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#21) "We Don't Really Do Software"
A Conversation with Praveen Sahay of Wave Equity Partners
“We don’t really do software”
Praveen Sahay is cofounder and MD of Boston based Wave Equity Partners. He’s an early growth PE investor who is often the sole financial investor at the beginning, investing $10 - $30m into “hard-tech” that moves the needle on climate, today, not 30 years from now.
I was introduced to Wave via a mutual friend and after a deep dive with the firm in Boston over a few days, I immediately thought to myself, here’s a firm completely under the radar, quietly investing in entrepreneurs and building companies that have demonstrable immediate impact rather than running around “impact conferences” talking about impact. And Wave has been at this way before all the cool VC kids jumped on the bandwagon and tried to pivot from straight up B2B software to climate tech.
There is a fundamental difference between building a hard Climate tech startup and a SW startup. I once read a great quip on LinkedIn, something to the extent of:
Anyone investing in "climatetech" but doing only software deals is just doing Climate VC Theatre
Wave is most definitely not onstage doing VC Theatre. They are backstage, behind the curtain, doing the real work, without asking for applause.
Praveen says, 10 years ago we saw the VCs retreating away from clean technology. And yet we all know we are running out of time.
We also know that a lot more is needed in addition to building more solar and wind farms, in order to solve our climate change issues. We need to enable a far more comprehensive transition: everything we do in terms of industry, agriculture, water, and waste recycling, all of these urban, long-standing, legacy fossil fuel-driven, utilitarian infrastructures, all have to become far more circular, decarbonized, and equitable ecosystems.
And so software alone is not going to do it.
We need to reinvent every process, every product, every chemical and every molecule that we use. This can only mean that we have to address the full stack of innovation: hardware, software and services.
We also know that the government has an important role to play in “subsidizing” and accelerating maturation of future innovation, yes, but we need entrepreneurs and risk capital to be the arbitrators of industry successes. The new solutions that we invent have to be more affordable and more effective. They also need to not disrupt existing industrial incumbents, supply-chains, and engineering skillsets.
All of these need to be addressed for the decarbonized future we are all driving towards, says Praveen.
Bright and Shiny Distracts Investors
While there has been some conversation and traction around investing in “atoms over bits”, investors continue to have a tendency to run after solutions which are “bright and shiny:” either science projects with no scope for scale-up or based on science fiction, but may not in reality fulfill our needs, economically.
And that happens primarily because of:
Lack of investor knowhow, disincentives;
Lack of the right investor base guiding the entrepreneur / startup journey;
Not realizing the unique nature of decarbonization / energy transition startups from classic software startups; and
As a result, overzealous and indisciplined investors start encroaching on government / DOE / ARPA-type mandates. These investors subsume the task of such organizations and seek to mature and de-risk technologies that may not be immediately profitable and affordable but are “worthy” moon-shots. The result is disenchanted entrepreneurs, failed startups, lost investments, and more importantly, lost technological breakthroughs. Examples include fusion technology demonstrators, direct air capture research, and green hydrogen generation.
However, there are many more immediate, profitable, sustainable venture scale solutions that are getting ignored for such more riskier research bets.
To address these solutions which are ignored you have to stand up and say, I'm going to think differently. I'm not going to rush into investments that everybody else is favouring today but I'm going to look at things which are in fact “out of favour.”
The false-comfort of herd-thinking
Venture investing is a lonely business. It is also a business where a few decisions determine significant outcomes.
Books have been written around contrarian thinking as a core tenet for creating alpha. However, dealflow is the life-blood of a VC. There is a mad rush to “be in the right deals.” The definition of the “right deal” however has devolved to being in deals led by certain marquee climate VCs — this is used as a signal of future success.
This fallacy has led to ignored, hidden in plain sight, startup gems. Investors just don’t have a method to unearth these opportunities. Further, if you want to be investing in startups which three or thirty other investors are looking at, then you're not going to change the world.
You have to look elsewhere. You have to look at the deals very differently.
And so, that was the genesis of Wave - we find solutions which are being ignored, even though they have the potential to be the biggest game-changing transformations. Full-stack innovations that are immediately scalable, affordable, and are comprehensive in nature.
From a risk perspective, we, the entire Wave Team, also want to avoid technologies where the gestation cycle could be very long. So we are only looking at companies that have commercial products in the marketplace - in the hands of the consumers and customers so that you can directly discover from customers why they are using the product, what delights them (and not)?
We seek answers to hard questions: In what way is it superior or inferior to your alternatives? Where is it making an impact on your balance sheet and income statements? What kind of carbon footprint and energy and water and resource efficiency is this giving you?
