Europe’s deep tech1 sector is currently witnessing a significant surge in both innovation and interest, heralding a wave of potential scientific and technological breakthroughs. These developments are building credibility for a vision of Europe playing a leading role on the global innovation stage. Central to this vision is the ongoing debate about European competitiveness, highlighted by the Draghi report,2 which emphasizes the need for Europe to enhance its innovation ecosystem and address investment gaps.
With Europe’s solid research foundation in place for these technological advances, the tangible impact is already evident in the realm of investment. From 2019–23, Europe’s share of the global investment in deep tech leaped from 10 percent to 19 percent.3 This upward trajectory is even more pronounced within Europe itself. As of 2023, deep tech accounts for approximately 44 percent of all tech investments in Europe, an increase of 18 percentage points since 2019.
This surge in technology investment has produced strong returns, particularly for deep tech. Since 2003, deep tech investments have consistently outperformed traditional tech sectors, delivering a superior net annual average internal rate of return (IRR) of 16 percent after all fees and costs, compared to just 10 percent for traditional technology investments.4
There are compelling reasons to be optimistic about Europe’s potential to become a powerhouse in the deep tech arena. Although it largely missed out on the growth in consumer technology that reshaped Silicon Valley, Europe nonetheless can build on its strong foundation of research and technological advancement and its formidable industrial heritage.
Despite this promising outlook, however, it is clear that European corporations are still cautious investors, since around 60 percent of the region’s top acquisitions have so far been made by non-European entities. Addressing and transforming this dynamic is the primary focus of this article as we explore how Europe can build on its deep tech potential.
What deep tech is—and what it isn’t
Deep tech is a dynamic and ever-evolving sector in which some technologies that were once considered cutting edge, such as large language models (LLMs), are now becoming mainstream. Within the constant flux, it has five defining characteristics:
- Focus on large-scale breakthroughs or pressing societal challenges. Deep tech fundamentally aims at delivering breakthrough scientific or technological advancements, such as AI or space exploration, or at providing solutions to some of the most pressing global challenges, such as climate change and energy transitions.
- Global scope. Deep tech ventures typically operate on an international scale in worldwide markets.
- High R&D intensity. Ventures in deep tech have a distinct life cycle characterized by intense early-stage research and development (R&D) and elevated technical risks. Substantial investment is directed toward technology development, often related to hardware.
- Founding teams with advanced technical backgrounds. Deep tech ventures are typically founded by individuals with strong technical backgrounds, often rooted in academia or corporate R&D. The demanding nature of the sector creates high knowledge barriers, resulting in a smaller pool of qualified founders. Compared to traditional tech founders, who usually spend two to five years in higher education, deep tech founders average five to seven years.5
- Significant funding requirements. Initiatives in deep tech generally demand big initial commitments from large and often specialized investors. They also need specialized equipment, facilities, and skills, adding to the costs before commercialization can begin.
Deep tech is segmented into eight investment areas, each marked by recent technological breakthroughs (Exhibit 1).
Deep tech promises higher returns than traditional tech
While the performance of individual funds varies in deep tech and regular tech, deep tech funds have, on average in the years available for analysis to date, generated outsized returns. Investments in deep tech outperform those in traditional tech, producing an average net IRR of 17 percent compared to 10 percent for traditional tech funds (Exhibit 2).6 It will be interesting to see in forthcoming analyses how these numbers evolve as there are more deep tech funds to compare on a like-for-like basis to regular tech, but all numbers available so far credibly point to deep tech as a solid investment theme.
Based on interviews with leading venture capital (VC) investors across Europe, this strong performance can be attributed to several factors arising from the characteristics of the sector7:
- Lower competition. The deep tech sector is less crowded due to high initial investment costs and technical complexity, reducing competitive intensity.
- Founders with significant technological knowledge. The founders of deep tech ventures are typically individuals with strong technical backgrounds in academia or corporate R&D.
- Opportunities in large markets. Among the total addressable markets (TAMs), deep tech typically targets those that are large, underpenetrated, or unpenetrated.
