By Maria Lepskaya (Runa Capital), Igor Kotua (Runa Capital) and Ivan Khrapach (Russian Quantum Center)
An abbreviated version of this article was previously published on TechCrunch. This is the full version.

Preamble

“The industrial infatuation with quantum computation is spinning a (qu)bit out of control, fuelling unrealistic expectations and creating a bubble that will probably burst. But even bursting bubbles can be transformational, for what doesn’t kill you makes you stronger. Many early investors will lose in a big way, but some will survive and prosper, paving the way for the brave new quantum world.”  Artur Ekert, one of the pioneers of quantum cryptography and a professor of quantum physics at the Mathematical Institute, University of Oxford.

Quantum hype on lock-down

The year is coming to an end, as well as all the 2021 craziness. Remember how the planet has been flipping between lockdown and freedom since the beginning of the year? Fortunately, freedom has taken its lead, but we all had a great chance to get the notion of superposition. This word may sound fancy, but it simply means being in two states simultaneously.

Believe it or not, superposition is a first-class citizen in a quantum world. Ironically, the quantum market has inherited this property from quantum physics. Is there a hype on the quantum market, you would ask me? Well, it’s a superposition of yes and no.

At the beginning of the year, it was not evident if 2021 would be different for the quantum industry. However, in March, IonQ announced its plan to go public via SPAC – the first IPO of the pure-play quantum computing company. Of course, it attracted a lot of attention to the industry, and by the end of summer 2021,  the amount of VC investments in quantum deals exceeded the same figure for the whole of 2020. This time also coincided with the easing of Covid restrictions around the globe, as if someone finally put an end to a quantum lock-down.

VC investments in the quantum industry will only increase, no doubt. But is it a real technological breakthrough or just a well-played FOMO? Let’s try to figure it out together.

Quantum landscape

Computing

The era of quantum computers started in the 1980-1990s when physicists Paul Benioff, Yuri Manin, Charles Bennett, Richard Feynman, David Deutsch, Peter Shor and Seth Lloyd proposed the first ideas and descriptions for quantum computing machines. However, only about 20 years ago, we saw real progress signs. Today, there is a whole ecosystem of quantum technology startups, including quantum computing (hardware and software), sensing, and communications.

Quantum computing is the hottest field in the ecosystem right now, and it’s easy to understand why: imagine you would have been an early investor in Microsoft or Apple. But why are quantum computers so special? Thanks to quantum physics, these machines could hack the computational complexity of classical computing and tackle problems otherwise, taking thousands of years on conventional devices.

There are many physical systems as candidates to become building blocks for quantum computers – qubits. Superconducting qubits have been perceived as leading because major players like Google and IBM have heavily invested in it. In essence, these qubits are macroscopic circuits printed on a chip, which go quantum when cooled to extremely low temperatures near absolute zero (−273.15 °C). They can be designed at one’s wish and need no trapping but suffer from unwanted interaction with an environment.

Later progress in the research of other candidates resulted in a new wave of quantum computing startups, namely trapped ions and cold neutral atoms platforms. Both of them are naturally good for quantum processors because they are microscopic objects known to have quantum properties for over a century. They have to be placed in an ultra-high vacuum to be controlled individually by advanced lasers.

Other natural quantum particles like photons and electrons are also good qubit candidates. Photons are used in waveguides as flying qubits in quantum photonic computers, operating at room temperature. Electron spin can be manipulated in semiconductor devices called quantum dots. These devices can be printed on a chip the same way as the processor inside your laptop. The difference is that quantum dots will require cryogenics to be useful. Both technologies are catching up and deserve attention.

We have been talking about hardware, which is a bit weird for VCs. But what about software? Every type of hardware needs software, and there is no exception, even for the quantum world. Someone has to write all those fancy quantum software to speed your bitcoin mining. “We have seen rapid progress in the development of algorithms for near-term quantum computers. Coupled with the rapid hardware progress, the world is poised to see exciting developments in the next couple of years,” says Alan Aspuru-Guzik, CSO, Founder at Zapata Computing and Professor at the University of Toronto. But for now, quantum computers are still expensive toys looking for real-world applications. Even though independent quantum software companies are already on the market, specialization is yet to emerge as quantum hardware matures.