What you also gain as an investor is a lot of time for due diligence as this process self-selects for a certain archetype of startup and entrepreneur. We have never taken less than six months to make a new investment. And the companies appreciate our diligence.
And surprisingly, ten years ago and even today, we are finding companies where we're leading $10, $15, $20 million rounds, where there are no competing term sheets from any other financial investor.
And that probably goes back to what we were saying before - we're trying to stay away from the bright and shiny objects, look deep into the nature of innovation, and work with entrepreneurs who have taken five, 10 years, and may have even raised 10, 15, $20m from angel investors and government sources to get their product to a place where it is already in the hands of the customers.
What we look at is being ignored by the mainstream investors.
Transformation Over Disruption
So there are a couple of things which we have learned in our due diligence and our approach. One is when you think about the traditional venture community and the approach to investment, the approach has always been, “will we disrupt existing technologies, will we disrupt existing industries?”
For example, Amazon disrupted the brick and mortar stores. That frame of mind, that approach, still prevails - even when considering the energy industry or the water industry or the plastics industry.
At Wave, we have come to the realisation that disruption for disruption’s sake is a very dangerous way to look at the energy transition space.
First, this is not an industry that you want to disrupt.
Energy and food and water are so fundamental to our daily existence. We want to be an enabler of transition rather than a disruptor per se. Because the amount of wealth or capital that you have there, the hundred plus years of expertise that sits there, and the desire of those industries for transition is overwhelmingly strong.
When you collaboratively design a more positive path to move forward, they immediately want to adopt it. We have seen it with our own portfolio: We have a deeply engaged incumbent ecosystem who are partners, investors, customers to our portcos, and all of the above.
We recently invested in a company, Maymaan, that makes engines that run on 70 percent water and 30 percent ethanol.
To build up the evidence-based conviction that this product leapfrogs current state of the art, is going to scale, and really change the paradigm of the industry, you have to be willing to do at least six months of of due diligence into these products.
You say to yourself: everything that I know tells me it should not be possible. But then again, this company has customers who are using the product in ways that we thought were simply not possible.
So at some point you have to say, OK, who is smarter? Do I think I know everything or should I actually open my eyes, talk to the customers who are using it, spend serious time deploying experts to look into the product, open the kimono and look at the guts of the material and see what makes it work.
Most of the investors are unwilling to do this hard work.
But we are willing to do that work - and we find a lot of time to do this kind of stuff because we're ignoring what everybody else is doing. We are not part of the rat race.
Velocity to Market for Hardtech
As Karthee Madasamy of MFV Ventures writes, it’s a “myth that deep tech companies require loads of capital and take forever to become large assets.”
And his team analysed the landscape to back up his statement. And their findings? Hard tech’s capital requirements are “on par with other sectors.” In fact, “the median deep tech unicorn took $115 million of capital and 5.2 years to get there.”1
If you want to make, you know, three, four investments a year we can actually do six months to one year of due diligence for each company - provided we're not busy with doing everything else. So that's how we have been able to find these companies. We do a tremendous amount of deep dive due diligence without any competition.
The focus of the due diligence is twofold. One is to understand the company, and the second is to understand the potential of the company and what you need to do in order to really scale the business and turn it into a market leader.
I mentioned before that most of the companies we are investing in are getting ignored by the mainstream investors. But it doesn't mean that these companies were bad companies. The majority of the companies we have invested in have already turned into market leaders or are on their way to being clear market leaders.
We have no fear our companies will be stolen away from us. We have never lost a deal once we concluded our diligence process for it.
And the attraction for the entrepreneur is that they finally find somebody who is willing to give them a lot of resources not available from other investors.
Our investment is only the beginning of the journey: So, in addition to capital, we bring to the startup the whole due diligence team and our operations team. This includes experts in sales and marketing and production and quality implementation and IP management and so forth that is of critical value as the company is trying to scale from a few million to a hundred million dollars.
Now Wave is being sought out by entrepreneurs and investors (both strategic and financial) because our companies are making good progress, generating press. So, increasingly, companies are finding us from all around the globe. Planet-scale problems need global solutions.
Hence, we are opening an European office (based in Norway) that gives us more feet on the ground. We decided that Europe is going to become an important playing field for us (more on the Wave European thesis in another post). We’ve made 4 investments so far in Europe.
We are now investing out of Fund III, which we are still in the process of raising. The target’s $400m. If you look at the three investments we made this year, they all found us. Word gets out among entrepreneurs and co-investors: they realised - here’s a rare firm that actually does not do just the occasional hard tech investment, but they prefer hard tech and they almost exclusively do only hard tech investments.
And they have built a firm.
Venture Beat: “Software solve the climate crisis: Deep tech investment is needed,” a guest post by Karthee Madasamy, founder and MD, MFV Ventures. 15/10/22