🌎 Welcome back to the CleanTechies PodLetter, VC edition. Today we are talking about the Climate Capital Stack.
We are keen to get your thoughts on this new format so let us know if you want to see anything in particular in these longer-form write-ups.
Let’s get into it.
What you’ll find in today’s PodLetter…
“Design for Finance” & Climate Capital Stack
Bad Investing Signals and the Difficulty with Voluntary Carbon Markets
Need for Transparency in Oil & Gas (O&G)
From Local Policy to Global Challenges
The (Hardware) Goal is Off-Balance Sheet Leasing
Different Types of FOAKs in Hardware
The Escalator of Impact and Scale
Insights
IRA
Climate x AI
Creating a Hardware MVP
What Shaun Would Build Today If He Was a Founder
Advice to Founders
Advice to VCs
Show Notes
Carveouts
💡 “Design for Finance” & Climate Capital Stack
NYCW was a pivotal moment for many of us current or aspiring climate professionals. It brought together large swaths of diverse talent all working in different assets to solve the climate crisis. Many of these gatherings were headlined by some of the smartest minds in climate and climate tech. An implicit goal we’ve had at the CleanTechies Podcast since then is to have as many speakers from the week as we can.
I’m excited to introduce the speaker of one of the most popular talks at NYCW and Managing Partner of Third Sphere VC, Shaun Abrahamson.
Shaun is an early-stage investor in the climate sector with a background in engineering and over a decade of focus on early-stage climate investments. Shaun’s engineering mindset involves constructing narratives with numbers and employing simple models to assess the viability of proposed ideas but combines that with the perspectives of advertising professionals, emphasizing the importance of understanding human behavior — a facet engineers might overlook.
Bad Investing Signals and the Difficulty with Voluntary Carbon Markets
VC can be a “herd-mentality” business, in which experienced investors like Shaun can rise above bad investment “signals” — precursors for a potential investment. Bad signals were present with voluntary carbon markets where the need for carbon removal is apparent but there wasn’t a viable business model due to market flaws and incentives. Shaun personally had to communicate this skepticism to limited partners who were excited about carbon removal. Climate, in general, has very intricate customer signals — the struggle being how to differentiate between what people should do for climate and what they will actually do. Acknowledging realities, even if they are unpopular opinions, will form a more accurate understanding of the climate landscape.
One interesting note was skeptics of the fossil fuel industry, given the industry's historical patterns of prioritizing power retention over genuine decarbonization efforts.
Need for Transparency in Oil & Gas (O&G)
The immense scale of resources spent by media and advertising to shape specific narratives about climate and industry can make it hard to see what is what. Shaun suggests engaging directly with customers as a reliable way to understand the ground truth — suggesting unconventional approaches like candid conversations where possible.
Still, there is a need for transparency in the fossil fuel industry — greater explicit communication about the industry’s intentions for growth alongside climate considerations would help guide startup founders. An interesting note is the bias in reports from established groups like consulting firms that often cater to incumbents seeking reassurance rather than providing realistic scenarios for early-stage climate founders or funds.
This gap is what has led to the rise of CTVC and other climate tech media groups (cough cough) seeking to distill relevant advice for climate founders.
From Local Policy to Global Challenges
Third Sphere VC started 10 years ago with a narrower focus on local government policy, specifically looking at the C40 cities group and its climate scenarios and where investment could help in meeting those goals. The fund has always cared about both decarbonization and adaptation/resilience, challenging traditional assumptions like grid reliability. In general, they avoid grid and generation areas due to limited expertise and instead focus on sectors like decarbonizing buildings and transportation.
The (Hardware) Goal is Off-Balance Sheet Leasing
Hardware has always been a tough sell for Shaun, especially in the early years. Investing in hardware still has its issues, but after a decade of investing, Shaun has insights that he uses to guide hardware starts like the development of a credit platform focused on off-balance sheet leasing.
