Failure Analysis of BDCs Deep Tech Fund
I wish my previous article had not been so immediately relevant...
My last article was about learning from our mistakes. That publication was, coincidentally, followed literally the next day by the announcement that two BDC funds were being shut down: IP-back Financing, and the Deep Tech fund.
The writing was on the wall for the Deep Tech fund for some time. When partners leave funds, it is never a good sign. However, the announcement and lack of apparent successors is problematic.
As reported by The Logic, the cancellation was accompanied by a public statement from BDC that reads as follows:
“Overall, this is a normal part of businesses reorganizing themselves to better serve their clients, which included some positions becoming redundant. Like our clients, BDC is becoming more productive, thereby allowing us to serve more clients while reducing our costs.”
Translated for those of us who may not speak corporate, this means that there will not be any public failure analysis.
This is a problem, for all the reasons I wrote about previously, but also because apparently BDC has not deprioritized deep tech and is “working on the thesis and mandate” for a second deep-tech fund. If that is the case, then we need to understand what went wrong with the first version if we are to have any hope for a different outcome in round two.
In this article, I will start the kind of failure analysis I would like to see done for the Deep Tech fund, drawing on the information available publicly and my own experience with deep tech commercialization. An analogous analysis of IP-backed financing will be deferred to a later article.
Investing in Deep Tech
The Deep Tech fund was established only a few years ago as a $200M fund aiming to invest $5M cheques in 15-20 deep tech companies. Originally meant to be a 12-year fund with the possibility of a 4 year extension, closure early represents a major blow to Canada’s commitment to deep tech (or perhaps, an affirmation of its complete lack of commitment to deep tech).
Reading between the lines of the public statements about the closure, it seems the closure was less a failure of the Deep Tech fund specifically as it was a reactionary and counterproductive response to BDC’s severe underperformance as an organization in aggregate, with losses totaling $1B reported in the two years leading up to the announcement. Even so, it is nevertheless worth reflecting on how it could have been done better, in case BDC follows through with the promise of a second iteration.
Timelines
Traditional VC operates on a 10-year cycle, with liquidity requirements starting 5-7 after a fund begins deployment. Deep tech, gated as it is by long development times and research, is often simply incompatible with this model, a model that is optimized mainly for biotech and B2B SaaS.
Investment in deep tech (think fusion energy, quantum computing, artificial general intelligence, autonomous robotics, etc.) requires tolerance to much longer timelines. This leads to a whole host of problems, not the least of which is forced liquidity of promising companies long before they have achieved their full potential. Patient capital is scarce in Canada. Deep tech companies have problems at both ends, struggling to find support to get off the ground, only for the small number that do to run into issues when their development timeline is mismatched from that of their investors.
The Deep Tech fund had timeline problems on two fronts. The first was structural: while 12 years is better than 10, the extra two years would not changed much in the long run. The 4 year extension would have helped, but even then, putting a hard time limit on truly disruptive technology development is always going to run into exceptions. How long have we been working on quantum computing, at this point? Second, the fact that the fund was shut down 4 years into its operational lifespan means we will never find out if that assertion is true, and reflects a fundamental issue with BDC as the parent organization for a fund that aims at creating long-term impact.
If BDC hosts another deep tech fund as their press release indicates, it will be critical to build in a tolerance for low liquidity on much longer timelines even than the first iteration intended, ideally removing the lifecycle requirement entirely, along with removal of any ability for defunding by the parent organization in response to external pressures like election cycles and unpredictable neighbors. Deep tech requires holding investments through the full range of market conditions and across political regime changes. Short term noise cannot play a role in decision making.
In any other investment context, an LP pulling out or failing to come up with capital when their commitment is called upon results in complete forfeiture of their entire stake in the fund. The consequences of failing to follow through on their commitment should be no less severe for BDC, if only for the sake of making such reactionary budget shifts not worth it.
Cheque Size
The BDC fund was designed to write cheques in the $5M range. In my view, this is too large to support emerging technologies by at least an order of magnitude. Canada’s premiere deep tech impact investors, Waterloo’s Velocity Fund, will tell you that most deep tech companies need about $1M to get off the ground and across the valley of death at pre-seed, and most of my research into deep tech funds tied to academic institutions supports this assertion.
Because of the oversized cheque, BDC’s Deep Tech fund had relatively few opportunities that fit the thesis, as most deep tech companies pre-revenue are raising rounds too small to be on their radar. Combined with the lack of deep tech investment in Canada generally, this means that companies have to survive the valley of death on their own before BDC was even able to get involved in supporting them further.
While the opportunities passed upon rarely form part of a fund’s performance metrics and is certainly not a dataset that will ever be made public, I suspect that many promising opportunities had to be turned down as a result of a mismatch between cash needed and the lower limit on BDC’s cheque size. This is symptomatic of the same risk-intolerance that plagues all of Canadian innovation. By insisting on a large cheque size, investments are only made after companies have made significant headway by other means, allowing for reduction of risk at the cost of many potential opportunities.
This is not to say that the $5M cheque size is not important, simply that it is not nearly as impactful as it could be without additional support earlier in the process. Deep tech companies need to raise Series A, too, but without a source of patient capital at a much smaller price point earlier in the pipeline, many companies will have failed, never launched, or left Canada long before the Deep Tech fund could have made a difference.
Any spiritual successor to the Deep Tech fund should aim for much smaller cheques, deployed much earlier in the process.
What Now?
Regardless of the performance of BDC as an organization or any structural issues in the first iteration, loss of the Deep Tech fund is a major blow to Canada’s deep tech ecosystem, as they were widely viewed as an anchor in the deep tech investment landscape. I expect that their absence will have a chilling effect on upstream investment by funds that previously considered them the most likely next investor in the chain, which Canada simply cannot afford.
If I am right in my assessment that the Deep Tech fund was just a casualty of broader efforts to course-correct at BDC, then it is clear that BDC’s risk tolerance is incompatible with deep tech generally, and BDC should ask itself some difficult questions about the unintended consequences of policy whiplash on an already fragile ecosystem before deciding that it is the right vehicle for delivering deep tech innovation.