De-Risking Deep Tech Startups
“ When you invest in a company facing a technical challenge, the first thing you do is take the white-hot risk off the table” Tom Perkins.
Founders usually ask how they should de-risk their startup for investors after many VCs have rejected them and when they feel they cannot convince investors despite their passionate pitch. I am inviting founders to think about de-risking the investment before they go to investors.
Let’s look at the main reasons startups fail and try to figure out the risks that startups face. We can put all of these reasons for failure into five main buckets. (1) product/market fit, (2) problems with the team, (3) technology risks, (4) competition, and (5) sales and marketing challenges. Based on these five categories, here are my recommendations for de-risking your deep tech startup.
1. Product-Market Misfit
If a startup is struggling to gain traction or experiencing stagnant growth, it may indicate a lack of product-market fit. Identifying this early allows the company to pivot, refine its offerings, or reassess its target market.
Having LOIs, unpaid pilots, paid pilots, and paid contracts are how you can prove product market fit. Obviously, you are the least de-risked if you have LOIs, and you are the most de-risked when you have paid contracts.
The next layer is showing low-churn, high engagement, and high net retention rates. If you show customers are sticking around, are using your solution and are paying more and more, you are as de-risked as you can get for a startup.
2. Team Risk
This includes the founders, advisors and your hires.
Proving that you can assemble a skilled and experienced team with expertise that is relevant to the technology you are building and to the industries you want to tap into is very important.
Having advisors with a track record in the field can also bolster the startup’s credibility and provide valuable guidance. But don’t oversell or name-drop, and do not list a ridiculous number of advisors. You need a handful of solid advisors.
Proving that you can hire and retain employees would be very important, especially in your seed round and after. The key from day zero is building a culture where your team can thrive.
In these three areas, the more ground you cover, to more you have de-risked your team. If you are a solo founder with an idea and no market experience, with no advisors, and you do not have any hires or the right hires, then you have a lot of work to do.
3. Technology Risk
You need to develop a functional prototype, an MVP, or a proof of concept to demonstrate and test the feasibility and effectiveness of the technology. The closer you are to the fully functioning version of the product, the more de-risked your technology is.
If you have never built a functional product (e.g. hardware, software, materials etc.) and think you can build one, you are in a high-risk regime. If you have experience building a similar technology category, you are considered less risky than the first scenario. If you have a live and functional product that has been manufactured/launched and used on a relatively large scale, has been shipped, and has been in the field for some time now, you are pretty much de-risked technology-wise.
4. Competition Risk
Thinking about competition and de-risking it are crucial aspects for the success of any startup. We need to know who your competitor is, even if you think there is none (never say that), and you need to clearly lay out how you currently differentiate or what is your compelling plan to differentiate or gain market share faster than them.
I would note that having competition is not a bad thing. To some extent, having competition is proof of market demand. For deep tech startups as they are making a paradigm shift it is possible that there are no similar solutions but there would certainly be a competing, legacy solution.
The other end of the spectrum is when you are in a crowded space with small and large competitors covering all aspects of the market (aka you are not the first mover) and your solution is not differentiated, you will have a hard time proving anyone whether this is a VC-backable startup or even if it's a good business idea (this does not apply to deep tech startups).
So what does de-risking competition look like? The most de-risked situation is when there is a high barrier to entry to your niche solution/market so that you can grow and create a monopoly.
If you are the first mover or other competitors are legacy players, you have a time advantage until others follow you. That is a great start. You will be the most de-risked if you have a differentiated solution, strong IP (e.g. data, network effect, etc.), IP protection, solid partnerships, and solid unit economics.
5. Sales Risk
Potential challenges and uncertainties that may hinder your ability to generate revenue and achieve your sales targets are the sales risk. If you or your team have some sales experience and industry knowledge, you have sold the product at hand before and you have generated substantial traction and minimal churn, then you are de-risked. However, for most companies, especially deep tech solutions, you are pre-revenue or early revenue and still have a huge sales risk.
Demonstrate your product is not discretionary and you have figured out any potential regulatory and supply chain challenges that might arise. Demonstrate that your team has sales expertise or you have advisors who have the experience. Demonstrate the sales cycle and how quickly you can sell (sometimes this is long, so show how you plan to shorten it) and potentially show multi-year contracts when the sales cycle is long. Show that you have proper unit economics and are not under price pressure from competition to capture the market.
One example of a long sales cycle is hospitals/healthcare. Selling software to hospitals can take months and years of back and forth. If you have not sold to hospitals before and have no sales lead that previously, you are then dealing with a hot white risk. If you are in it now for a couple of years and have been selling to hospitals and have been optimizing the sales cycle, you have then slightly de-risked the sales. If you are doubling/tripling your growth YoY with a growing number of customers and growing contract size, you are getting closer to the cool-blue risk category.
De-risking sales is not easy, especially for deep tech startups with unique and niche solutions. Present a clear sales and marketing strategy and prove it works as much as possible. Demonstrate that your strategy should work with as many data points as you can gather and stay nimble to change course.
You can’t de-risk everything for investors
Remember, you can’t de-risk everything for investors. If you do, then I would argue you won’t need an investor, and you could probably go for debt financing instead of VC money. Try to minimize the risk as much as you can, de-risk the white-hot risks, and turn them into red-hot or even cool-blue risks.
If you have one or no white-hot risks, several red-hot risks and one or no cool blue risks, you are in pretty good shape risk-wise for an early-stage deep-tech startup. You don’t have to do all the work yourself. Find partners, investors, and mentors who help you move away from the white-hot risks toward cool-blue risks.
