Sidney Scott, the solo general partner of Driving Forces, recently made a surprising announcement on LinkedIn. After four years of navigating the venture capital world, he decided to shut down his $5 million fintech and deep tech VC fund. Scott cited increasing competition for a limited number of hard tech and deep tech deals as the primary reason for his decision. He acknowledged that while his first fund had performed well, the challenges faced by smaller funds like his made it difficult to compete in the current market.
Scott expressed gratitude to individuals such as entrepreneur Julian Shapiro, neuroscientist Milad Alucozai, and others who had supported him throughout his journey. He also highlighted his involvement in building the first AI and deep tech investor network with Handwave, collaborating with investors at prominent companies like Nvidia, M12, Microsoft’s Venture Fund, Intel Capital, and First Round Capital.
During his venture capital journey, Scott made approximately two dozen investments in companies like SpaceX, Rain AI, xAI, and Atomic Semi. The total portfolio yielded an impressive net internal rate of return (IRR) of over 30%. This solid performance surpassed the average deep tech IRR of 26%, as reported by the Boston Consulting Group.
Reflecting on the past five years, Scott noted a significant shift in investor preferences. Previously, most investors favored software-as-a-service (SaaS) and fintech over hard tech and deep tech. However, the landscape has changed, with many companies now directly investing in deep tech. This ironic shift is driven by the realization that deep tech offers unique opportunities despite requiring extensive capital, longer development cycles, and specialized expertise.
Scott observed that fintech investors who had previously rejected his deals were now raising hundreds of millions of dollars specifically targeting deep tech. Notable VCs heavily involved in deep tech include Alumni Ventures, Lux Capital, Playground Global, and Two Sigma Ventures. Deep tech now accounts for around 20% of all venture capital funding, up from 10% a decade ago, signaling its mainstream appeal to corporate, venture capital, sovereign wealth, and private equity funds.
While Scott acknowledged the influx of capital into deep tech, he expressed concern that many newcomers may face a rude awakening in the next three years. The rush into deep tech investing has been swift, creating a typical VC inflation cycle where valuations soar, making it increasingly expensive for solo funds like his. Despite the challenges faced by the broader startup ecosystem, deep tech has experienced successes in areas like robotics and quantum computing.
Scott anticipates a “bullwhip effect” in deep tech investing, with early-stage investors and VCs attempting to replicate prior breakthroughs or high-profile successes. However, this could lead to unrealistic expectations and significant pressure on startups to perform. Venture capital is prone to cycles, and if market conditions shift, investor sentiment could quickly turn negative.
Given the small pool of experts and builders in hard tech and its capital-intensive nature, valuation inflation can occur rapidly, driving up startup valuations. This can have detrimental effects on the ecosystem, including funding struggles, slower development, potential shutdowns, and a decline in investor confidence.
Scott’s decision to step away from the venture capital rat race highlights the challenges faced by smaller funds in an increasingly competitive landscape. While deep tech continues to attract significant investment, there is a need for caution and a focus on sustainable growth to avoid potential pitfalls in the future.