The Deep Tech Bubble: One VC’s Exit and a Look at the Industry’s Future
Sidney Scott, a solo general partner at the venture capital firm Driving Forces, has made a surprising decision: he’s shutting down his $5 million fintech and deep tech fund. This, just four years after its launch, throws a spotlight on the evolving landscape of deep tech investing and raises questions about the future of this burgeoning sector.
Scott, who started his fund in 2020 with backing from influential figures like entrepreneur Julian Shapiro and Intel Capital’s Aravid Bharadwaj, highlighted the challenges of operating in a "wild ride" market. He achieved a solid internal rate of return (IRR) of over 30% for his portfolio, which included investments in companies like SpaceX and OpenSea. This performance, while impressive, wasn’t enough to justify continuing.
The "Deep Tech" Shift: Scott’s decision is directly linked to the dramatic shift in venture capital sentiment towards deep tech. "Five years ago," he explains, "most investors avoided hard tech and deep tech in favor of software-as-a-service (SaaS) and fintech." This was partly due to a "follow-the-crowd" mentality, with SaaS seen as a safer bet. Moreover, deep tech investments were deemed risky, demanding significant capital, longer development cycles, and specialized expertise, often involving novel hardware and building technology around scientific breakthroughs.
However, the tide has changed. As Scott observes, "those same reasons are the exact reasons why a lot of companies are now directly investing into deep tech." Fintech investors, who once turned down his deep tech deals, are now raising hundreds of millions of dollars in funds specifically targeting this sector. This influx of capital is fueled by the realization that deep tech, with its potential to solve complex problems, is no longer a niche area but a key driver of innovation.
The New Deep Tech Landscape: This sudden surge in interest has drawn a slew of new players into the deep tech space. Alumni Ventures, Lux Capital, and Playground Global are just a few of the prominent VCs who have raised billions of dollars to invest in deep tech. Indeed, deep tech now accounts for approximately 20% of all venture capital funding compared to 10% a decade ago. Boston Consulting Group (BCG) has even reported that deep tech has "become a mainstream destination for corporate, venture capital, sovereign wealth, and private equity funds."
A Potential Bubble?: While this rapid growth is a positive sign, Scott cautions against unchecked enthusiasm. He believes this surge in capital, combined with the limited availability of quality deep tech deals, is creating a potentially dangerous bubble.
"This wasn’t easy, but it’s the right choice for the current market," he wrote. "The phase of valuation inflation can be sped up, driving up startup valuations rapidly… This impacts the entire ecosystem, causing funding struggles, slower development, and potential shutdowns, which can further dampen investor confidence and create a negative feedback loop.”
A Bullwhip Effect: Scott predicts that this influx of capital will lead to a "bullwhip effect" in deep tech investing. This phenomenon describes the overreaction of investors to recent successes, leading to an artificial boom. With more funding available, inexperienced investors may enter the market, pushing valuations higher and creating an environment where startups feel pressured to perform. If the market shifts, investor sentiment could turn negative quickly, causing a sudden downfall.
Navigating the Deep Tech Future: While Scott’s departure from the venture capital rat race is a personal decision, it serves as a cautionary tale for the industry. The deep tech landscape is certainly evolving, and while the potential for major breakthroughs is undeniable, the current frenzy around deep tech investing merits careful scrutiny. As investors, entrepreneurs, and policymakers navigate this rapidly shifting landscape, a balanced approach is crucial. Focusing on long-term value creation, fostering sustainable growth, and ensuring responsible investment practices will be key to unlocking the full potential of deep tech and minimizing the risks of a bubble bursting.
