The concept of space as an investment sector appealing to venture capitalists is only a few years old, but we've seen a substantial change across the funding landscape in a short amount of time. As early uncertainty gave way to confident excitement followed by today’s tempered optimism, both VCs and the companies looking to benefit from their funding have undergone an evolution of their perception of the commercial space industry, or “NewSpace,” and consequent strategy.

Historically, domestic funding for private space companies has come from the United States government through NASA. Startups looking to develop a product, service, or technology could, with a reasonable amount of confidence, expect support in the form of contracts or grants that were, in general, relatively forgiving. While NASA does still provide some grants, the amount of support has decreased over the past several years. The agency's view seems to have shifted to the point where NASA feels that it's taken the required technology development for the commercial space industry as far as is necessary. At this point, NASA believes that the NewSpace sector should be able to grow on its own — primarily through private investment.

NASA's exit from speculative financial support of commercial space may seem a bit hasty, but it's certainly true that many business cases for consumer services are starting to make much more sense. The driving factor behind a viable business case in NewSpace is usually the cost of hardware combined with the cost of launching that hardware into orbit, and that cost has started to drop noticeably — to the point where industries no longer need to rely on government support to deploy useful products and services in space. "Five decades of Moore’s Law means that the same space missions for communications and Earth observation can now be done with satellites the size of toasters," says Rob Coneybeer, managing director at Shasta Ventures.* "Together with lower launch costs, this means that a startup can launch a constellation of smallsats to provide highly useful commercial services for less than $30 million dollars, when the cost used to be billions of dollars for limited utility."

This drop in launch costs does not mean that launch costs aren't going to continue being a major concern. For the foreseeable future, finding room on a rocket (and being able to afford it) are likely to be the most significant obstacles to companies hoping to either deploy hardware in space, or provide services based on anticipated satellite constellations. For most companies, their business models have a baked-in assumption that launch opportunities will increase while launch costs will decrease. This assumption drives how they plan and consequently present their horizon to VCs. In general, it's a safe assumption to make, but companies can develop their models based on wildly different timelines, which can have a substantial impact on their potential profitability.

The risk here, which VCs need to be aware of, is getting caught in a valley of death (or a valley of acute unpleasantness, at least), waiting for launches to get frequent or affordable enough that business model assumptions begin to be reflected in reality. For companies looking for funding, this is a fine line: it's necessary to believe on a fundamental level that the industry will exhibit rapid growth in order to raise capital, but that belief needs to be balanced with a tangible plan that can be delivered on with some certainty. One way to address this is to invest in Moore's Law, adds Coneybeer. "If the business model (such as selling bandwidth) benefits directly from technology advancement at the speed of Moore’s Law or greater, that’s every bit as good as launch costs declining by 50 percent every 18 months. Think of it this way — for the same cost per kilogram of launch, a 2x improvement in bandwidth carrying capacity is the same as cutting the cost of the end-user service by 50 percent. That’s amazing progress, independent of decreasing launch costs."

Forward-thinking VC firms are starting to get much more comfortable with NewSpace investments. It's no longer something too exotic to take seriously; rather, it's just exotic enough, thanks to a little bit of that romanticism that comes with anything related to space travel. A few years ago, only outlier firms were investing in space, but now it's very mainstream — most tech-focused funds with plays in enterprise hardware or other frontier tech (such as virtual reality, quantum computing, or robotics) have already or likely soon will make a space investment. Space investment doesn't necessarily mean investing in hardware, though, and the industry is currently seeing a bias toward investing in data and services, as opposed to hardware, which tends to be more expensive and significantly riskier.

While data and services may be a safer investment for VCs, companies in those segments of NewSpace depend on having reliable operational hardware in space to make their businesses viable. With NASA taking a step back from supporting fundamental research in space hardware, there's an opportunity to invest in companies looking to make a transition from research to product, as long as the timeline to market is reasonable.

The funding landscape is much different outside of the United States. In Europe, the European Space Agency (ESA) and its member governments are just starting to ramp up their investment. Companies in Europe will also be able to benefit from a much longer period of non-diluted funding for early technology development.

Additionally, countries such as Argentina and Costa Rica — to name only a few — are initiating space programs with no historical “baggage.” As a result, they are able to leapfrog expensive arcane satellites and go straight to smaller, efficient satellites and constellations. Their advanced starting point offers the potential to make a great deal of progress in the commercial space sector despite (in fact, in spite of) decades of history.

NASA's belief is that they have set the table for the nascent commercial space industry — effectively seeded it with technology and innovation to the point where NewSpace can grow on its own. But the risk is that NASA's withdrawal from an investment perspective might be premature, providing a distinct advantage for countries with both commercial and government investment. There's a real risk of domestic space companies getting left behind due to the lack of funding for high-risk, high-reward space technology.

This is not to say that there isn’t still investment potential for domestic NewSpace startups. Some segments are starting to get crowded — imaging and Earth observation, for example, is full of companies collecting massive amounts of data without necessarily being able to articulate what needs they're going to be able to fulfill or who their customers are. This is driven by the availability of funding from VCs interested in space but wary of hardware.

We'll likely see a few big winners emerging from that segment in the near future, especially with the application of machine learning and artificial intelligence to the massive amount of Earth observation data that will soon be available. The launch segment has a lot of competition at the moment, but it's also one of the biggest bottlenecks, and is a driving factor in how quickly NewSpace as a whole will be able to mature. Launch innovation is, to some extent, limited by physics, but it's too early to consider that problem solved. And until everyone around the world is connected to the internet, there's a massive opportunity there as well. Many companies are trying to make persistent, pervasive, affordable connectivity a reality, but nobody is actually doing it yet.

At this point, it's likely to get increasingly difficult to raise early stage money in NewSpace, at least for companies reliant on domestic funding. Many VC funds have portfolios that seem to be approaching levels of diversity and exposure throughout different NewSpace segments that will make newer deals less attractive. The overall amount of dollars will probably increase throughout the industry, but the majority will go to later stages of funding. Things may change when the industry starts to see more successful exits, but with a few exceptions, that hasn't happened yet.

In general, the key to attracting VC funding in NewSpace is the same as attracting VC funding in any other industry: find a really big problem, have a unique advantage in solving it, and be able to confidently execute a roadmap toward commercial profitability. "Have an idea with proven end-user demand and a compelling use case," says Coneybeer. "Think of space as a means to an end-user, and not an end in itself."

Where NewSpace differs somewhat, for both companies and VCs, is the importance of having a long vision, and recognizing the inherent complexity and difficulty of the outer space environment. VS

* Shasta Ventures has invested in Accion.