Creating a New WAVE: A Fundraising Journey

Praveen Sahay, Class 8

Starting a new fund is a test of nerves even in the best of times—starting a new cleantech fund in 2009, in the midst of a recession when all major VCs were retreating from the sector, seemed completely unwise. But we launched WAVE anyway, and have thankfully survived the many obstacles we faced along the way. Those of you who are dreaming of your own funds may find our story both daunting and inspiring.My career had its origins in the energy industry, but I naturally drifted toward the cleantech sector as it emerged as a new investment category. After earning degrees in nuclear physics and oil geophysics, I had spent several years with oil, energy, and petrochemical firms. As a venture capitalist, however, my interactions were limited to technology startups and I craved the opportunity to work with companies that made physical products to fulfill our most pressing needs relating to energy, infrastructure, and environment. I saw a great deal of cleantech investment recklessness by other investors and wondered if there was a more responsible and profitable strategy for investing in sustainability.

The Logic Behind the Leap

Even as investors were losing fervor for the cleantech sector, my cofounders and I had three good reasons for taking what appeared to be a daring act: starting a new cleantech fund.

1. The world still needed new breakthroughs in alternative energy, resource efficiency, and sustainability.
2. Our unique strategy skirted the challenges faced by other cleantech investors and promised to be profitable.
3. A sovereign fund had agreed to anchor WAVE with a $100 million investment.

Unfortunately, as the economy continued to waver, we lost our anchor investor. Historically, sovereign and corporate investors have been creatures of comfort—they climb in when the wind is nice and the weather pleasant, but are quick to jump ship at the first sign of a storm. Within months of launching the WAVE fund, the anchor had frozen its investment program and laid off 70% of its workforce. We were marooned before we had a first close.As the markets fled uncertainty, the uniqueness of our strategy also became an obstacle. Even when our strategy appealed to investors' rational judgment, we could not persuade the limited partners (LPs) to bet on a first-time fund with an unproven strategy. Cleantech LPs faced with the losses and continuing challenges from previous fund commitments were exasperated and had become very risk-averse. Try as we might, we could not fight their negative market emotions with logic.The four WAVE founders were staring at a big question: What now?

The Founding Team: Assets and Liabilities

The founding team of WAVE spun out of VIMAC Ventures, the firm where I completed my Kauffman Fellowship. As a result, the founding team bears the strong mark of the Kauffman Fellows Program. Bob Roeper was my interviewer during the final selection process for Class 8 in Kansas City in 2003, and Mark Robinson was my mentor during the two years of my fellowship. Still, our best find was Chip Schroeder, an acclaimed energy professional who had spent over 30 years financing, managing, researching, and regulating nearly all sectors of the energy industry, both in the United States and abroad.Through years of working together, we had bonded strongly and respected each other's complementary skills. Some of us were consummate technologists, others international marketers, financiers, manufacturing experts—and, hopefully, all good investors.VIMAC Ventures was also a great source of comfort. We had built our investment track record over the decade we had spent together at the firm. The firm supported our venture, gave us office space and administrative support, and offered access to their network of high net-worth (HNW) investors.When we tallied up our balance sheet, we identified both assets and liabilities in pursuing our idea for a WAVE fund. In the liability column, we listed the following:

• a new fund,
• a new strategy (more on this below),
• a fallen-out-of-grace sector,
• the absence of institutional fundraising experience,
• a severe global recession,
• a risk-averse climate in which investors wanted only liquid investments and were averse to a 10-year lock, and
• no anchor investor.

The last factor, we learned, was the most debilitating. In the asset column, we listed the following:

• a novel strategy,
• a decent investment track record (mostly information technology, not cleantech),
• sufficient capital to finance a two-year fundraising process,
• office space and support staff (courtesy of VIMAC Ventures), and
• a willingness to suffer the agony, frustration, and financial sacrifices that would be needed to achieve success.

