Why Do Investors Invest in R&D Startups?

As a Venture Capitalist, Strategic Investor, and Public and Private Funds manager, one of the most critical factors one considers when evaluating companies is their ability to stay ahead of market trends and remain relevant. The relevant entities in any industry understand that increased market participation, cost management benefits, advancements in marketing abilities, and trend-matching are all reasons companies invest in Research and Development (R&D).

R&D measurement service and custom sensing solution are one of the main activities that we as RVmagetics do. Being a startup founded in 2015, we have now had a very condensed experience with entities that aim to invest in niche R&D efforts (specifically strategic investments), and now that we have a certain overview – we find it relevant for the like-minded companies and investors to see the environment from our perspective as well. This article can be a short documentation of the current learnings we have had, which we will look back to, and update in the future.

Generally, the Answer Seems Obvious:

But let’s still identify the common truths, that through R&D, companies can gain innovative insights that can help them improve their products and processes, reduce costs, and increase profits. These insights can help companies identify and take advantage of new opportunities, overcome market challenges, and maintain a competitive edge.

As a Strategic Investor or anyone managing a fund intended for R&D investment, one already understands the valuable ROI from R&D. Companies that invest in R&D can create a sustainable competitive advantage, drive innovation, and stay ahead of market trends. These companies are more likely to attract investment and have a greater chance of success in the long term.

So in general an investor invests for a variety of reasons, but the primary goal is usually to make a profit or to increase their wealth. This applies to a firm or a fund as well – making sure the spent resource serves the goal of getting a higher return from an initial lower investment. Here are some of the most common reasons why investors invest:

• Building their wealth: Investors may also invest in order to build wealth over time. By putting their money into investments that have a history of growth, they can accumulate more assets and increase their net worth.
• Achieving certain financial goals: Investors may have specific financial goals, such as saving for retirement, paying for their children's edu­cation, or buying a home. Technically this is slightly different from the above, as it doesn’t aim to make one rich, but to achieve a specific financial goal over a specific period of time, while spending the least amount of resources possible.
• Diversifying existing portfolios: Some investors may invest in order to diversify their portfolio, spreading their money across different types of investments in order to minimize risk. Some VCs / Investors might treat investing as a carefully calculated betting strategy – the more diverse and high-in-volume are their portfolios, the less is the risk. This includes securing Intelectual Property an Patent acquisitions as well, as it gives the “petter” a higher position of power, thus better odds
• Value-based (supporting a cause): Some investors may choose to invest in companies or funds that align with their values or support causes they care about, such as environmental sustainability or social justice. The cause does not have to be all that altruistic – it might be a focused investment to solve an own challenges – should the challenge be big enough, and should the startup undersell the solution – the profitability of this investment has the chance to get high as can be.

In Case of R&D

Investing in R&D can be challenging and costly, but the benefits are significant as we have showcased in a variety of our previous notes, articles, and most importantly through the work RVmagnetics does. Companies that invest in R&D can create new and innovative products that meet consumer demand, increase efficiency and streamline production processes.

Furthermore, R&D efforts can lead to deductions and credits that can reduce a company's cor­porate income tax. This means that not only do R&D investments help companies remain competitive and relevant, but they also help them reduce their tax liabilities.

Investors often invest in Research and Development activities because they offer the potential for high returns on investment specifically in a niche field of creation of something new, or exponentially upgrading an existing solution. Here are a few reasons why investors might choose to invest in these types of companies:

• R&D comparative growth potential: R&D companies and startups are often at the forefront of innovation and have the potential to develop new technologies or products that disrupt existing markets. This means they may have a higher growth potential than more established companies.
• Early-entry to market: Investing in a startup or R&D company can offer an opportunity to get in on the ground floor and potentially see higher returns as the company grows.
• Diversification: Including investments in R&D companies and startups can help investors diversify their portfolios and reduce overall risk by investing in a range of different types of companies and industries.
• Intellectual property (IP) and patents: R&D companies and startups may have valuable intellectual property or patents that can provide a competitive advantage and potentially lead to significant returns for investors.
• Value-based approach: environmental sustainability, and social, economic impact are other drivers for R&D investments, as the motivation is a little more direct and clear both at the end of the R&D investor and R&D provider.
• Tactical reasons: – not caring about winning their own advantage but preventing competition from winning their competitive advantage. Or just getting more insight (see behind the curtain, with no intention to buy at all). Or if a startup is somehow competing with their own technology – either keep them busy for a while (to slow them down) or
  • Buy-to-shut
  • Buy a missing puzzle (1+1 = 3)

A few notes to the above: no matter the industry, clearly knowing the niche goal is the only way to have an R&D process as fast and inexpensive as possible. R&D is known as expensive and slow, this is not necessarily wrong, however in a lot of cases, the definition of the goals and processes the R&D activity wants to achieve is a main factor contributing to slowing down (and thus increasing the cost) of the R&D effort.

