E686 | Jan Hofmann, Viessmann Generations Group and Christian Hernandez, 2150: From Climate Hype to Industrial Reality

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2:32This show is not investment advice, and the hosts of this episode may be invested in the funds and companies featured. Let me just first ask you, why do you say that climate tech is not dead, but instead we are just having stronger models than ever before in this ecosystem? So there is a prevalent meme about the fact that the climate tech is dead. Let's backtrack to climate tech becoming a word in 2020, 2021, before that was clean tech. So maybe it's an evolution, but for me, climate tech is simply technologies that are better, faster, cheaper, that improve industrial process, that actually generate value, and also happen to do some good for the planet.

3:16And that has not abated, right? People still want to buy stuff that's cheaper, faster, better, and are deploying it at scale around the world. If actually, if you look at what gets categorized as climate tech by CTVC or others, you actually have seen an increase from last year to this year in terms of capital deployed. We can talk later on about where that capital is going. And if you look at my CRM system and my deal flow, we looked at 2 ,500 companies last year that categorized themselves as climate tech, which is why they came to us. That's a pretty healthy deal flow. So no, I would not say it's dead.

3:48I think it's simply it's morphing and evolving into different categories and definitely a stronger filter about what will get backed and what will get scaled. So a question I couldn't agree more. I mean, that's why we are on the same page when it comes to investing, so to say. I would add a different perspective that is complementary to Christians. And I would say that the underlying need for capital hasn't changed. So the need for investing into climate technologies that would use CO2 emissions that preserve our planet. I think the need is even bigger than two, three, four, five years ago. So it's just, let's say, some noise that has found space above the need for these investments.

4:30So when you think, for example, of sustainability and all the typical three angles as part of sustainability, I think there is some movement around thinking sustainability in a bigger scheme, in a bigger context, for example, including resilience. And when you think about the Central European climate tech investments that we look at at least one group in particular, not only, but in particular, what we see is that the need is still the same. The willingness to go into these positions is still the same. It's just a different, let's say, naming, a different phasing that is used describing the same need and the same kind of investments.

5:11If we make it super concrete and talk about the pool that is completely undeniable that you're describing here, how do you see customers reacting? How do you see regulation developing? How do you see the infrastructure demands maintaining a very strong pool for climate sustainable, strong solutions? So what we see on the customer side is that when you think about very central aspects like very basic human needs, there is heat, there is energy, so electricity, all these needs have not changed but are actually growing. And when you think about how to serve these needs, for example, heat, it's a common denominator that we have in the European Union, but also far beyond that, that we need to have solutions that are sustainable in the long term.

6:03And now coming back to the world of sustainability, in the end, sustainability can also be substituted by resilience. So we need solutions that are able to serve the need of heat, for example, on a very long-term trajectory. And for example, district heating solutions that we are quite active in are solutions that are serving these customer needs and they are growing heavily. And when you think about what just happened in Berlin a few days ago in the electricity grid and the infrastructure there, this is, let's say, screaming for solutions to protect very central human needs like electricity and also with solutions that are increasing the resilience of a society.

6:49So that goes even beyond climate tech only. Yeah, and I think that, I mean, we talked about the elephant in the room, which is the perception that regulation is going the wrong way. And that is true in one country in North America, where in the last government, we had probably the most aggressive deployment of capital to support the scaling of climate positive solutions. And that has very, very, very quickly been retrenched. And actually, if anything, pulled back. But I think focusing on just the US would actually forget the rest of the world. Whereas, as Jan says, there's still all these needs.

7:25And if you look at what happened in the last year, right? So EVs actually accelerate around the world The UK is actually the second largest market for both Tesla and BYD outside of their home markets. 24 % of all cars sold were electric. Solar became the cheapest and fastest scaling deployment of energy around the world. Battery prices were getting slashed down, deployment of solutions. So yes, there is headwinds in one country around anything with the word climate around it. But there's actually significant momentum just simply because it's back to the term I used earlier. cheaper, faster, better to do it that way.

8:02You talked about the word resilience, which I think is becoming a port-a-mento for climate. So adaptation, resilience, energy, independence, all these things are talking about the same thing. I actually went to a defense tech conference recently, and they had five companies on stage. And three of those companies I would have called climate tech, they called defense tech. So fine, semantics, let's actually find those companies that can actually support the resilience, defense, energy efficiency, and costs, and scale them out as quickly as possible. I care less about semantics than I care about them rolling out.

