The Diligent Observer Podcast

Episode 27: "Water is Critically Underinvested" | Water Technology Expert Doug Lee on Why 0.2% is Not Enough, Barriers to Entry in Hard Tech, and Creating Win-Together Scenarios

Andrew Kazlow Season 1 Episode 27

Today's episode explores three ideas that caught my attention: 

  1. The “conjoined twin” - Water touches every form of energy generation. Doug’s laser focus on this point made me consider what other interdependencies we often overlook.
  2. Market signals can mislead on timing - It’s often said “It’ll take longer and cost more than you think.” Based on Doug’s comments, this saying applies even more in industrial applications - these things can take a long time to percolate, even when the market is responding positively. 
  3. The future bill always comes due - Doug’s perspective on how we underpay for water today by borrowing from future resources was a new one for me. I understand the “I want it now” mindset applying in consumer scenarios, but Doug’s experience suggests it applies just as much in the industrial setting. 

I explore these ideas and more with Doug Lee, Co-founder of Flathead Forge. He is a rare combination of successful founder, veteran operator, and ecosystem builder in the industrial water sector. After leading multiple water technology companies to successful exits, including what is now Enerflex Water Solutions, Doug co-founded Flathead Forge to reinvent how hard tech companies scale. His journey from developing patented water treatment technologies to integrating acquisitions at Suez/Veolia has shaped his conviction that sustainable innovation requires more than just capital - it needs an integrated ecosystem of technical expertise, market access, and execution support. Today, he's applying these lessons as a venture builder, helping a new generation of founders navigate the unique challenges of commercializing industrial water solutions.

During our conversation, Doug shares:

  • A framework for evaluating water technology investments that emphasizes the "why" and "who" before diving into technical or market specifics.
  • Why water technology requires different investment horizons than traditional venture capital, including specific examples of adoption timeline challenges.
  • A venture builder model designed specifically for hard tech that addresses key failure points in traditional investment approaches.

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[00:00:00] 

Doug Lee: This water, as we said, is essential, but it's critically underinvested.

energy and water are conjoined twins. 

water is a wonderful place to play if you know how to make it work.

Over the last 20 years, we've pulled over a billion people out of severe poverty, mostly due to the access that they have to reliable and affordable energy.

You can think you're a subject matter expert, but there's flavors of these things that you just, you really have to get into the details of. 

Every business is a people business. A lot of the biggest mistakes I've made is around those people.

these people are so much smarter than us. It's like, okay, they have to be right, they can be right, but at the wrong scale

we as a society are not great at, paying for the present. We love to put things off to the future.

 God didn't put me on earth to be a passive investor. He meant for me to sweat and work. 

Andrew Kazlow: My guest today is Doug Lee, water technology expert and co founder of [00:01:00] Flathead Forge. With over 30 years of experience, involvement in multiple successful exits, and several patents to his name, Doug is a walking masterclass in industrial water investing. In this episode, we discuss the unique challenges of scaling water technology companies and how his picks and shovels model at Flathead Forge is transforming the way energy transition companies are built and scaled. I hope you enjoy learning from Doug as much as I did. 

 Doug, thank you for being with me today.

Doug Lee: Thanks, Andrew. Pleasure to be here.

Andrew Kazlow: Okay. So Doug, I'd love to start with what is exciting to you right now in your world.

Doug Lee: Well, I am just fascinated with all of the second order effects around energy. And energy, especially those of us living here in Texas is kind of front and center, we think about oil and gas but, globally, we're really more talking, more around the energy transition. When most people [00:02:00] think about this, they're thinking about those prime order effects, and how we generate that energy, how we can invest around that?

Where is this coming from? How are we using it? And those are all interesting. I do find that interesting as well. But, I'm sure as we'll talk about later, I deal mostly in water and some other categories. When I think about energy, I get really interested in the second order effects and where how do we generate our energy. What are the critical dependencies around that? Just to illustrate how important this is, there was a great report put out last year by the folks over at Liberty Energy, Chris Wright and the team over there. If you haven't read this or haven't seen this, you really should go look at it.

It's well researched, it's just a bunch of fantastic facts. But the key things that I take out of that is over the last 20 years, we've pulled over a billion people out of severe poverty, mostly due to the access that they [00:03:00] have to reliable and affordable energy. So energy impacts life. There's a quote in there from Chris that, "Energy is essential to life and we need a lot more of it", and we see that today in the headlines of everything coming around with AI and data centers and, power consumption that's going to be driven from this and Microsoft buying three-mile island and nuclear.

