By J. Brant Arseneau, 9Point8 Capital
The space industry is dramatically growing, and some say spending will reach one trillion dollars by the late 2020s. Putting that in perspective, the current largest industry in the US economy is the real estate market with approximately $2.2 trillion in annual revenue, or about 13% of GDP. The space industry at one trillion dollars would most likely put it into the top 15 industries in the US by revenue; a significant contributor to the overall economy and in the same category as real estate.
Although, this growth is currently being driven by several large companies backed by billionaires, hundreds of new startups have been formed by entrepreneurs in the past several years that are seeking opportunities and promising innovation. In fact, there were over 150 new startups in 2019 alone. These startups require funding and space is a capital-intensive business. It requires large amounts of spending in research, development, terrestrial testing, space testing and commercialization.
With all this growth, where will this capital come from and what are the current challenges?
Like the space industry itself, the capital market that supports it is nascent and evolving as the industry matures. Adding this to the recent downturn in the overall economy, space capital will be difficult to secure in the immediate future. Startups did however manage to attract $5.7 billion in financing in 2019, exceeding the previous year’s $3.5 billion. This was largely allocated to the largest companies. Capital sources that are available to other industries, such as Fintech and AI, are not fully formed yet for the space industry. Space startups will need to be creative; their capital journey will be different from other industries for now, but things are evolving.
Developed industries are supported by mature capital markets that supply funding to companies throughout their lifecycle from startup, through growth to maturity. The sources of capital often come from both non-accredited and accredited institutional sources that include bootstrapping, friends and family (FF), angel, strategic, venture capital, private equity, and finally the public markets. Attracting investors at each of the stages begins with demonstrating that a startup has a great team, large potential market, an innovative product, and a way to defend their ground (or go much faster their competitors).
And that’s just the beginning. Moving from one investment stage to the next includes showing investors that the company has demonstrated efficient use of the capital raised to date, and that additional shareholder value was created and will continue to be created in further rounds. Depending on the stage, investors look for certain criteria such as post-revenue for a Series A investment and possibly cashflow breakeven for a Series B investment. Often where candidates are looking to go public, such as IPOs, the market looks for $100 million in annual revenue with 30% growth. These hurdles may vary between industries and business models (e.g. SaaS vs enterprise software).
Unlike the capital supply described above, the space industry has only just begun the process of privatization and is only starting to rely less on government funding. Although a close partnership with government agencies is still vital, the space industry will need its own capital market to fund its exponential growth. In the meantime, capital supply for space startups appear to be disorganized and inefficient. The type of traditional capital eco-system described above is starting to form for the space industry, but investors and entrepreneurs still face many challenges in the near future, including:
- Large capital requirement; building products and services for space is capital-intensive and startups often need a significant amount of capital, compared to other industries, just to prototype and test their products before any chance of revenue can occur. Typical investment sizes at the various traditional stages may need to be increased by both entrepreneurs and investors.
- Delayed financial performance; space companies also need significant capital earlier than most other industries. For example, they often raise an institutional Series A round before any revenue is achieved (see figure above). Raising capital earlier to fund longer development time also delays achieving revenue and growth milestones watched by investors. Traditional investment hurdles used by investors may need to be shifted to accommodate this difference in markets.
- Clogged funding pipeline; there is an early-stage bottleneck problem for startups because that the vast majority of the capital in the market today is devoted to later-stage investments. Traditional capital sources are not equipped to fund early stage, pre-revenue companies, so these companies often are bootstrapped until they get a lucky break or fizzle out; extinguishing a lot of innovation in the process.
- Misaligned venture capital; currently there is a deadlock with VCs, where the majority of the traditional firms that have already raised large funds do not have the expertise or domain knowledge to feel comfortable in the space sector. Conversely the new dedicated space funds with the domain knowledge do not have the track record to raise funds of significant size. As the space market matures these two will come more aligned.
- Lack of risk mitigation tools; there is a lack of insurance for the variety of types of space companies and activities. There is a small market developing for underwriting satellite risk by some of the major reinsurance companies but because there is a lack of event data the premiums are extremely high. Comprehensive insurance coverage for the industry is key for private businesses to transfer the risk that was previously assumed by governments. Until this happens, investors will need to factor the assumption of these risks into their decisions.
- Limited exit history; because the space industry has been serviced by private companies for only a short while there has not been a lot of opportunity for investors to exit their position and realize their investment gains. The lack of exit data disrupts the institutional investors metrics and makes it difficult to benchmark and evaluate opportunities.
- Long investment horizon; initially space companies will have investment horizons as long as 12-18 years, but currently, most venture capitalist typically look to exit an investment in 7-10 years and have their funds setup against that time horizon. This mismatch in horizons will need to be address before VCs enter the market in mass. The investment horizon will be eventually shortened because the road to commercialization will become quicker as more space infrastructure is built out.
- Changing government role; the traditional lead role of the government as “general contractor” and main source of funding is changing and is becoming that of an important customer and a major source of revenue. This may seem like a slight nuance, but startups will need to understand the difference and be able to work with government alongside other customers.
- Economic downturn; while this is not limited to the space industry, it’s worth mentioning considering the current change in the economic cycle. As the economy accelerates to the late part of a cycle, capital for space will tighten and most investors will retreat to the sidelines. Existing startups will need to pull available levers to extend their runways and new entrants may need to reconsider their timing to enter the market. Having said that, truly great ideas often get funded in any market.
- Market sentiment; a bearish, or negative, view of the space market may develop if more mature ventures don’t start to thrive and show financial growth. A negative sentiment can affect the whole market and can slow down capital formation. Large failures can turn sentiment quickly, and with the current bankruptcy of the broadband satellite company OneWeb, the space industry may have some challenges in this area ahead.
An increase in capital may come from the development of alternative financing vehicles such as equity crowdfunding, investment syndicates and new and fresh venture capital firms that bring different approaches to the market that take into account the nuances of the space industry.
As the space industry matures and the capital market that supports it forms, a lot of these challenges will be addressed and will be solved. For now, both startups and investors will need to work harder to find one another and understand the risk reward to each other in a market with little data, less transparency and general market headwinds.