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Fascinating trends and provocative questions

Rob Day: July 30, 2008, 7:47 AM
With a column title like that, I'm sure to under-deliver, but here goes... A couple of recent trends I've noticed that are worth highlighting: 1. "Super angels" seem to be taking an increasingly important role in the world of cleantech venture capital these days. By using this term, I mean family offices, foundations, etc., so "angels" is kind of a wrong term, but the point is non-traditional institutional investors representing high net worth and/or mission-oriented investors who may or may not have the same IRR goals as traditional VCs. This is potentially a really healthy development in light of the capital gaps we've noted before, but it's also simply noteworthy just how much more active these kinds of investors are becoming, particularly regarding direct investments (versus indirect placements in VC firms, etc.). 2. There seem to be an awful lot of stories in the various online rags these days about cleantech startups that are SEEKING big rounds of financing, versus the more typical silence about fundraising until the money is actually in the door. It's interesting, because usually privately-held companies want to be much more quiet about their growth plans, for competitive reasons. Does this trend represent a PR strategy shift to raise the profile of companies ahead of big rounds of financing, ignoring competitive impacts? Does it show that companies have been struggling to raise these big rounds, and are forced to go advertising to harder-to-reach investors (like, perhaps, Super Angels)? And/or does it simply reflect a more competitive green business media space these days, where the reporters are digging more and more to get "scoops"? Perhaps some of these journalists could chime in with their perspective on why the shift is happening, but at least on this site we'll continue to err on the side of discussing actual deals and not just passing along fundraising advertisements...
  • Aptera raised a $24mm Series C round, with investors now including Idealab, Esenjay Investments, The Simons Family, The Beall Family Trust, and Google. This syndicate is a good example of the first trend noted above...
Speaking of this cleantech VC "thing" not being easy, in today's PE Week Wire, Dan Primack asks a provocative question:  "What I’ve been pondering... is about the new class of cleantech investor, and if there are enough experienced bodies to satisfy the VC market’s appetite." In other words, does sector-specific deals experience matter in cleantech venture capital, and if so, is it a limiting factor. As we've discussed here before, generalists coming into cleantech aren't dummies, when they jump into the sector and begin engaging with cleantech investors and startups they can bring a lot of quite valuable and often complimentary skill sets and networks, etc.  So while sector-specific deals experience probably does matter, generalists can quickly get up to speed in a couple of targeted markets, especially when they look to co-invest.  We've co-invested with smart generalists and look to continue to do so when appropriate, because so many cleantech opportunities overlap into other more traditional investment sectors (think batteries and consumer devices for one illustrative example of such overlap) that the teamwork can be quite powerful. The real challenge comes from the fact that cleantech markets are so broad and diverse, that even after spending most of my career in these markets, and several years now as a cleantech specialist investor, I'm still learning all the time about new technologies and applications I hadn't previously had exposure to.  There's a multi-year learning curve even for the smartest investors, and so naturally new entrants to the market will have to either pick one or two sub-sectors to focus in on for their first few deals (and for the most part they've tended to go where the action already is -- solar, et al), and/or go later-stage as follow-on investors backing already well-established companies even if still pre-revenue.  IMHO, this dynamic is a major reason why we've seen these waves of over-heated activity in late-stage and in certain narrow subsectors within cleantech, even while the overall cleantech investment sector remains underinvested relative to the amounts going into other tech sectors (the "health care venture bubble", as I jokingly refer to it).   The new entrants are naturally driven in these directions. Dan does posit a potential counter-argument, that the cleantech sector is so "easy" to find good investments in, that experience doesn't matter -- to paraphrase, that anyone can fall out of bed and find good cleantech venture investments.  I'm not sure how well that hypothesis will survive the next 12 months, but it'll be fun to track... Readers are encouraged to get back to Dan with their own comments, and/or to leave comments here. Other provocative questions:  Is nanotech finally ready to get real?...  Are all the low-hanging carbon offset fruit plucked already?...  And finally, are VCs really this dumb? (ouch)

      No solar exits?  No problem!