“I think we’re far from a proper assessment of the computational power that synthetic quantum systems will unleash. The focus of the industry over the last couple of years has been about a computing paradigm called NISQ, applying the formalism of digital gates to systems (ion, superconducting circuits mostly) that have not yet implemented error correction at scale. On the other hand, I’m convinced that approaches closer to the hardware available, focusing on the precise control of the interactions between the quantum constituents (represented mathematically by the Hamiltonian operator), will lead to new computing paradigms. So-called “Quantum Simulators” are already performing computational tasks in the field of fundamental physics far beyond what supercomputers can do. I expect that the interplay between hardware and software actors will lead to much progress in this field and a widening of the applications that will benefit from this new power.” says Christophe Zurczak, Managing Partner at Quantonation.

Communication and sensing

On the other side of the quantum solutions, there is quantum communication. It is an “antidote” for almighty quantum computations, breaking traditional cryptography. We all have secrets, and quantum communication aims to keep them safe in the post-quantum era. Unlike quantum computing, quantum communications have already shown their efficiency, and there are established market leaders as ID Quantique. Private investments came here first. Why did quantum cryptography start early?

Many quantum cryptography protocols do not necessarily require creating so-called quantum entanglement, which is challenging to realize in practice. In addition, quantum communications use all the advanced achievements of photonics, the birth of which happened before the era of quantum technologies.

Despite early success, quantum communication is an emerging industry that needs to be looked at, as the market may change when universal quantum computers are available. One of the key use-cases for quantum communication is the link between quantum-computing modules. All quantum hardware has a scaling issue, meaning that at some point, they all require to couple different processing units together, and the best way to do that may be through quantum communication modules.

Last but not least is quantum sensing, which stands apart from other categories as it does not revolve around computing. Quantum sensors are tiny devices, which enable precise measurements of electromagnetic fields, temperature, and pressure. There are numerous applications for these sensors ranging from analysis of magnetic materials at the atomic scale (Qnami), space navigation, and biomarkers detection (QDTI) to camera stabilization in your smartphone. Stay tuned for quantum selfies!

Undeniably, there are a lot of categories and prominent applications out there. But every deep tech venture has an inherent risk of not making it through the prototype stage. Sometimes it happens just because it is too early. Remember nuclear fusion? In the 20th century, governments put a lot of money and hope into this technology, but only today is there real progress. So how do we know it is high time to invest in quantum technology?

Market trends are the best indicators we have to judge the maturity of the quantum industry. While they don’t perfectly reflect technological progress, they showcase investors’ willingness to put money into the industry. According to the BCG, in the next 3 to 5 years, quantum computers manufacturers will generate $5B – $10B of revenues. McKinsey expects chemical and pharma industries to be the first potential users of quantum computing, enabling the accurate simulation of larger numbers of atoms and molecules – something that is not possible today using classical supercomputers.

Although quantum technologies seem to be brand new for many VCs, some investors foresaw this movement several years ago and now are making their first quantum exits.

Take a look at IonQ, a US-based manufacturer of ion-trapped quantum computers. The company was founded in 2015, and it went public in 2021 through a SPAC at a $2B valuation and traded at $6B at peak. It made IonQ the first publicly traded pure-play quantum computing company.

Berkeley-based Rigetti also goes public through a SPAC this year. The company is developing a superconducting quantum computer, which already could scale up to 80 qubits. Rigetti will raise $458M at a $1.5B valuation.

Public offerings of IonQ and Rigetti are undoubtedly an achievement of 2021. They set the valuation benchmarks for the whole industry, which impacts the valuations of all quantum deals. But even more importantly, these IPOs show venture capitalists could make money from the quantum industry without significant commercialization of the technology.

There are also other exits, such as M&As, which happened earlier. One of them is Swiss ID Quantique, a world leader in quantum-safe communications and quantum sensing. In 2018, half of the company was acquired by South Korea Telecom for $65M and became a fund returner for Qwave, a sister fund of Runa Capital. Thanks to this investment, we realized the potential of quantum technology early and expanded our investment focus.

Today, a quantum processor is a complicated device requiring a lab environment. This makes cloud access to quantum processors more preferable, which was not possible during the emergence of classical computers. As a result, quantum hardware manufacturers develop their own cloud-based operating systems. Right now, it is hard to imagine someone would build a large quantum OS company as Microsoft did in the 80s. An opposite to Microsoft is Apple, which has both hardware and software in-house (full-stack). “Although technology maturity will still take many years, the future winners in the quantum computing market will be determined in the next two years. We are expecting a first consolidation phase led by the ten leading full-stack quantum hardware players”, –  says Benno Broer, CEO at  Qu&Co. Probably, this is a path the quantum industry may follow, collecting pieces of the stack via startups acquisitions.

