Third Sphere New York Climate Week 2023
Full video presentation and searchable transcript below. Get the deck here.
So this is how we sort of see the relationship between impact and ultimately funding startups.
We think that if you’re going to have rapid change, you need things that can grow quickly.
I think the first person that sort of articulated that very clearly, I think, is Mez.
I can kind of see where he’s sitting.
And that’s what makes sense to us, is that there are some things in technology which can go very, very fast within like 10 years.
And that’s what we’re interested in.
Our team is growing.
I think some of you met us when it was Stonely and Sean Show.
I really shouldn’t be the person speaking, it’s just I was the last person working on the slides.
So that’s how we delegate.
But yeah, I kind of an unusual mix of backgrounds.
The way we like it, we consider ourselves to be a low consensus team, because at the stage that we invest, it’s very hard to know what’s going on.
So someone has high conviction and the rest of us just try not to veto.
And so we’re about 10 years and about a hundred early stage investments.
And then a lot of the credit for making lists like Fortune and Tech Punch goes to my team.
I’m generally not on those lists, fortunately.
But yeah, I think we have done a good job working with founders.
There’s a few folks that can object.
See some of them sitting in the audience.
And this is how we think about impact.
So we’ve invested across, obviously, lot of mitigation.
We were interested in obviously reducing the amount of greenhouse gases, but from the beginning we worked on adaptation and resilience.
We didn’t view that as giving up, we just viewed it as necessary.
And so for anyone who’s looked at sort of article nine taxonomy in the EU, we’ve invested across pretty much every area of that taxonomy.
And just a level set on scale of avoided carbon.
It’s about a year of Apple emissions from their peak, which I think was 2015.
So not insignificant, we’ve got work to do, but like Apple scale is nice.
It’s a relatively modest AUM.
I think we manage about $140 million, not a trillion.
So that feels pretty good.
And then the way we organize, we have, you know, we’ve built We do a lot of introductions.
I think a lot of you are on the receiving end and you showed up, so I consider that to be good.
I guess those are good introductions.
We have a credit platform, and I think by the end of this, that will be clear as to why we made that decision.
And then we’ve spun out a few things along the way.
So I think our default for our team, we’re all product people.
I think we sort of follow the patterns around and say, what do you need?
If we don’t have a person to email, we build stuff.
And so that’s why we have so many pieces, including things that we’ve swung out.
All right, so what is design for finance?
This is unfortunately still reality, right?
So if you believe that startups are going to have outsized impact, there’s a lot of things you can do to help founders, but raising money is still a big issue.
And so we kind of spend time over tenure, We run an accelerator.
We start a credit fund.
And it feels like the unlock that we have to solve if we want to increase the probability of success of all the great folks that we meet at the very early stage.
And so the inspiration for this is, [NON-ENGLISH SPEECH] Like no one set out with the best of intentions to have their chair look like this.
But this is kind of what happens with a lot of startups.
is you set out and then you wonder after your five why your cap table is a mess and you can’t raise or you can’t borrow money.
Right, and so it’s not the intention, it’s just there are ways to help people not make mistakes.
And that’s the central idea.
We are not trying to reinvent anything, it’s not a breakthrough idea, it’s literally just trying to use the things that are there and avoid mistakes.
The more elaborate version of this is there are ways that have nothing to do with the end customer to make things better, faster and cheaper.
And so again, there’s lots of interesting design, there’s user experience, there’s lots of parts of design and building a startup, but there really isn’t enough, in our opinion, especially for climate, on how to design for finance.
And so simple example for model three, We talk a lot about battery prices.
Those things are very important, but going from 170 R pieces to two is certainly a way to make better, faster, and cheaper hardware.
And so this is the fun cap table part, and I’ll spare you all the details, but if cap tables work the way we all hope they do when we start companies, then you have something that looks like this, right?
you have founders who start off owning most of the company, and you add layers of ownership of equity owners.
So series A, B, C, you have an option pool, so your team can participate in the upside, and hopefully when you get to exit, you sell the company for more than the valuation that you raised in the last round.
Couldn’t be simpler, right?
