THE FOUR HORSEMAN OF SPACE FINANCE
THE SPACE INDUSTRY HAS COME A LONG WAY IN THE PAST TEN YEARS. Not only have key technologies such as launch reusability and 3D printing in space been demonstrated successfully, the nature of space finance has also evolved significantly. Ten years ago, the industry struggled to attract early-stage angel capital. With that problem now largely solved, venture capital firms and other institutional investors have entered the industry in a meaningful way. Despite this, space finance remains perhaps the biggest challenge to truly opening up the high frontier. This begs the question as to why space financing is so hard. Additionally, we can ask how is space different from other industries? And what can we as an industry do about it?
First Principle of Investments
To better understand space finance, it is best to start with the basics about any type of investment. In general, the governing principle is risk versus reward. As the chart below shows, for a higher level of risk, you would expect a higher return. This is why equities typically have higher returns than debt. Since debt holders are paid first, and equity holders get what is left over, the debt holders are in a superior (and less risky) position. For this lower level of risk, a lower return is required.
However, at the upper right of the chart, you can see some anomalies. For example, why would private equity (primarily a US-based invention) have a higher return than emerging markets, which are typically economies that have much more systemic risk? The answer is that while you can buy emerging markets in a mutual fund, you can’t necessarily do that with private equity. Therefore, private equity is less liquid (e.g. you can’t sell it at the push of a button on the open market). This lack of liquidity means that investors need a higher return in order to agree to this.
The Four Horsemen of Space Finance
In the case of space, not only are the investments risky, they are usually illiquid. If that weren’t bad enough, there are two additional negatives that typical space investments have that many other industries do not. They require high capital expenditures (CapEx) and have very long-term horizons for investment payback. Collectively, I call these four challenges (risk, illiquidity, high CapEx and long-term horizons) the Four Horsemen of Space Finance.
High capital expenditures, of course, mean that investors must inject a large amount of capital up front, before a product or service can be created that ultimately generates revenue. If the time horizon for that payback is quick, which would be the case for software, for example, then CapEx may not be that big of an impediment. However, if the payback is 5-7 years or more, there are few investors who would be willing to invest in that type of business plan.
Looking at the four characteristics of space finance – high risk, illiquidity, high capital expenditures and long-term horizons – you might ask yourself, why would anyone want to invest in space? The answer of course is that the potential returns can be enormous.
Given the Four Horsemen of Space Finance, there are essentially four groups of capital available to the industry at this time: benefactors, sovereigns, strategics, and crowdfunding. These each have their positive benefits, but also their drawbacks.
In recent years we have seen the advent of benefactor capital. Entrepreneurs such as Jeff Bezos, the late Paul Allen, and others have put their own capital to work for the benefit of space. While this has had a significant impact on the industry, it remains small in comparison to what is required, and is by definition narrow in scope, e.g. focused on a specific part of the industry.
Sovereign wealth funds are also potentially well suited to space, particularly given their long-term horizons. However, since most of the sovereign wealth in the world has complications related to both ITAR (International Traffic in Arms Regulations) and CFIUS (Committee on Foreign Investment in the U.S.), there have been challenges with this category as well.
There are larger companies in the ecosystem that can afford the long-term horizons and slow payback because they ultimately see NewSpace ventures as outsourced research and development. These are, of course, the larger strategic firms. While this can be a good source of capital for companies, it also puts them on a path of less independence in the future. Many entrepreneurs therefore shy away from this type of capital, choosing instead to go it alone in the capital markets.
In recent years the rise of crowdfunding has had a significant impact on global finance. Essentially these are micro-investments from typically small investors. You can think of a public company as a gateway to crowdfunding in the sense that theoretically anyone can buy shares in as little as one share denomination.
However, the recent rise in crowdfunding is typically through sites and platforms that aggregate small amounts of capital. Kickstarter is perhaps the best known of these platforms but there are many others. While these platforms are interesting and they show promise in being able to fill the gap in space finance, the capital pools are still too small to really move the needle.
In conclusion, if the industry wants to continue on the journey of creating healthy capital markets for space, the Four Horsemen need to be minimized. This will require lowering risk and reducing time horizons by engaging in more industry collaboration and standards. It will also require minimizing the number of companies that fail, and having more examples of companies engaging in successful exits (such as IPOs). Last but not least, creating more retail investor demand for space and ways for retail investors to participate will also be an important next step for the future of the industry.