can get past the complexity and see the value. Because if Europe is going to realize the full potential of its Deeptech sector, it’s essential that private investors play a central role in the funding and development of the most promising ideas.

State of the market

To understand why investors should be pivoting to Deeptech in Europe, let’s look at some context. Over the past 15 months, worldwide VC activity has been trending down sharply.

Europe lagged that trend by one quarter but has now seen four straight quarters of funding declines. According to CB Insight, European startups raised $10.4 billion in Q1 2023, down 12% from Q4 2022, and only about one-third of the amount raised in Q1 2022. It’s the lowest quarterly total since Q2 2020 as deals fell to their lowest number since Q3 2023.

But there are bright spots. And one of them is VC activity moving to DeepTech. At the 2022 DealBook summit, BlackRock CEO Larry Fink predicted that the downfall of FTX would cause venture capital firms to rethink where they put their money. “It’s not going to go to all this stuff that provided us good utility to get food quicker, or find a taxi sooner,” Fink said. “I think it will be much more hard science, and require a lot more technical understanding.”

Fink’s prediction is playing out in Europe. According to Dealroom, European DeepTech startups raised $17.7 billion in 2022. While that’s 22% less than 2021, it’s still up 60% from 2020, making this one of the most resilient startup investment sectors. Indeed, during the last 6 months of 2022, Deeptech had the second-best performance in terms of VC for any sector in Europe: Funding only fell 9% from 2021, compared to the overall 45% drop in VC.

What is Deeptech and why is it hot?

Defining Deeptech is critical but can also be tricky because it encompasses so many types of technology. One must be wary of startups labelling themselves Deeptech. On a high level, a Deeptech startup has generally developed bleeding edge technology based on breakthrough technology. This technology is then commercialized into a product that addresses a deep socio-economic challenge or is poised to deliver societal disruption

As such, Deeptech is a huge playground that can encompass everything from AI + ML to Climate Tech to Quantum Computing.

Dealroom’s research revealed that: “LPs in Europe see Deeptech as the 2nd most promising segment in Venture Capital.” There are a confluence of actors giving rise to this optimism.

The trends that have driven VC investment over the past decade like cloud and SaaS remain interesting but are crowded, making the chances to back new giants even slimmer. But as tech momentums slows in some areas, we are experiencing major technological breakthroughs in new fields that are maturing into viable commercial products. The innovations are happening in part because there is an urgent need for tech to solve major challenges facing the environment and society: climate change, aging population, saturated and obsolescent health systems and agricultural pressures.

Governments, in search of solutions, have recognized that tech has a key role to play. They have responded by creating more favorable regulatory frameworks. In some cases, such as climate, the regulations have set targets which have served as catalysts for the creation and adoption of tech solutions.

Policymakers have also introduced incentives and financial support to boost DeepTech investments. In the U.S., the Inflation Reduction Act, passed last year, dedicated $370 billion to climate-related spending (but goes way beyond that).

Meanwhile, Bpifrance continues to expand its DeepTech Plan which has earmarked €3.5 billion for programs to reach the goal of generating 500 Deeptech startups annually. This plan intersects with other ambitious French startup and research initiatives around Clean Tech, Bio Tech, and Health Tech. These and other government programs by the EU and various member states recognize that Europe is home to some of the best scientists and research institutes and has already given birth to some great Deeptech companies.

How is Deeptech changing the venture capital playbook?

The rise of Deeptech use cases pose a substantial challenge to classic venture capital analytical models. These companies are seeking larger financing rounds with completely new rules for investors. Let’s look more closely at 4 of the factors that define these Deeptech startups:

1. From asset-light to asset-heavy

SaaS business models are characterized by their asset-light characteristics. This has been key to their funding. Because they are not capital intensive, they can use all the cash to fund gain in market share and build dominant positions.

Not so for Deeptech start-ups. These startups have higher R&D expenses to develop the innovation that drives a new product. Commercializing the product (which often comes much later) then requires typically big capex spending which will limit their free cash-flow. Together, these dynamics mean Deeptech companies must have more funding up front.

2. From recurring to non-recurring revenues

SaaS has been a key investment thesis because it has a great business characteristic: You are able to enjoy predictable cash-flow as an investor once the customer has been acquired and over its lifetime.

In Deeptech, businesses like AgTech, SpaceTech or Robotics for example, your P&L is much more like that of a company selling one-off goods or machines. In fact, 83% of Deeptech ventures are designing and building a physical product. Recurring revenue can be added under the form of services, but even this does not have the margin characteristics of a software license. Some companies are responding to that by transforming their revenue models to “as a service” form giving at least the recurring part. This is the case in Robotics, for example.