      Rob Day: July 24, 2008, 3:59 AM
      Are you frustrated that the current macroeconomic mess, and the resultant slamming shut of the IPO window, has denied you the ability to invest in some of the bigger-name privately-held solar companies? Are you skeptical or optimistic about the prospects for a wave of solar exits over the next 18 months? Well then, it's your lucky day. As a proxy, I've talked InTrade into establishing a new market in the IPO prospects of four high-profile solar startups. Now you can go and purchase or sell contracts that pay out if Ausra, Miasole, Nanosolar, and/or Optisolar IPO by December 2009. Just follow the link above to see -- you'll need to open and fund an InTrade account if you want to participate. I was inspired by PEHub's Alex Haislip, who yesterday asked if anyone had ideas about ways to evaluate the risk/reward profile of the large "venture capital" rounds that have gone into these companies. If enough of a liquid market can be formed around these companies' IPO prospects, it might give an indication of that answer... InTrade and other "virtual markets" can be an effective way of determining the consensus (albeit not always correct) judgment about the likelihood of political, economic, financial, etc. events -- you can also see how they're evaluating the ongoing Veepstakes, for example. Unlike polling or other types of info-gathering efforts, it represents people putting real money down and thus can be a better indication of what they're really expecting to see happen. So sign up with InTrade and start trading! We'll check in later and see what we're learning...

      Odds and ends

      Rob Day: July 23, 2008, 5:24 AM
      First, some deals:
      • Li ion battery startup ActaCell has raised a $5.8mm Series A, led by DFJ Mercury and including, Applied Ventures, and Good Energies. Expect the energy storage sector to get even more attention going forward as some anticipated exits come to fruition, and as the political campaigning season and other developments focus attention on the transportation applications for batteries.
      • Performance Plants, a developer of agrotech innovations with applications in biofuels and food crops, has raised a C$13mm round of financing, led by Ceres Global Ag Corp., and including Eastwood Capital Group and a syndicate of Boston-area private investors such as Saturn Asset Management, plus Montreal-based Endurseaux Inc.
      • PE Week Wire reported today that Athenix, another developer of ag and biofuel techs, has raised $10mm in "Series S" funding from return backers Hunt Ventures, Intersouth Partners and Polaris Venture Partners.
      • PEHub's Alex Haislip reported today that Optisolar's April $132mm round of financing has been expanded by another $77.8mm. Alex also jumps on board with me in arguing that these kinds of investments are hard to categorize as "venture capital" per se...
      • Sweden's QuNano AB has spun out a new venture, Sol Voltaics, to develop multijunction PV cells. The list of seed investors is long, so here's a cut-and-paste: "The seed investors in Sol Voltaics include funds advised by venture capital firms Provider Venture Partners of Stockholm, Teknoinvest and Nano Future Invest of Oslo, joined by LU Innovation together with LUAB, the investment arm of Lund University (Sweden), as major owners, along with the founders and employees of QuNano. A new investor will be Scatec Adventure AS..."
      Other items:
      • We've added a few new blogs to the blogroll: Carbonflow's Karla Bell is writing on carbon trading subjects at Shai Agassi's Long Tailpipe is worth checking out (ummm, not sure I phrased that as well as I could have)... and Andy Bochman and Chris Davis' PowrTalk always has some good perspectives.
      • Cleantech IPOs are expected to lead the way when the IPO window re-opens... And the linked CNet article also notes further down John Doerr's use of the contrast between the $25mm Google required to get to exit vs. Bloom Energy's $250mm (and 7 years) and counting. Which begs an obvious question -- doesn't using that comparison as Exhibit A in an argument for going later and bigger in this sector require an assumption that both companies were equally good investments, or at least that Bloom Energy is a very typical cleantech investment? There are plenty of other good arguments to be made in support of their making such a shift in investment strategy, of course, but I was struck by his comment at the time, and I'm still struggling with it even now.
      Also, the California Clean Tech Open has announced their finalists... And finally, take the cash!!