8:38There's two specific points I would love to touch on. One is, and both of them fall within resilience, one is energy and one is industry. If we start an industry, could you talk a bit about how the rise of industry as a focus area for climate, At least to me, it seems like where we would have a couple of years ago spoken more clearly about climate as the header. Now it seems to be more often industry as the header, the need to change how industry works, the need to digitize, the need to make everything in the supply chains more resilient. All of these topics all fall within climate. But now I'm seeing more phrasings that use the word industry rather than climate.

9:20Can you talk a bit about that and both the technologies that you see maturing and coming to the market within industry? I would like to build on what Christian said regarding semantics. So basically, when you look at the business models that we touched upon with what you just said, I think not that much changed. But the kind of angle that you look at them has changed. So in some years back, let's say 2020, 2021, the discussions had pretty much semantics and let's say purpose driven. So we wanted to save the climate. And this has been the key driver for business models to be perceived as a good business model.

10:02And nowadays, it's much more about the economic opportunity of this business model. And this, I think, is the rephrasing. But if you look at the business models, it's still the monetization of CO2 reduction. It is still about the monetization of energy efficiency gains. So it's pretty much at the same spot right now, but a different angle to the problem and also to the solution. And this comes back to the semantics, as Christian said. What do you think, Christian? Yeah, this is going to be boring because we're agreeing on a lot of stuff. So last year out of Davos came out a term I had not heard before called green hushing.

10:45So not greenwashing, but green hushing. The notion that people were still taking action to deploy solutions that made industry more energy efficient or companies more energy efficient or reduce their CO2 footprint, but nobody wanted to talk about it. They did not want to be in the crosshairs. I highly expect there will be very little language around climate initiatives at this year's Davos. But people are still buying. People are still deploying. People are still putting industrial heat pumps into their factories to replace natural gas because it makes economic sense. So interesting stat about energy and industry.

11:20So everybody right now is talking about the energy demand from data centers between now and 2035, 2040. And yes, we're going to need a lot of energy to actually power or chat GPT queries, for sure. And that's highly concentrated in a couple of different nodes. Northern Virginia, Ireland, Sweden, the rest of the world, the largest load of energy demand that will be needed between now and 2035, 2040 actually comes from the electrification of industry. The current grid cannot support it. The business case is there. So the demand is there. So that's number one. And it's like three times bigger than data center energy load.

11:59Electrification of vehicles, which is 1.5 times bigger from memory. Electrification of cooling, which actually is still bigger than data centers. So yes, data centers are going to be a driver of innovation around energy sources, energy efficiency, but we need it for the whole rest of the economy around the world. What's your read on our current trajectory to meet the demand of electrification? Because one part is like we've all seen these charts showing that if everything that has been signaled around data center build-out was to come to fruition, we would be maniacs below demand or below supply in electricity.

12:39And I think we could do similar charts. I'm personally not, I haven't checked that out, but I'm pretty sure that we could do the same thing for the demand for energy, for the electrification of our mobile, our car fleets and our industrial base. So what are you seeing? And do you see the energy grid as a core investment area, investment space for you? So the grid, I think there's two components to it. One is the source of energy, where, I mean, my favorite example is Microsoft's recommissioning a nuclear plant in the US for their data centers, three mile islands. Japan actually beginning to talk about nuclear again after effectively being a taboo subject.

13:19I think one of the largest recipients of climate tech dollars in the last year was actually nuclear fusion. By the way, if we solve nuclear fusion, we're having a whole different conversation. We're talking about energy abundance and what we do with that. But that's still 10 years away every 10 years. So there's a lot of stuff going on around energy supply, geothermal, which I think Jan can talk to as well. Geothermal is magical. It's the most democratically available source of energy. It's just expensive to get to. And then the second is transmission of that energy from where it gets produced to where it gets consumed.

13:53We lose about 30 % of electricity through transmission lines. That is a solvable problem. There's actually some pretty cool companies. There's one, I think, in Germany that actually runs a little robot on top of the cables and actually coats it so that you can actually lose less electricity as you transmit it. There's a couple of others in the U.S. So there's both the production and the transmission. We've looked at a bunch of transmission solutions. We haven't done anything in that space yet. We have looked at fusion and other stuff. Some of it feels a bit too CapEx heavy for a venture capital of our size, fund of our size.