 These are great but this is not where my skill sets lie. And this is not where I can really move the needle. I get excited about how do we make that energy? And what are you going to need to do that? Quickly you find out that energy and water are conjoined twins. It's very difficult to separate these two. There's almost no example of a form of energy that you can talk about that doesn't touch water. So, that's what's really interesting me right now.

Andrew Kazlow: So Doug, give some more examples of these second order categories that most people don't think [00:04:00] about, Same, give some more examples of the common second order effects that most people don't think about where there's a huge opportunity and there's a ton of activity.

Doug Lee: Sure. Our base energy today, the bulk of it's coming from three forms. and It's coming from oil and gas. Oil, if we take that as a single category, it is our single largest form of energy. Followed by coal, which has been declining, but it's still the significant form of energy globally. And third would be, natural gas. We talk a lot about, replacing these energy with wind and solar and other categories. These are growing and they're important, but the bulk of our energy still comes from these three forms. So when you think of that, and even think about the transition, we

doesn't take long to think, okay, well, what do we need to make that happen?

And so let's think through some of these examples right now. If we're going to produce oil, water from the formation generally comes with this. And increasingly over time, the concentrations of this water, the volumes of it are increasing, not decreasing. So water is this co-product with it.

If you're going to produce the oil, if [00:05:00] you're going to produce the gas, water will come with it. But that's not the only example. We take the others as well and how we actually utilize this energy water touches it too. And let's continue through. Coal, generally, we're mining these coal, but the way we separate coal from the other minerals is through a froth flotation process.

We actually segregate this in water. We hear about these tailings ponds, the critical minerals that we utilize to drive our silicon chips, the critical minerals around how we generate power and electric motors, all generally are mined and then separated through some type of a water-based process. Once we get that pure form of whether it's a mineral or a purified form of that energy, we're generally burning it in some form, you know, a coal or natural gas, petroleum products. Generally there's cooling loops that are around this equipment. So there's cooling cycles and water that's required around this. And battery manufacturing, everything we do, water starts touching this extensively. These conjoined twins, [00:06:00] energy and water that are very difficult to separate from each other. It doesn't stop there either, by the way, if you think about, why did we burn that energy? What were we making with it? What products were we making? And you'll find almost downstream of everything that the manufacturing facility itself has a critical water component to it. So, right down to the products that we wear, what we eat, the medicines that we use, how we make these things. Some examples that are in the energy transition space, things like biofuels, the bioreactors that we use to grow those organisms and make those biofuels are water-based. Geothermal energy, we have all this heat, but that heat is trapped in water in these reservoirs. It's just almost impossible to find a way that you're going to make energy or utilize that energy that doesn't touch water, and to me that's gets exciting.

Andrew Kazlow: Well, Doug, it's funny. You and I have talked about this in the past, but when we think about the "water market", it just feels overwhelming because of what you said just now that it really [00:07:00] does touch every facet of life. It's necessary for almost every single industrial or residential process. Like it's just everywhere.

So, walk me through Doug's like mental model of the water market. um, not, I'm I'm not looking for specific numbers. I'm going to hold you to, but just like, how do you break down and think about this space? Like a new opportunity comes, how do you bucket things into your mental model?

Doug Lee: There's a great podcast by a great investor group, venture group called a Burnt Island Ventures.

Tom Ferguson, hosts this podcast and um, he titles it The Fundamental Molecule. So, there are also focused water investors and great ones, it's The Fundamental Molecule, but we think about this as an investor in a market and how we play that, which is really your question. 

A few things really jump out, people think water, and most folks will think about municipal water. They're going to think about the water they drink, the [00:08:00] water that's in their sewage, and these types of things. Absolutely this is a key piece of the market. Um, It is a very large segment of the market. But let's start by talking about my playbook for a second that is not where I am playing. I think that is a great place to play. But we're talking more about infrastructure and we're talking about large contract operations and generally governments. And that's no judgment on anybody else, we critically need investment in these areas. But where I can help and where I feel that we have a unfair advantage is in the industrial side of these things. 

This water, as we said, is essential, but it's critically underinvested. The market and where investors have gone in general, and there's some good reasons why it's been underinvested, but let's speak for a second about some numbers here and put this in context. Investors are primarily driving to what we would call pure tech or soft tech. You know, I like the framing that Peter Thiel uses of atoms versus bits. Most of the investment over the last, 30+ [00:09:00] years has gone into bits. It's going into software. It's really this hyper-growth area where your product, once you find product-market fit, your cost of production is essentially zero for the product. 