      The seed stage capital gap (or: Why I learned to stop worrying and love the national labs)

      Rob Day: July 22, 2008, 5:21 PM
      One thing entrepreneurs commonly get frustrated about when dealing with early stage VCs, particularly in cleantech, is when the VCs tell them "we like the idea, but it's still too early." After all, it's "early stage" venture capital, so how can an entrepreneur's idea be "too early"? What gets wrapped up in this, as well, is the fact that many entrepreneurs and researchers are working on some truly impressive ideas, but with long development paths ahead of them.  Fusion, geothermal, even cold fusion (yes, cold fusion) are areas where I myself have seen some really intriguing entrepreneurial efforts -- efforts that, as an environmentalist, I could get excited about.  But as an investor, I cannot back at this stage. There are two major reasons why venture capitalists can't go into very early stage efforts very easily. The first is structural (apologies in advance for oversimplifying a lot in this section, just trying to move the prose along...).  Venture capital funds are amongst the most illiquid of all asset classes LPs might put their money into -- but they still want returns sooner or later.  Most VC funds are structured with a 10 year limit from time of launch.  But of course, that means you can't invest even in year 1 with an expectation of 10 years to an exit, because what if it slipped a year or two?  The time from initial investment to exit typically has to be 5-7 years at MOST -- preferably much less. Factor into the equation that an exit is most likely only going to come once a company has significant and growing revenues, and not when the technology is simply brought to market, and very quickly the VC's decision-making starts to be clear.  For example, at @Ventures, when we say "early stage cleantech venture capital", we're typically looking for companies that are zero to two years away from commercial revenue (and preferably on the shorter end of that range). Now, structural challenges could be addressed with creative thinking.  But the reason for the 10 year fixed life of VC funds is not only because of the LPs' needs for liquidity, but also because of the time value of money.  Discount rates (not that they're often used in the industry, but still...) are really high for venture capital investments.  That reflects the high risks associated with launching any new business, along with the high expected returns of the asset class.  Let's paint the picture with some numbers: Put those two together, and you've got a picture where a VC who knows that the technology in question should work (there's rarely any "science risk" associated with an internet startup, after all, just market and execution risks) expects to achieve a minimum 40% IRR at least 35% of the time. What I just explained is where the oft-mentioned "5x" (or in other words, "we look for investment opportunities that we think will at least grow to 5x our initial investment") comes from in venture capital.  Because if you return at least 40% IRR over 5 years on a million dollars, you've turned it into $5+mm.  If you do that with the kinds of success rates Fred Wilson talks about (let's say 35% 5x investments, 35% 1x investments, and 30% wipeouts, to vastly oversimplify), you will have returned 17% per annum, not including the management fees, etc.  (And, obviously, also not including follow-on investments, and assuming all initial investments are the same size, etc., etc., etc.). Still with me?  Sorry, but it gets even worse from here... The point is that if you achieve 40% IRRs on your wins, and your "wins" happen about a third of the time, then you're delivering what your LPs are typically expecting when they put money into an early stage VC fund.  A lot of SWAGs in the above analysis, true, but I'm just trying to get a point across so... It's hard enough to achieve a 5x in five years.  But really, the investors are hoping for 10x, not 5x, to bake in some of the risks, etc.  So a 10x in five years would equal an IRR of almost 60%. Looking at it that way, with such a high hurdle rate, it starts to be understandable why the holding period for institutional venture capital investments can't be 10 years to be successful.  If you put $1mm into a new technology development effort expecting it to turn into $10mm in 10 years, you're really targeting a 26% IRR, a big drop from the 60% IRR for 10x in 5 years.  If that's your upside scenario, your overall portfolio results won't look very good... Or, to put it another way, if you want me to put $1mm into your seed-stage company with expectations that it'll exit in 10 years, based on typical returns hurdles, I need to be expecting that it'll be worth over $100mm at that time.  Not hoping, expecting.  And that's even if my LPs don't begin to hate me anyway, for locking up their capital for that long. A nice little 100x, right?  We've witnessed a few of those in the history of venture capital (I've even had the privilege of working with an investor who sourced one...).  So you can hope for it to happen.  But it's not an event you can credibly plan an investment in expectation of.  So clearly, the "time value of money" means that it's very tough to achieve venture capital type returns when your investment holding period is going to be more than 7 years or so. In cleantech, it can be even harder to justify going that early.  Because there can be significant science and development risk still associated with some of these technologies at that stage.  We've already seen some high-profile investments taking seven years (and counting) to achieve commercialization, much less an exit.  Quite often, if you're looking at that long of a holding period, you're looking at some kind of R&D effort on the front end, and that adds additional risk.* Let's take an example -- cold fusion, which if it works would be a great thing with huge market potential.  InTrade (which as a trained economist, I love) says that the most high profile current cold fusion effort (Dr. Arata's, linked to from above) has a 15% chance of being replicable -- of "working" in a lab.  Now, even if it's replicable, then it would take a long time to commercialize, because there's a big difference between finding excess heat and generating power, not to mention designing the equipment, building the devices at cost-effective levels, etc.  The last fusion-related plan I looked at was talking about 10 years to commercialization (and that was the entrepreneur talking, who's probably optimistic), from a much more progressed development stage than Dr. Arata's lab experiments. So if I need to believe a $1mm investment in something at that stage would turn into over $100mm by the end of 10 years... but then I also have to discount further to account for the 85% chance the thing just plain doesn't work... I need to believe my $1mm will turn into AT LEAST $733mm over those 10 years, to justify the investment. Why did we just walk through that boring hypothetical numerical journey?  What I'm trying to illustrate is why VCs can't be counted on to consistently go out and find the ideas that will take longer than 3-5 years to commercialize, and give them the financial resources to come to market.  (And, in fact, the emergence of more dedicated cleantech "growth stage" funds illustrates how VCs are moving even more toward shorter holding period strategies these days -- but I digress). Early stage cleantech venture investors, to be effective, need to be disciplined and pragmatic... There are seed stage funds who specialize in going in early, but as the above hypothetical exercise illustrates, they're going to have to be ruthlessly selective, and thus a lot of promising technologies won't attract their capital. There are angels who might be willing to use their individual bank accounts to back these kinds of efforts, with more patience or at least lower returns expectations.  But that's even more hit-and-miss than the seed stage industry. By and large, what I've described above is exactly why the government plays a vital role in sponsoring early stage research, when it's in a sector (such as renewable energy) where we care about it a lot as a society.  Because there's an inevitable capital gap between where the wild-eyed scientist has a brilliant but long-path-to-commercialization idea, and the stage where the institutional VCs can step in to help them build a company. Whether at the national or the regional level, we need to see strong government support to fill that gap. *Regular readers will note that I have previously argued against those who say that cleantech necessarily involves more capital and longer development periods than other sectors.  And my arguments on this point are still true.  There are plenty of investment areas across the widely varied cleantech sectors that will resemble the relatively quick development/ commercialization paths of IT, software, internet, services, etc.  And even the longer-development challenges in other cleantech sectors are most often reminiscent of similar challenges in semiconductors, biotech and other popular VC sectors.  So please don't take this column for anything more than a hypothetical exercise talking about the difficulties in backing visionary, breakthrough technology development efforts in ANY market -- cleantech or otherwise.