Shaun also stresses not reinventing the wheel and instead leveraging existing trends. He emphasizes that successful hardware companies often start by assembling components like "Lego pieces" rather than immediately delving into complex production and manufacturing.
Different Types of FOAKs in Hardware
The first FOAK approach is what we mentioned before — assembling existing components in a novel way. The second, riskier approach involves investing significant capital to develop an entirely new product before generating revenue. Shaun prefers the former, emphasizing that climate investors should prioritize proven solutions over high-risk endeavors given the current level of skepticism. This is also informed by what Shaun calls an “extensive playbook over the last 30 to 40 years” for investments in hardware.
Shaun recalls that companies often didn't raise more than $100 million before going public, which complicates how these FOAKs would raise capital and still be capable of venture-scale returns..
In preparation for the need for alternative financing methods, Shaun emphasizes the need to qualify market interest effectively. He stresses the importance of specific customer signals and the value of having customers commit with deposits or contracts rather than relying on vague interest or unpaid pilots. This can be through a techno-economic model where founders iteratively secure commitments to validate market interest.
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Escalator of Impact and Scale
In his talk at NYCW, Shaun presented the "Escalator of Impact and Scale," a framework shown in his Design for Finance talk. The components include grants, venture capital, customers, partners, lenders, and off-balance sheet structures. He provides some takes on each component:
Grants: Hit or miss — some startups do well with them while others don't even apply; there are also lots of efforts to automate grant applications and grant writing
Venture Capital: Customer discovery is generally done well but there is room for improvement in getting more commitments from customers to get more VCs to invest
Partners: Corporate VCs, for example, are helpful not only in their capital but in their collaboration and implicit agreement to pilot/partner
Lenders: There has been more education in the post-Silicon Valley Bank era — founders are asking more questions about venture debt which is a necessary financing method for hardware
Off-balance Sheet: The term "off-balance sheet" can be misleading — it might be better framed as a distribution partnership; this financing method would be popular for private investors because it keeps the cap table cleaner
The least understood component is the off-balance sheet structure, but there is an ongoing effort to explain it more effectively.
📝 Insights
IRA
In the early stages of startups, policy may not have significant impact as policymakers aren’t very tuned into the specific challenges faced by early-stage founders. Rather, policy is viewed as a supportive force, providing a tailwind for faster scaling.
However, policy is a factor bad noise to investment signals in climate — genuine demand is still necessary beyond beyond short-term cost advantages provided by new policy. Policy also becomes more relevant in underwriting considerations for specific industries, such as those eligible for the Investment Tax Credit (ITC).
Climate x AI
AI streamlines business functions, such as grant and Request-for-Proposal (RFP) automation. In verticals like product design, AI's ability to enhance iterations increases the likelihood of cost-effective solutions, like more affordable heat pumps.
Potentially my favorite point of the whole episode, AI plays a crucial role in automating tasks related to manufacturing, operations, inspections, and maintenance. The hardware superpower of generating proprietary data further strengthens AI applications, especially in areas like remote sensing and refining control systems for complex processes.
The synergy of AI and hardware creates opportunities for a data moat against competitors.
Creating a Hardware MVP
Different types of hardware MVPs require unique financing. For high-volume, inexpensive items, there are options like crowdfunding, low-volume launches with suppliers or Amazon, and 3D printing. In the B2B realm, despite potentially larger products/order sizes, similar equivalents can be applied such as building a pipeline and shipping a 3D-printed version. The key is not to fall in love with the technology, be honest about customer needs, and navigate scaling challenges. Cashflow management involves pre-selling to generate revenue and establishing partnerships with supportive companies willing to contribute cash, provide loans, or be on the cap table. While some hardware ventures may succeed on a larger scale, there is a bias toward high-volume, low-cost products.
What Shaun Would Build Today if He Was a Founder
He would build a company in the "climate defense" space, focusing on a full-service adaptation company, particularly for real estate. This would involve aspects like insurance, physical changes, and first responders.
