Many cleantech investors were cheered by the successful IPO of A123 this past week.
I noted a very interesting column on PE Hub (sub req'd), by Lawrence Aragon, one of the finer private equity journalists out there.
(We need to caveat all this by acknowledging that it's unlikely much of the VCs' returns have been realized yet, there's typically a lock-up period. So here's hoping the market valuation holds up. Still, Lawrence's approach of using current valuations is still quite useful for our illustrative purposes...)
Lawrence takes a look at estimated investment totals and returns for major VCs in the company, and concludes that these investors didn't produce "a huge return", because the major holders only got like 4x or 5x. But let's look at that a little deeper. One thing that really struck me about Lawrence's column is that his assumption seems to be that these were all venture investments, and that therefore if you don't get a 10x you didn't get a "high voltage charge" for "venture investors".
I would argue that much of the pre-IPO capital that was put into A123 wasn't "venture capital", at least in the sense Lawrence seems to mean it. Let me illustrate what I mean: If you have the chance to make 2x on an investment over 1 year, would you do it? Sure, 100% IRRs are pretty sweet. 2x over 2 years, 3x over 3 years are all pretty attractive returns as well, on an IRR basis. So when Lawrence points to 4x type returns to "venture investors", he seems to be assuming that these were long-term holders, but many weren't. The Series D was in 2007, for example, and was at an approximate pre-money of $300M. Right now, that return looks pretty good on an IRR basis, even after an extra year's delay past the originally intended IPO date. North Bridge, for example, was looking at a much higher multiple on their investment before they had to pump in an extra $10M as part of a May 2009 Series F, and while that very late round yielded a much smaller multiple, it was over just a few months, and probably looks great right now on an IRR basis.
So I don't think Lawrence crystalized the point he was trying to make. However, I think the A123 experience illustrates a couple of important principles at work in cleantech investing today:
1. I continue to have a hard time thinking about pre-IPO equity investments at pre-money valuations in the hundreds of millions as being "venture capital". At very least, we need a new sub-category to describe this type of investing. We have early stage investing, the Series As and Series Bs that are what most outsiders think of when they think of "venture capital" (if at all), typically aiming (read: "hoping") for a 10x return over 5-7 years. Then you have "growth stage" venture capital, which is later-stage VC investing, aiming for a 5x in 3-5 years. But as I noted back in that August 2008 post, much of the Series E (June '08, ~$100M raise, approx. $1B pre-money) appears to have been provided by first-time investors. These investors weren't brought into the raise as "venture capitalists," I guarantee you. Instead, it's probably best to think about that type of investment as a "mezz equity round". In other words, the expectations were probably for a 2x in 1-2 years. That's not necessarily better or worse investing than "venture capital" as Lawrence is referring to. But it's certainly different. It means a simple analysis of returns based on multiples is useless if all these types of investors are bundled together.
2. Growth and even "equity mezz" financing isn't as low-risk as it's made out to be. It's worth noting that those Series E investors are the ones who didn't make out so well. Right now it's looking good as A123 trades almost 50% above its IPO price, so if that holds up through their holding periods they may still make out with a 1.5x return. But the initial offering price appears to have been at just about the same post-money (around $1.1B) valuation of the Series E. So a zero return at that price. And since my write-up last August after the Series E, apparently investors needed to pony up an additional $99M Series F round according to the updated S-1... and that was at a significant down round valuation (something like $9.20/sh vs. the Series E's $16/sh).
A lot of non-VC investors such as family offices and hedge funds have been brought into these kinds of mezz equity rounds in the past. The pitch to those investors is, "hey, this company is going to IPO, and you're going to double your money over a year or so -- you can't lose!" What we've learned about these kinds of rounds in thin-film solar, and now with A123, is that even at that late stage there's still plenty of risk of an exit not happening in the timeframe anticipated, or at a lower than hoped for valuation, or perhaps not at all.
There's this theory out there that being a very late investor into cleantech is the way to go because the risk has been taken out of the equation. Do the later investors into thin-film solar companies still feel that the risk of a timely and high-valuation exit was low? Do the Series E investors in A123 feel like the risk was low in retrospect, after a year of holding their breath amid high cash burn and a down round and no exit window in sight? It worked out for A123. But so far, for most of the large late-round investors in cleantech, the exits still haven't appeared. We all know early stage cleantech venture capital is risky. But when I see it said/written/implied that we somehow can conclude with confidence that early stage cleantech VC doesn't make sense because it's "too risky, too long" whereas growth stage is the "smart way to do cleantech", I just shake my head. And when anyone tells me I "can't lose" on a later-stage investment, I run away as fast as I can, because there's no such thing.
So basically, I look at the A123 IPO and am cheered. I see it as being a sign of more good exits to come, in a sector that really needs them. And I believe it shows us something about the shape of cleantech venture investing right now.