      More Q2 numbers

      Rob Day: July 21, 2008, 5:16 AM
      PWC Moneytree/ NVCA and VentureSource both released their Q2 venture capital tallies over the weekend.  The picture they presented matched well with the results that came out earlier from the Cleantech Group and Greentech Media. As always, these groups (because they're looking broadly across sectors and not just looking to be inclusive about what's clean or green tech) come up with lower numbers than Cleantech Group or GTM.  The Moneytree total for U.S. cleantech VC in Q2 was $883.6mm into 65 deals (note: link opens pdf), and the VentureSource total was $817mm into 32 deals for the "energy and utilities" sector -- including $650mm in 26 renewable energy deals -- versus the Cleantech Group's $1.49B U.S. total. Despite continued growth, the Moneytree cleantech total would put the sector at still less than one-eighth of all VC investments in the U.S. Both the Moneytree and VentureSource survey results showed record quarters in terms of total dollars, but as driven by big deals.  While they don't break down the stage question for cleantech in particular in their releases, in terms of venture capital overall the two surveys both noted that later stage investing is continuing to grow, while early stage VC remains fairly steady (so the Moneytree write-up talks about early stage declining as a percentage of dollars, while the VentureSource write-up talks about how early stage remains "fairly steady"...). Perhaps the most telling thing is that the Moneytree survey write-up noted that Thomson Reuters had had to change their definition of cleantech to provide "greater precision and scope" -- in other words, cleantech is now mainstream enough that they needed to tighten up their definitions and give it more emphasis.  Thus, they revised their Q1 totals up from $625mm and 44 deals (note: link opens pdf) to $871mm and 60 deals.  Will VentureSource follow suit? Deals from the past couple of days:
      • Carbonetworks, a provider of software to help companies manage their carbon-related activities, raised a $5mm Series A led by NGEN Partners.

