Capital Series: John Tough, Energize Capital
This episode is part of our Capital Series hosted by MCJ partner, Jason Jacobs. This series explores a diverse range of capital sources and the individuals who drive them. From family offices and institutional LPs to private equity, government funding, and more, we take a deep dive into the world of capital and its critical role in driving innovation and progress.
John Tough is Managing Partner at Energize Capital, a leading climate software investor. Energize partners with best-in-class innovators to accelerate the sustainability transition, and they have both an early-stage traditional venture vehicle as well as a growth vehicle.
In this episode, Jason and John delve into the firm's origins and John's motivations for co-founding it. They explore his early career at Kleiner Green Growth and his pivotal role as employee number three at Choose Energy. The discussion also covers Energize's approach, LP composition, evolution, and the alignment between LPs and the venture and growth vehicles.
They then examine the shifting macro environment's impact on LP investments in climate tech, company criteria, check sizes, leadership roles, diligence procedures, thesis-driven aspects, and the comprehensive post-company support offered by Energize.
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Episode recorded on Aug 16, 2023 (aired on Sep 13, 2023)
In this episode, we cover:
[02:34]: The origin story of Energize Capital (formally Energize Ventures)
[07:26]: John's insights from being both a VC and an entrepreneur
[09:01]: His decision to anchor in the Midwest
[12:35]: Launching an early-stage venture firm
[15:30]: The pitch to GMs
[17:34]: Impact and thesis-driven vs. opportunistic approaches
[19:53]: Traditional venture vs. growth strategies
[22:31]: Energize Capital's current thesis
[25:15]: Value for founders working with Energize
[27:28]: LP base evolution
[30:43]: Tailored corporate engagement strategy
[31:59]: John's answer to "why software only?"
[35:55]: Current climate tech observations the role of international deal flow
[40:28]: Current (late 2023) LP sentiment amidst market uncertainty
[44:39]: Rise of dedicated institution-based climate capital pools
[46:38]: Energize Capital’s evaluation criteria
[50:42]: Controllable and uncontrollable factors in this space
[52:59]: Who John and Energize want to hear from
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Jason Jacobs (00:02):
Today on the MCJ Capital Series, our guest is John Tough, managing partner at Energize Capital. Energize Capital is a leading climate software investor. They partner with best-in-class innovators to accelerate the sustainability transition, and they have both an early stage traditional venture vehicle as well as a growth vehicle as well.
(00:24):
We have a great discussion in this episode about the origin of the firm, what led John to helping start the firm in the first place, his early career at Kleiner Green Growth and the very successful startup that he was employee number three at, Choose Energy. We also talk about the approach at Energize, the LP mix, how that's evolved over time and how much overlap there is between the LP mix and the venture vehicle and the growth one. We talk about what John has been seeing in terms of the changing macro environment and how that's been affecting LP dollars flowing into climate tech and, of course, we talk about what types of companies they look for, their check size, whether they lead or not, their diligence process, how much of it is thesis driven and what you can expect working with them when it comes to post company support.
(01:15):
Learned a lot in this one, and I hope you do as well. Before we start...
Cody Simms (01:21):
I'm Cody Simms.
Yin Lu (01:22):
I'm Yin Lu
Jason Jacobs (01:24):
I'm Jason Jacobs, and welcome to My Climate Journey.
Yin Lu (01:30):
This show is a growing body of knowledge focused on climate change and potential solutions.
Cody Simms (01:35):
In this podcast, we traverse disciplines, industries and opinions to better understand and make sense of the formidable problem of climate change and all the ways people like you and I can help.
Jason Jacobs (01:48):
With that, John Tough, welcome to the show.
John Tough (01:51):
Hey, Jason. Thanks for having me.
Jason Jacobs (01:53):
Thanks for coming. I'm excited for this one. You, like my last guest, Ben Kortlang, you are a veteran of clean tech before it was called climate tech.
John Tough (02:06):
That's right.
Jason Jacobs (02:07):
You also are growth stage, and you also are software focused and a climate fund, which is going to ruffle all these feathers and get some crazies upset, and you're in Chicago, which is not the most common thing for a venture firm. It feels like there's a lot to talk about here, and you're... I was going to say you're a person in LP in our fund. I don't know if I'm allowed to say that.
John Tough (02:27):
Yep, all those facts are true. I hope that the last one is not as rare in the future.
Jason Jacobs (02:34):
Awesome. Well, thanks for coming. Maybe to kick things off, talk a bit about the recently renamed Energize Capital and what you do.
John Tough (02:46):
Yeah. The firm began as Energize Ventures. We've been in the market since 2016 and, at first, we had one strategy, which was venture capital leading series A to series C investments in climate software companies, so the megatrend of climate, the megatrend of digitization leading investments there. The space has grown, and we can talk about some of the metrics that we measure to track growth, but the space has grown so much that, about 18 months ago, we launched a growth equity strategy as well with the new leader of that strategy within the firm, and then we just closed on the fund there, bringing 300 million of total capital into our growth strategy. With that, we decided to rename the firm to Energize Capital so we could have the two strategies, venture and growth.
Jason Jacobs (03:28):
Got it, and venture, you're one fund in on the venture side?
John Tough (03:32):
We've raised two funds on ventures, the most recent one, a $330-million fund that we closed in 2021, so we are in that three-ish year fundraising strategy for each of them.
Jason Jacobs (03:44):
How did the firm come to be and why did it come to be?
John Tough (03:48):
Yeah, so why? You mentioned Ben. I've been in climate now since before it was cool, since it was called clean tech. My first ever job was at UBS, which is actually the building right behind me here in Chicago. I was a biology and chemistry major, and I was hired in a bank because Clean tech in 2006 was bioethanol, and guess where they make a lot of that? Here in the Midwest. Bankers were rushing to take bioethanol companies public. They're the big new technology. I got hooked into the space back then, but I've been doing it ever since. I moved to the West coast because that's where I thought I had to be to be in innovation for climate and began my investing career at the Kleiner team that was called Green Growth Fund. Loved the experience. Felt like I wanted to be an operator, so I left to become one of the early employees of a firm called Choose Energy back in 2012 which was in energy marketplace, so digital, software marketplace for primarily renewables.