So again, this is what we sort of, when everyone is getting started and we are usually one of the first investors, this is what we all sort of hope is gonna happen.
And what happens most of the time is something that looks a bit more like this.
And what you should take away from this is that the team gets nothing.
And what we take away from this is also the early investors usually get nothing, which is not awesome for us.
And there’s no one to blame for this, right?
We are having a major venture market correction because people get excited and everything is awesome and then you pay too much and valuations get out of hand and then the team gets nothing.
And so we have a massive cap table, so I don’t wanna say that’s the case, but this is part of design for finance, right?
Really thoughtful teams don’t take money with bad terms.
they didn’t take money at super high valuations because they did the math on what happens in two years if valuations come down.
And that for VC finances, what how we think about design for finance.
So there’s a few ways that you can get in trouble with the cap table.
These are just a few.
Actually, there are many, but some of the popular ones, especially recently were announced that you were unicorn because I mean, who knows in three or four years you could be.
And that turns out to have been a bad wager almost universally.
Right, and so the problem there is you have investors with a lot of money telling founders that they’re great, and they’re gonna be awesome, everyone feels good, and then the market corrects, and you have broken cap tables for lack of a better description.
They are the problems if you’re building a hardware startup and you do the math and you realize you need a lot of money, you sometimes sell too much of the company too quickly.
right, also not optimal.
And then the bargain that I think happens in VC is that you’re basically signing up for a minimum amount of growth, usually.
Right, so like you’ve got to, when you take money, you’ve said, I will grow revenue by about three times.
And it’s not always clear that people understand that’s the bargain that is being struck.
And that’s the other way to get in trouble, is you don’t, in fact, grow for often very good reasons.
But then you get stuck at a flat valuation and you can’t pull off the healthy cap table that we all know and love.
So this is unfortunately hard if you work in climate and I’ll tell you why.
I’m not trying to, it’s not supposed to be a downer.
But there are some very important differences and I think the main one is traditional VC is relatively easy and apologies to the generalist VCs.
I can claim that I was one for about seven years.
But it is a really fun thing.
You sort of look for large markets and things that you think can grow fast, and you can pretty much wire money to anyone who meets those criteria.
And obviously, for climate, that’s a bit different.
If we sincerely believe in impact, we should have some math that gets us to, ideally, every dollar of revenue gets you some incremental climate benefit.
And then the other thing that we realize is, yeah, There’s probably some physical stuff.
Can’t just do this in the cloud on a smartphone.
And so again, don’t have to believe me.
I think we’ve tried to make this point a few times.
If you look at some of the best generalist investors, they just don’t do hardware.
They don’t need to.
It’s not the thing that rational people would sign up to do.
But it turns out in some of the best climate portfolios, at least from our perspective, you land up at about 2/3.
And I’ll come back to why that’s important, because you have to go beyond cap tables.
And so here’s a sort of– we played this bingo game a few times.
I found it often forward as emails, rejection emails, past emails.
And they have things like uncomfortable with IP protection for hardware.
And I’m sorry we’re not going to play bingo.
I just figured we’d get to more fun stuff than they go.
But if you do a quick analysis of the reasons, about half of them are finance reasons.
Like, this is not about, I don’t think your team can do this.
It’s not about, I don’t believe in climate.
It’s not about anything for the most part.
It generally comes back to, I don’t see how you actually fund this, and that’s why I’m not investing.
And that is, from our perspective, is the biggest problem as a climate investor.
So a little bit of reality check on some of these things.
We’ve tried to do the math.
So the fun part about people telling you that hardware is hard to find is that they never provide data, so we had to go and find out.
And so I think what, you know, one of the objections is there’s not a lot of hardware investors.
It’s true, there’s fewer.
But I think for a lot of VCs, from a supply and demand perspective, they have far more competition doing software.
So like just selfish years investor, we like this.
But it is partially true that once you set out to build a hardware company, the number of investors at every stage is relative to the number of companies.
It’s much smaller.
The thing that is most certainly not true is that the outcomes are worse.
The failure rate is slacking higher.
I think it’s like 10% higher.
but not enough that most people care if you’re building a portfolio.
But yeah, the outcomes are not bad.