      We got BOTH kinds of cleantech here:  Solar and PV

      Rob Day: July 18, 2008, 8:42 AM
      Seems like it's all solar, all the time in cleantech VC land these days.  Here are the deals and tidbits from this week:
      • ATV also led a $14mm Series C in Nuventix, a developer of cooling technologies for advanced lighting and other applications.  New investor Braemar also participated in the round, as did existing investors CenterPoint Ventures, InterWest Partners and RHO Ventures.
      Other news and notes:  IBM's Drew Clark on the opportunities and challenges for investors in smart grid technologies...  Andrew Dougherty pointed me to this parody of BP's marketing campaign...  Finally, and painfully, climate change will mean more kidney stones???

      Opening up a time capsule from 1981

      Rob Day: July 14, 2008, 3:45 AM
      I recently took ownership of a copy of the 1981 National Geographic special report on energy: "Facing up to the problem, getting down to solutions." It's turned out to be a fascinating look back at what's changed -- and more frequently, what hasn't changed -- over the past 27 years. The magazine focuses on energy supply issues, and while climate change is mentioned in passing, it's the high cost of energy that's "the problem" referenced in the report's title. Most striking is how much space is devoted to the very same technology development efforts that we're still working on today. On the one hand, it's encouraging to see the clear progress that's been made in the maturation of key technologies like solar and vehicle/ building efficiency since the writing of the report. On the other hand, it's sobering to realize just how few of the report's predictions have come to fruition. $85 per barrel oil by 1985 ("conservative estimates", but of course way off) was expected to drive significant adoption of coal-based synfuels in particular, and the report's authors also expected domestic oil production to increase. Nuclear was supposed to play a much bigger role in supplying electricity... So while they expected energy imports to flatten, they were expecting other technologies (including green power) to step up much more than actually happened. But it's hard to blame the report's authors -- after all, they were working off of predictions from the US Department of Energy! I've made a chart comparing their predictions of the U.S.'s 2000 energy mix with how things actually turned out...

      Of course, this won't be a surprise to anyone who's been observing energy issues in the U.S. over the past few decades. So what's much more fun is to see early mentions of technologies we care about now:

      • In their section on vehicles, they explain how battery-powered electric motors will soon start to be integrated into cars, perhaps "paired with small combustion engines in hybrid systems -- electric power for low speeds, combustion for highway cruising." And of course, "efficiency may also be increased by using flywheels to equalize power demand on batteries."
      • Wilson Turbopower's Bruce Anderson, from his days as a solar lobbyist, is quoted as predicting that by 1985 homeowners will begin putting panels of solar cells on south-facing roofs and walls.
      • Nuclear fusion is described as "the ultimate answer to the energy problem"... but the report's authors acknowledge that "commercial fusion will not come before the year 2000." Wind power, meanwhile, merits almost zero attention -- except for a cool picture of a partially wind-powered Japanese oil tanker ship. "A number of large wind turbines are already in the experimental testing or development stages," the authors note. "But it would take 30,000 large turbines and thousands of smaller ones to supply 10 percent of the nation's electrical power needs by the year 2000."
      • Regarding uranium-based fission power, "the question is not can we, but will we."
      Fascinating stuff. But sobering to note that the current fervor around clean energy sounds a whole lot like the attitudes felt 27 years ago. The big differences, of course, are that a) many of the technologies really have matured quite a bit and gotten a lot more cost-effective; b) high energy prices now are driven not only by unrest in the Middle East but also by challenges in supply ("peak oil", etc) and environmental limitations (eg, climate change); and c) clean energy is now a big business with heavy economic players making big bets on its success. So no, I don't think the "clean energy bust" of the Reagan years are about to be repeated. The differences are big ones. But sobering to note the similarities, nonetheless.