(04:43):
I saw firsthand the opportunity to create a more capital light business that also still accelerated renewables, and I was immediately hooked. I saw firsthand in the 2000s how hard it was to grow an infrastructure firm with venture capital money, and so I've always wanted to be on the software and more capital side of the equation for investing. That was the origin story for Energize which we launched in 2016.
Jason Jacobs (05:08):
What came first for you? Was it the seeking to become an investor capital allocator or was it seeking to do something in climate, and how did those two ultimately come to intersect?
John Tough (05:20):
When you're a biology and chemistry major, you really want to solve problems and system problems, so I've been most interested in how the whole system works together. I've been that way since high school. I was just fascinated from the early days about how new technologies could drop in costs over the course of five years and how entire systems would be built around them, infrastructure systems, services systems and then software. After my experience operating at Choose Energy, I wanted to be able to help scale the next generation of companies, and I wanted to get back to the investing side which is the reason I was one of the first members here at Energize.
Jason Jacobs (05:56):
When you think about scaling software and you think about the energy transition, what is different about... Actually, let me ask another clarifying question. Do you think about it as climate or energy, or are there sectors that you focus on, because it seems like one of the big differences between clean tech 1.0 and now is that clean tech 1.0 is very energy-focused, not exclusively, but pretty, and climate tech is the entire global economy. How do you think about it at Energize?
John Tough (06:27):
Yeah. I think, of the 30 firms that do this, I think we all have a different definition, which makes it pretty fun actually. When we launched the firm, it was that idea that climate is broader, it is the energy transition, it's the carbon markets, it's resiliency, which is both infrastructure climate resilience and cybersecurity resilience, and then this huge bucket we call industrial digitization, which is built environment, critical infrastructure, you name it.
(06:55):
Our broader belief is anything that helps digitize that ecosystem helps change happen faster. Climate broadly is about how do we help address the change that's happening around us in a more immediate timeline? I think we all know we could let utility sales cycles be regular for the next 20 years and a new innovation would happen then. How do we pull it all forward? I think the climate investors in the market today, whether it's energy or critical infrastructure, whatever it is, it's how do we pull the future here a little faster, and that's how I define our segment.
Jason Jacobs (07:26):
Gosh, I have a bunch of questions. One question is, you started as a VC and then you became an operator and then you went back to VC, talk through that a little bit because I'm finding... and technically now I'm a VC, but it's quite different than-
John Tough (07:41):
You're a VC now. You don't know it yet.
Jason Jacobs (07:45):
As a firm we are, what I am, yeah, because I'm still sorting that out. Talk me through a little bit the decision process and also just what you're finding is similar or different about the two paths.
John Tough (07:58):
I was fortunate to be at KP, meeting a bunch of great firms with that team. I realized that most of the entrepreneurs who were coming there were coming for the name that was behind me on the door. They were coming for Kleiner. I'd go home and I'd really be like, oh, I really want to be able to provide something that is unique to me to help these entrepreneurs scale. That's why I wanted to leave to go be an entrepreneur. I wanted to go be the third employee at the company. We sold it in 2016, and it was a successful exit. I felt like I needed that experience. I needed to be in the trenches so that when I was on the back on the other side of the table that I could speak as an operator to the entrepreneurs.
(08:32):
In most of the boards I'm on and I'm fortunate to be on today, that is my relationship with the company. There are many financial investors. There's not nearly enough investors who have the operating background. It's helped us win deals. It's helped us connect and help solve problems faster. I feel like I am a better investor and operator of, ultimately, Energize as well because of that experience I had at Choose.
Jason Jacobs (08:56):
When you went to Choose, did you anticipate that eventually you'd want to find your way back into venture?
John Tough (09:01):
Yeah, I'm curious. I don't know how you thought about MCJ when you launched it, but I have five-year plans, and it was on the five to seven year plan of getting back onto the investing side of the equation. I was at Choose for exactly five and a half years before it was sold and I was in the Bay Area still. I came to this life moment where we had our first son and I knew that, if I stayed in the Bay Area, it'd be another five to seven years. I had to believe that I could work innovation and climate not in San Francisco. I really thought I had to be there, and then one day I woke up, took my wife and like, "It doesn't matter where you work anymore." It really doesn't. It's about the community you create around you. I think you've done a great job with that at MCJ. All of a sudden, it clicked and now we're Energize. We have 25 employees here in Chicago, 1.2 billion in managed capital these days, and it feels like the first inning.
Jason Jacobs (09:48):
I want to unpack that. You have the successful outcome. You had that transition point where you determined that you wanted to go to the Midwest. Did you have roots there by the way? What led you to the Midwest?
John Tough (10:02):
Yeah. I'm Canadian and, growing up, I lived in the US, Canada and England. My wife is from Chicago, and it's an incredible city. I had no ties to really anywhere in the States, but I did like the centrality, I did the Midwest ethos, and we've actually adopted a lot of that ethos here at Energize ourselves.
Jason Jacobs (10:22):
What came first? Did you decide that the next step was building a venture firm or did you decide that you were going to anchor in the Midwest and figure out what you're going to do? How did you ultimately end up doing what you're doing where you're doing it?
John Tough (10:34):
I anchored in the Midwest and then, for about six months, actually I got an office downtown away from the house, away from the kids just so I could think through options, create some structure. Chicago in the Midwest in general has really boomed in terms of their own investment community, and so I spoke with a bunch of great firms locally in the Midwest primarily. I woke up again and I was like, "I need to work on something I care about."
(10:55):
Listen, I think there's incredible innovation in the next app for consumers. I think that the data infrastructure layer for Amazon is really cool. It just doesn't grab me. I was a chief revenue officer at the company, at Choose. I need to believe in what I sell. If you don't believe in it, you won't do it for a long time. It's just going to be a blip. I wanted this to be my last job wherever I went next. When Michael Polsky of Invenergy called to say, "Hey, we're launching this effort. You want to be part of it?" For a week, I was like, oh, my God, am I going to be back in climate? I love it, but I hate it at the same time, and then again, of course, I'm going to be back in this. This is it. This is what I want to do the rest of my career.
Jason Jacobs (11:36):
How did he describe the effort at the time, and how far into the effort were they?