14:26But that is a significant amount of focus across defense tech or energy independence funds or climate tech funds and something that will be critical. The carrying grid can just simply not support the energy load that's coming. Period. And the speed to build a new nuclear reactor, even a small nuclear reactor, or to build a new hydropower plant is just decades. It just takes way, way, way too long. I couldn't agree more, Christian. And if I may add a different perspective once again from our portfolio. So as you know, we have Gritech as part of our majority portfolio. And Gritech is basically electrifying the cities.

15:03So what they are producing are technical stations where you have, for example, transmission from high voltage to mid voltage within the electricity grid of, for example, Europe. And what we see there is that the whole discussion is not covering the end-to-end perspective. So from electricity generation to electricity usage. But we have kind of isolated discussions. So we discuss electricity usage at the point of, for example, data centers. We discuss generation around nuclear power plant and taboo topic. What we don't discuss is how to bring that all together and how to make sure that our grid is able to connect both dots, so the generation and the usage.

15:46And what I think is, coming back to your question at the beginning, we miss two things. not only, let's say, the extent of investments, so it needs more funds like 2150. And second, we miss the integrated view from generation through transmission to the usage. And you know what the biggest gap right now is? Transformers. Right now, if you wanted to buy a transformer, you're probably waiting at least a year to get a new one. And we know how to make these. We know how to make these at scale. So if I had all the money in the world, I would go build a transformer plant. The demand is there. The man's going to be there for a long, long time.

16:24And it's not rocket science. I mean, Lily, we know how to make them. It's not rocket science. We just need more of them. Let me ask the two of you another question when it comes to climate and industry and the built world. A lot of people are talking about capital discipline and the importance of being able to build in a disciplined way in this category. Can you talk a bit about how we as VCs are coming to grips with that and how founders that oftentimes come from the pure tech sector is also learning how to play in this sector? Yeah. So right now, the hardest place to be in climate tech is raising a Series B or Series C for building physical stuff.

17:06And by the way, I don't think you can be a climate tech investor without investing in some physical stuff to replace bad physical stuff, along with software, along with low CapEx stuff. Just CapEx, the meme that VCs don't like hardware, but you need to build some of these physical stuff. Therefore, you'll need a factory. Therefore, you'll need a capital infrastructure. what we spend a lot of time with our founders doing, especially when we'd look at early at the investment initially, is how much capex are they going to need? And where is that money going to come from? And ideally, the answer is not from my money.

17:42It shouldn't, equity is a very expensive piece, part of the capital stack. At which point do they become bankable so they can get financing, non-dilutive financing from, be it a grant, be it a bank, be it a financing organization. So just to put a metric to it, across our portfolio, for every euro raised of equity, our portfolio has now raised 0.75 cents of non-dilutive funding, and most of that is commercial paper, debt. To go build factories, to have working capital, to go build inventory. In a five-year's time, I expect that ratio to be completely skewed. I expect to be like three to one, five to one of debt versus equity.

18:21working with them very early on to understand that capital stack and capital formation needs, probably pushing for them to have a CFO sooner than you would in a traditional pure software company because the CFO needs to understand capital markets, the structuring of the product, off-take agreements, well, interest payments and warrants that comes with some of this debt. And that's very different to traditional venture. I didn't think I'd be doing this much structure finance many, many years after my MBA, it is very much a part of the advice that we have to give the founders and the need for them to scale.

18:55And then secondly, on where the capital is flowing on the equity side, a lot of higher bar in the last, let's call it 18 months or two years on what's getting funded. Yes, of course, team matters the most, business model matters as well, but also path to profitability is probably something that comes up way earlier in the conversations and it would have back in 2020, 2021, when the next round was just around the corner or being preempted. Jan, do you have similar observations? I do, but I'm not going to copy all that, all what Christian just said. Just in a sentence, I would say it's professionalizing the whole industry, what's going on right now.

19:34And it starts with the port course, goes through the funds, but also on our end as investor, I think it covers the whole chain and professionalize a lot. Can you ask both of you, and you, Jan, as an LP, and you, Christian, as a VC, what's your take on the current state of VC capability within this part of it, being able to actually meaningfully help build companies that are hardware intensive? because we're seeing, I think, a lot of generalist VCs being interested in this space, talking about the importance of resilience and doing investments that touch the real world, the atoms parts of the world.

