Starting A Climate Studio - Where Is The Money?
On Twitter and in the My Climate Journey podcast Slack, there have been recent questions about the venture studio model, and whether it might be a good vehicle for building companies and organizations to address the climate crisis.
Studios for climate change mitigation startups & NGOs would be awesome
Yes, they certainly would be awesome! But what are studios, exactly?
A startup (or venture, or product) studio is an organization that combines elements of a venture fund, an incubator, and an operating company. Studio partners or principals typically conceive and launch companies, and the studio often has its own pool of capital that it uses to seed those new ventures after they are pushed out of the nest. As we'll touch on below, there are as many flavors of this basic formula as there are studios. See here for an overview, which concludes that
You’d be forgiven for wondering what defines a startup studio after all this. The point is that the definition does not really matter. It’s a vessel for an assembly of smart people, well-versed in making things and starting companies, working out every and any which way they can best apply their energy, experience, network and knowledge ;).
Last year, we at The Data Guild made a real effort to raise a small fund for a mission-driven venture studio. Our scope was broader than the “climate change mitigation” projects that Jack called for above, but I think the lessons from our experience (spoiler alert: we did not raise the fund) might be relevant to those who come after us.1 So here goes.
It's The Investors, Stupid
I think there are some important and unresolved questions about what kinds of companies, projects, and initiatives are most likely to be effective in climate mitigation, adaptation, and overall decarbonziation of the global economy. In other words, what are the kinds of efforts that studios focused on the climate crisis should develop within their portfolio?
I plan to write more about these questions before too long, but for this post my thoughts gravitate toward how a studio might be resourced. This emphasis flows from our own experience, in which we had no shortage of ideas and theses to pursue (some really good ones!), but nevertheless ran into significant headwinds when it came time to convince those with capital that our approach as a whole, and our team, constituted a good bet.
So here is something of a brain dump of what we discovered over the course of several months in late 2018 and early 2019. Your mileage may vary, as the saying goes.
All Studios Are Weird, Even The Normal Ones
The first thing we needed to wrap our head around is that venture studios, while not unheard of, are still pretty unfamiliar to most investors. And for investors, unfamiliarity translates directly into perceived risk. This isn't necessarily fatal - the studios that are out there have all overcome this comfort gap, obviously. But as we looked around, it became clear that most studios that felt like reference points for us seemed to have one or both of these two properties:2
- The studio is focused on a well-defined space that an existing investor community is comfortable with and actively looking to invest in, (e.g., High Alpha, Betaworks), and/or
- The studio is co-founded by one or more folks with a very strong startup track record - in many cases with a big enough exit to provide a good fraction of the fund themselves (Expa, Obvious, Atomic)
Exacerbating the unfamiliarity problem is the fact that, as the article quoted above concluded, there isn't a settled model or structure for studios - each one is a bit different. This is in marked contrast with venture funds as a class, which have well-defined mechanics and metrics; while, say, seed- and growth-stage funds are very differnet in terms of check sizes, the metrics they look for in potential investments, the ownership stake they aim for, and other factors, investors know and understand these variables. There is little ambiguity about how a given fund should work in order to make its investors happy, even if delivering those returns is less straightforward.
Studios are off the beaten path for most investors, and there are no established models or accepted patterns you can point to. Compounding the challenge even further is that studios are neither fish nor fowl - neither a fund, nor an individual startup. This is a big one, because most investors fall cleanly into one of two camps. An investor who is used to evaluating and picking individual companies - whether using their own money or other people's - expects to make decisions on an individual basis, by examining a company's team, market, technology, and metrics. When they were interested in what we were up to, and a number of them were, these investors would often end up telling us that they'd be thrilled to look at individual companies as we spun them out, but that an investment in the studio itself wasn't in their wheelhouse. In the case of partners at VC firms, some of them were flat-out prohibited by their own limited partner agreements from making investments in other “funds” - they were the fund.
When we sounded out investors who invest in funds (i.e., as limited partners), we ran into quite different challenges. This investor cohort is generally not comfortable in sizing up the risks and prospects of individual companies; instead, they are looking for exposure to a portfolio of companies at a certain growth stage, in a certain sector, or sharing some other quality. While a studio does offer a portfolio, and might seem like a good fit, these folks were much more likely to become gun-shy once the differences between a studio and a more traditional fund came into view. Why, exactly, would they trust the Guild partners to do a good job of allocating capital between our own projects, when our background was in technology and entrepreneurship - not investing? From their point of view, it made more sense and felt safer to have professional investors - i.e., the partners of a venture fund - perform this function.