John Tough (11:37):
It was super early. There was three folks working on it. There was Michael, Juan Muldoon who's a partner here and then Amy Francetic, who's now at Buoyant. It was zero. It was early stages, no capital raised, but the concept was this. The Midwest has an enormous number of energy renewables and infrastructure companies on the Fortune 2000. Most of them are within a hundred miles of Chicago. They know how to operate big assets. They know how to think about the next 20 years. What they are not good at is software and digital solutions. Let's reach out to those groups. See if a few will become LPs and see if we can learn from them the problems that they have, and then we go to them with the answers.
(12:19):
I think what opened my mind was, when I've been in other investing roles, it's usually "what's the technology? Let's go find the problem." In climate, it has to be, "what's the problem, let's go find the technology," because if you're too early in this space, you lose all your money. I love that combination.
Jason Jacobs (12:35):
The first step it sounds like was almost customer development with potential funders, but also to understand what their pain points were and then use those pain points to then form an initial thesis.
John Tough (12:48):
Correct. That's well summarized. The beauty is the customers know. They know what they want to buy. They know the problems they're going to have budget for in the next two or three years. When you're launching an earlier stage venture firm, you need your first few deals to go pretty well. This is a simple answer. Being able to de-risk the first few investments, and I'm happy to talk about a few and how we de-risked them, was really important, and we proved that the network provided that intelligence and then we were able to convince a few of them to become LPs.
Jason Jacobs (13:14):
Well, I do want to hear about those investments, but I don't want to jump there because I want to understand first like, okay, you started doing this customer development, so what did those next few stages look like? What were you doing? What were you learning? How did it go? Were there key inflection points along the way, any color to just help us get in your head from that time?
John Tough (13:32):
Yeah. The beauty of being in this space for a little bit longer is the issues of five years ago are still probably the issues of today, and then the question is has the technology emerged to help solve it? From experience, just as an example, I knew that decentralized assets were becoming harder to manage. A power plant used to be a big central asset, and now there was rooftop solar, EV charging. A utility has a huge problem trying to monitor these assets and deploy them. Knowing a few of the problems just created a simple market map of here are the problems we think you're having or you're about to have. This is a big key. We would not go to the innovation groups of these firms.
(14:08):
Every Fortune 2000 firm now has a chief strategy officer or a chief innovation officer. Their budgets are fleeting. Their budgets change year to year based on what's in the Wall Street Journal. We would go to the GM of a business unit that we knew had the problem more or less, and we would get the budget from them. The LPs who have committed came from a business unit, not from a innovation budget.
Jason Jacobs (14:33):
Interesting. I mean, I would think that, I'm way less experienced working with strategic LPs than you, but it would come from ventures or a corp dev group that maybe did directs alongside of fund investments, but you actually got them from GMs. These GMs, did they tend to have experience doing fund investing and/or direct investing historically, or was this a new concept for them?
John Tough (14:54):
This was in 2016, '17. It was pretty new, and so we were convincing them to create a budget. We had RunKeeper. There's education and then there's budget creation. It's really hard to create budget, but when you're early you have to, and so we would create a few examples of how our investments would deliver feedback positively or negatively to their decision making and be honest about it. Once we got the first few, that reinforcement from those groups help bring in the next. Every incremental one tended to be just a little bit easier, not that easy, but easier.
Jason Jacobs (15:30):
What was the pitch to these GMs?
John Tough (15:30):
Yeah. The pitch, even if you're strategic, the pitch has to be financial first. That was a big takeaway for me. No organization, no GM who's going to take their capital from their budget and give it to you is in the money-losing business. Financial first returns, even though you're investing in impact, has to be the goal, and then, number two, we through our investments will help identify companies that you may partner with or become a customer of to help accelerate your path to a more sustainable future. That was the pitch. We've made 25 investments fund firm life to date, 21 of them have a customer contract with one of our limited partners.
Jason Jacobs (16:14):
What about the customer development and understanding the problems versus the thesis evolution? How did that go, and how did you balance making sure that the thesis matched the needs of the customers with making sure that you weren't optimizing around the needs of some edge case of a particular customer versus the broader market?
John Tough (16:32):
Totally true. The key for us is that the way we do deep dives here at Energize is that we know that problem. Like I mentioned, an investor needs to hear that problem a few times before they raise their hand and say, "Hey, I hear a repeating issue. I want to go find the technology that solves it so there cannot be an edge case in how we approach it." Maybe the other benefit here was the first few LPs were on the corporate side. We were always clear that our goal would be financial first. We would not include the corporates in our investment process technically. They would provide information. They might get customer intros.
(17:07):
After the first 45 to 50 million came from corporates, the rest came from non-corporate. It was that reinforcement mechanism and access to information that actually excited then our institutional Lps. It excited our big family offices to then join and really commit to the fact that our LPAC at our firm will be financial first. We have this special relationship. About a third of our capital today comes from corporate entities, but it will always just be a part of our process and will not drive the process.
Jason Jacobs (17:34):
When you think about the motivations behind the firm and the funds, is it purely profit seeking or does impact play a role? If impact plays a role, how do you think about impact?
John Tough (17:47):
Yeah. The way we feel about it is we're all here because this space matters to us. I do believe that 10-ish years ago, you probably had to make a sacrifice financially to get a big impact. We don't feel that way anymore. We are financially motivated. We are impact motivated, and we don't think you need to make a sacrifice to do both of those. We, with every investment, have an impact strategy. We, in our term sheets, have the companies commit to tracking specific KPIs around impact and ESG that we believe are important.
Jason Jacobs (18:21):
On a company specific basis or standard across the portfolio?
John Tough (18:25):
Yeah. We have about 10 across the portfolio and then, depending on the company, we ask them to commit to a subset of them based on what we think is relevant to the business. We put that in a term sheet. We track it quarterly. We have the head of impact and ESG in Lauren Densham here who lead an ESG committee amongst all of our LPs, and we report that. It's been incredibly well-received by the companies and the LPs.
Jason Jacobs (18:46):
How much do you balance thesis driven versus opportunistic? Do you ever stray from the thesis because you find an exceptional theme and opportunity, or are you really just out hunting to fill specific voids in the thesis that you define?
John Tough (19:00):
Yeah. The fun part about our space is that, every few years, it surprises you about how certain technologies get pulled forward. Five years ago, you weren't hearing about direct air capture at all. Now, it's here. Same in hydrogen. Obviously, solar and wind and batteries have been pretty active.