The margins can be fantastic. You just have a different set of investment risks and profiles and timelines. That's not true for hard tech investment atoms, what we would call. So these hard tech investments, first of all, what I'm talking about around water and specifically into industrial water the numbers I'll throw at you here though, to tell you how underinvested this is.

Last year was the best year we've ever seen in venture and growth investments into water, but $1.12B was invested last year into the type of categories I'm talking about here. So I'm not talking about building a water pipeline for a city or a water treatment plant. You know, these can be, or desal plant.

These can be billions of dollars standalone facilities. What I'm talking about is this venture and growth investments into technologies, hard [00:10:00] tech in particular. Although there is a lot of software involved with this as well and sensors and monitoring, but $1.12B dollars. Okay, sounds huge, right? And we should be really excited. Actually, I think it was about 30%, 29, or 30% increase over the previous year, to over 2023. Fantastic!

I don't know if you'd hazard a guess in the category of just we took clean tech and I would categories what we're doing in water is clean tech investments. 

I don't know if you'd hazard a guess, but I'll give you the answer in the interest of time here. I think it's around 0.2% of the total investment into clean tech last year. So clean tech is drawing all of this capital and water is just critically underinvested. Now you can look at that is, is a problem or an opportunity and I look at it as a huge opportunity.

Andrew Kazlow: All this clean tech investment that requires water to function, to actually deliver its promise. And we're only seeing 0.2% [00:11:00] of the total clean tech dollars towards industrial water venture.

 Wow. 

Doug Lee: Well, the obvious question is why?

why Why would that be? It's so obvious to us, you know. We just talked, it's The Fundamental Molecule, life is essential. Energy can't be done without this. It's hard, Andrew. 

Here's some key things. In hard tech in general, but water specifically, the timelines are longer to develop these types of projects. There is very capital intensive. There's a huge execution risks around these types of these technologies. So when you combine these things, boy, capital intensive, long timelines, you know, I'm taking a hard tech risk. 

There are some reasons why investors are afraid to be in this space.

However, if you take the other side of the coin, if you're any good at what you're doing in there, if this truly is where your unfair advantage lies, then you have to look at the other side of this. Those same barriers are there for other [00:12:00] people. 

So this becomes a moat. These are hard assets typically, and these are generally long life assets.

So when we talk water as a service, or we talk about how would we do this? We can get to the how later, but the why is, why is not enough money going into this space isn't because there aren't fantastic returns available. It's not because there is no dependencies and what we're saying at the top of this discussion around the dependencies isn't true. It's the risk profile and finding teams that can actually do that.

 You know, I look at the moat and I look at the durable assets and the long term reliable cash flows that these types of businesses can generate.

When we look at this from an investment perspective, we're always looking at how we get our money back and how we exit these businesses. One of the fascinating data points that we've studied, this last year is the multiples that these types of companies trade at. When we look at oil field services and we look at these types [00:13:00] of typical industry businesses that we've operated in our own past as investors. He's traded terrible multiples, you know, four or five times.

EBITDA is kind of this benchmark everyone will throw at you. But when you look at these water technology businesses in particular, you're seeing transactions that trade in the high tins on private transactions. Public companies are trading well into the 20s+, and then there's some exceptional data points that we look at last year with low 18 months ago, Evoqua and, Xylem. Xylem coming together. We look at the Veolia Suez transaction. When you look at when you can get past a critical, revenue point, which is typically around that 100 million plus of revenue, your valuations are spectacular. And you just don't see this a lot in other hard tech investments. And hard tech like NVIDIA, okay, obvious exception, but, uh, around this space, water is a wonderful place to play if you know how to make it work.

Andrew Kazlow: Look, I'm still trying to wrap my mind around [00:14:00] this massive misallocation of dollars. One question that comes to my mind is, can you speak to the effect of what I'll call unbridled optimism around some of these more emergent clean technologies? The history of investment in water, I would imagine is much more consistent. This is an asset that everyone has known for a long time, needs to be around and needs to receive investment. Do you think that percentage is materially affected by the reality that's just been invested in for a long time and we don't have the breadth of need for aggressive near term investment?

Or do you think that it's just a miss on behalf of the current broader market?