In our experience we have had the smoothest, fastest and most effective solutions of MicroWire technology – where the use case had a specific problem to be solved, or a clear added value to be reached – this in fact does not only refer to the technical, but also the economical definition of the use case, as where there is a valuation of a problem there is a possibility to justify an investment.

Overall, it is never lost on us that investing in R&D companies and startups can be a high-risk, high-reward strategy, however if our clients and partners do not succeed, neither will we (especially as a supplier of our own sensors). Investors who are willing to take on more risk may be attracted to these types of investments because of their potential for significant returns, and we at our end are attracted to the potential of the technology by the value MicroWire can add, especially in a long term cooperation.

Why Investors Keep Investing in Your Solution?

Let’s first clear out what are the main dealbreakers in R&D investing that might stop the investment coming in.

The investor landscape is constantly evolving, and in recent years, there has been a shift towards seeking out solutions that have already been validated by clients, partners, revenues, awards, transparency, and founders. This marks a departure from the previous focus on promising ideas in the IT sector, as even industry giants like Microsoft and Meta are no longer on the rise. The combination of war, inflation, and uncertainties in global supply chains, coupled with the collapse of Silicon Valley Bank, has made investors more cautious and conservative.

As a result, startups looking to secure funding need to demonstrate a track record of success and prove that their solutions have been tested and proven in the market.

So finally, when embarking on /especially/ an R&D-heavy approach, there are several challenges that an experienced investor should be prepared for, to keep the portfolios afloat.

Firstly, obtaining funding can be difficult, particularly for service businesses without collateral. This can take up a lot of time from the founders, reducing contact time with the operations, team, and clients.

Secondly, commitment and focus are essential for R&D efforts to pay off, and it's important to properly incentivize the people involved. R&D talent is neither, cheap, nor fast to find – thus creating the relevant team, and being able to trust the R&D leads in their responsibilities as well as organizing the work of R&D limited staff to be able to handle the right amount of projects simultaneously – is a task of utmost difficulty, high responsibility and clear feedback from the success of projects. Is it the investors’ job to put together the team – No, however, the team factor has one of the most direct influences on the investor’s decision to keep the investments up – again, bet the jockey, not the horse.

Thirdly, clear KPIs should be established, and projects should be given enough time to develop naturally, but not allowed to drag on for too long. Cash flow management is also important when growing a business, and hiring needs should be anticipated ahead of time. Despite these challenges, investing in R&D is a smart choice. For some businesses, R&D is part of their DNA, and they see opportunities where others see problems. Pursuing R&D projects can refine processes and fix broken workflows, ultimately allowing companies to do things cheaper and better. R&D keeps businesses fresh and dynamic and is a game-changer that tests assumptions and interrogates new ideas. Whether it's building something brand new or simply evolving to survive, R&D is always worth considering.

Investment is however not only in the form of Investors interested in R&D startups are financial, but also strategic inputs and the time spent on a startup, especially an R&D startup with high-potential, and need for strategic guidance. The general flexibility in this sphere is relatively low on pro-rata investment rights, liquidation preferences. There is often the needs and expectations on anti-dilution rights, as well as on the vesting of the founders’ equity, the company’s valu­ation, and board control.

Pro rata rights are often considered supreme, because they allow investors to acquire an additional stake in a company, which is often seen as the biggest source of returns. Investors are more flexible on the option pool, participation rights, investment amount, redemption rights, and dividends, which have a smaller effect on potential returns and hence are more likely to be negotiable.

Once investors interested in R&D startups have put money into a company, they become active advisers. They interact substantially with 60% of their portfolio companies at least once a week and with 28% multiple times a week. They provide a large number of post-investment services, including strategic guidance, connections to other investors and customers, operational guidance, help hiring board members, and help hiring, especially valuable employees. Intensive advisory activities are the main mechanism investors use to add value to their portfolio companies.

The feedback from startups (green flags):

Translating the day-to-day work on the ground, into the general overview: an IR department (or in many cases the responsibility for IR) shall be able to communicate the day-to-day activities of engineers, manufacturers, designers, etc. into the language understandable for a non necessarily technical audience. Call it an IR responsible or an Investors’ Communications Manager – the idea remains the same – there needs to be trusted contact point having a firm trust, not only from the investors but also from all the stakeholders and internal personnel across departments .

Communicating strategies and strategic changes is crucial, and transparency and consistency are essential to building credibility. An Investor Relation responsible must have clear, straightforward answers to investors’ questions and explain metrics and signposts investors should use to monitor progress against the plan. Especially in R&D strategies tend to change based on important findings regarding the technology, parts, environmental conditions, and so on – naturally, the potential outcome, necessary investment volumes, and engagement from different stakeholders might need to be adjusted – which an investing body must present to with their important input (this in fact goes both ways, should an investing body need to apply strategic changes to a project).

Accummulative focus on the Success of the Company, The Tech and the Client If the management board of a startup is pushing the internal notion of the prioritization of the client’s needs, the improvements of the own solutions (the tech, the R&D service, etc.), as well as achieving the general growth potential of the startup – it can be considered a big green flag, which should be nurtured and encouraged at each stage of the company development further down the line. The most important thing is for all employees, departments, stakeholders, from each level to fully grasp the company's overall plan and how their individual roles fit into it. This understanding allows them to make informed decisions that benefit their specific work environment. As a result, employees become knowledgeable workers whose success is measured by the quality of their output, rather than how much they produce.

