The Space Reviewin association with SpaceNews

investment panel
Esther Dyson (right) moderates a panel on angel investment at the Space Venture Finance Symposium featuring (from left) Paul Schlosberg, Lee Valentine, and Stephen Fleming. (credit: J. Foust)

The challenges of funding space startups

As has been said any number of times over the years, one of the biggest challenges facing any new company in the space industry, particularly those developing new launch vehicles, is not necessarily the technology but the financing (see “Opening wallets, closing windows”, The Space Review, April 30, 2007). Convincing skeptical investors that the technologies are ready, the potential markets are sufficiently large, and the regulatory issues addressable can be as difficult as the nuts-and-bolts of building the vehicle itself. It’s little surprise, then, that the ventures in the entrepreneurial “NewSpace” realm that have made the most progress to date are primarily those self-funded by a wealthy founder, from Robert Bigelow of Bigelow Aerospace to Elon Musk of SpaceX, among others.

That situation makes last week’s announcement by XCOR Aerospace something of a minor milestone for NewSpace. The company announced that Boston Harbor Angels, a group of individual “angel” investors, had invested in the company, the first such group investment XCOR had received. The size of the investment wasn’t announced, although according to the Boston Harbor Angels web site, it typically commits between $250,000 and $650,000 to a company. That may seem like a tiny amount of money—insufficient to buy even a typical house in some parts of the US—but for a small company like XCOR both the money and the vote of confidence in the company by the angel group can be critical.

The problem for startups is that the vast majority of the capital in the market today is devoted to later-stage investments. “What that means is, the hurdle to get into institutional funding is getting harder, even with more capital coming into the marketplace,” Higginbotham said.

But why is it so difficult for space ventures to get money in the first place? It’s not because there’s a lack of investment in general in the economy: plenty of money is going to ventures in other sectors of the economy. To give one example with tenuous links to space, “personal radio” company Slacker, which broadcasts its programming via the Internet and eventually via satellite, just raised a $40 million second round of financing, on top of a $13.5 million round earlier this year. (To further strengthen the links, and the contrast, Slacker’s senior advisor is Lon Levin, co-founder of XM Satellite Radio and chief strategic officer of NewSpace startup t/Space.) As some speakers noted during the Space Venture Finance Symposium, held last month in Dallas, the challenges range from a scarcity of early-stage funding in general to continued skepticism about the potential of emerging space markets.

The early stage bottleneck

Investment in companies in any sector of the economy spans a wide spectrum. In its earliest stages a company will seek money from friends and family (or, as one speaker put it, FFF, for “friends, family, and fools”). As the company grows, it will seek out larger investments from angels and, later, venture capitalists. More mature, larger companies will attract the attention of private equity firms and investment banks. In those late stages the dollar amounts can get staggering: last month a private equity firm, Cerebus Capital Management, agreed to buy Chrysler from DaimlerChrysler for $7.4 billion.

The problem for startups is that the vast majority of the capital in the market today is devoted to later-stage investments. “There’s this perception out there that there’s massive amounts of private equity available,” said John Higginbotham, retired chairman of SpaceVest. “True statement. But, 99.5 percent of it is available for later-stage situations, the vast majority of it devoted to buying out and restructuring” large companies, including, in recent years, satellite communications companies like Intelsat, Inmarsat, and PanAmSat. Even large VC firms have had to move “upmarket”, putting larger amounts of money into a smaller number of deals, he said.

Because of that shift, there’s actually less money available now for early-stage institutional investments than in the recent past: Higginbotham estimated that the amount had dropped in half, from $2 billion to $1 billion, in just the last five years. “What that means is, the hurdle to get into institutional funding is getting harder, even with more capital coming into the marketplace,” he said.

“There’s actually a lot of people out there who can write fifty and one hundred thousand dollar checks,” Fleming said. “There’s not that many who can write one million, two million, five million dollar checks.”

One VC firm that hoped to bridge that gap was Red Planet Capital. The firm was established to make seed-level investments in companies that planned to develop and commercialize technologies that had relevance to aerospace and space exploration, using funding provided by NASA in a model similar to In-Q-Tel, the CIA’s investment arm. However, as Peter Banks, a general partner in Red Planet Capital, recounted, that effort ran into a hitch when “there were concerns in the federal government, at a high level, about the appropriateness of the government investing in private firms.” By early this year NASA informed Red Planet Capital that no money for the fund would be included in the agency’s fiscal year 2008 budget proposal.

With Red Planet Capital no longer in operation, “this bottleneck area depends very heavily on angels,” he said.

Contrarian angels

So how do you convince angels, either as individuals or groups of them, to invest in a space company? One panel of the Space Venture Finance Symposium tackled that issue, with three of the four participants—Esther Dyson, Stephen Fleming, and Lee Valentine—all active investors in space startups. The fourth, Paul Schlosberg, was an angel investor, but was skeptical of space ventures in general.

“My professional background was dominated by 31 years on Wall Street,” Schlosberg said when asked why he hadn’t invested in space companies. “Wall Street takes a cynical viewpoint, which is, show me the bottom, show me what can go wrong, and the upside will take care of itself.” He added that in this new market, there was no proven way of measuring the risk and return of investing in these companies.

“That’s not to say that I think it’s a completely bad or stupid idea,” he added, “but my role as a contrarian is driven by wanting to tangibly measure what I’m going to make, what’s my risk, and what’s my liquidity. And this area right now violates all of those items. So, in the typical Wall Street fashion, until you show me, I’m going to go someplace else. I’m going to buy IBM.”

Angels who have invested in space companies agree that there can often be a mismatch between angels and companies seeking investment. “Angels like to invest in groups, they like to invest close to home, and they like to invest less than $1 million in total,” said Fleming. “Then you start comparing that to space deals, and sometimes it’s hard to find a group because no one else is as crazy as you are to invest in space, it’s usually in some godforsaken corner of the country like Mojave, which is not close to home for anybody, and frequently they need a lot more than a million dollars.”

He later suggested that there’s a need for angel groups that are focused more on industry sectors than on geography: groups that invest in space companies regardless of location, rather than investing in companies in various industries in a particular part of the country. “There’s actually a lot of people out there who can write fifty and one hundred thousand dollar checks,” he said. “There’s not that many who can write one million, two million, five million dollar checks.”

“You fall in love with your spouse,” said Schlosberg. “You should not fall in love with the investment.”

“Angel investors are more like people who buy football teams,” said Dyson. “They fall in love and they think it’s going to last forever, and they’re not trying to get out.” Because they’re investing their own money into the company, they don’t have to worry about providing a return in a hurry, although, she said, “some day they are going to want to get out so they can go invest in some other foolish thing.”

Schlosberg, ever the contrarian, disagreed. “You fall in love with your spouse. You should not fall in love with the investment.”

The recent investment in XCOR Aerospace may be a sign that you don’t need to fall in love with the company to believe it’s a good investment. After all, it was done by a group of angels based on the opposite side of the country from Mojave. Whether the event is an anomaly or a sign of a changing investment climate for NewSpace companies remains to be seen, but even contrarians like Schlosberg can be hopeful. “I am a huge believer in that if you build it, and build it right, they will come.”