Europe’s Deep Tech Surge and Its Potential to Unlock Global Innovation

Original article from Mckensey Website

Europe’s deep tech sector is currently undergoing a dramatic transformation, experiencing a surge in both innovation and investment. This dynamic field, which focuses on breakthrough scientific and technological advancements, is positioning Europe to play a leading role on the global stage. The ongoing debate around European competitiveness—highlighted by the influential Draghi Report—has emphasized the need to strengthen Europe’s innovation ecosystem, fill investment gaps, and enhance its research and development (R&D) capacities.

A Promising Landscape for Investment in Deep Tech

The numbers tell a compelling story. Between 2019 and 2023, Europe’s share of global investment in deep tech grew from 10% to an impressive 19%. By 2023, deep tech represented approximately 44% of all tech investments in Europe, marking an 18 percentage point increase since 2019. This upward trajectory reflects the growing confidence in the sector’s potential for generating high returns and spurring transformative advancements.

Deep tech investments have consistently outperformed traditional tech sectors in terms of returns. Since 2003, deep tech has delivered a net annual average internal rate of return (IRR) of 16%, significantly higher than the 10% IRR seen in traditional tech investments. This superior performance is a testament to deep tech’s ability to disrupt industries and drive long-term value.

What Sets Deep Tech Apart?

Deep tech is defined by its focus on large-scale innovations or solving major societal challenges. It includes advancements in fields like artificial intelligence (AI), space exploration, energy transitions, and climate change solutions. Deep tech ventures often operate on a global scale and demand high levels of research and development. These ventures are led by founders with deep technical expertise, typically rooted in academia or corporate R&D.

The life cycle of deep tech ventures is characterized by high initial investment costs, technical complexity, and long development timelines. These ventures require substantial funding and specialized equipment before commercialization can take place. Despite these challenges, deep tech companies often yield significant returns due to their breakthrough nature and expansive market potential.

Investment in Deep Tech: A Key Driver of Innovation

European deep tech’s rise is fueled by several factors, including technological breakthroughs in fields like quantum computing, AI, and next-generation sequencing. These innovations are being driven by increasing societal demands for solutions to pressing issues such as climate change, energy security, and technological sovereignty. European nations, with their strong research foundations and industrial heritage, are well-positioned to capitalize on these trends.

The deep tech sector’s strong performance can be attributed to several factors, such as lower competition and the fact that deep tech ventures often target large, underpenetrated markets. Moreover, deep tech ventures generate a higher proportion of patents—40 to 45% compared to 15 to 20% in traditional tech sectors—providing investors with additional security and long-term value.

Dispelling Myths About Deep Tech

Despite its promising potential, deep tech is often misunderstood. Four common myths about deep tech are frequently cited as reasons for hesitation among investors:

1. Myth 1: Deep Tech Ventures Have Higher Failure Rates Than Other Tech Start-ups
   • In reality, deep tech ventures have failure rates similar to traditional tech start-ups. While early-stage risks are higher, deep tech ventures tend to have lower failure rates in later stages, thanks to large markets and patents that act as a competitive barrier.
2. Myth 2: Deep Tech Ventures Have Longer Funding Cycles
   • While it’s true that the funding cycle in deep tech is slower in the early stages, the pace accelerates as ventures move toward commercialization. Deep tech often experiences faster funding rounds in later stages compared to traditional tech ventures.
3. Myth 3: Deep Tech Ventures Are Less Likely to Achieve Unicorn Status
   • Although deep tech start-ups are fewer in number, they have a higher likelihood of reaching unicorn status (a valuation of over $1 billion) than their traditional tech counterparts, with a unicorn ratio of 0.62% compared to 0.54% for traditional tech.
4. Myth 4: Deep Tech Start-ups Are Less Capital Efficient
   • While deep tech ventures require higher initial investments, they are more capital-efficient in the long term. This efficiency is driven by funding sources like government grants and hybrid debt instruments, which do not dilute ownership.

How Europe Can Capitalize on Its Deep Tech Ecosystem

Europe’s deep tech sector is gaining global prominence, with the region’s share of global deep tech funding nearly doubling from 10% in 2019 to 19% in 2023. Regionally, deep tech now represents 44% of Europe’s venture capital (VC) tech funding—a significant increase from 10% in 2010.

However, despite Europe’s robust capabilities in research, manufacturing, and development, the region has traditionally been hesitant to make high-risk investments, resulting in a fragmented market and limited growth funding. European deep tech companies still face challenges scaling up and achieving successful exits compared to their global competitors.

To fully realize the potential of Europe’s deep tech ecosystem, three key actions are recommended for European investors:

1. Engage with Deep Tech Ecosystems
   • Deep tech ventures require specialized knowledge and significant initial funding, which is often beyond the capacity of traditional VCs. To overcome this, investors should tap into two types of ecosystems: funding (combining public and private financing) and enabling (working with universities, governments, and corporations). Building strong relationships with these stakeholders is critical for accessing the resources needed to navigate regulatory environments and technical hurdles.
2. Adapt VC Strategies to the Deep Tech Sector
   • Traditional VCs must adapt their strategies to the unique nature of deep tech. This involves developing expertise in relevant technologies, hiring specialized teams, and building an ecosystem of partners and allies to support deep tech ventures. A holistic approach to funding and development will enable VCs to effectively guide these ventures through the complex technical and commercial phases.
3. Build Stronger Partnerships with Start-ups
   • For deep tech to thrive, corporations must rethink their approach to engaging with start-ups. Successful partnerships should focus not only on technology but also on holistic collaboration—through joint ventures, acquisitions, or investments in deep tech VC ecosystems.

Conclusion: Europe’s Opportunity to Lead in Deep Tech Innovation

Europe stands at a crossroads. The rapid growth of its deep tech sector presents a unique opportunity to lead the global innovation landscape. By fostering stronger partnerships, adapting investment strategies, and leveraging its research and industrial capabilities, Europe can solidify its position as a deep tech powerhouse.

As the sector continues to expand, European investors and corporations must embrace the transformative potential of deep tech. The path to success lies in collaboration, strategic investments, and a commitment to overcoming the technical and financial challenges inherent in this high-risk, high-reward sector. By doing so, Europe can not only capitalize on its deep tech potential but also set a global example of how to build a thriving innovation ecosystem in the 21st century.