Digital water infrastructure

Many investors have grown familiar with the global trends changing in the way water is supplied, transported, treated and used. Those mega-trends, however, have not translated into much investment from the venture community.

Events such as the recent droughts in California have renewed focus on Silicon Valley’s role in providing new water solutions. The good news is that the commercial market for water solutions is bigger than you might think, and that venture-stage companies in water perform better than many investors and entrepreneurs realize.

From drought to flood, pipes to pumps, agriculture to industry, the water market needs innovation more than ever.

Where is the Silicon Valley for water?

Just a few hours drive from Sand Hill Road, California’s major agricultural production areas require heavy water use to sustain production. Recently, water wells serving hundreds of families in the Central Valley have run dry, leaving people without water flowing from their taps.

Yet the Silicon Valley for water remains in formation. Water and wastewater companies receive only a few hundred million dollars of investment annually — about 1 percent of angel and venture capital. That percentage has remained relatively constant in recent years, despite increasing attention to water needs.

The debate over whether water represents an attractive investment for Silicon Valley is ongoing, but many proponents say water is the next oil. Nevertheless, many sceptics cite challenges in sales growth for innovative water products and services as potential barriers to entry for tech firms. The New York Times recently noted that “the water crisis simply may be a poor match for the Valley’s skill set.”

Water startups are performing better than many tech startup peers

The water industry is yet to birth its own Google or Amazon, but for good reason; the water industry has far greater variation in market segments compared to the tech industry. It might prove hard for a water startup to achieve hockey stick growth if it sells engineering construction services for dams. However, the hockey stick might be realistic for a startup selling water data analytics to oil and gas customers.

In a large and changing market, water startups have performed better than many tech startup peers. Below is some surprising data and some promising companies.

Water startups have been high performers: Lux Research compared the time to profitability for water startups against a set of 3700 startups across electronics, energy, agriculture, nutrition, life sciences and infrastructure. Those 3,700 startups offer a range of solutions, from materials to devices, IT and services. The water startups begin by lagging the average; after 5 years, 14 percent of the water startups reached profitability, compared to the 17 percent overall average. Nevertheless, at the 10-year check-in, 31 percent of water startups were profitable compared to a 26 percent average. By year 15, however, 50 percent of water startups were profitable, greatly exceeding the 42 percent average. Therefore, it appears that as time increases, these water startups become disproportionately more profitable compared to startups in other industries.

Another cut at the data suggests strong performance in the 5 year period up to 2014. Lux provides an overall rating for each of the companies it analyzes. In 2009, 22 startups received a positive rating in 2009. 5 years later, those 22 positively rated startups yielded; one failure, two acquisitions and eight that reached profitability. The remaining 11 companies have averaged more than 300 percent growth since 2009.

What does that data really mean? At a minimum, it suggests there are plenty of good businesses among water startups.

What are water Entrepreneurs Saying?

CEOs of water startups believe not only in their own prospects, but in the prospects of their industry peers. Imagine H2O is an accelerator program for water businesses and has accepted 60 companies out of more than 450 applicants. In a survey given to more than 20 of its CEOs, almost all indicated that they would invest in water startups other than their own. There are also many investment opportunities in the water innovation sector. Imagine H2O’s portfolio accounts for more than 10 percent of angel and venture investment in water, and most of the constituents of its portfolio plan to raise capital within the next six months. There are plenty of opportunities for strategic investors and venture firms to put money in the water sector.

Historically, water startups have performed well in a rather unfavourable regulatory and capital raising environment. There is little competition to finance water startups compared to other industries. There are only a handful of investment firms that specialize solely in water, and most Silicon Valley investors do not focus on the water industry. Imagine H2O’s companies report that over the past few years, they have felt little change in competition among venture and angel investors to get into water deals. Water startups are also displaying positive growth despite minimal regulatory support. Now, regulatory trends are in their favor. The low price of water creates a common concern among would-be water investors. Interestingly, water and wastewater rates are rising across America, generally faster than any other utilities.

The Energy industry receives far more investor attention than the water industry, but in some customer applications, firms spend far more on water than energy. This poses a huge opportunity for water startups to capitalise on these high costs, and encourages firms to seek cost effective solutions. Nevertheless, water is generally cheap. Historically, Federal, state and local governments within the U.S. have offered minimal support or incentives to encourage the adoption of new water innovations. That also means that water startups have achieved strong performance organically, even in a historically unsupportive regulatory environment.

Unsurprisingly, companies that address water scarcity believe that the recent droughts in California has made selling and financing much easier. If these droughts and trends continue, and future regulation allows for a more favourable business environment, the performance of these startups should only improve.