Conclusive part after the identification of aforementioned main challenges to look out for, and the relative feedback from the startups is that Investors interested in R&D startups look for companies with the potential for big exits, which can generate a 100-fold return on their investment. As such, they focus on finding companies that have the potential for big exits rather than on estimating near-term cash flows. Investors interested in R&D startups are most concerned about the management team and how it can contribute to the success or failure of their portfolio companies. To ensure that the entrepreneur hits specific milestones and reaps monetary rewards, deals are structured in a way that allows entrepreneurs who hit specific milestones to retain control. However, if they miss those milestones, investors may bring in new management and change direction.

Noticeable Red Flags in the Industry

In our experience, as well as from the reference of similar startups, strategic investors in various industries and sectors of high-demand R&D (Aviation, Automotive, Healthcare, Civil Engineering, etc.) – we have managed to gather insights on what are some of the main notions and practices to stay away from – both as a firm, startup, investor or governmental body – in order to have a successful R&D activity .

• Ignoring the „primum non nocere“ – first, do no harm. This classic medical definition smoothly slides in here too.

  For the party providing the R&D service – it is utterly important to not overdo, overcharge, focus on the specific part of the solution while forgetting the bigger picture, or to accidentally create an “ego of the idea” when the success of the idea becomes a higher priority then the success of the project or a product.

  For the investor, doing harm might be in the form of micromanagement, a spreadsheet-based invasive approach, not distrust or miscommunication with the engineers and scientists responsible for the R&D project, pushing a solution over its limits, etc.

  Here, we have an experience of the Customer Flow being longer and more complex with especially big corporations, working with different processes, set up business cultures, different time zones – makes our Startup ability for fast delivery of difficult solutions – konger than anticipated. This often contradicts the notion that time/resources battle are going to be agile when working with a startup.

  There are surely more examples of doing unnecessary harm, none of them have a motive of harming the project, but the opposite – thus all the parties involved should have expectation setting and checking to make sure they at lease, are doing no harm to each other’s operations

• The „Fast, the Cheap, and the Good“ concept is often touted as the ideal way to approach any project. However, when it comes to research and development (R&D), this concept is not applicable. This is because R&D is a complex and multi-faceted process that requires a significant investment of time, resources, and money.
  • In R&D activities, can hardly ever be the most critical factor. Instead, it is essential to focus on accuracy and thoroughness to ensure that the research is conducted properly and produces reliable results. Rushing through the R&D process to achieve faster results can lead to a waste of resources and potentially damage the involved parties’ reputations.
  • Similarly, R&D cannot be undertaken cheaply either. It requires specialized equipment, and skilled personnel, and often involves extensive testing and validation. Attempting to cut corners or skimp on resources can lead to subpar results, which can hinder the success of the project in the long run.
  • Lastly, R&D cannot always produce immediate results or guarantee that the end product will be good. This is because the R&D process is often iterative, requiring multiple rounds of testing, modifications, and improvements. It takes time, effort, and resources to develop high-quality, innovative products that meet the needs of customers
• Complete and utter clarity of outcome: because R&D is not usually Cheap or Fast the investing entity wants to know that the investment will be successful, rightfully so of course, however, an investing entity should also be mindful if a complex R&D provider gives complete guarantees over outcomes of the Research and Development effort. The single conceptual definition of research is the activity of finding an unknown, thus guaranteeing an R&D outcome would have to come with a redefinition of the term Research & Development, to the term Documentation & Development.

  Our experience shows that cooperation in R&D is most successful with clear definition of the goals, and often checking (and if necessary, re-definition) of these goals – to make sure no resource is wasted, or often, to make sure no resource is wasted any longer. The proper expectation checking gives the opportunity to clarify or adapt the outcome on the go.

Summary

To conclude, Investor relations (IR) initiatives play a significant role in bridging the gap between management, R&D leadership, and shareholders, and must continually strive to serve the interests of their organizations, as well as shareholders. Effective IR requires transparency, consistency, and dialogue that focuses on identifying gaps in perspectives and discussing them directly, in a fact-based, well-supported manner.

No need to think of this in a framing of a strict, corporate, milestone/spre­adsheet-based approach, as the concept of Investor Relations easily translates to a Startup with a team of 2, as well as to a scaleup with a team of 50+ full-time employees. A n investor, especially one focused on R&D is a ready for action one – coming in with high expectations not from short-term low rewards, but for long-term big exits.

An R&D service provider, especially a startup – is looking for strategically aware stakeholder, both internally and externally. A successful one considered the needs of clients, the development of quality of their services and the overall company growth (Investment Validation) into one platform of high priority.

In our experience, this kind of transparency in strategies, and effective solutions to their challenges is what motivates our strategic investors to initiate their talks, further interest and eventually the secured investments.