A Hard Tech Renaissance is Happening and Canada Risks Missing Out
Over the past two years, as the tech world emerged from the rubble of the ZIRP crash, an undercurrent of hard tech that has been quietly developing began to rapidly accelerate. And not just around AI. Today, we’re seeing renewed interest in hard tech on a number of fronts:
Global conflicts shining a spotlight on defense tech
A reversal of globalization driving interest in supply chain and energy technologies
A new golden era of space accelerating research into communications, manufacturing and transportation technologies
A growing focus on climate change accelerating research into climate and sustainability technologies
Last week, Y Combinator put a spotlight on this movement in its most recent request for startups, which Techcrunch noted had a significant emphasis on hard tech. At the same time, it seems like every VC who rushed to set up shop in Miami is now tripping over themselves trying to find office space in SoCal.
I left my wallet in El Segundo
Canada has a long, proud history in hard tech and there is no shortage of Canadian entrepreneurs working in these areas today. In fact, many individuals and organizations across the country recognized this shift early on and have worked over the past several years to build support for this country’s most ambitious hard tech founders. Prominent accelerator Creative Destruction Lab, for example, has programs dedicated to space tech, energy, mining, AI, climate, manufacturing, ocean tech and quantum computing (amongst others).
Yet despite all of this support, Canada still risks missing out on the hard tech renaissance for one key reason: a lack of early-stage capital for hard tech startups.
What is Hard Tech?
Let’s start by defining what “hard tech” is.
Hard tech (also known as deep tech) typically describes a category of startups whose product development involves solving significant scientific or engineering challenges.
We’re not talking about B2B SaaS here. We’re talking about technologies for which success is not a foregone conclusion. Technologies for which the underlying R&D is genuinely hard and, at the end of the day, might not actually work.
It’s worth noting that, contrary to popular belief, hard tech does not necessarily involve hardware. While many hardware-based startups fall into this category, a significant number of software-only companies do as well. In fact, it wasn’t long ago that almost all tech was considered “hard”.
When we were building Aster Data twenty years ago, the engineering challenges we had to solve were really really hard. No one had ever created distributed database software designed to run on commodity hardware before. What started with Mayank’s PhD thesis at Stanford (which itself was 5 years of hard work on his part), was followed by 6 months developing a prototype that could only execute 8 hard-coded SQL queries.
But that was enough to convince David Cheriton, Anand Rajaraman, Josh Kopelmen (of First Round Capital) and Ron Conway (of SV Angel) to invest.
After that, it was another year before we had a semi-functional beta version of the product (one that was held together by virtual duct tape and still couldn’t do database joins) and a year more before we had a dollar of revenue. Seriously…this stuff was hard!
But guess what? Early investors weren’t scared to invest in the company. In those days, the first round of funding was rarely enough to get to first revenue. It was par for the course.
Which leads me to suggest an alternate definition of “hard tech”:
Hard tech startups are companies for whom 2 or more rounds of funding are required to generate initial revenue.
Rather than defining hard tech in terms of the underlying technology or the subjective difficulty of the engineering challenges that need to be solved, we can think about these companies in terms of the amount of capitalization required to get to first revenue.
The corollary of this definition?
Hard tech startups not only require angel investors and Pre-Seed VCs who are willing to invest pre-revenue, but also Seed VCs and potentially even later VCs.
The Vanishing Hard Tech Investor
It used to be that most tech startups fit my definition of “hard tech” and most early-stage investors were fine with that. But over the past dozen or so years, things changed.
Today, there’s an entire generation of investors who grew up in the era of The Lean Startup and AWS and all of the other developments that made it seem like every startup should be able to hit a million users or $100K MRR or whatever other arbitrary metric investors deem appropriate within 18 - 24 months.
An entire generation of investors who believe that any company that doesn’t have traction within its first 18 - 24 months is not “VC-backable”.
Let’s be clear: this idea is utter nonsense.
The average life of a VC fund is more than 13 years, with many lasting 16 or more. So it’s simply not credible to claim that a startup which needs 3 or 4 years to get to initial revenue is not VC-backable or won’t exit within the time horizon required by a VC.