All Investing Is Personal
Roy Bahat, the head of Bloomberg Beta, is one of my favorite humans in venture (something something damning with faint praise). Roy wrote up some advice that Beta provides to its portfolio companies when they are pursuing followup funding. It contains a number of useful insights and guidelines, but the one that stuck with me (and which certainly held up during our own raise process) is that investment decisions are made by individuals who have their own interests at heart. In many cases, those interests are not simply, or not only, those of maximizing returns according to dispassionate criteria. In the case of established partners at a venture firm, for example, their bias may be to seek outsize, legacy-making gains at the expense of more modest, if likely, successes. For associates at those same firms, there may be powerful incentives not to look stupid, credulous, or unserious. And for anyone who is managing or allocating someone else's money, there is pressure to be able to account for or explain away failures - which often means to fail in good company.
These motivations vary from one investor to another, and part of the fundraising process is coming to terms with each prospect's motivations. This is always good practice, which is why Roy took the time to write it up.
I bring it up here because, in light of the above discussion, it is crucial for anyone looking to raise funding for a climate-focused studio to be clear-eyed about how a potential investor will make their case to their own stakeholders - rationally, emotionally, and tribally. Another option, though, is to pursue investment from those who answer primarily to themselves. Were I to take another swing at this, I would strongly consider restricting our investor search to high net worth individuals - that is, a class of investors who are free to follow their own counsel, and who do not need to protect their own career and professional reputation. Put a little differently, investing in a climate studio in 2020 probably requires both autonomy and courage.
Return Models Are BS - Important BS!
Until this point, we have been implicitly assuming that a studio focused on the climate crisis would at least claim to offer the same potential for returns as other venture portfolios. Leaving aside for the moment that even most venture funds don't make “venture returns”, there are some legitimate questions to ask here. Before continuing, I should point out that this is an area where there's a ton of jargon - and, while this jargon probably won't get anyone killed, I do think that it largely obscures some simple truths.
You can think of (desired, putative) investment returns as lying on a spectrum. At one end, we have so-called venture returns. There's a lot of lingo that gets invoked here - IRR, preferences, power laws, unicorns - but it all boils down to venture firms trying to make a shitload of money for their limited and general partners with a small number of huge, home run successes. At the other end of the “investment” spectrum are foundations and philanthropies. We don't usually think of these entities as investors - after all, they expect to lose everything they hand out. But if we expand the definition of “returns” to include both financial metrics and positive impact on the world, then it makes more sense to view venture and philanthropy as the two ends of a single spectrum. The question is: where should a studio that is aimed at addressing the climate crisis position itself on this spectrum? To be clear, I do not think there is a single right answer here. But it is crucial to be certain on your answer early in the process, since your return (or lack of return) model will create a top-of-funnel qualifying filter for the investors you should approach.
Relatedly, what is the return model? Does the studio expect to generate a portfolio that will, in aggregate, return venture fund-style gains - just with a particular sector focus? Is it adopting a philanthropic model in which the investors are effectively (or literally) grant-makers who do not expect to even recover their capital? Or will the studio attempt to stake out one of the many shades in between? One option is a so-called social enterprise model, in which portfolio members are expected to operate as sustainable businesses, and to return the invested capital, but are not held to the same standards for growth and returns as traditional venture-backed companies.
While there are large investor pools accustomed to the two extremes (venture and philanthropy), and who might see a studio model as a relatively mild diversion from the typical fund structure, the territory in between is more sparsely populated. This is probably a good subject for a followup post.
In This Essay I Have
To summarize: Studios are weird and unfamiliar, and investing in one is already perceived as risky - risk that usually must be offset by track record, comfort with the sector/thesis, or both. A studio focused on the climate crisis is doubly weird, because its mission will likely (and maybe correctly?) be viewed as a complicating factor. Add in an unproven or under-articulated return and/or impact model, and the weirdness starts to curdle into freakishness.
None of this is to say that the right investors don't exist for a studio focused on the climate crisis, but rather to suggest that investor identification is probably the first thing to consider. If I were going to attempt another raise in this space, I would certainly include someone on the core team for whom raising a fund was a natural motion. As a team of builders, we at the Guild didn't have either the right network or, frankly, the mindset to reach deeply enough into the investor pool.
Our inability to raise money for a mission-driven studio doesn't justify any larger conclusion about the viability of the approach, although I do hope the lessons we learned in battle can benefit those who come after us. Please let me know if you have any questions!!