- Higher patent generation. The 40 to 45 percent share of deep tech ventures with patents is more than twice that of traditional tech ventures. This higher patent output could create a financial safety net for investors.
- Unique life cycle. The life cycle of deep tech ventures is characterized by intensive early-stage R&D. The complexity of deep tech during the initial investment phases creates significant uncertainty. However, once deep tech start-ups master the technical difficulties, they are more likely to succeed in commercializing their product than traditional tech companies.
Debunking four common myths about deep tech
Deep tech is frequently shrouded in misconceptions, partly because its life cycle is different from that of conventional tech start-ups. These misconceptions undermine deep tech’s growth. There are four prevailing myths.
Myth 1: Failure rates of deep tech start-ups are much higher than those of other tech start-ups
Reality: The failure rates of deep tech start-ups are, in fact, similar to those of traditional tech start-ups, with some notable differences. They are comparatively slightly higher in their early stages of development but actually lower in the later stages (Exhibit 3). Higher failure rates in the earlier stages can be attributed to high research and technology-development costs as well as the “big swing” nature of the investments in products that often have few analogs or precedents.
In the later commercialization phases, when the technology is turned into a business, the odds of failure diminish for two primary reasons. The first is that markets for deep tech solutions, such as those addressing the energy transition, are typically expansive enough to support multiple players, thereby reducing competitive intensity. The second reason is that the sector benefits from significant investment in technology development, often tied to hardware, leading deep tech ventures to generate more patents than their traditional tech peers. These patents not only act as a barrier to competitors but are also frequently a source of value in their own right, even if the company itself does not succeed.
Myth 2: Deep tech ventures have longer funding cycles and slower exit timeliness
Reality: Again, the facts are much more nuanced. While the funding cycle for deep tech ventures is slower in the early stages, often taking 12 months longer than traditional tech to progress from seed to Series A, that changes as they mature into the engineering and commercialization stages. The funding for deep tech ventures accelerates rapidly from Series B to Series D, often outpacing traditional tech. One analysis reveals that the median time between funding rounds from Series B to D for deep tech ventures decreases from approximately 23 months to 20 months,8 but for traditional tech ventures, it increases from roughly 20 months to 23 months.9
Would you like to learn more about our business-building practice, Leap by McKinsey?
Myth 3: Deep tech ventures are less likely to achieve unicorn status
Reality: There are fewer deep tech than traditional tech start-ups, which leads to fewer unicorns in absolute terms. But recent research shows that deep tech start-ups exhibit a “unicorn ratio” (a measure of a start-up’s likelihood of reaching a valuation greater than $1 billion) of 0.62 percent, which outpaces the 0.54 percent ratio for standard tech start-ups.10
Myth 4: Deep tech start-ups are less capital efficient
Reality: Given the intricate, innovative, and large-scale nature of the technologies involved, deep tech ventures typically demand up to 40 percent more funding to reach the revenue stage than conventional tech ventures (Exhibit 4). Notably, despite their higher initial funding requirements, deep tech ventures demonstrate superior capital efficiency (in other words, the ability of a company to leverage its capital to generate revenue and boost its valuation). The enhanced efficiency can be attributed to a significant share of funding from sources that do not dilute ownership, such as government grants and hybrid debt instruments. These types of funding often come with fewer strings attached, enabling start-ups to allocate resources more effectively toward growth and innovation.
How Europe can capture value from its deep tech ecosystem
European deep tech is becoming more prominent both regionally and globally (Exhibit 5). Globally, the share of deep tech funding for European ventures has nearly doubled, rising from approximately 10 percent in 2019 to 19 percent in 2023. Regionally, deep tech now represents a significantly larger portion of the overall European VC tech funding, increasing from about 10 percent in 2010 to 44 percent in 2023.
This rapid growth is driven by a combination of technological breakthroughs (particularly in AI, quantum computing, and next-generation sequencing) and societal demands (including the urgency to address the climate crisis, energy security, and economic resilience, and the need for European sovereignty in defense and technology).