I highlighted Uber just because I like the capital intensive comments so much.
It always makes me smile.
Definitely not a hardware.
I think that what was the word asset light was the description.
But yeah, I mean, just to, like at the top end of outcomes, there just isn’t that much difference.
The path usually looks a bit different, but you get to the same place.
And then I think the other thing, and this is, you know, I just, I don’t know that like tech investors, I think we like looking to the future so much that we sometimes forget to look back.
And so thanks to Vesemur, they did the numbers on, you know, clean tech was, you know, generally has, is generally derided as a reason, was a reason when we started not to invest in climate.
And one of the interesting things is simply, yeah, if you didn’t generate revenue, it was hard to raise money.
That probably hasn’t changed, and probably shouldn’t change for BC.
But it turns out that if you looked like a company that had product market fit and could sell things, you could raise money.
Probably had a good outcome.
And we’ve got a few examples of those.
One of the things, and so from a cap table perspective, one of the concerns is hardware is super capital intensive.
Again, you can run the numbers.
If you imagine that you have to raise twice as much or three times as much every round, yeah, you get 2.
7x return as an investor versus four, right?
So like there’s a bunch of assumptions, but basically you can see how hardware is twice as hard if you imagine that you need to raise three times as much money.
So rationally as an investor, no one should do this.
But from our math, we find that you raise about 1.
2x more equity.
So this isn’t a reason to sit out.
And I think increasingly investors realize that.
What is interesting is that there is no doubt that you have to raise non-dilutive capital.
The capital intensity is there.
It just doesn’t show up on the cap table.
And so as a VC, you don’t have the dilution.
But you do have this new wonderful thing you have to figure out as a founder, which is how do you leave your VC relationships and wander off into the actual capital market where there’s a lot more types of capital?
And the good news is you thought there was a lot of private equity.
These numbers are like 100 times bigger than the stuff that we discussed in VC.
People are excited about the billion dollar fund and billion dollar commitments.
OK, the non-delusive action is actually amazing.
And the question is, how do we, as climate investors, help founders to go from– I know how to get my venture capital.
How am I going to figure out this?
This is how.
Open to better names, but for the moment, it’s the escalator of impact.
(laughing) Seems laughing ’cause it was his name.
(laughing) But this is roughly the order of events, and I think what’s a little bit different in our experience is the role of customers and partners.
So we don’t normally think about customers as investors.
We don’t usually think about partners doing more than maybe being a supplier or a distributor.
But they show up everywhere.
They show up on cap tables.
They offer terms.
And then off-balance sheet we’ll get to.
But this is, I think, maybe the most interesting of all of this is that when you look at things that really get supercharged in hardware, they tend to figure out a way to work with a structure that lives off the balance sheet.
We’ll go through some examples.
So, trying to use colors, we’ll share this afterwards, but yeah, there’s a lot more complexity.
I love being a VC, but we are definitely not the main part of the show.
There’s a lot about the folks that you should know.
And actually, there’s a lot more money than venture.
So here’s sort of in our ideal world.
We have Acme, Climate Co.
, and they grow.
In the beginning, it looks like nothing is happening, as it should be in all of tech.
And then it suddenly looks like overnight there was a success.
It still amazes me that this is how it works, but this is how it works.
And then you drag along the benefits, right?
Whether it’s CO2 avoided or increased resilience, That’s what we’re going for.
And if we map out the most common way in which that happens, you are using probably in the first five years a mix of grants and venture funding.
And you can see that those things get more interesting as you start to generate revenue.
So I don’t want to miss the opportunity to say revenue and customers are an amazingly important part of fundraising.
I think people easily forget that and that’s unfortunate.
But we haven’t found great success stories that don’t include early revenue.
And this is sort of where you land up, right?
If you can design well, you’ll start off with venture, you’ll have grants, you will probably get a loan ’cause you have revenue and that’s how you get loans, generally, and then eventually you get to do an off-balance sheet structure which is where things get very interesting, right?
If you’re worried about having access to capital to move physical things around the planet, it’s almost certainly not happening on the balance sheet of a startup.
And so Sunrise is probably the best example, maybe favorite, but very extreme example.