The rationale behind this choice lies in addressing the shifting risks associated with climate change, especially in safe asset classes like infrastructure and real estate. The recent adjustment in pricing by reinsurance companies to reflect changing risks creates a significant investment opportunity.
🚀 Advice to Founders
Stress-test your co-founder relationships
Shaun emphasizes the importance of stress-testing relationships when forming a founding team. He shares an interesting example of two founders who, after meeting nine months ago, decided to artificially subject their relationship to stress. The idea is to create situations that mimic the challenges and pressures a startup environment might bring. The process was very fruitful and helped evaluate how the individuals responded when faced with difficulties. Ways of doing this early on include intentionally setting challenging deadlines or tasks to observe how individuals work together under pressure.
All-In on Techno-Economic Models
Techno-economic models are a growth hack, particularly in hardware startups. The key is to focus on models that allow the repetition of processes numerous times, ideally tens of thousands or more. He views techno-economic learning curves as a critical factor and describes them as the "network effect of hardware."
To do this, founders must minimize soft costs and customization, instead choosing simplicity and ease of implementation. The goal is to reduce the need for on-site visits and streamline the delivery and setup process for scalability.
🏦 Advice to VCs
Find an Economic Narrative
Shaun advises those interested in climate investing to align strategies with practical outcomes rather than focusing solely on idealistic climate-related goals. One way is to frame the investment narrative around the opportunity to rebuild a significant portion of the economy.
Diverse Capital Attracts LPs
Shaun notes a shift in sentiment with LPs towards a more pragmatic approach and advises fund managers to explore opportunities beyond traditional venture capital. Underwriting for new assets is highlighted as potentially more interesting than early-stage venture capital.
Be a Climate-Fund for a Reason
What advantages does a climate fund offer over top generalist funds? Identify and articulate these before becoming a climate-fund. If these don’t seem to hold up, reconsider how you plan to be competitive in climate.
📝 Show Notes:
Topics
4:10 Intro
8:10 Balancing returns vs. impact
11:36 Bad investment signals in climate
20:59 What is Third Sphere
27:47 Mistakes Hardware founders make
31:39 Design for Finance
49:46 Which climate capital stack segments are underutilized
1:00:51 Insights
1:03:45 IRA
59:24 Climate x AI
1:08:39 Hardware MVP
1:14:15 Building a company right now
1:17:47 Advice to founders
1:23:25 Advice to VCs
Links
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This podcast is NOT investment advice. Do your homework and due diligence before investing in anything discussed on this podcast.
🚨 Carveouts:
Somil
I want to take this carveout to thank all of our readers (especially the ones who made it this far, that is dedication and we appreciate you). We put lots of time and energy into figuring out how to use this platform as best we can and all of your support and engagement is literally what makes this possible. We are super excited to build a community and more content around the work we have done — we’re ending 2023 strong and so appreciate all of you for being there to witness it. Thank you all so much from the bottom of my heart.
— also taking this break to celebrate Thanksgiving with family 🦃🍁.
Silas
Similar to Somil, I want to thank everyone for reading, sharing, and offering us feedback. In particular, I also want to thank Somil for joining this endeavor in the summer and really helping us expand this. If you have not connected with him yet on LinkedIn here is his link 🔗. These past ~2.5 years have been incredible being able to have so many incredible guests on to share the lessons they have learned by being early entrants into this Climate space.
One final thing, if you’re interested in some IRL action, we are co-hosting another ClimateTechies event in NYC on the 2nd Thursday of each month (Dec 14th - Location: ~Union Square). Reach out to me directly if you’re interested in attending. Last month we had a really cool demo from the folks at CLIP. (If you want to demo your stuff, also LMK)
— I hope you had a great Thanksgiving! 🧑🤝🧑🍁
#136 Hardware as an AI Moat, Design for Finance with the Climate Capital Stack, & More w/ Shaun Abrahamson (Third Sphere VC)