This last factor, we learned, mattered most.Unhesitatingly, we decided to continue moving forward, making three changes we hoped would help address our liabilities. We reduced the size of the fund from $250 million to $150 million, targeted fundraising activity to only those investors that had specific cleantech mandates, and decided to begin investments by raising seed capital from HNW investors even before achieving a formal close.These efforts were less fruitful than we had hoped. Lowering the fundraising target did not make things easier: we quickly learned that most cleantech fund-of-funds were themselves cash-strapped after several years of aggressive activity. The pension funds and endowments had taken a "haircut" in their public portfolios and were forced to cut back on private equity (PE) allocations (a phenomenon known as the "denominator effect"). In other words, we found no category of LPs that were obvious takers of our offering. The only glimmer of light came from the HNW investor network—people with limited resources but who were willing to help us move forward.It was going to be a very long road, yet we were solidly optimistic because of our uniquely promising investment strategy and assets. Before exploring the details of our strategy, it is useful to consider the industry context.

Cleantech Industry

Since the early 2000s, renewable energy has experienced a spectacular rise and fall. Initially touted as the next trillion-dollar technology frontier, the industry has quickly become entangled in polarizing debates over climate change, public policy, and federal grants. The early champions of the venture capital industry cheered from the front, arguing that the cleantech opportunity would be far bigger than anything we have seen in the past. Investors who had made their careers in the IT and biotech industries jumped overnight into industrial technologies, piling hundreds of millions of dollars into companies at hyped-up valuations. We even saw a startling cultural shift among the VCs, who began forming political alliances and cultivating a permanent presence in the lobbying corridors of Washington.Now, we have seen the aftermath of this craze. Though a few startups supported by determined leadership and government handouts enjoyed accidental success, overall, investors have suffered big losses. With waning federal support (the crutch that had supported investors' hopes), the overall investor sentiment also suffered a steep decline.This decline is evident in both the public and private markets. In figure 1, the WilderHill New Energy Index (NEX) shows a decline of 60% since 2008, compared to a 20% increase in the NASDAQ.1 On a relative basis, that shows a shocking 80% underperformance for the cleantech sector.

Figure 1. WilderHill New Energy Global Innovation Index (NEX) Compared to NASDAQ, 2006–2012.Author's image; data from Yahoo! Inc., "NASDAQ Historical Prices" and WilderHill New Energy Global Innovation Index, "NEX Total Returns".

Cleantech Challenges

In order to convince LPs to invest in WAVE, it was essential that we provide a logical explanation for the sector's underperformance and articulate mitigating strategies. Technology startups are always risky and often fail to achieve market adoption (i.e., "cross the chasm") even when they have solid technology, management, and capital—cleantech faces these same challenges and more. Bringing a cleantech breakthrough to the market requires solving three very complex problems.To be successful, the startup must accomplish the following:

1. solve a very tricky problem involving complex physics, chemistry, or biology;
2. scale that breakthrough a million- or billion-fold in order to achieve market scale and relevance; and
3. successfully deploy the solution despite the conservative and regulated nature of the markets that insist on a decade-long proof of reliable operation.

Stated directly, there is no place for "alpha" or "beta" solutions in the marketplace. The cleantech solution must be perfect and have proven its worth (preferably for a decade).Unmistakably, this investment model does not fit a VC fund's 10-year lifecycle. In a show of sheer enthusiasm, early investors jumped into cleantech in the hope that the government or the public markets would embrace immature companies. Others hoped that industrial giants (like pharmaceutical multinationals) might acquire promising startups at hefty premiums. Unfortunately, the legacy industrial companies turned out to be conservative buyers who preferred cash flows over fancy new technologies: they stood silent as cleantech startups withered on the vine.Ironically, even as the VC-funded companies shriveled and died, the cleantech industry itself was undergoing rapid technological progress. Solar, wind, and biofuel industries really came into their own, quickly turning into new global industries worth tens or even hundreds of billions.At a time when the cleantech industry is giving birth to whole new technologies, why are VC-funded companies failing? Where are VCs going wrong? Is it the technology, business model, expertise, or something else? We needed clear answers to these perplexing questions.