(19:15):
We're generally looking at the problems that can be solved the next two to three years within our venture strategy, and that means finding areas where there's already some established footprint of the infrastructure, and where software does best is helping the infrastructure scale. We're looking at the S curves of technology and saying which technology today is most ready to scale and then let's go find the companies that will help them. We're big believers in the carbon markets. I know we've invested in Patch together. Those types of businesses that enable the next generation of infrastructure and sustainability companies to exist, we look at investing there.
Jason Jacobs (19:53):
Now that you have the two different approaches, the more traditional venture and then the growth, are there separate teams that manage each of those or is there overlap across and, same question in terms of investments, does the growth fund tend to pick off companies that come from the venture side first or are they out playing their own game?
John Tough (20:12):
Yeah. Good question. You're asking questions like an LP does, Jason.
Jason Jacobs (20:15):
It's like pledging. It's like who are the people that are the toughest on the pledges, the people that got the toughest time when there were pledges, so pay it forward. Right?
John Tough (20:25):
Yeah. You've been trained well. We felt that it was important to separate the strategies. We felt that we needed a strategy lead for each. Juan Muldoon and Tyler lead ventures here. Kevin Stevens heads our growth strategy, so separate teams, separate analyses. About half of the capital from our growth funds will go to existing ventures deals, but through independent, and that's a really big part for LPs. They don't want you marking your own book once you have a critical eye. This is the reason we launched Growth. We are so surprised at how much bigger the market is today than it was even five years ago. That's why there's going to be an enormous opportunity at the seed stage all the way up through growth in the next five years. The talent wants to work here. The economy is telling us that this is an important segment now. Regulatory is telling us it's a must-have segment. I think our space is woefully underfunded, and so, when we thought about how do we capitalize, we felt we had to scale with the opportunity because very few others were.
Jason Jacobs (21:22):
Maybe just more of a logistical question, but just for the venture strategy, typical stage, typical check size, lead, board seats, et cetera, and then same question for growth just to frame how to think about the firm for listeners?
John Tough (21:35):
Yeah. For all the entrepreneurs out there, we'd love to talk to you if, so software and capital like business. Our venture strategy is series A to C. We have done no revenue businesses in ventures up to 10 million. The average is about 4 million in annual revenues at investment. That's an important inflection for us. Usually, it means you have enterprise accounts, you have some revenue sophistication, and that's an important part for a big check. Our average up-front check in ventures is $15 million, and we've led every deal we've been a part of for the last three and a half years. We are term sheets, board seats, usually a board observer seat as well. We really want to be that partner and work with other existing names in the ecosystem. That's ventures, so four million-ish average entry. Our growth strategy, it's about 30 to 50 million of revenue just to give that step change in approach, and it's about a 30 to $50 million check for every deal as well, board seat, board observer.
Jason Jacobs (22:31):
I'm so curious about the thesis definition in terms of what goes into defining the thesis, how do you staff and resource for it internally, and then is it like a one-time exercise on an annual basis or at the outside of a fund or is it something that's living and breathing and evolves over time?
John Tough (22:48):
Yeah. We have an internal document that tracks the areas of interest for us that are going to be active the next two years and then two to five years. We actually share that with the LPs going into a fund. We say we're going to do five investments per year which is pretty focused for a venture firm. When we construct this portfolio at the end of three years of 15 companies, you should expect these are the segments you're going to get exposure to. That really helps the LPs know where we fit an ecosystem. I found that's very helpful. Some firms do more infrastructure in deep tech. When we describe our areas, it comes across as very specific, and I think that helps them frame their budgeting process.
Jason Jacobs (23:27):
Talk a bit about the current thesis.
John Tough (23:29):
Yeah. It's funny because the times change and yet I still think we're in really early innings for a few spaces. The electrification and mobility, the electrify everything theme, wind, solar, heat pumps, the whole space, there is a tremendous impact opportunity just by moving from heavy hydrocarbon to renewable energy and renewable electricity. We are highly focused there. I think that's the next-two-year opportunity. One of the subtle and secret best buyers of climate products is the industrial world. It's the built environment. It's critical infrastructure. It's transportation firms. We've found that, if you have a service or software that helps them accelerate their path to sustainability, they have enormous budgets, and so we're focusing a lot there right now.
Yin Lu (24:15):
Hey, everyone. I'm Yin, a partner at MCJ Collective, here to take a quick minute to tell you about our MCJ membership community. We're just born out of a collective thirst for peer-to-peer learning and doing that goes beyond just listening to the podcast.
(24:27):
We started in 2019 and have grown to thousands of members globally. Each week, we're inspired by people who join with different backgrounds and points of view. What we all share is a deep curiosity to learn and a bias to action around ways to accelerate solutions to climate change. Some awesome initiatives have come out of the community. A number of founding teams have met. Several nonprofits have been established, and a bunch of hiring has been done. Many early stage investments have been made, as well as ongoing events and programming like monthly women in climate meetups, idea jam sessions for early stage founders, climate book club, art workshops and more.
(25:01):
Whether you've been in the climate space for a while or just embarking on your journey, having a community to support you is important. If you want to learn more, head over to mcjcollective.com and click on the members tab at the top. Thanks, and enjoy the rest of the show.
Jason Jacobs (25:15):
Just a random question that I have is I'm thinking back to my founder days, but I would imagine for a thesis driven firm like you, you aren't going to invest in the first company that you meet in the space. It's like looking for a house. You'll go to that first house and be like, "Wow, this seems great. We love it," but we're not in a position to buy that house because we need to run the process and look at houses of different shapes and sizes and also look at other houses of a similar shape and size and refine our criteria in the context of the broader market. As a founder, I understand why it benefits you to talk to everyone in the ecosystem before making a decision. If a founder catches you when you're early in that thesis development, what incentive do they have to talk to you and be forthcoming with information?
John Tough (25:56):
Great question. You're an LP again. Good to get you to be an LP in our firm. What we've done historically is we use that LP base, the commercial one I referenced, to get a lot of information. We do these deep dives. They're 30 to a hundred pages long. We do all of that with existing intel before we have to go speak to a founder. Actually, when we are reaching out to a founder, and hopefully many who are hearing this know this, we're actually usually giving them the first 20 pages of our deep dive. You don't need to educate us. We're not like that West Coast tech firm who has an associate running climate for them. We know your space. We studied it. We know the customer need. You're going to take the meeting with us hopefully, and we're going to introduce you to a few customers, and that's the value.
