On average I see over 1,000 deals per year, DD in more significant detail 10-15, and invest in 2-4. This means there is quite a bit of time spent on deals that didn't make it. But, whether I invest or pass on deals, there is always learning. This post is part of a series on learnings from (un)successful DDs.
Deal economics can break an otherwise very attractive investment
I passed on a quantum sensing deal I watched/DD-ed for 2 years.
- Tech is a fundamental leap forward (trapping atoms in a vacuum using only optical forces while the rest of the world requires electro-magnetism)
- Team proved they can deliver below budget and on time
- Lead VC is quantum-focused
Why did I pass? Deal economics do not work. I target 30x returns for Seed deals. In this case, it means an exit of £700m-1.5bn (post-assumed dilution). I methodically went through all potential addressable markets, competing legacy and emerging technologies, and shaved off any unlikely use cases that can be easily competed away. In the end, the required exit was lower than the addressable market (all of it). From the 3 core markets - a) atomic timing (500m), b) navigational devices (5-15bn), and c) gravitational instruments (4bn), only timing was left in scope in the near term. The lead VC based its conviction on a potential explosion in the 5G/6G telco markets, and assumed a downside protection from a potential IP sale - this was not enough for me. Why did I not see these issues sooner? A number of competing technologies came out recently (limiting the market opportunity) and the term sheet on the round came out only a few weeks ago (limiting the returns). Till now the market looked like it could be 15bn. The DD re-emphasised a few key learnings:
- Deal economics matter even when the team is top-notch and the product is groundbreaking
- Don’t follow the crowd blindly - do your work and stand by a well-informed decision no matter how emotionally vested you might be in the deal
- Take your time if you can and reserve the right to change your mind (and say “no” if you don’t reach conviction)
I walk away with a deeper understanding of the quantum sensing market and a clearer view of what I seek in an investment in this space. I am DDing a deal that addresses 90% of use cases - autonomous land and aerial vehicles. More to come soon - but again, I reserve the right to say “no” if I don’t reach conviction.