Our Insight

One way out of this dilemma, we reckoned, lies in recognizing that while the cleantech markets are large global markets, their implementation typically requires locally situated entities for successful execution. Unlike the IT and communication markets (software and semiconductor products do not require local manufacturing), the energy, industrial, and water markets usually rely on locally operating physical plants that require large infusions of local capital, operating skills, and business networks. Additionally, these markets are subject to local policy regulations, financial incentives, and political influences. Due to these factors, most industrial solutions are what we term glocal: global in scope but local in execution.Therefore, a cleantech market is not a single monolithic global market but an aggregation of distinctly separate markets. A true technology breakthrough, achieved after significant investment of time, money, and effort, is a very valuable asset that can monetize several disparate large markets. However, the traditional investment model limits the application of that breakthrough within the confines of one company, one management team, one market, and one exit. Consequently, even when innovations are successful, they produce suboptimal returns because they monetize only one of several possible markets. In seeking to maximize that one-shot opportunity, entrepreneurs tend to pick the largest and the most challenging market, taking in hundreds of millions in equity financing and narrowing the exit window to a blockbuster IPO or M&A. It is no wonder that cleantech startups have overwhelmingly failed and many in the LP community have become skeptical of investing in industrial solutions.

The WAVE Model

The above logic gave rise to our spinoff strategy. At WAVE, we decided to secure a controlling interest in proven solutions and then commercialize them in multiple distinct markets by spinning off locally incorporated, standalone companies. These spinoff companies would then leverage local managers, capital, and partnerships to accelerate market penetration.This was our plan:

• Rather than seek 20 new technologies to build a high risk–high return portfolio, invest in only 4 or 5 platforms.
• Once a startup demonstrates success in a home market, clone that company in additional 3-5 product markets or geographic markets.
• Through this spinoff approach, build a portfolio that has only 4-5 platforms and 10-15 spinoff investments, minimizing technology and development risks and maximizing revenues and cash flow.

By propagating proven, breakthrough solutions to address existing demand, we believed the WAVE fund could build a portfolio consisting of high-conviction bets, and potentially achieve superior returns at lower risk. This strategy not only recognizes the glocal nature of the cleantech industries, but also transforms that potential challenge into an advantage.The spinoff strategy allows the fund to circumvent the common impediments that challenge traditional cleantech investors. By tapping into platform technologies that are already in the market, we avoid the long technology-development cycle and associated capital risks. Also, the spinoff companies maximize local content—attracting the most experienced managers, investors, and industrial partners, and accessing the policy benefits that are restricted to locally domiciled entities.

Beyond the Naysayers

Critical voices are a feature of every fundraising meeting, and we were offered advice running the full gamut from "meet me after you've returned the first fund" to "we only invest in top tier funds." We found several investors who commended us on our strategy and applauded the progress of the first two companies, but asked, "How do we know you'd be successful with your future investments?" One of my favorite gems is, "We would be more comfortable if this company were an NEA or a Kleiner portfolio company." In other words, they like what we do but are still very wary of the fact that we are a small new fund.We tried to not take these disparagements personally—one look around the desolate fundraising landscape is enough to know that such experiences are commonplace. The VC world is overflowing with the carcasses of would-be funds as well as funds that were successful until a few years ago. While a significant number of angel funds have sprouted and a few have even achieved institutional status, that phenomenon is limited to the social and IT space. The cleantech space has been the most severely impacted by market changes. Not only are new funds extremely rare, even established cleantech funds are struggling to stay afloat, and the generalists are abandoning the space.Even though many institutional LPs think our approach has appeal and our initial investments look promising, they still want to be the "first to second." They inevitably prefer to step into a second close or a second fund. Luckily for WAVE and for our portfolio companies, there are several individuals (including senior Kauffman Fellows) who have willingly taken the risk on our team.

Beginners' Luck

With the support of HNW individual investors and family offices, those who already knew us, we have invested nearly $20 million in two exceptional platforms. Diligent and skillful selection of the platform companies is the key to the fund's success, for one successful technology can spawn multiple successes; hence, in choosing platform investments we look for very specific selection attributes. The three most important filters are as follows:

• technology (maturity, competitive barrier, and market impact);
• market (multiple existing markets, access to lower cost financing); and
• control (majority ownership).

When these success drivers are available, our experiences suggest that the other key factors (e.g., management teams, co-investors, and channel partners) can be readily recruited.The two portfolio companies, which are part of the new WAVE fund, provide an excellent illustration of our investment strategy. With early progress of the two platforms (briefly described below), we have been able to demonstrate our path to success. These successes have not been enough to overcome the LP aversion to being first, but have attracted significant interest for follow-on closings.

