By Nicholas Borroz, PhD.
Venture capital is an important source of financing for space firms. Every week, headlines trumpet how it is funding the proliferation of exciting space businesses. VC arguably epitomizes a key difference between the “new” and “old” space industries. It is a high-risk, high-reward approach to financing that aligns with newer firms’ entrepreneurial spirit. One can argue that VC has been necessary for catalyzing today’s renaissance in humanity’s engagement with space. VC is not automatically a wise financing option for all space firms, though. It is like fire –potentially useful, but also potentially dangerous. Many space founders are technological wizards, but this expertise does not necessarily translate to financial savviness. They are vulnerable to using VC unintelligently, in ways that hinder rather than help their success.
Two downsides of VC are obvious, even for the neophyte. First is that you can lose control of strategy, becoming beholden to the all-important valuation multiples that VC funds seek. Any indicator that does not inform valuation multiples becomes of secondary importance. VC funds formalize levers of influence to ensure portfolio firms pursue indicators that matter to them.
The second obvious downside is that you give away stakes in your firm, potentially losing out on payouts later. In exchange for giving financing, VC fund managers will demand ownership in portfolio firms. How much ownership should the fund get in exchange for financing? If you want to increase the value of your stakes, answering this question depends on how much your firm’s valuation will multiply. Remember: most VC portfolio firms do not yield fantastic returns.
VC is well suited towards some types of business. For firms that have large capital expenditures, for instance, and which must spend money before they earn it, VC arguably makes sense as a financing source; good luck taking out massive loans from a bank before earning revenue. For firms whose business strategy involves making “land grabs” to grow their market presence quickly, focusing more on sales than on profits, VC can also make sense. VC may also make sense for firms that are developing transformational technologies with little commercial precedent but which, if successful, will dramatically change the structure of the space industry.
But for firms that are none of these things, it is worth considering if VC is necessary. Think twice about VC if your firm does not require significant capital up front, if you do not want or do not need to rapidly grow your market presence, and if you are not developing a technology that will transform the industry. It may make more sense to pursue other sources of financing – bank loans, government research and development grant programs, or angel investors, for instance. If you do decide that VC makes sense given your business model, approach VC carefully. VC fund managers are in the business of finance. They work day in and day out considering and negotiating transactions. Most space founders have limited experience interacting with VC.
There is an inherent information asymmetry that you must try to overcome when dealing with VC. Do your due diligence. Talk to many VC funds. Compare their terms. Speak to their portfolio firms, both those firms which were wildly successful and those firms which failed to make a splash. Receiving VC is like entering into marriage – if it works out it can be wonderful, but if it doesn’t then you are in for a world of hurt. It’s worth doing your homework before rushing in.
The last piece of advice is this: consider having in-house finance expertise. Someone who knows finance can help you assess whether it makes sense to seek out VC, and how to approach VC intelligently if VC makes sense given your goals. Do not assume that you can learn the ropes by yourself. If you arrogantly overestimate your decision-making abilities, and if you encounter an unscrupulous fund manager, then you’re very possibly dooming your business to failure.
There are several ways to make sure you have such in-house expertise. One option is to include someone with a finance background as one of your founders. This will ensure intelligent financial thinking is firmly entrenched in your business plan from the get-go. Another option is to retain experts as board members. A third option is to simply contract out financial strategy support services. The key element to all these options is you want the in-house expertise to have your interests at heart. If finance experts have an arrangement with a fund where they benefit from you receiving financing from that fund, this would obviously be problematic.
VC is an important source of financing in the space industry, it makes sense for certain types of business models, and it is partially responsible for today’s stunning revitalization of the space industry. This article’s intent is not to demonize VC. It is instead simply to advise founders to be wary. Do not be so starstruck by headlines about VC-fueled success to blindly seek out VC for your own space firm. Educate yourself on VC’s benefits and risks. Approach VC cautiously.
Nicholas Borroz manages Rotoiti, a consulting firms servicing customers in the space sector. He also runs Filling Space, a website that interviews space experts. He recently completed his doctoral studies in international business at the University of Auckland.