3. From Execution risk to Technological + Execution risk

When considering a late-stage investment, a VC investor is financing execution risk. The company has product-market fit and strong traction with customers. If I put $100m + in this company, will it scale as planned? The likelihood that it will scale successfully can be assessed through its historic metrics as well as the breakdown of key Unit Economics. Its progress can be measured by continued monitoring of the right set of metrics.

But in Deeptech, you are still financing Technological risk. An investor is being asked to inject large amounts of cash at pre-revenue or little revenue level. The product could still fail. This is typically a substantial risk that some investors prefer to avoid.

4. From no/low regulation to important regulatory barriers

Certainly, no startup is immune from the possible impact of government regulations. In Europe, rules around data, privacy, market competition, and platforms have all been subject to major new regulatory frameworks adopted by the EU over the past decade. And beyond that, specific areas like FinTech and HealthTech naturally fall under strict sets of rules that govern those verticals.

Yet Deeptech puts investors even deeper into unchartered waters from a regulatory standpoint. Because the research is fresh and possibly even creating new categories, it can be hard to predict how policymakers might react, and it they do, how they may try to restrict or direct the development of these breakthrough technologies. This lack of visibility is just one more item adding to the discomfort of investors.

Put all these factors together, and they create a strong rational for investors to remain on the sidelines when it comes to Deeptech. Such reticence creates its own risks for this sector. Getting this funding from late stage + Growth investors is critical for Europe. In a recent report on Deeptech investing in Europe, Pitchbook highlighted this problem and used AI and machine learning to illustrate the point. While VCs invested about €38 billion into US-based AI startups in 2022, European companies only raised about €10 billion. For sure, there is a big funding problem that needs to be tackled.

How to make the right Deeptech investment decisions

The good news is that Deeptech investing can be demystified so investors can avoid common traps and seize the opportunities. And this is an important aspect to remember: The Deeptech startups that succeed can have a massive impact across many parts of society and the economy which, in turn, means huge returns for investors.

Crossing that Deeptech investment chasm starts with adopting a form of due diligence specifically designed with these challenges in mind. Let’s look at 4 elements of that new analytical approach:

1. Assess sturdiness of future revenue by understanding customer contracts.

In most cases, Deeptech companies have no or little revenue regarding amount of cash raised to date. Gaining a conviction on a company’s growth rests in gaining comfort on future revenues. Much more than in your typical SaaS business.

For Deeptech investments, this can be done through analysis of contractual commitments from future customers. Do they have signed contracts with firm commitments in dollar value? Or simple oral agreements or non-signed LOIs? These are not the same.

Also, what is the level of customer dependency? Does the company already have a diversified set of future customers, or is it still at proof of concept with a limited number of customers?

Finally, many Deeptech scaleups face the challenge of serving large customers. A startup David with a corporate Goliath as a main customer has no room for execution mistakes.

2. Understand the company’s position in the value chain

Investors need to know what interdependencies a Deeptech startup has with other actors in the value chain and what leeway it has.

Some Deeptech companies will have strong interdependencies with other corporates whose role might be critical to the delivery of the company’s product or service. Is the startup able to limit its dependency here? This is critical from a margin perspective, for example, where the startup might face inflationary pressures if it has no possible diversification in its supply chain. Worse, it could face unexpected moves by partners which might hamper its own operations (if they stop deliveries or implement strong price increases that make the startup’s product non-viable).

3. Cash, cash, cash.

In assessing an investment in Deeptech, cash is also a critical component. DeepTech is characterized by significant capital expenditure which may take up to several years before generating revenues. And specific constraints such as seasonal or gestation periods must be considered in AgTech and BioTech startups.

More than in any other venture investment thesis, cash burn must be assessed in a very precise way by testing multiple scenarios. This must include moves made by actors of the value chain as mentioned above, inflationary pressure on wages, and technical problems that could lead to longer development costs or pushing back revenue gains. For example, how does a change in the waiting time for purchase authorizations change the timeline for revenue?

Due diligence should heighten attention to future cash flows, with case-based rigorous stress tests aiming to provide investors with a solid understanding of the company’s cash runway under different hypotheses, including the potential and complex impacts of hedging solutions which may be deployed.

4. Intellectual property complexities

The strength of IP plays a fundamental role in protecting ownership of disruptive technologies. Patents are critical, but the threat of competition might impede many startups from investing in them. In the end, if a company has strong, defensible IP, or better, patent protection, then the value seems clear.

There is no way to eliminate all risk from startup investing. That is the nature of the game, no matter which sector. But the right metrics and the right due diligence designed specifically for nascent business models can improve visibility for investors and deliver the confidence to make bold investment decisions. For investors, Deeptech represents a rich target to deliver the returns they need for their portfolio while also having a positive impact on the planet and on society at large. That’s a winning combination.

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Raphaëlle d'Ornano

Managing Partner + Founder D’Ornano + Co. A pioneer in Hybrid Growth Diligence. Paris - NY. Young Leader French American Foundation 2022. Marathon runner.