Company 1: American Aerogel

American Aerogel manufactures panels of the ultra-high-performance insulation material called aerogel. We knew of the challenges facing other aerogel companies, but we liked this one because its product offered 500% superior performance at a lower price. Also, they already had customers raving about them and did not need massive capital to get started. As of this writing, they have generated an overwhelming customer demand and are nearing profitability in the pharmaceutical shipping market. Customers enjoy lower shipping costs and simultaneously eliminate distribution spoilage due to temperature excursion. The company has a clear roadmap to generate multiple spinoffs to address other industry verticals (e.g., trucks, containers, buildings) as well as geographical regions (Asia, Europe, etc.). They have a truly disruptive solution that offers customers not only a 75% reduction in energy usage, but also the elimination of spoilage—worth billions—that occurs in the distribution and storage of food and pharmaceutical products. Consequently, the product offers instant customer profits and investment payback.

Company 2: Green Conversion Systems

Green Conversion Systems (GCS) addresses the waste-to-energy market at the municipal scale and competes with industry majors like Waste Management Inc. and Covanta. We liked them because they had proven capability to process unsorted municipal solid waste at the lowest cost and with the highest diversion and cleanest emissions. Because all of the technology components had been validated in several European facilities, the company and its consortium partners could provide 20-year performance guarantees and raise project equity and debt from private markets. In other words, they did not need any pricing favors, federal grants, or municipal mandates to operate profitably.Recently, GCS won a global bid to build the first of seven waste-processing facilities in the city of Los Angeles, each costing about $350 million. Additionally, they have won four more offshore projects, creating a book of business approaching $2 billion. In a market where other startups have succeeded only at the pilot stage and with public subsidies, the success of GCS is truly remarkable. As their story reflects, a startup can hold its own against massive global competition in a mature market without relying on government mandates or subsidies. The company is now weighing options for launching spinoffs in other regions of the world with interested industrial partners in Latin America and Asia.

Keeping On

We are still far from the goal of raising $150 million, but there is no looking back. As WAVE's companies have gathered momentum, they have also needed more capital, which means that fundraising for the companies has consumed much of our time. We formed small limited partnerships with several HNW investors to keep the companies moving; because adding other investors may be disruptive to our strategy, we have tried to avoid dilution. Raising capital in multiples of a hundred thousand dollars has been a tardy process. Simultaneously, we have been trying to make progress toward the first close on the WAVE fund. Thankfully, the closing seems imminent.When I speak to my friends, the conversations often veer toward the difficulties and ignore the fact that fundraising can be a great deal of fun. It is a privilege to shape and propagate a new perspective with passion, and I feel enriched both intellectually and emotionally. Nonetheless, more than a hundred days of travel bring their own drama of missed flights, lost luggage, and sleepless nights in rooms occasionally shared with snoring colleagues.I vividly remember a night when three of us checked into a plush hotel in Riyadh at 4 am. Because we had to leave for a meeting in three hours, we just had time for showers and a bit of rest, so we asked for a single room for a few hours. In response, we received the sternest looks and hints of the "morality police." On another occasion, we landed at Abu Dhabi airport instead of Dubai. Unlike the latter, Abu Dhabi does not issue entry permits on arrival, so the authorities detained me at the airport (I didn't have a U.S. passport), while my colleagues went ahead with their meetings in the city. Who knew you could go to jail for fundraising!On occasion, things did get very rough. One partner's son was diagnosed with an advanced stage of cancer, and another lost two family members within a week. Other times, money would be running so low that we not only couldn't pay the rents but even struggled to pay the receptionist. At such times, we would bite our tongues, resolve that we would not let down the people who had trusted and supported us, and accept whatever sacrifices were necessary to keep going. We endured the hardships not because most investors said no, but because the few who said yes were so steadfast in their support that we could not let them down.Will it get easier now? Maybe. Continued growth curve of the portfolio and the participation of reputable institutions in the second close will be key. Several brand-name LPs have signaled interest, but as we all know not every tree bears fruit. In other words, we expect 2013 to be smoother than 2012 but are not counting on it.