In reality, the claims that hard tech startups are not VC-backable is a red herring. What actually happened is that we’ve ended up with a generation of investors who have only ever had to worry about distribution risk. A generation of investors for whom technological success seemed a foregone conclusion: throw enough engineers at the problem and success is all but assured.
Think about that for a minute. There’s an entire generation of “tech investors” who have no idea how to underwrite technnology risk.
As a result, these investors avoid investing in anything that looks or smells like hard tech and retreat to the safety of B2B SaaS, with it’s prolific, easy-to-analyze and widely-available metrics. The “you can’t get fired for buying IBM” of tech investing.
What’s worse? Many of the OG VCs who made their names investing in hard tech are now riding off into the sunset. One of many examples is Foundry, who recently announced that their current fund will be their last.
When we were raising the initial round of funding for DataHero, we were very transparent with potential investors that we likely wouldn’t achieve initial revenue with our first round. We were building the world’s first cloud-native BI platform and that was going to be “hard”. When we walked through our likely development timeline with Foundry’s four partners (Ryan, Brad, Seth and Jason), they didn’t bat an eye at the possibility that we would need a second round of funding before generating any revenue. To the contrary, they led us through a detailed discussion of non-financial milestones that we could achieve to help them to gain confidence about making multiple pre-revenue investments.
Today, it’s hard to find investors like that. Instead, this is more common:
Who’s Going to Write the Next Check?
If VCs around the world are struggling to invest in hard tech, why is Canada in such a risky position? Let’s start with another anecdote:
Several years ago — when I was still living in San Francisco — I was a mentor for one of Canada’s hard tech accelerators. The program’s mentors included numerous Canadian angel investors and VCs, all of whom (presumably) had some interest in hard tech.
One of the companies in the program was a startup that was using hyperspectral imaging to improve the efficiency of mining (back before using hyperspectral imaging was considered cool). The founder had deep experience in the space: he spent years as a mining exec before going back to school specifically to earn a PhD to solve this problem. He was completing his PhD, launching the company, participating in the accelerator and lining up his initial pilots all at the same time.
Suffice to say, as a Bay Area investor, this was an absolute no brainer — despite the fact that the path to actual revenue was likely to be a lengthy one. I commited to make an angel investment in the company halfway through the program. But to my surprise and disappointment, not a single other mentor — angel investor or VC — invested in the company (despite the fact that the founder consistently received feedback that he was one of the best to have ever participated in the program).
The most common refrain I heard as to why other mentors weren’t interested in investing in the company had nothing to do with the founder, technology, or market but, rather, was some form of “I don’t know who is going to write the next check.”
I later came to realize that what this really meant was, “I don’t know who in Canada is going to write the next check.”
Shorly after the program completed, the next checks came:
While it might be easy to dismiss this anecdote based on geography (undoubtedly, some of the investors in the program were legitimately unable to invest in an Australia-based company), I’ve seen versions of this dynamic play out over-and-over again since returning to Canada. And it ties directly to the corollary I shared above:
Hard tech startups not only require angel investors and Pre-Seed VCs who are willing to invest pre-revenue, but also Seed VCs and potentially even later VCs.
In Canada, there are almost no Seed or Series A VCs that are willing to invest in companies pre-revenue. As a result, angel investors and Pre-Seed VCs whose investor networks are predominently in Canada are unlikely to invest in hard tech companies, as they have no line-of-sight to follow-on capital.
I’ve previously written about the fact that Canadian VCs need to get out of Canada. And this is one of the big reasons why.
If early-stage Canadian investors continue to make investment decisions that are influenced primarily by the the availability of downstream capital from other Canadian VCs, any advantage that Canada has in hard tech will soon be lost.
But if more early-stage investors spend time abroad (especially in Silicon Valley), they’ll be able to form a more complete picture of the demand for companies by downstream investors. And they’ll have more confidence investing in hard tech companies that they know will require multiple rounds of funding in order to generate initial revenue.
I’m going back to SF next week. Who’s in?