Doug Lee: No, I wouldn't point at either of those. I would point to, we as a society are not great at, paying for the present. [00:15:00] We love to put things off to the future. We don't like paying for the things that are important to us today. So we push a national debt on to the next generations.

We push all our health care consequences of lifestyles on to our future older self. And we do this with water as well. We don't value water effectively, you know, most people don't pay for water other than industrial customers and things like this. But even what we allow our industries to do is borrow from the future.

So we've been depleting water resources that are our best resources. That are very challenging and difficult to replace. It's not because we don't have the technologies to be able to treat waters that are lower grade, that are less valuable, especially to human consumption. Yet we'll take reservoir water or surface waters, we'll take groundwater. We will utilize this for industrial purposes. And then it is not reused. It's not recovered. so We're not [00:16:00] paying the true cost of this water today. And so, while our energy consumption has increased astronomically, and an investment has gone into energy, when I say these conjoined twins, one of the twins is doing real well, and the other one has been underfed, and is really kind of struggling to get the resources it needs. But the bill l will come due, and it's becoming due. There was an article in the Houston Chronicle. The Governor Abbott has reached out to the mayor here in Houston, I live in Houston. And has proposed that we move water, our drinking water, fresh water, from Houston to West Texas. 

Well, Why? Because we're severely limited in the amount of fresh water that we have available in West Texas, and there's tremendous needs for this. Can we take water from um, one region of the state and move it to another? Sure, of course, technically we can. Is it wise to do [00:17:00] that, and what would the alternative be? 

Well, goodness, we have billions of gallons of water that are being produced every year. In West Texas today, it's called produced water. It's water that comes with our production. And the Permian is the most prolific energy source we've got in this country. Water will come with it and it's coming, in a tremendous amount. What do we do with that water today? Well, a small amount of it gets recycled and reused for the next fracs. But we could never use all of the water that we generate back for those fracs. So the bulk of that water moves by pipelines to disposal. Where we put it back into disposal wells, and it's gone. Why don't we reuse that water? There's a lot of reasons why it's hyper saline water. It needs a lot of treatment. Of course, it's been in direct contact with oil and gas products and other minerals that can partition into that water. But there's been so much great work done by academics and great industry partners to show that you can effectively and cost [00:18:00] effectively treat that water and use it for other beneficial purposes. 

I'd love to see that happen rather than move water from Houston to West Texas. I believe West Texas deserves all of the water. I want to see the state and this country thrive. But the way we do that isn't by taking these most valuable resources, it's by finding ways to beneficially reuse what we have, and it takes investment to do that and it takes a long term thinking.

And we always generally take the shortcuts in life unfortunately.

Andrew Kazlow: So Doug, let's do a thought exercise because I'm curious to see where you'll take this. Assume you had a checkbook for a hundred billion dollars, let's call it. And you had to allocate all of that to fixing the volume into the water space. It's five years down the road. What are the categories that you have invested this money in and why? 

Doug Lee: I strongly don't believe that you can do these things out of just, we want to be [00:19:00] green, we want to be environmentally and ecologically responsible. That should be a given, right? But too many times we approach large checks like that, yet this approach that we're going to do a social good, and it's not sustainable financially, which means long term, ecologically it won't sustain.

We see a real shift in sentiment right now around net zero goal. it's because so much capital has gone into these things. We just talked about this small amount of cleantech investment that's gone to water relative to everything else. It's because subsidies have skewed where that money goes. And so how can we find ways that make sense ecologically, as well as financially? And my answer to that question, is first of all, I would put it into the types of categories where we can get synergies across multiple opportunities. So, if we're going to treat water, let's find water that's low value today or no value or potential liability. I [00:20:00] would argue that today, produced water is being treated as a liability, not an asset. And if we were only to try and desalinate that water to try and provide that water as fresh water, nobody pays enough for what that fresh water is worth to justify the cost of desalinating it. So, if we were to just put the $100B into, say, treating all of the produced water we generate in West Texas. And ironic, that might be the number that it would take. It's a big number. It will never make money back. And so it will always be a liability. It will always depend on subsidies.

However, if we look at what else can we do with that water that's high value, what else is in that water? It gets really exciting because there's a small amount of lithium in that water. There's a lot of salts that are in there. What can we do to make other products from this?

And this is where we are putting investments ourselves today in some technologies around it. We look at trends globally. I've had the good fortune of working a lot in South America and the Middle East and [00:21:00] other parts of the world.