(26:38):
We do that in most of our deal connectivity. It's growing inbound these days, but most of it's outbound, and that is how we originate. That has worked well. Most of these founders are very frustrated when they have to describe what climate is to a generalist venture firm.
Jason Jacobs (26:52):
Do you like engaging with these companies when they're in a process? If you're first engaging with them when they're in a process, is it too late?
John Tough (26:58):
Too late. Our average is about nine months. We call it the midair refuel. Our best processes are when we've got to know a company, we create a process, make some intros, we listen to a sales call, we give feedback, we see how they respond to that feedback and we say, hey, listen, you could wait two years to raise or we can create a step up from the last round and get in right now. Existing investors tend to be complementary to us, and it's worked well, and it's helped us not get into the very competitive process, which can happen in other areas of the early stage environment.
Jason Jacobs (27:28):
In terms of the LP base, well, it'd be helpful to understand the chicken-and-egg between having the capital to deploy and having a track record of companies that you've backed. That can be case studies of what the LPs would be buying if they invest, so just how did you navigate that chicken-and-egg in the earliest days, and then it'd also be helpful just to understand what did the LP makeup look like in that initial fund and then how has that evolved over time?
John Tough (27:53):
The chicken-and-egg one is a doozy. It's funny, we get asked from a lot of the institutional LPs these days like, "Show me your 15-year track record here," and short of very few funds that you had been on last week, they'd be one of them, they have a good record. You don't want to know the track record of anybody who's doing this for 15 years. It's not good. You couldn't have done it and been that successful unless you started more recently.
(28:14):
Our message to them has been we're going to hire people from industry, I know you have as well, who respect the customer, who respect how this industry is different, and we'll find the right companies, but realistically, this is a strategy that was born today. It was born in the last five years. You're going to benefit from the returns by being early in an early fund manager, and that takes an evangelist. Full stop. It takes LPs who have some belief outside of returns probably in a first fund to want a fund like ours, like yours to win, and so we got kiss a lot of frogs. We probably took a thousand meetings the first fund, probably more actually. It took about two years from start to finish. Now, a third of the capital was corporate in that fund. A third is institutional, so pensions, endowments, and then families. Families have been the backbone of the climate space.
(29:05):
Realistically, to get this space going, high net worth, big family offices have gotten us to today. The pensions, the endowments, they've been excellent. We have a few that have been here since the beginning, but most of those big institutional firms are going to show up in five years, and so kudos to the big family offices that have supported the space since 2016.
Jason Jacobs (29:25):
Now that you are on your second fund in the venture bucket and you have the first growth fund that's fully raised, what are you seeing in terms of how the LP base evolved from fund one to fund two, but also what's the crossover of LPs from the early stage to growth? How much overlap is there and, to the extent that there's different types of LPs there, what do those LPs look like?
John Tough (29:48):
For us, we've benefited from a few more institutional limited partners showing up. These are sovereigns who've shown up. Actually, the problem with our space has been they're coming usually from oil and gas and they're saying, "We have X, Y, Z dollars in oil and gas. We need to step that down over time. We're looking for climate or climate infrastructure investors," and the amount of capital that oil and gas had sucked up in the last decade. Our space is actually more capital efficient than oil and gas. Full stop. It is, and so these firms look at funds like ours and say, "We need to deploy more capital," and so it's created a big opportunity for SPVs we've found, which has helped bring them in. That's probably been the biggest surprise, which is institutional LPs are now showing up for a second fund in our space, which is nice. Still, full support from corporates, it's a competitive advantage. The check size and the ability to scale up when companies scale is what the institutions have brought.
Jason Jacobs (30:43):
How do you engage with the corporates, and how are they involved in the fund and with the portfolio companies, and how much of that is uniform across and guidelines versus case-by-case based on the needs and capabilities of the specific company?
John Tough (30:59):
It's a great question because it's really bespoke. We to this day, and I know this is an anomaly, have a monthly LPAC with our top limited partners. That includes the different stakeholders I mentioned, the institutional, families and a few corporates. In addition to that, about once a month to once a quarter, depending on the corporate, we have a catch-up with them and, actually, we try to speak with different members of the organization to learn about their budgets, the problems they're trying to solve, et cetera. It's usually us asking them questions and asking them about how they see the future so we can better inform our investment process. They want financial returns. They will not sacrifice. They don't want to lose money, but if you don't deliver within a fund, some strategic insight, customer relationship, channel network opportunity, they're probably not coming back. There's definitely a strategic intent for some of them. You got to balance it. We never sacrifice the companies. We always put them first. We always put our investment first, but we do believe that you can serve both parties well.
Jason Jacobs (31:59):
There's certain climate purist circles that will look at the fact that you're a software-only firm and they would say, "You're not a climate firm. It doesn't matter if you invest in software for climate. If you're only doing software, you're not a climate firm. We need to move out of them to have any meaningful impact on the problem. Why software only, and also how do you respond to the people that might say such things?
John Tough (32:17):
I thought you had a great answer online, just so you know, which is climate buyout, climate growth, climate software, climate hardware, climate infra. We need it all. We need it all. Full stop. There's not one solution. To believe there's one solution is not to know how the system works. The best example we have in our portfolio from ventures one is Aurora Solar. It's pretty well-known at this point, probably the largest software company in climate. Full stop.
(32:40):
The average rooftop solar system in America costs about $30,000. 10,000 of that is hardware. The hardware has declined by 98% in the last 12 years. It's the soft cost, it's permitting, it's installing, it's designing, and that is where software does best. Software does best when the hardware costs has come down enough and now we need to put as much of that hardware into the real world. Again, we're trying to drive impact and change now, not in 10 years so, when nuclear comes and there's a software for it, great, we'll help, but for today, we believe that there are great investors who do infra and do do deep tech. They will do that, and then we will help those technologies scale.
Jason Jacobs (33:16):
If you look at a software venture firm or a software growth firm, or call it a software fund, or a venture fund or a software growth fund that's more generalist in approach, but that similarly goes out and likes to get to know the companies with long runtime and has looked at whatever sector they're evaluating before they come just like you do, is there any difference between the sport that you're playing and what they play other than the fact that you only do it within companies that are trying to accelerate the clean energy transition?
