The Industrial Future Is Taking Shape. VCs Are Missing Out

On Nov 27, 2022

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The battle to dominate industrial technology is ramping up as government intervention in economies becomes far more prevalent. Investors — once enamored of asset-light firms and high returns — better be prepared to put in billions of dollars towards this, or risk being crowded out.

This isn’t just a reaction to the fallout from Russia’s war in Ukraine and geopolitical tensions between the US and China. The past two years of goods shortages and labor shocks have exposed weak and clunky supply chains across the globe. To ensure we don’t end up there again, governments are bolstering their multi-billion dollar industrial policies to incubate the next generation of hardware, including chips, 5G base stations, electric vehicles, batteries and high-tech machinery and systems.

At the same time, they are drawing in — and incentivizing — companies with the know-how. Big corporates are spending, too. Japan’s industry ministry this month announced it was joining forces with some of the nation’s largest companies, along with International Business Machines Corp., to develop chips for quantum computing and artificial intelligence. Along with the provision of subsidies, Tokyo is seeking more funds to build advanced manufacturing facilities. In the US, S&P 500 firms recently reported record capital expenditures of $222 billion on new machinery, buildings and technology — a sign that they have a positive outlook on future consumption despite fears of an imminent recession. Equipment investment grew at 11% while that on intellectual property rose 7%. The past few years have shown how high the costs of industrial dysfunction can be, and no-one wants to get left behind.

As governments and companies bet on the physical industrial future, venture capital and private equity firms are largely sitting on the sidelines, having been burned on gambles that have either run their course or weren’t grounded in reality. Some are doing smaller deals, but this capital isn’t flowing in a big way into areas like energy storage, grids and mining where it’s needed to solve problems like power and material shortages and waning productivity. For instance, as of 2021, 77% of all VC funding in the US went toward software, e-commerce and cloud companies, while energy and manufacturing accounted for just 4%.

This has been perpetuated because private investors typically stick to pattern recognition when making decisions, backing tried-and-tested businesses with predictable red flags and returns. Meanwhile, they stay away from hard tech because it takes a long time to sell products and is capital intensive.

With soft tech out of favor now, though, there aren’t many options for private capital. Avoiding this cycle of industrial upgrade may prove foolish. Sure, interest rate increases are likely to put pressure on this type of money. But in the long run, investments that relieve pressing issues like the energy crisis and fractured production lines are bound to prove lucrative because there aren’t many affordable ways to fix the problems.

This backing is important. Governments may be good at seeding strategic sectors, but they aren’t as savvy at picking winners or choosing the right technology. Allocating capital over the long-term isn’t their forte either, nor is building and growing business models that work. In addition, the state can’t afford to fund such industrial undertakings forever, especially in tough economic times.

Some long-term investors are trying to tackle the issue. A climate fund founded by Bill Gates recently backed a technology that uses surges of electricity to shatter rocks and ores to reduce energy and emissions at mines, investing €12 million ($12.3 million) in the venture with Robert Friedland’s I-Pulse Inc.

Governments know these ambitions come with massive financial needs. China’s securities regulator recently announced it would allow state-backed firms to issue long-term debt for technology development and innovation. In the US, the energy department’s loan office has been active, funding startups from hydrogen storage to other next-generation ventures. Still, they are constrained in their ability to take necessary risks and assess whether firms can go from proven and viable to profitable.

Without private capital and expertise doing its part, we’re in for many more failed technologies, high costs and frequent shortages.