And other parts of the world often are drawing water from seawater and desalinating that water. Some of these climates in Saudi Arabia and Oman in particular, quite arid and very limited in where they were getting their water desalination. The technologies have improved incredibly around how we can recover that water treated and recover components with it. If those components have value, we can valorize that water and recover value that's subsidizing that cost of treating it for that low value, but high ecological impact. I think that we look at other uses around cooling and around these types of systems around, the data centers that we hear so much about coming online right now, consume a tremendous amount of water. Tesla just announced or it's been speculated that their lithium processing facility in or outside of Austin, they've significantly miscalculated how much water that's going to demand. 

Where do we get that water from? I think these are the opportunities where I'd put that $100B, is [00:22:00] where we can find synergies between one need and big anchor need with large volumes, but we can recover additional value from that water and additional uses.

And let's reuse this water in a circular manner over and over again. It is The Fundamental Molecule.

Andrew Kazlow: Doug, let's get a little bit more tactical. We've been kind of macro trends themes. Let's assume that you meet a new startup working in the industrial water space that for whatever reason you haven't heard of before, let's say there's a new startup that you've met.

They're doing some cool work in the space. Without getting into specifics on what the company is doing, what are some of the first sets of questions you would be asking of this opportunity to decide whether or not it's worth double clicking and exploring for potential investment?

Doug Lee: I'm going to partially answer a question you didn't ask and then come back to that, because I have so [00:23:00] many mistakes that I've made over the years the, where a lot of people started, where I used to start, I've learned is not the place to start. And so the obvious answer that some people might be thinking about to say is, you know, we really dig into this technology.

We got to make sure this technology is X percent better than the other, and where's the proof of that? And let's look at a pilot. Let's look at this data, or maybe they might say, well, let's, this is market. We're going to look at this market and we're going to, what's the TAM and we're going to attack that.

And I used to do that too. And most of my mistakes have come when I've done. Not that those things aren't important, but they're second. There's a few things that are more important than that. So where do I start is the why. Why do we need this? Why is this so different?

What's the problem that we're trying to solve here that we can't do now? We really try and peel at that why, first. And then the second one [00:24:00] that I'm focusing on is the who. Who is this individual, or the team? I'd like to understand a lot about those individuals because at the end of the day, people buy from people.

I love all the great tech we've got and AI is blowing my mind on what we can do and it's super exciting, but it's still a people business. Every business is a people business. A lot of the biggest mistakes I've made is around those people. And so if I can get, understand those two things. Then getting back to what we probably learned in elementary school about the who, what, why, how, when, where, how am I going to build this tech? How am I going to deploy? This is my business plan. This is my strategy. Okay. Very, very important. I care more about the why and the who. What is generally the technology itself? Very important. And your IP and this and that, but, it's after the why and the who for me.

Andrew Kazlow: Doug, could you give an example of a opportunity that at first you were like, no, that's not going to go anywhere, but you [00:25:00] double clicked on the why and the who and flipped your tune a little bit.

Doug Lee: I have a fantastic one for you. And it's actually a company that's headquartered here in Houston. I have no money invested in these guys. Okay. So, I would love to, but I don't right now. An individual that I've known for a number of years, uh, we meet regularly. Just young entrepreneur, just one of these fantastic individuals that you just know. You just know they're going to be successful. I do, You don't know what they're going to do, but you just see what they're doing. You see how they operate their life. I got to know him after I'd heard about a water business in the oil field side of things that had some of the founders had a falling out and broke it up. I knew both of the founders and I'd heard two different sets of stories around what happened. Well, this individual that I'm about to tell you about a business of that I really struggled to understand and accept at the beginning, but the why and the who convinced me, this individual just has such high character.

[00:26:00] Just how they exited a bad situation spoke so much to me, right? And the kind of person that I'm getting to the point in my life where I want to be choosy who I work with. This is that kind of person. We had a breakfast meeting and he was telling me that he was going to leave a business that's rather successful that he was in to go and take on a startup in the lithium space. Specifically how he presented the opportunity to me and what he was going to do. It just is a very crowded space. This category we call DLE or Direct Lithium Extraction was how I understood the technology at the time. It's not that whether they did truly had a different, uh, what, when we talk about those technology what's. It's very crowded, very challenging, even with the great why, even with the great who, my advice was don't do it. Like really, I was like, don't do this.