John Tough (33:50):
Again, another great LP question. I would say this. The climate tribe, and you guys have done a great job defining it, knows its people. It knows those who are here and who will stay. Part of the reason we changed to Capital was, when I was in this space in 2010, 2012, everybody left. Every generalist who claimed they were going to do this for a decade, they all left. I think we've actually seen the exact same thing this cycle. Everybody who was going to focus on it has moved on to generative AI. Those who care about this and are doing this for financial and impact reasons recognize that firms like yours, like ours who know this space is different, requires different attention, requires a different go-to-market, respects regulatory.
(34:29):
The space just operates different. Full stop. When a generalist tries to come in and say it behaves like regular software, they don't believe it. The entrepreneurs don't know it. They know it's different, and so it almost helps sell our case. It is a question we need to keep monitoring is will it ever converge? Maybe 30 years from now it will, but for now we think this space behaves more like healthcare and health tech than it does other areas of the ecosystem.
Jason Jacobs (34:51):
How important is climate motivation as a criteria for the founders that you back?
John Tough (34:59):
Almost every investment we have, we can trace a direct impact to climate. In a few of the deals we've done, they didn't have a climate goal, but we knew that technology could be addressing climate, and so we actually brought them to climate. One example is a firm called Sitetracker. They were in telecom, and they were helping decentralized telecom 5G towers, and the operators deploy them and maintain them, and we said, oh, my goodness, the EV charging and rooftop solar ecosystem will be the same. How do you help EV go? How do you help Volta? How do you help ChargePoint deploy their chargers?
(35:32):
Sidetracker has become the default backbone for the entire North American and Europe EV charging network. Almost every network is deployed and managed through it. That's helped them scale. They had zero energy revenue before we joined. We take that thesis to some of the companies and then, when they see the impact, they get very motivated by it. I think this is the point of the space, that you have to be creative to address all aspects of the climate opportunity.
Jason Jacobs (35:55):
If you step outside of Energize and just look with a bird's eye view at the climate technology innovation ecosystem and, specifically, the capital stack, what do you see? Is there over-saturation? If anywhere, where are there gaps? Where are the biggest pain points and opportunities?
John Tough (36:13):
That's a great question. First, I think the whole space is under-capitalized still. I believe that the talent that decided to work in this space in the last 18 months is going to create an enormous number of pre-seed, seed and later-stage opportunities in the next 36 months. We need you to be a $500 million seed fund, Jason. That's how big we need you to be to serve this opportunity.
Jason Jacobs (36:36):
Although our strategy breaks when we get over, say, 150 or so, but that's another issue.
John Tough (36:40):
So just raise it every year.
Jason Jacobs (36:41):
We could get more global. That's something we think about, because either we need to start playing the more traditional sport to grow our assets under management or we need to stay disciplined about not raising our fund size as we look beyond this vehicle, or we need to get more global and bring on one or two partners in other parts of the world. Anyways, I don't want to derail.
John Tough (36:58):
No. That's perfect. It's global. Out of curiosity, what percentage of your deal flow do you think is international?
Jason Jacobs (37:04):
If you look at the companies we've backed so far out of the, I think, 82 companies that we've backed as of this recording, 84% of them are in North America. We've got some global reach we're treading carefully, but it is an interest area to expand over time. We just don't want to get over our skis, and North America is where we are.
John Tough (37:21):
Europe is arguably ahead of North America on all things climate, mobility, approach to energy transition. It hasn't gone well for them for some reasons that I think are good lessons for us to learn. Theoretically, my guess is, if you had three partners in Europe, you could do another 50 deals in the last few years. The opportunity there is big. I look at where the opportunity is, and I just say it's everywhere, venture, growth. I don't know credit well enough to know what that means, but it does feel like the big asset managers, the Apollos, the Blackstones, they've all gone into infrastructure because that's big dollars, easy fees. The work we're doing is company building work. It's harder, and it does have to be more of a craft job than just bulk asset deployment.
Jason Jacobs (38:02):
I spoke with another growth investor in climate recently not on camera, but what they were saying is that they were frustrated that there's not a lot of early-stage companies that are mature enough to pop up on their radar where the fruit is ripe enough that they're even worth tracking. What are you seeing?
John Tough (38:20):
The market, how you define growth, really defines what scale means here, but launched Energize. I don't think there were many companies in climate with software capital, light services with more than 50 million of revenue. There weren't many. In our first ventures fund, now there's six or seven that are over 15 approaching a hundred or more in revenue. To me, that just shows the growth of the space. Everybody is going to be surprised at how big this is in a few years. I have no doubt that big growth funds will show up in the market in six or seven years again, but for today, you really need to be a student of the market to know where the opportunities are because they are there.
Jason Jacobs (38:58):
You mentioned that most of what you do is outbound and that it tends to be out of cycle. Who and what level of people within the firm tend to do that outreach, and what is the typical entry point in terms of how you frame engaging with these companies?
John Tough (39:13):
The sourcing in our space, the outbound I mentioned, so the deep dives that we run when we have the problem, and then we can try to go find the software, the solution that will help solve the problem, every person on the team, myself included, has at least one of those at any given time they're doing. Usually, it's about two or three. By the time of a second meeting, I'd say a principal, if it's an associate, the principal has joined, but a principal or partner is joining if it wasn't one they originated. We have principals take board seats here alongside partners as well. You have to be very creative.
(39:42):
One of my most fun stories has been we couldn't get one of these entrepreneurs to speak to us recently. We found out what charity they like to donate to, and we donated to the charity, said, "We did this. Will you take a meeting with us?" and then took the meeting, and we actually made the investment. Again, there's no code to how this space works in venture overall. With our space, it's okay to be a little different and weird. Run it your own way. There's no playbook like there is in other parts of venture.
Jason Jacobs (40:09):
Well, it's reassuring to hear that that's true because we're certainly not following much of the playbook over here. Or we're following a playbook, but it's not a playbook that's been followed many times before. Yeah.
John Tough (40:19):
Yeah. You're making your own play, and that makes it more fun. If this is going to be a 20-year journey, 30-year journey, you better do it your own way or you're going to burn out.
Jason Jacobs (40:28):
What are you seeing out there from an LP standpoint just in terms of some of the turmoil and uncertainty in the market over the last year-plus and heading into 2024?