VCs are not the only ones who bet on the quantum industry. National quantum programs worldwide have invested more than $9B in the ecosystem across the last 15 years. For instance, the Chinese national project “Quantum Control” already spent $1B for this period; now, they are increasing funding. The European “Quantum Flagship” initiative spent €500M during the last 20 years and will spend over €1B for the next ten years. France stands out across European countries with a €1.8B budget for the “Plan Quantique” in the next five years.

The American continent is also not far behind: Canada already spent $1B for its national program, and the US will spend more than $1.2B in the next five years.

Undoubtedly, governments worldwide understand the importance of quantum technologies and the amount of funding that indicates it. Unfortunately, state funding closes the doors for some VCs who want to invest in “sensitive” sectors. “Sufficient investment to enable quantum startups is currently probably the main bottleneck towards establishing a strong European quantum ecosystem. Efficient, innovative ways to leverage private investment in synergy with government grants will be key to success in translating leading European expertise into leading industrial capacity. We have a window of opportunity we cannot afford to miss in this sense in the next few years.” Tommaso Calarco, Director at Institute of Quantum Control.
For sure, quantum investors should understand the specificity of each sector, and Runa’s quantum startups map could give them a hand in this endeavour.

*map is shown on October 2021

After the early success of quantum communication, Runa’s team decided to study the quantum landscape in more detail. At the time, it was not apparent if the quantum market even existed. We created a map of the quantum startups ecosystem and are now eager to share our findings.

Runa’s quantum startups map is divided into twelve quadrants, each corresponding to particular quantum technology and a stage of startups. We define three stages, including R&D, prototype, and product. The R&D stage is the earliest stage for scientists to build the first operational prototype. There is already something functional at the prototype stage, but usually, it is a handcraft functioning only in the lab environment. Finally, there is at least one fully operational product or service at the product stage that the company can sell to an end customer.

In terms of technology, we divide all startups into four categories: Sensors & Advanced Materials, Quantum Software & Algorithms, Quantum Communication & Internet, and Quantum Computing & Hardware.

We have featured in the map 120 startups with 31% in the product, 47% in the prototype, and 22% in the R&D stages. Surprisingly, there are not so many startups in the R&D stage out there. Due to the affordable grant funding and the specifics of the industry, the origins of which come from university laboratories and R&D centers – often, these spin-offs are in an invisible phase for a long time inside labs and are in no hurry to get out of them. Considering that about 400 laboratories are dealing with quantum technologies worldwide, and a maximum of two startups can spin-off from each laboratory, we can estimate how many quantum startups will be in the future. We anticipate this figure will remain stable in the coming years because the number of labs and the number of scientific groups could not grow out of nowhere. However, the situation may change if a hardware breakthrough drives the new wave of quantum software startups from outside the labs.

Quantum hardware startups with products typically raise the largest rounds relative to other categories. A massive example is a photonics startup PsiQuantum, which raised $650M to date and (fun fact!) has a grandson of Erwin Schrödinger among its founders. Compared to other types of quantum computing, photonic computing requires enormous amounts of capital, especially for optical chips. If it turns out it is possible to demonstrate and sell the first computers using fiber-optic connections instead of chips, this can significantly reduce capital expenditures in the future. There are plenty of concerns about quantum photonic computing, but players like ORCA may change the balance of power in the industry one day.

The second place in terms of funding is taken by quantum software. Interestingly enough, the first two places share a common property – they all have a pretty big “jump” in funding when startups go from the prototype to the product stage. Probably, this fact reflects investors’ expectations of market maturity: if these startups make it to the product stage, there is a big chance they will have a lot of demand. However, the situation is different with sensors and communications, where the “jump” is small. Perhaps, investors don’t have enough conviction about these markets yet.

Not surprisingly, distributions of total fundings and valuations are very similar. Again, the first place is taken by hardware startups. Among them, photonics players make the most significant contribution as, on average, their valuations are two times higher. Probably, photonics is the icing on the cake for venture capitalists. But if you look at it from another angle, the corresponding “jump” of funding is also very significant. Yes, these companies raise more money at higher valuations – but this simply reflects their greater needs for capital rather than extraordinary investors’ excitement.

VCs are not really in favor of quantum sensors and communications. Communications is perhaps the most state-funded category. And when it comes to cybersecurity, governments strive to keep such resources under greater control.

Sensors, on the other hand, do not have this problem. Nevertheless, although there are already practical sensor applications, this market is still not sexy enough for VCs. Sensors have inherited a hardware curse from the general venture capital market. Quantum software that has no hardware to run yet attracts much more capital. “I am thrilled to see that quantum software start-ups are figuring so prominently in total funding and valuation cap. With appropriate software, I foresee that we can use quantum computers to take the role of a ‘programmable molecule,’ allowing simulations to be performed with speeds and accuracies out of reach of conventional computers. Such simulations will be invaluable in the fields of material and chemical design, accelerating the development of, for example, more efficient batteries, catalysts, and solar panels.” says Prof. Dr. Harry Buhrman, founding director QuSoft.