I just felt that his time and kind of entrepreneurs would have better opportunities for himself and his time than this [00:27:00] one. He did it anyway, he joined the group. He's now CEO of this company. It's a company here in Houston called Altillion. And what I really understood is I've got to know the business, and the team there was I didn't have a good understanding of what they were doing.

I'm not sure that they did either in the first six or eight months either. I think how it was presented was what they really believed at the beginning. But what they really do is so different. And it is so differentiated that anybody that is doing DLE actually is a potential customer to this group.

And that was the disconnect that I didn't understand to begin with. And this is what the risk is, you can think you're a subject matter expert, but there's flavors of these things that you just, you really have to get into the details of. And it's been a real learning for me to surround myself with subject matter experts that can advise me around areas that I don't really fully understand.

It can give me the nuance to it because there's just opportunities that get [00:28:00] missed fundraising is the hardest thing we do. And I think most founders do. And so, if you're not pitching to the right people and telling that story in that way, then people like me can miss it and pass when it wasn't fundamentally wrong. I was fundamentally wrong. So they're just an example to me of, you know, taking the time and don't take a snap judgment, really getting to understand this thing, and again, the importance of that who. Because once this individual really got inside that organization and really started shaping that messaging, this is now how they're doing. They're dealing with some of the largest mining companies and largest resource owners on earth.

Andrew Kazlow: Doug, I'd love to talk a little bit more about the Flathead Forge story and your investing in the picks and shovels concept, which I love that approach. Tell me the story on how you guys kind of centered around this vision, how the organization [00:29:00] came together and how you're helping, maybe not yet deploy a hundred billion dollars, but a little bit of capital towards this pain point.

Doug Lee: Yeah, look, it's the product of a lifetime of investment learnings for me. In my background, kind of where I've done a number of startups that come from. I'm an operator, I'm a founder. I've done a number of these businesses and the ones that have worked well are around this area where I have focus and subject matter expertise, but it took me a while to really learn this because, I had a couple of successful exits. And when I looked at some of the investors that I really respect around me

and even some of the people that were on our cap table, I'm like, that's what I want to do. I thought that's what I wanted to do. And what, what did I mean by that was, well, I'd love to be able to deploy capital to somebody else's business and let them be the operator, let them do.

Have all of the stress, let them spend all this time on the road [00:30:00] away from their families. And, uh, boy, I get this nice check that comes back in a few years. And, boy, that sounds like a great way to do these things. That was one of the elements of where I wanted and I thought I wanted.

The second one was, boy, I've got money now. I've got some cash. So my brother and I, my brother lives up, I'm originally from Canada and, he still lives up there. We have an office up there in Calgary. And let's form a family office. So this is back in 2009. So 16 years ago I think, and you know, we've got some money.

Let's form a family office and let's diversify our investments. Let's not just, okay, I, I do water, you know, this is what I know, but boy, that's all my eggs in one basket. And that's in diversify and invested in real estate deals, did a hotel deal up with disaster. We uh, did uh, uh, a home builder here in Texas.

 We did it like a manufacturer's rep business where we set up offices. We had an office in Monterey, Mexico. We had an office [00:31:00] in, Muscat, Oman. We did all sorts of things. We acquired a company from Apollo. A subsidiary company of their portfolio company of theirs.

It was distressed asset. We thought, you know what let's do a distressed asset turnaround. We know the market and customer way we could turn around somebody else's problem. Everything that was outside of our core competency, we sucked at it. We lost money on the things that were where we were.

We had these core competencies. We did really well. So, 16 years slow learner, right? And it said, you know what? I think that we could be really good in our area of focus, but we need to do if we really want to have impact. We need to do this at scale. If other people are going to trust us with their money as LPs into what we do, we need to be able to prove that we're really good at what we do, that we have an unfair advantage.

And this is what Flathead Forge is about. And so I mentioned some of the challenges early around water and hard tech in particular. We took 16 years of learnings as a single family office, and a bunch of years [00:32:00] before that as an individual investor. And we distilled it down into a few things. And this is what we call Flathead Forge. We call ourselves a venture builder. I'll try and give you the highlights of what that is and what we've done about it. But we don't feel that capital alone is enough. We don't feel that we can just be great pickers because we've got this experience in this sector and we know a lot of people and let's just give them money. And that's enough we have to do. That's one of the examples that I just gave about being a passive investor. And if I'm not going to be directly involved, if I'm not going to sweat other people might do very well at that. That's not, God didn't put me on earth to be a passive investor. He meant for me to sweat and work. So, we have to get actively involved, but we're going to do this at scale. There's only so many hours in the day. We need to build an ecosystem that helps these companies, these portfolio companies, and these founders. What do they need that's unique in hard tech that we can do to amplify the outcomes for them and to [00:33:00] accelerate how long it takes to get to those outcomes. And the third thing we try and do is avoid, we call it mortality. I know that's not a great word, but we want to prevent failure. So first and foremost, we never want to lose our investors money. Okay. Our worst case can't be losing their money. But that's not the only thing that matters is, okay,