John Tough (40:39):
You're seeing some of this, too. For 2022, late 2022 and early 2023, it felt like every reason, every meeting started with, "We're going to tell you no, but we'll take the meeting.' You just have to persevere through that with the LPs. They're also looking to see who will persevere is my hunch here. The sentiment I would say is already far improved versus six months ago. I'd say the budgets for 2024 from the allocations for LPs are becoming available, but there's a lot of skepticism. I think a lot of generic, more mass market limited partners showed up to our space in the peak. A lot of them got big exposure to SPACs, which have dramatically underperformed.
(41:20):
I joke that clean tech is no longer called clean tech anymore because it became a four letter word. So much money was lost in 2008 to 2010, and so our whole goal as emerging managers right now needs to be prove that this space will deliver financial returns. Nobody will do it just for the impact metrics. The growth in revenue, the growth in gross margin of the businesses ultimately will be the reason that more of these LPs continue to show up. What are you seeing?
Jason Jacobs (41:47):
What are we seeing? We're a little different because we're out raising our... It's our second fund, but it's our first with a traditional structure and first time including institutional LPs. I think, historically, it was all strategic, well-placed individuals who backed us, and that was by design, and directionally we didn't want to lose that inclusivity, but we wanted to bring in an underlying layer of more sophisticated capital. How that's manifested is large family offices. It is the outsourced CIOs that work with those types of families, some of whom are introducing us to other clients and some of whom have discretionary capital on behalf of other clients. It's the subset of funds that are serious about climate. It's a subset of endowments that are serious about climate. Once you get much beyond that like the big pensions and sovereigns and stuff like that, we're just too small.
(42:36):
The other thing is, just given the macro, and so that was kind of MCJ specific, but given the macro, I think it seems like a lot of the big players are sitting on their hands. It seems like the ones that aren't sitting on their hands are going with the old trustee, which puts emerging managers in a hard spot, and it also puts climate in a hard spot because, while climate is almost bipolar in the sense that on the one hand it's newer and people still have scar tissue from 1.0 and where's the DPI, but on the other hand, there's the tailwinds of doom and all the big net-zero commitments and the IRA and the increasing flood of talent. It's like, well, gosh, it both feels inevitable and impossible at the same time, which is a pretty weird place to be.
John Tough (43:20):
Perfectly summarized. Perfectly summarized. I have nothing to add. I think, those that persevere and invest, my father-in-law says, "The easiest form of diversification is time. Don't try to time the market. Just do the same amount every year. Those that persevere through this market will be the brands of the future in our space." I fully believe that. I believe you will be. I hope we will be, and I think the entrepreneurs deserve it.
Jason Jacobs (43:43):
Fundraising in this environment feels a bit like graduating college during a recession or things like that, but to give it a different spin, it feels a bit like when my son's out shooting hockey puck, giving him a weighted stick to use or if you're out marathon training, training with some bricks in your backpack or training when it's exceedingly hot conditions relative to what you'll be doing on race day. It's like, if you can thrive in that environment, then once someone unties the hand that's behind your back, you're going to feel like a hero. It feels a bit like that. It's like, gosh, when the markets open up even a little bit, we're going to feel like life is on easy mode because we headed out to experience life when life was clearly on difficult mode.
John Tough (44:21):
Yeah, and you have a team. You have the experienced team who's been through this, too. I've felt like, if I didn't have a team, it would be very hard. You need that group to rely on, commiserate. The highs are high, lows are very low in raising a fund in a firm. That balance is critical, and that's what helps you get through it.
Jason Jacobs (44:39):
Well, one question I have is just, I mean, I mentioned that we're too small for the pensions and sovereigns. You mentioned the pensions and sovereigns in terms of some of your LPs. I don't need to know any names, but I'm just curious for the ones that are participating in the sector. Do they tend to have dedicated climate or decarbonization mandates? Do they have separate teams that work on it, separate pools of capital? Is there a consistency in terms of what you're seeing across or is it case by case, and what are you seeing?
John Tough (45:04):
The biggest difference between 2017 and raising in 2022 and '23 was there are now dedicated groups at large institutions for energy transition, sustainability broadly. There are now groups with pools of capital, and some of it is coming from the oil and gas for the real assets world. It's coming to the climate world, but there are now leads who have to deploy capital and need to map the space. That's resulted in a ton of first meetings where they're just mapping the market, which is fine, but at least they're here now. That's a big difference. I'm curious if you've felt the same.
Jason Jacobs (45:42):
Yeah. In fact, actually, you could ask me the same question when I asked you the question about why should a company take a meeting when you're in market mapping mode. We get some big endowments that starting to come in and saying, "Hey, we're not in deployment mode. We're in mapping the market mode, but we have to talk to you. Everyone keeps pointing to you. You're one of the key players in the state, and so we'll take the meetings and invest even if it's very low probability that they'll come into this vehicle because, directionally, we're just trying to play the long game." Similar to the whole time diversification, we're just going to put one foot in front of the other day in and day out and, if there are people that we ultimately want in our tribe, it doesn't matter if we can have them now or not.
John Tough (46:21):
Yep. Perfect. You have to take it. You're not going to say no. Right? I think the answer is even if they're market mapping, you're going to take the call. It's long-term relationship development. The space will need more capital. If you want to go international or you just want a new fund a few years, you have to develop it now.
Jason Jacobs (46:38):
You talked a bit before about some of the tangible criteria like revenue targets and things like that when you make investments. What are some of the intangibles that you look for beyond the key metric thresholds that an algorithm could suss out?
John Tough (46:52):
The financial KPIs are just one equation. We have six ways to evaluate a company. There's the product, the market, the team, the economics of the customer contracts, the deal and then the impact. We rank everything zero to five at our firm. Nothing gets funded unless the average is 4.5 or higher. The deal is only one part. There's so much other, and the customer economics is only one part.
(47:15):
The true intangible for us is the entrepreneur and the team's respect for the market. Do they recognize this is different? Do they recognize that this is going to require running through walls, going to DC, having to do probably a few more pilots than you'd want to, having technical innovation goalposts move on you a little bit. It's just a hard space, and so we want to see somebody who knows what they're getting into, has run through the wall before and will run through it again. It's hard to test in a two-week competitive process, which is why we do the average of nine months before we invest of knowing somebody. We make customer intros. We give them feedback. Do they listen? It is just a big part of being successful in this space. Everybody wants to do well until it's hard, and so you have to see, once it's hard, did they persevere is just what we're doing.
