Why Venture Capital is Failing in Water…

By Brian V. Iversen, Founder and Managing Partner of Cimbria Capital

William Signius Knudsen immigrated from Denmark to the United States in February of 1900. When arriving on Ellis Island, he was twenty years old with limited education, some work experience related to building bicycles, little ability to speak English, and only $30 in his pocket. But these humble beginnings did not prevent Knudsen from advancing the next forty years of his life into some of the most demanding roles in American business and public service. In 1940, after a remarkable career in positions with the Ford Motor Company, and while President for General Motors, President Roosevelt recruited Knudsen to lead the conversion of the industrial complex in the United States to a war-focused production system. Knudsen received a commission as a lieutenant general in the U.S. Army, the only civilian ever to join the Army at such a high initial rank. His expertise in mass production distinctively helped the U.S. outproduce Hitler’s war machine and win WWII. Knudsen was from the working class, an immigrant, a moderate capitalist, and a humble servant of the country who served him, the United States of America. He was also an unparalleled knower of industry and human nature. Knudsen once said:

“Most often, when men with money meet men with experience; the men with the experience get the money, and the men with the money get some experience.”

Knudsen’s words allow for several interpretations. To me, his words mean that we always have to respect and appreciate the knowledge, influence, and power of the incumbent. In a current time of disruption, it serves as a reminder and warning to those casting to the wayside the people who came before us. If we don’t respect, understand, and appreciate the world as it used to be and currently is, we may misread our ability to make a positive and lasting change.

As investors in the water industry, I believe it serves us well to keep the insights of Mr. Knudsen in mind. As most of us are aware, the water industry and its incumbents (water-focused Fortune 500 companies, OEMs, service companies, general contractors, municipalities, etc.) are deliberate and conservative. Not because they are lazy, overly administrative in nature, or because they ‘don’t get it’, but because they serve and master the most important and delicate sector in our global system, the water industry. Conservative decision-making is therefore typical in this sector since disrupting the processes and systems that reliably provide clean water – and have done so for decades - is a sensitive endeavor, even if supported by the best of intentions.

Water investing is still in its adolescence and it has to date - narrowly and wrongly – been defined mostly as ‘water technology’ investing. As a result, the first wave of venture capital investment firms have ‘hit the ground running’ by pouring [pun totally intended] capital into early stage water tech companies, most of them failing (sometimes miserably). In addition to the typical hype and ‘over-reaching’ [and under-thinking] when investing into new investment categories and asset-classes (think: dot.com, renewable energy, blockchain, cannabis, etc.), we have to be aware of the ‘returns reality’. The 5-10x investment multiple does not exist in the water industry as a repeatable event. This is because neither the incumbents nor the [very few] financial investors are incentivized, nor have the money, to overpay for ‘up-and-coming’ water technologies or business models.

This conclusion rules out the venture capital investment model as a viable investment approach in water since venture capital portfolio management relies on one or several high multiple exits to make up for the losses expected in a risky portfolio of this kind. In other words, the overall risk-return profile of the water industry deals a lopsided hand – in the wrong direction - to venture capitalists.

So, what type of investment and finance model works given the water industry’s pressing need to renew itself and improve its chances against population growth, aging infrastructure, and tightening regulatory requirements? In my view, the growth equity and private equity investment model seems more suitable [I realize that I am entirely biased here – but in my defense, my firm Cimbria Capital is deliberately positioned as a growth equity and private equity investor due to these conclusions]. The private equity model – especially the ‘hands-on’ version of it – aims to invest in business models rather than technologies, it reviews investment opportunities across the entire value chain of water, not just technology investments, and it is more conservative (read: more risk-averse). It aims for investments with risk-return profiles that consistently returns its entire capital investment, and in most cases receive a 2-3x investment multiple over 3-6 years. Therefore, the private equity investment approach suits the water industry well because the return expectations are more aligned with the sector’s traditional growth patterns and are also more representative of the exit multiples currently available in the industry.

In my view, the water industry is similar to most other commodity-based industries with an upstream, midstream, downstream and service component – with steadily increasing water prices allowing for investment opportunities across this value chain. Cimbria Capital is one of very few hands-on private equity investors seeking 2-3x returns throughout the water industry, and in doing so provides an alternative to limited partners seeking diversification beyond energy, tech, and other sectors.  The unhurried, calculated, and traditional cycles of the water sectors are fairly set.  So, let’s remember the lessons gleaned from Knudsen’s quote on ‘experience and money’ – it is only those investors who know the fixed realities of a sector that will ‘get the money’. Successful water investing requires subject matter expertise, appropriate financial partners and models, and realistic prospects. Cimbria Capital represents this professional formula so it can win for investors, portfolio companies, and water resiliency.