Financing Startups In Capital-Intensive Industries

Steve Taub, Managing Director, JetBlue Ventures

Steve Taub, Managing Director, JetBlue Ventures

Venture capital has proven to be a very effective way to finance innovation across the entire breadth of the global economy. However, entrepreneurs in capital-intensive, often heavily regulated sectors like aerospace, energy, transportation, semiconductors, and therapeutics often find it’s more difficult to raise the money they need to finance their businesses. These are enormous markets that need innovation to solve important problems, but the barrier to entry can be steep.

The problem is not surprising to people who understand how venture capital works—these industries often need a lot of capital and time to develop their technology just to prove it works, let alone generate any revenue. VCs tend to prefer software companies that can give laptops, pizza and coffee to a handful of engineers who can quickly develop a “minimum viable product” they can sell to prove their value proposition.

The past few years have been an exception to this rule, as companies building electric cars, rockets, quantum computers, fusion power plants, and the like have raised huge amounts of money at high valuations. Unfortunately that door seems to be closing. The stock market decline, inflation, and interest rate hikes have cooled a once-hot market.

So, how can entrepreneurs finance startups in these capital-intensive industries going forward? Experience has shown several ways to make it happen.

With some creative thinking, it’s often possible to come up with a capital-efficient business plan even in a capital-intensive market. Companies can find smaller markets that generate early revenue while they focus on technology scale-up and cost reduction. Air Company, one of JetBlue’s investments, has done this successfully, using their technology to convert CO2 to alcohol to sell as vodka while they develop the technology to make other products. The vodka market isn’t as large as others and it doesn’t do as much for the environment—but vodka doesn’t take years to get to market and Air Company can sell the product for over $100 per liter, which is many times more revenue than what future markets might generate.

“While market conditions are once again making it difficult to finance capital-intensive innovations, creative and flexible entrepreneurs have many paths toward realizing their dreams”

Another approach is to partner with incumbents who have existing assets the startup can leverage. Founders could consider requesting access to another company’s assets or supplies instead of building their own.  This is famously how Tesla built its original Roadster—they started with the Lotus Elise so they didn’t need to invest billions in an entire assembly line, although the final products actually had relatively little in common. Another successful strategy has been to acquire used equipment or even entire car and battery factories, which is usually a lot faster and cheaper than buying them new.

Entrepreneurs can also look for non-VC funding options. High net-worth individuals have funded ambitious capital intensive projects like nuclear power technology or space tourism. The government has a number of programs to finance innovations, like Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) contracts offered by many agencies, or more focused programs like DARPA and ARPA-E.

Smart entrepreneurs have also realized that they can use debt to finance portions of their development programs. Vehicles, machine tools, capital equipment, real estate, computers, and even satellites can be leased or mortgaged instead of paying for them with scarce, expensive venture capital money. Large-scale, first-of-a-kind projects are too risky for project financiers, but once the technology is proven at scale there is an entire market dedicated to financing projects that have predictable, contracted cash flows.

Finally, it may make sense to consider an early exit. Founders can spend time developing and de-risking their technology to the point where it can be sold to a new owner with deeper pockets who can take it the rest of the way to commercialization. This is a common strategy in the pharmaceutical and medical device industries, where companies are often acquired after the early clinical trials show promise but before the expensive large-scale studies needed to gain full FDA approval.

While market conditions are once again making it difficult to finance capital-intensive innovations, creative and flexible entrepreneurs have many paths toward realizing their dreams.

Weekly Brief

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