Jason Jacobs (48:03):
What are some examples? Assuming it's a software company that fits all the criteria that you laid out and stuff like that, what are some red flags for you or things that you just won't do?
John Tough (48:14):
I think what's important to note is that there's impact as, quotes, exhaust, which is, okay, it happens, we're not investing because of it, and then there's impact because there's intent. We fully do believe that both of those are aligned and you don't need to make sacrifices. Knowing that an entrepreneur really believes that is important for us because there's a lot of ways to spend your time. This is how we choose to spend ours. We want to know that we're aligned in mission. That's important.
(48:41):
The other angle, the biggest red flag, and we've seen a few of these in our time, is continuous pivot. The number of firms I've seen that did blockchain that then took their blockchain solution to some other form of the carbon markets is crazy. They're in it for the cool tech. They're trying to find the market. That never works. It never works. I think we want to find people who are in it for the solution, and then the tech is the second level.
Jason Jacobs (49:04):
Funny that you say that, because in between RunKeeper and when I started MCJ, I tried to start a company and I got the band back together with my co-founders from RunKeeper, and we had a tech, and we were going to build a studio because it was a new tech and we were going to experiment and try to apply it to different markets. It actually might've worked out quite well financially. It was a really fun area to experiment, and I think the tech had applications in a lot of places in interesting ways, but what was really missing for me was purpose. I just found myself clamoring to start with the solution and then work backwards to finding the best way to address it, and so I ended up giving the money back to our investors and then heading into climate because I felt like I was doing things in reverse. Like you said, you have to do it in an area that you are really passionate about because it's so hard that, otherwise, you're just not going to be able to stick through the ups and downs over the course of a long journey.
John Tough (49:59):
Yeah. You have kids. I have three. I love telling them what I work on. We all have mentors. I mentioned Michael Polsky earlier, his co-founder, a guy named Jim Murphy. These are people who've been in climate and successful for 40 years way before it was a thing, knowing that you can create a career, have tremendous financial impact and tremendous environmental impact. I think, once more and more entrepreneurs see what these pioneers have created, it's only going to create a positive impact. I'm very excited for what's going to happen in the next 10 years. I think we have no idea how big the space is about to get because of how visible some of the successes are becoming. It makes me nervous because we have to build the firm and you have to build the firm to be ready for that. It's just a generational opportunity.
Jason Jacobs (50:42):
If you had to pick one thing, what's the biggest thing that you're worried about that's within the purview of what you can control at the firm, and then same question about something that's outside of your control as it relates to your ultimate success?
John Tough (50:54):
Oh, that's a good one. I'd say the number one thing we can control is the people we hire and the culture that we instill. We are a firm that doesn't have deal attribution despite our LPs insistence every time. We are a firm that make five-ish new deals per year. We do everything together. It's a we. Energize is we. I think you can control that. I think that the moment you let somebody who's counter to your culture come in, they can ruin it. I love that I can wake up and know we have the right team.
(51:20):
The hardest thing in our space in general that we can't control is the public perception to our space. Whether we like to believe it or not, most big financial players, governments, customers, LPs, they read the Wall Street Journal, Bloomberg and USA Today to learn what they're learning about climate. I hope in the future they are also listening to your podcast and your series, but that's what they're reading, and so I wake up and I'm like, oh, there's another article saying that EVs are bad for the world. It just sets us back. It just does, and so that's frustrating, but that just makes us work harder.
(51:54):
I would love to throw it back to you. What do you think you can control and what can you not control?
Jason Jacobs (51:59):
We can control putting one foot in front of the other trying to be intellectually curious and undo knots of areas where there's nuance and lack of understanding and build bridges and not only help to get more talent and capital into the space, but help it get allocated and anchored in a way that is productive for the transition. That's what we can control.
(52:18):
What we can't control, it's like heading out sailing. You can control the boat and your preparation and the sails. I'm not a sailor. There's a lot of things you can control, but you can't control what kind of storms you're going to face along the way. You can't control a shark attack. You can't control another boat not seeing you and going right in front of your path as you're outgoing.
(52:41):
Yeah, I think, similar to you, we try to control the things that we can control. We want to check the weather report and check the maps and build a plan and factor in our surroundings and seasonal patterns and stuff like that. At the end of the day, everyone has a plan until they get punched in the face as Mike Tyson says.
(52:59):
Well, great, John, for anyone listening that's inspired by the work that you're doing as a firm, who do you want to hear from and how can we or our listeners be helpful to you and to Energize?
John Tough (53:10):
Yeah. I'd say, at Energize, what we're trying to do is help accelerate the sustainability transition. We love working with co-investors across the board, earlier stage like yourselves, to later stage. We are always trying to find more entrepreneurs. If you're any of those and you don't know us yet, please reach out. I think this ecosystem example of fostering collaboration, and then maybe part two, and this is as a tribute to you, Jason, I don't think people realized how much of a gap there was in understanding our space until MCJ and your community came on board. If today is literally inning zero of the baseball game, anything that we can do at Energize to help support MCJ and the community, let's do it together. Let's do it. We want to do it.
Jason Jacobs (53:52):
Anything I didn't ask that I should have or any parting words beyond what you just said, which is perfect parting words?
John Tough (53:59):
Let's do more investments together.
Jason Jacobs (54:01):
I agree. Well, John, thank you so much for coming on the show. Thanks for all the work you're doing at Energize. Thanks for your support and belief in us personally as an LP. I'm looking forward to doing more with you and the Energize team and with everybody that's working to accelerate the transition LFG.
John Tough (54:17):
Let's go.
Cody Simms (54:18):
Thanks again for joining us on My Climate Journey Podcast. At MCJ Collective, we're all about powering collective innovation for climate solutions by breaking down silos and unleashing problem-solving capacity. If you'd like to learn more about MCJ Collective, visit us at mcjcollective.com and, if you have a guest suggestion, let us know that via Twitter at mcjpod.
Yin Lu (54:45):
For weekly climate op-eds, jobs, community events and investment announcements from our MCJ venture funds, be sure to subscribe to our newsletter on our website.
Cody Simms (54:54):
Thanks, and see you next episode.
