Venture investors dip a toe into water tech

Water may be the new oil.

With the globe’s fresh-water supply shrinking due to pollution growth and severe drought in places like California, water is looking less like a cheap commodity and more like a precious resource.

So can venture investors strike it rich in the water business? Experts say that while the multibillion-dollar deals haven’t shown up just yet, many smaller opportunities are presenting themselves in a rapidly innovating and growing sector.

For now, venture money is not exactly pouring into water technology. It’s more a trickle than a cascade.

“It’s less than 1 percent of all venture dollars,” says Tom Ferguson, vice president of programming at Imagine H20, a San Francisco accelerator focused on innovative water startups. “But anecdotally, there is definitely a growing interest. We are getting regular, consistent, inbound calls from venture investors inquiring about the opportunity in water.”

One reason is the sheer size of the market. A Goldman Sachs report, “The Essentials of Investing in the Water Sector,” pegs the global water market at $425 billion. The report breaks the market into subsectors, including services for water testing, filtration and desalination, drinking water, wastewater, and industrial water treatment.

What’s more, over the next two decades, at least $1 trillion will be needed to repair or replace the aging water infrastructure nationwide, according to the American Water Works Association. The recent catastrophe in Flint, Michigan, where public tap water was contaminated by aging lead pipes, underscores this point.

“You won’t just see an upgrade to the existing infrastructure; you’ll also see new technology for the monitoring and management of that infrastructure,” Ferguson says. “It will all be next-generation stuff, and a lot of it will come from startups. Companies that offer new water technology could have a field day, so entrepreneurs and investors are figuring out how to tap into that.”

Ferguson says companies coming out of Imagine H20 are positioned to capitalize on the opportunity. Imagine H20 startups have raised about 10 percent of all early-stage investment in the water industry since 2009, he says.

Nexus eWater, for instance, recently raised $2.1 million from Australia-based ANU Connect Ventures and others. Nexus claims to be the world’s first water recycler for homes. The product collects a home’s grey water — the drain water from showers and laundry — and cleans it for at-home reuse, such as irrigation and other non-drinkable purposes.

Nexus estimates the U.S. market for this kind of water-recycling product is $15 billion annually. The company is launching in drought-stricken California, and its customers include new-home builders, existing homeowners, water districts, cities and energy utilities.

Another interesting company from the Imagine H20 accelerator program: Valor Water Analytics, which recently raised $1.6 million in a round led by Shore Ventures.

The water-tech startup delivers analytics to utilities to help them eliminate water loss due to network-wide leaks. Valor says the California drought is placing financial pressure on water utilities, and its technology is designed to fix efficiency issues within their operations in real time.

Meanwhile, water-analytics startup WaterSmart Software last year raised $7 million in Series B funding from Westly Group, Apsara Capital and Physic Ventures.

WaterSmart’s software analyzes information from millions of water meters and helps utilities engage their residential customers and offer personalized recommendations on how consumers can conserve water.

Jed Smith, managing partner at Catamount Ventures, says the water sector is no longer flying under the radar, especially as water prices start to skyrocket. “People used to perceive water as low cost, almost free,” he says. “But in a lot of places, the costs are starting to go through the roof, especially in southern states like Texas, Georgia, Arizona and California.”

Those rising prices have created an opportunity for a company like Banyan Water, which helps large corporations and institutions, such as college campuses, reduce their water usage and save millions of dollars.

Banyan Water, which raised about $1.5 million in a round led by Catamount Ventures, offers a monitoring system that tracks irrigation water used on a property and sends alerts if it detects leaks. This helps facility managers take greater control of their water use.

“Banyan is proving that it is possible to cut down water use for outdoor irrigation by up to 60 percent annually,” Smith says. “Our customers saved 2 billion gallons of water last year and they will save 3 to 4 billion gallons this year.”

Perhaps the biggest problem with the water business is that it is unlikely to produce the next Facebook or Google, precisely the kind of investments that VCs thirst for.

“The notion of creating a new Google-style venture-backed company is really difficult to do in the water industry,” says Jeff Garwood, managing member at Liberation Capital, which focuses on investments in the power and water sectors. “Going from zero to a billion dollars in revenue in three years? That’s not going to happen in this industry.”

One of Liberation’s leading deals in the water space is Desalitech, which has raised more than $22 million. The company makes purification systems that convert seawater to drinking water. Its customer base includes Coca-Cola and P&G.

To show the efficacy of its desalination technology, the company recently sponsored the “Brew the Charles Challenge.” Desalitech pulled about 4,000 gallons of water from the Charles River and the Boston breweries Boston Beer Co and Harpoon Brewery then turned the water into beer.

“Even though Deaslitech is a revolutionary product, the speed at which the world will embrace it is slow,” Garwood says. “The sales cycle is different than bits and bytes over the Internet. But this is still a very interesting investment with very nice growth prospects.”

In fact, recent data from Lux Research, which focuses on emerging markets, found that water startups can be high performers in the long term. Lux compared the time to profitability for water startups against a set of 3,700 other startups across a variety of industries.

“At five years, 14 percent of water startups reached profitability, slightly lagging the 17 percent overall average,” says Tamin Pechet, a Lux Research board member and a serial water entrepreneur and investor.

“But at the 10-year check-in, 31 percent of water startups were profitable compared to a 26 percent average. By year 15, 50 percent of water startups were profitable, beating the 42 percent average.”

Ferguson agrees that water startups can be very reasonable investments, providing a 3x to 5x return on capital. But can they return 100x? Probably not. And he’s OK with that.

“What we can’t afford is that this sector gets frothy once again, like it did a decade ago when cleantech was all the rage, and then come crashing down,” Ferguson says. “That would be a disaster.”

Ferguson says VCs would flood into water deals only in the unlikely event of a wholesale change in the dynamics of the water industry.

“VCs are smart,” he says. “There’s a reason why they’re wary of this industry. The sales cycles are long, the risks are high, and there have not been many examples of companies that really nailed it in a VC timeframe. Let’s face it, these are not Snapchat deals.

“Still, we absolutely welcome venture money. There are a lot of solid base hits available in water, even if the home runs have not happened yet.”

Tom Stein is a Palo Alto, California-based contributor. He can be reached at tom.stein@yahoo.com.

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