you didn't lose my money. I didn't give you it just to have it sit here and you give it back to me. It's the same amount roughly in 5 years from now or 10 years from now. I need a time matters, time on my money matters. And the amount of that comes back. So we are trying to build an ecosystem that can do that. And several things are required in hard tech to be able to do that. First of all, we know that as we invest in these companies, that there's a people component to this, and we need to surround them with a lot of subject matter experts. And so in our language, we call them Sherpas. These are highly technical engineers and scientists for the most part. However, there's some other Sherpas that are from a legal [00:34:00] background or finance background. It's just pretty light in our world relative to what you might see as an entrepreneur in residence or something like that in another fund. Our Sherpas are very technical. And so can scale by giving them access to this team that's beyond just us as managing directors. 

Secondly, we want to give them channels to market. If they have to go and build their own sales organization from the ground up every time, if they have to try and get in the door with a customer every time, if they'd have to try and deal with every objection that comes up, you know, I don't, Hey, it's a first of its kind, or it's serial number one of something, you know, that's a tough sell. Can we do things that break those barriers down? And so we've invested in a number of businesses that we founded. So this gets into what we call a venture builder, where we said, okay, if we're going to do this at scale, we better build these ourselves. We better build a platform that leases equipment so that we can buy equipment from our portfolio companies, put it into this platform and lease it to a customer.

So we lowering the [00:35:00] risk for a customer. If this fails, we're lowering the cost of trying before they buy it. It's not the long term, a customer wouldn't want to own that and buy it. And they'll buy that directly from the portfolio company. But can we build a business that does that? And that's a company we started called Prodigy. And then that's not the only thing though. How are you even aware of these products? How would you find these new technologies? How would you do that? And so we built a digital channel to market and this is a business we call resin8. These are businesses that we founded. There wasn't another founder that brought it to us.

We just recognize, we think this is going to have to be there. The third element that we think is important in hard tech company that's going to have to be in our ecosystem is execution. Most of the founders that we meet are very good technically. They're brilliant in some thing they do. They know their technology. But the side that they're not terribly great at often is the execution side of, okay, now I need to put that into a customer's facility. Where is that [00:36:00] going? How do I even do that? Do I understand the upstream and downstream equipment around that? How are we tying in? The civil works around this, are they prepared to go through a HAZOP with a customer and deal with the risks around this and meet their needs?

And so we've got a project development team that we put together and we're back to group of fantastic founders who are executing, they're execution focused, and that's a company called Pivotal. And so, those are the three key elements of what we started with. And then we started deploying capital into these early stage companies or mature ones, too.

We, we're a first fund, by the way. It's not a huge fund. It's a $50M fund. And, very hard tech focused, but for us, we look at this and say, to achieve those goals that I just mentioned for don't lose your funder's money, let's accelerate the timelines and let's amplify these outcomes.

Okay, great. One of these is the stage attraction that these companies have to have in order to meet the hurdle for what we're looking for. We will take some moonshot bets. [00:37:00] We will take some calculated risks, but with a smaller portion of our cap, structure. And so our fund construction is such that probably what 70% of our capital is going to a little more mature companies where they're well beyond proof of concept and they're generating meaningful revenues.

The bulk of our capital is going into companies that are already generating EBITDA. Water is so critically underinvested. It's amazing because we've got this beautiful hunting ground that very few others want to participate in. We can find these opportunities that are prime to grow if we can put them into our ecosystem. That's kind of the very long winded answer to what your question is.

Andrew Kazlow: So Doug, let's say you're sitting down with an angel investor. They say, you know what, I'm excited about water. I think there's something here. But Doug, I don't want to pay your carry. I'm going to do this on my own. I'm going to go find some deals and just deploy direct, which is what a lot of angels do.

What words of caution or key risks would you [00:38:00] encourage this individual to focus on as they're evaluating these individual deals?

Doug Lee: We talked first about the why and the who. So, I'm not going to repeat myself there, but, that's where it would start for me. 