20:23But sometimes I think to myself, are they really as value-add as they were as B2B SaaS investors when they all of a sudden have found this investment space as well? To me, it's a bit like the intersection point between psychology 101 and economics 101 so on psychology 101 everybody is running towards where the money goes so this is a bit like everybody was running into climate tech now everybody is running into defense and on the economics part you can only win if you have a competitive advantage so and this is why we have invested for example into 2150 because it's a combination of people that bring expertise, experience, and the right conviction to the table.

21:09And it also holds true for ourselves. We don't go into positions where we do not have competence. And we don't go into positions where we don't bring something to the table that, let's say, brings the company to the next level. And this is, once again, I think a professionalization of the whole industry. What you said between the line and this is a bit like, are we going to see VCs, let's say, drying out for sure? We will also see companies drying out for sure. But I think that once again, if you have these kind of pivotal changes as we have right now, it's just a moment of separation. So who is going to win and who's not?

21:53Yeah, and it's a very different skill set to talk about hardware, right? And working capital and cost curves. It still happens that my partner, the other Christian, his prior career was actually inside industrials, actually inside factory floors, building physical stuff and rolling that out across different geographies. Most people know me as the Facebook guy, but actually one of my early jobs was building early mobile phones and understanding building materials and going to Taiwan and looking at factories. So there's some knowledge, not that we're experts, but at least there's some understanding of what it takes.

22:28However, we also need partners that can help us. And that's a large part of why we're excited to have the Wiesman Group as one of our anchor LPs for Fund2. This is a multi-generational group that actually built a massive company out of Germany and then obviously had a fantastic exit a couple of years ago. The expertise that they have in-house around what it takes and actually being able to spar with them around some of the things that we're looking at is pretty important. and having somebody kind of inside the tent that's willing to say, that's just crazy, don't even go there, has been pretty critical.

23:03And then secondly, it's also understanding the pathway to profitability. So yes, when we invest in a company that's making a hardware, the first unit is going to be insanely expensive. It was made by hand. It's a multimillion-dollar piece of kit. At which point does the price start coming down? Is it the 10th unit? Is it the 100th unit? is a thousandth unit for it to be profitable. And we spend a lot of time when we're looking at investments, understanding how they get the cost down. And obviously some of the cost comes down just because you're buying more volumes. Some of the cost comes down because you've done it multiple times.

23:36And then at which point does it actually start having profitability on a per unit basis? And at which point it's become profitable at a company basis. Actually, I literally had a board this week in which we were talking about their pathway over the next 18 months to increase profitability through better purchasing, better scaling of the manufacturer. That's a very different conversation to a SaaS B2B software board conversation. I will talk about the black swan moment that happened in climate hard tech last year. So overall, VC had a PTSD moment with Silicon Valley Bank. We all spent the weekend literally not knowing if the industry was going to survive by Monday, and we did.

24:18Climate tech had a black swan moment with the elections in the US and the withdrawal of the IRA. Billions and billions of dollars that had already been deployed, or so we thought. People had already started building 200,$300 million factories in the US. Shovels are in the ground building these factories. And all of a sudden, you show up at the next board meeting and that money is gone. And I know funds that have exposures of like a billion, 2 billion, 3 billion across their portfolio, that there is no ability for that individual fund to make up for it. So that is definitely going to lead to some challenges in terms of just some companies dying.

24:56And there were some that already died last year, to some funds having significant troubles on both performance and ability to raise again. And then a question mark around this whole sector of the asset class and how it continues. I knew there was a risk. So luckily, we were not very exposed. We had a bit of exposure to IRA capital in the portfolio, but generally we don't back companies that can only exist if grants get given. But if you only could exist if somebody willingly gave you 200 million because you were cool, that's going to create a massive knock-on effect across the whole sector and this year, next year, the year after that.

25:32Let me ask you both to summarize this first part of the conversation in a principle that you think will anchor climate investing in the years going forward. Don't do it because it's good. Do it because it's good business. If I should make one as well, it's actually, it's exactly that. That's how I am feeling that every single investor that I have come across that are really performing well still and having good traction in their fundraisers, both from the investor side and the founder side, honestly, they're explaining exactly that. And you can actually, you can say that it's a bit of the green hushing part because you do not want to be leading with that in your decks and in your materials anymore.