Runa’s quantum startups map provides a spread helicopter view of the quantum ecosystem. But as you already see, this ecosystem is not that big. Quantum startups are still rare species, just like their investors.

The Quantum VC Club

According to Crunchbase, there are about 300 active quantum startups worldwide that have already come from a stealth mode.

Here at Runa Capital, we started investing in quantum startups long before the buzz around them appeared. In 2013, QWave Capital, the quantum-focused experimental sister fund of Runa Capital, made its first bet.

Of course, we are not the only investors in quantum technology, but still, there is just a handful of them around the world. According to Crunchbase, there are only fifteen VCs, including venture capital funds and accelerators, that invested in at least three quantum startups. Together with entrepreneurship and university programs (Creative Destruction Lab, Innovate UK),  incubators (European Innovation Council, AGORANOV), micro VCs (Acequia Capital), investment banks (Bpifrance), government offices (In-Q-Tel, National Science Foundation, SGInnovate) and agencies (EASME) this number increases up to 30.

The undisputed leader by the number of investments is a Paris-based Quantonation, which backed 15 quantum startups to date. Runa and Quantonation have co-investments in French Pasqal (cold atom quantum computing), Swiss Qnami (sensing), and Dutch Qu&Co (quantum software).

*diagram is shown on October 2021

Another noticeable fund is a US-based DCVC with six quantum investments. The firm seems to be more focused on quantum software (BEIT, Q-CTRL, BoxCat, Agnostiq, Horizon Quantum Computing), but also it backed superconducting quantum computer company Rigetti, which is soon to go public. Parkwalk Advisors owns third place in this list having in its portfolio five UK quantum startups: Quantum Motion Technologies, Oxford Quantum Circuits, Riverlane, Phasecraft, Nu Quantum. Runa Capital invested in four quantum startups, and it gives us an honorable fourth place together with HTGF, Oxford Sciences Innovation, Airbus Ventures, Bloomberg Beta and Techstars.

Top accelerators also do not hesitate to invest in quantum technology. Techstars, Plug and Play, Y Combinator, Entrepreneur First have access to very early-stage ventures, which allows them to “catch” startups before others notice them. This is especially beneficial in the quantum industry, with dozens of startups staying in the invisible phase.

Despite all the buzz, quantum investments are still not mainstream. There were about 90 quantum investments in 2021, which is quite close to 2020. The amount of funding is also small compared to other venture-backed industries: $1.4B in 2021 and $0.7B in 2020.

“We are currently creating and investing in a market of “quantum toys” in the form of first-generation quantum computers, but these are critical for finding applications that we don’t know about at the moment. These applications may have an even greater economic impact than those which we already know”, says Serguei Beloussov, Chairman at Runa Capital, Founder and Chairman of the Board of SIT, Founder of Acronis.

For sure, quantum investments are a long-term game, which demands patience, expertise, and commitment. And the situation is unlikely to change soon – generalist VCs certainly could participate in the growth rounds, but the early-stage quantum venture is undoubtedly the destiny of specialist VCs.

Do you have any questions on the article or are you a founder of a quantum startup or a VC investor interested in collaborating on quantum investments? Don’t hesitate to email me (ml@runacap.com ) or Dmitry Galperin (dg@runacap.com).

Acknowledgments

Thanks to Dmitry Galperin (General Partner, Runa Capital), Serguei Beloussov (General Partner and Chairman, Runa Capital), Nicolas Gisin (Co-founder, ID Quantique), Christophe Zurczak (Managing Partner, Quantonation), Benno Broer (CEO and co-founder, Qu&Co), Alan Aspuru-Guzik (CSO & Founder, Zapata Computing), Matthias Winter (Senior Partner, McKinsey & Company), Alex Fedorov (Junior Principal Investigator, Russian Quantum Center),  Konstantin Vinogradov (Runa Capital), Daniil Okhlopkov (Data Lead, Runa Capital), Harry Buhrman (Founding Director, QuSoft), Tommaso Calarco (Director, Institute of Quantum Control), Artur Ekert (Professor of Quantum Physics, University of Oxford), Denis Kalyshkin (Principal, I2BF Global Ventures), Daniel Shaposhnikov (Partner, Phystech Ventures) who reviewed the draft of this article and provided valuable feedback and quotes.

January 26, 2022