Let’s talk about risk. In an earlier column I discussed how investors see, and quantify, the return they expect to see when they consider investing in a company. But we did not talk about how investors view the other side of the risk-reward equation.
Of course, risk is actually quite a complex question. One that consumes a lot of ink – electronic and otherwise – as well as a lot of airtime both in online and formal education. Risk management and risk mitigation are very wide and very widely discussed topics. A comprehensive discussion of either is well beyond the scope of my fairly limited formal training or experience. And certainly, beyond the scope of a column like this.
But I do think it is worth discussing risk in the limited context of how the space sector poses a challenge for the venture investment community. And also, why the sector has, and is, disappointing that community which, in turn, is leading to the sentiment that space companies are not “venture backable.”
First of all, let me describe how I think investors – particularly venture investors – think about risk. Please bear in mind that these are my impressions and that they are generally true – although each individual investment firm will likely have their own specific approaches to this topic.
The first thing to understand, particularly for readers from public sector or public policy background, is that investors expect to take risks. In fact, taking risk is the basis for how an investor expects to make money. Every investor believes that if they can identify risks and “price” them correctly – in ways that other investors miss – then they will eventually be able to sell their investments at a profit to those investors who did not have the same insight. In other words, for an investor, high risk is not a bad thing. But it has to come with the chance of a high reward. This means that the fundamental skill of an successful investor is to learn how to match the risk to the reward.
In general, the “venture” investors, especially, those coming from “deep tech” or “hard tech” backgrounds tend to categorize risk into two main categories: Technical Risk and Market Risk.
Technical risk, fairly obviously, refers to the risk that technology which the target company is trying to bring to market will actually work, and that it will offer a solution that is genuinely a unique improvement over, or replacement for, the solution already on the market. Most tech investors have, or employ, expertise to assess these kinds of risks. The risks that need to be considered include not only an evaluation of the technology, but also an evaluation of the Founder and The Team and whether or not they have the ability to successfully navigate from their concept to a viable product.
Market risk, also fairly obviously, refers to the risk that the company’s technology will not be economically viable. In other words, can the company design a product that customers want, then find the customers to buy enough of it to make it worthwhile. And can they build an organization that can produce the product at sufficient scale to achieve the kinds of results the investor is counting on in their valuation assessment. These are highly non-trivial factors to predict accurately. It is probably fair to say that one of the things that marks very successful venture investment managers is their ability to accurately predict market risk and to provide the right support to the companies they invest in to help them overcome these challenges.
With those two risk categories in mind, I would say that there is a third category of risk that is often not identified explicitly but which is very important in the space sector.
This is execution risk.
By this I mean the risk that even with the best technology and an exciting product and a good plan for making and distributing it, the company will be unable to execute the plan. Now, it is probably true that this kind of risk usually gets considered by any investor, but I think that assessment is often subsumed under the other two risk categories and not considered as a separate topic. After all, basic competence, skill and attitude are definitely part of the due diligence that an investor would perform for any investment.
But in space successful execution requires more than competence, aptitude and attitude. Getting to space successfully, and reliably, requires some very particular expertise and experience. In fact, the need for this experience is often seriously underestimated not only by investors, but also by the founders of the companies they back.
Getting working technology into space – and proving that it can be made to work economically – is much harder and riskier than it looks. This is because the environment if space and the economics of deploying and operating space assets imposes constraints that are not found in other sectors. These constraints are also not obvious if you have not experienced and survived them (or not).
That is why Space Heritage matters.
Here, it is important to note that Space Heritage does not mean simply having flown a certain technology or product and proving that it could be made to work in space. Gaining space heritage is also a matter of testing whether a company has the required expertise, experience, wisdom and insight to navigate all of the challenges of getting a system to space and operating it reliably.
I am fond of saying that, to paraphrase the old adage from military affairs (about weapons and logistics): “in space amateurs talk about technology, professionals talk about process.”
This has always been true about working in space. Effective processes are an absolute requirement to design, build, launch and operate spacecraft reliably. And by “reliably” I mean consistently enough to be able to run a successful business that depends on the successful operation of those spacecraft. Without effective processes any success in space will be fleeting at best – or non-existent at worst.
But the nature of the space business has shifted over the last decade. In today’s space market, to be competitive, businesses need to find processes that are effective and also efficient. The need to combine effectiveness and efficiency is a response to the challenge posed by the “New Space Revolution” – which is really about trying to apply more entrepreneurial approaches to going space to reduce the capital cost and make it more accessible for more types of investors.
I think it is fair to say that this combination of effective AND efficient processes is proving to be elusive.
Some – mostly traditional space – companies are working to take processes they know are effective and make them more efficient. They are meeting with some success. But, they are also finding that some of these processes are so deeply ingrained in their corporate culture that they are not easy to forgo or even modify.
Other companies are trying to start from the efficient, entrepreneurial approach – which relies on nimble decisions and risk taking and eschews the burden of process as much as possible and gradually enough process to ensure reliability without sacrificing they efficient approach to solving problems. These companies are finding that while their processes are more efficient, these processes are not always yielding results which generate enough experience or data to demonstrate their capacity to deliver results reliably. In other words, their specific technologies may seem to work well on the ground, but they have been unable to successfully fly a spacecraft that puts them to the test in space.
The net result is that execution risk is posing a significant hazard for investors. Without the experience of having been to space the average tech investor does not understand where the dangers are, and they also don’t understand why avoiding some of these dangers is, seemingly, much more expensive than it ought to be.
I would argue that the result is that many space companies are significantly undercapitalized because neither they, nor their investors, recognize the nature and magnitude of the risks they face in trying to get their technology working, in space, economically and reliably.
Believe me, that is a topic worth its own discussion. So, I think I will make that the topic of the next column. Stay tuned. As always if you have comments or data that you would like to contribute to this discussion, please contact me through LinkedIn.