And yeah, I think By any venture definition of success 13 years to get to a billion dollars in revenue It’s great like I think the known vests is that I know of adventure would be upset about that as a goal or an outcome What is interesting is to think about like Grants that we use along the way right your your local governments your state governments your tax dollars at work everywhere.
So like there’s lots of bad things we can say about PG&E if you live in California and have power outages.
Sunrun exists because they play a role, like a pre-major role in as a partner and with capital.
And so this is what Sunrun’s story looks like.
What’s unusual about Sunrun is they got to the off-balance sheet structure within like three years.
So this is a you know probably an unusual team that knows the capital markets very well but this is doable if you pick the right asset and you have the right team that’s aware that you you know can go and get non-delusive funding early there’s not a lot of venture here or at least it’s not more than you would have in a software company and I think that’s probably the most important if you get nothing else out of today your venture piece of whatever you build should look like a software company there’s absolutely no reason it shouldn’t right in terms of the number of rounds and the size of the rounds but if you’re gonna do that you’re gonna be able to do what’s unwanted or at least some variation and so this is one of our portfolio companies Kelvin, they didn’t figure out non-diluted in year three, if you know Marshall and the team.
But they have got on track to probably by next year unlock off balance sheet.
And what that means for their team is that there is a part of their sales pipeline that buys product from them.
And the non-diluted piece means there’s another group of customers who get to show up and say, I would like to buy an hour pay later option.
Much, much simpler version, and so this is one of our latest investments, and the only takeaway here is revenue is very helpful.
They raised almost no venture, and so I’m not going all the way to the end, it’s older than eight years, but just to make the point, the total amount of venture that this company raised as a hardware company is four million dollars.
And the reason that they could do that is they had revenue and they had margins and they had a lot of banks who were like, oh, you look like a company, we understand.
And so there’s a way, there’s always a path.
And I think what’s a little bit interesting to us is everyone is aligned that having customers is great.
Everyone, having customers that are willing to pay you and having cashless to put it all over is amazing.
But the thing that’s actually the most amazing is that you don’t have to keep getting venture dollars.
You don’t have to sell more of your company.
And now I’m talking myself out of a job, but I’m still excited about it.
And then, you know, this is the part that I think stumps us the most, is we see really interesting, so this is not a company we invested in, but they were saying of companies like that, where the science is amazing, the team is fantastic, they are all the right people who will be customers at some point in the future when the product is shipped.
But it’s brutal in terms of how you access capital.
There’s no access to lenders.
There’s certainly no off balance sheet option.
And so we spend a lot of time trying to convince people to not do this.
Again, it’s our point of view.
We’re going to need everything.
I’m not suggesting this is the answer.
But from our perspective, if you’re designing for a high probability of getting capital, you’ve got to figure out how to get revenue.
Otherwise, you land up in this perpetual, probably broken cap table situation.
How do you actually do this?
There will be an interesting discussion to reveal more, but I’m going to do a quick first pass at that.
So back to the colors.
Yeah, we think that they are– We know how to do pitch decks.
It doesn’t always feel that way.
We know how to run adventure processes.
We’ve helped a bunch of teams.
But this is how we think the capital stack works.
There are interesting lenders.
That’s not news to anyone.
How you get to that point, I think, is not set enough, which you really do need revenue.
Otherwise, there’s too much pressure on the equity investors.
Ultimately, we think a lot of those situations end up with the founders getting nothing, which really sucks.
actually probably unethical.
We’ll save that for another time.
And eventually, if you do this really well, you get to the really fun part, which is the magic trick of buying our pay later and off balance sheet.
And I think the final point is it’s very hard as a VC to learn the stuff.
We have tried to work on credit for about five years.
I still don’t feel like I understand and we’ve invested the time.
A lot of that time is learning alongside founders.
But I think we definitely have religion on, this is not an either or thing.
We shouldn’t be having a debate about this is a thing that belongs here and BC goes over here.
It’s likely not gonna work.
We really do think that the fastest growing, most transformative companies in the next decade are gonna be all of the above capital stack.
It will involve everything.
And on that note, we’ll be ready for a more fun conversation.