Retrospective

We often ask ourselves: If we had a choice, would we do this again? In any case, who needs another venture fund?Three years ago, my answer would have had the ring of intellectual discourse—today, I know that I am doing this (and would do it again if needed) not because the world needs it but because I need it. It does not matter if others see the need or not; though it would be great if they did, that is not the raison d'être for starting WAVE. Instead, WAVE was born because I (and the other founders) made this choice. Two related learnings stand out:

• Startups live or die on morale. If you let the difficulty of raising money destroy your morale, it will become a self-fulfilling prophecy.
• People give money to people, not to causes.

Giving birth to a new fund (or, for that matter, any kind of new venture) is an act of creation that becomes a process of self-discovery. Until I try something new, I really do not know who I am. In the process of starting WAVE, I (and my partners) have gone through heights of exhilaration and depths of despondency unlike anything I have experienced before. There have been numerous turns of events and surprises that threw wrenches in the works, as well as unexpected acts of generosity that softened the hard knocks. At every critical juncture, we found people who were willing to throw us a lifeline without any show of greed. Much to their credit, the founders of the two portfolio companies patiently stuck by us even though we repeatedly cut short their capital aspirations.Ten years ago, while writing the essay in my Kauffman Fellowship application, I reflected why I wanted to become a Kauffman Fellow. I wrote, "I want to learn the art of venture investing and spread the culture of responsible entrepreneur-ship across the emerging regions of the world." WAVE embodies that vision. In order to propagate clean technologies across different regions, the fund forges partnerships with local entrepreneurs and industrialists to build high-growth ventures that create local jobs, cultivate the entrepreneurial ecosystem, and improve the environment.This investment approach resonates with our deepest values. When confronted with the question of whether we should invest in a company that improves the shopping or entertainment experiences of our children, or one that secures their ability to sustain and enhance their future, the answer becomes starkly clear. At WAVE, we seek out only those solutions that create positive impact without the artificial crutch of government subsidies. Both of our companies solve real economic problems, eliminate waste, improve recycling, enrich the environment, and create high quality jobs—all without increasing cost to the buyers or taxpayers. It is indeed gratifying to concentrate efforts behind such promising solutions and spread their application across the planet.Inevitably, this fundraising process has spilled into the family domain and redefined my closest relations and deepest beliefs. As the sole breadwinner for my family, I recognized I was taking a risk that could financially destabilize the family. However, the weekly gyrations have actually brought us close together and deepened our "irrational" faith that it will all work out. The experience may even have stirred entrepreneurial instincts in my family: both my sons started new high school technology clubs and became enthusiastic participants in business-plan competitions, and my wife Sunanda initiated events to promote her passion for art and culture. In the past three years, she has emerged as a locally celebrated folk painter, started a very successful cross-cultural event, and exhibited her art at many local museums.This tortuous process has also brought the WAVE partners together. We have stuck closely despite varying personal challenges. We have a stronger sense of each others' strengths and proclivities, and have developed a deep respect not only for each others' abilities, but for who we are as individuals. I have experienced a level of goodwill, trust, and unquestioning support that I had never, ever dreamed of.Finally, this challenging experience has softened my rough edges and fortified my sense of purpose while giving me the humility that is so necessary to develop empathy. I am sure there is more work to be done, but it is a gratifying feeling to be on the right path—to feel that I am in harmony with my destiny. This would not have happened without this fundraising experience—so thank you WAVE, and thank you Kauffman Fellowship for the constant support and encouragement!

Praveen Sahay

Praveen is cofounder and Managing Director of WAVE Equity Partners, a private equity firm based in Boston that invests in proven breakthroughs in sustainability solutions. Of particular interest are platforms in efficiency, energy, water, and environmental technologies that can monetize several industrial and geographical markets. Praveen is engaged in managing the firm, leading the investments, and guiding the portfolio companies. Previously, he spent several years with in the energy and petrochemical industry and worked as the National Elections Coordinator (CIVPOL) for the United Nations Operation in Mozambique during the country's democratic transition in 1994. Praveen holds an MBA from the University of Chicago, a Master's in Nuclear Physics, and post-graduate degree in petroleum geophysics. He received a UN Peace Medal for his services in Mozambique.

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1 Based on data from Yahoo! Inc., "NASDAQ Historical Prices," Yahoo! Finance.

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