European investors have lots of untapped opportunity
Europe has robust foundational capabilities in research, manufacturing, and development that can support deep tech growth, but the region has traditionally had a risk-averse investment culture and a fragmented market.11 This aversion to high-risk investments results in weaker growth funding and limited exit strategies compared to its global competitors (Exhibit 6).
Recommendations for European investors in deep tech
To fully capitalize on Europe’s deep tech potential, European VCs and corporates can and should focus primarily on three areas: engaging with the broad deep tech ecosystems,12 adapting VC strategies13 to the deep tech sector, and building stronger partnerships with deep tech start-ups.
Engaging with deep tech ecosystems
In traditional technology realms, the partnership between the founder and the VC (or VCs) is often sufficient. In deep tech, however, VCs may not fully understand the intricacies, nor are they typically equipped to provide the extensive initial funding required (for example, for large-scale physical infrastructure such as building battery plants or constructing production facilities).
Overcoming these challenges requires tapping into two types of ecosystem (Exhibit 7):
- Funding: The funding structure often blends public and private financing and is closely linked to local industry funding, with universities and governments frequently serving both as enablers and financiers. These scenarios often necessitate the involvement of infrastructure investors or specialized debt schemes.
- Enabling: Deep tech companies often need to work with universities that hold intellectual property, professors with relevant expertise, governments that provide funding, accelerators and incubators14 that provide specific capabilities, and corporations that serve as partners.
Strong relationships among stakeholders in these networks are crucial for accessing the specialized knowledge and resources needed to overcome technical hurdles, navigate regulatory environments, and secure funding.
Adapting VC strategies to the deep tech sector
VCs need to apply to deep tech their traditional capabilities in investing in and building up start-ups. But to be successful, they must build additional capabilities. In practice, we’ve found that VCs could benefit from focusing on three key actions:
- Clarify rationale and constraints. Given the excitement about the outsized opportunities deep tech offers, it’s tempting for VCs to rush in with investments. But to be successful, they must be clear-eyed about their reasons for entering the market, their strategy, and their constraints (see sidebar, “Deep tech evaluation criteria for VCs”). This reflection and analysis provide a clear baseline and a useful reference for leaders as they evaluate investment opportunities in deep tech.
Develop expertise in the field. Deep tech founders can be frustrated with the lack of detailed expertise that generalist VCs bring to investment and development conversations. Too often, VCs rely on their generalist knowledge and expertise, which, while helpful, can also create breakdowns in communication, strategy, and trust. VCs need to invest in hiring experts or networking with leaders in the field to provide a baseline of knowledge of the relevant technology.
For example, an early-stage generalist VC firm that builds specialized teams for quantum computing, biotechnology, and advanced materials must ensure that each team includes members with deep technical knowledge and the business acumen to assess markets and technologies. This enables the VC to more effectively bring its own capabilities to bear, such as refining the go-to-market strategy, aligning the product pricing with market expectations, and ensuring that the operational plan supports rapid scaling.
- Build up an orchestration capability. The unique nature of deep tech companies—high initial investment costs and complex technical challenges—requires VCs to rely less on their own capabilities and more on their ability to orchestrate an ecosystem of targeted partners and allies. That includes, for example, co-investing with deep tech funds; establishing a partnership office to configure and manage alliances and relationships with ecosystem partners; developing close relationships and possibly cross-functional teams with technical universities; and collaborating with spin-off VCs or early- and middle-stage VCs to identify potential spin-offs.
- Build stronger partnerships between corporations and deep tech start-ups. As deep tech’s importance increases, corporations must rethink their approach to engaging with deep tech start-ups. Successful partnerships should not only focus on technology but also emphasize holistic engagement—through collaborations, acquisitions, or investments in the deep tech VC ecosystem.15
For Europe, advancing deep tech isn’t just an opportunity—it’s an imperative for strengthening its competitiveness. By building up an ecosystem of partners, from VCs to corporations to universities to governments, Europe has an opportunity to lead the field and build value for the region.