When you get into these things, you really have to look yourself in the mirror and be honest about some of the risks that you're taking. If they especially come from a technical background, I would suggest that those that have the best advantages are coming from those technical backgrounds more so than a finance background. I think it's easy to be lost in a spreadsheet and things can look fantastic.

I can't tell you how many deals that I've brought to me that, the spreadsheets and the model looks fantastic. But you can make a spreadsheet, say anything you want it to. So let me give a few things that I think that they should look at then if it's not those others. Scaling economics, I think that it's really good.

It's really easy as a angel investor, I would say, but any investor, including ourselves to fall in love with the [00:39:00] story. I love this story, and these founders are so good technically, so many of them are just, I mean, PhD, MIT. You can fall in love with the story of what this is, and these people are so much smarter than us. It's like, okay, they have to be right, they can be right, but at the wrong scale, right? And so they can make it work in a lab or they've got a pilot, they've got these things and you're technical enough to really understand what that is and validate that. But think around how you actually commercially deploy this and will this scale? And I think that sometimes these things really don't scale.

 The other ones I would caution them and say that they really need to look at is let's say it does scale. Let's say it's a great founder. Let's say all of the other things we've checked, we're checking the boxes. It's this adoption risks. It's this we get back to this timeline. So we ourselves, I just went through that long explanation for how we've attacked these problems, but you have to be able to answer for yourself without an ecosystem like ours. [00:40:00] How are you going to attack? This issue of adoption, how quickly will this be adopted? Who will be adopting it and what kind of considerations are they're taking?

How long will that take? You can be right about the tech. Hard tech takes a long time. Water takes a long time. Think very carefully about your timelines of your investment because you can be right, but what happens is your cap table gets screwed up because you need a lot more money because you're getting all of the market signals that it's working, but it's just taking long. And boy, we've got a lot of those in our history too. I guess those would be a few of the things I would point to.

Andrew Kazlow: Doug, any final thoughts for our listeners?

Doug Lee: Yeah, look, because your listeners, I think you've mentioned are mostly angel investors and are considering being them. I think there's some real lessons that I found and so that I've adopted. It's almost my constitution now. We've hit it hard, but, you know, I love this book [00:41:00] from Naval Ravikant, and he's got this almanac that gives these little lessons learned.

And I love a lot of his learnings, but one of them is this, we talked about this focus area, but, finding something that you have this specialized knowledge. Find and build around that specialized skills or knowledge. We talk about focus.

We talk about these things. If you want diversification, go and buy the S&P go and buy QQQ. If you're an angel investor It's not about diversification anymore. It's a concentrated bet. So concentrate your bet in an area that you have this unfair advantage. There are a few other things that I would really encourage other investors to think about. We talked about getting actively engaged.

You can invest your capital, but you can invest time, you can invest your network, you can do all of these other things to come up that learning curve early. Invest in those ways. It's a lower risk way to do it to begin with, but you build these relationships from it. You build this network that you can build from and we make [00:42:00] smarter decisions together.

So find others that compliment your skills and build us. And so we talked about collaboration a lot in our organization and our culture is, is I used to be this lone wolf and thinking I could do it. It doesn't work very well, collaboration. I think I'd ask them to think hard about how they structure their deals.

This is a common mistake I, I see being made and that, uh, they're looking for protections. You know, it's your money. You've worked hard for it. You've risked so much for it that you try and put these protections in, but you actually undermine your own opportunity, in my opinion, when you do that too often. 

Finding these win together scenarios, I think are really key. And then lastly, I would say, give back. Give first and give back. If you give first, you give something of yourself, whether that's knowledge or time or just, just give to others. There's this next generation of founders that are coming up and boy, do we need them. But mentor them, be generous.

Be generous with your time and [00:43:00] your network. And yes, you'll get burned. Yes. Some people won't appreciate it, but those that do it's your signal for that. And it's good karma anyways. And that's the business I'm in 

Andrew Kazlow: well, Doug, we will end it there. Thank you so much for joining me today. This has been a masterclass. Thank you for spending the time. And I very much look forward to our next conversation.

Doug Lee: Thank you, Andrew. Appreciate it. 

 

Andrew Kazlow: Thanks for listening to this episode of the diligent observer. I'm your host, Andrew Kazlow. And if you're looking to make better bets as an angel investor, subscribe for more at the diligent observer dot sub stack. Dot com.

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