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Why These Companies Are IPOing (Revisited)

Rob Day: June 30, 2011, 9:41 PM

Almost a year ago, I wrote about several cleantech IPOs that were taking place at that time, in somewhat skeptical terms. And I wasn't alone. With the renewed, recent spate of cleantech IPOs and filings (Kior, Luca, et al), I looked back on that same column and thought it was worth bringing up and discussing again.

How are those IPOs from back then doing now? A123 is trading way down, Codexis is down significantly, Tesla is a little bit up, Amyris is quite a bit up, PetroAlgae is a pink sheet, and Gevo lowered their offering price but has been fairly flat since the IPO. So it's a mixed bag, not a resounding set of successes from which to draw inspiration. And yet, here it is summer again and we're seeing another wave of cleantech IPOs.

So is anything different? Actually, I think so -- and in a somewhat positive way. Last summer I wrote that those IPOs were basically happening out of necessity: the funders of those companies had backed them with certain exit timing expectations, the 2009 IPO window had been slammed shut, the companies were running out of money, and so those companies were pushed through whatever tiny IPO window opened back up, ready or not.

What's not different now is that many of this summer's cleantech IPOs are similarly more akin to funding events than to liquidity events.  Companies like Kior and Luca are looking to Wall Street to provide growth and early-on project financing.  And why not?  VCs and PE firms aren't lining up to provide "first project" capital anymore, so biofuels and other capital-intensive companies have been looking to corporate balance sheets for that capital, but that often requires giving up a lot of value to the corporate partners. On the other hand, Wall Street seems willing to more cheaply provide the "first project" capital for many of these companies -- at least for now.  

And that's one thing that's different: that this is an accepted funding path. One lesson VCs appear to have learned from cleantech IPOs over the past couple of years is that companies that have a) commercially-viable byproducts, b) a long-term story to tell around attractive primary products, and c) brand-name venture backers can indeed ask Wall Street to pay for their first commercial-scale production facility.  So that's what several of these companies appear to be trying to do. It also certainly doesn't hurt that oil prices are high right now, and many of these companies are directly replacing oil. 

And the other thing that's different is that there appears (at least subjectively, to me) to be a difference in terms of the quality of the companies (overall) that are IPOing this year. These are companies with better stories to tell Wall Street in terms of longer-term prospects and value proposition. And in several cases, they have recently raised a new financing round, rather than being low on cash. I'm guessing that's because some of the sense of 'IPO or bust' isn't in place for this year's crop, and that these companies are filing for IPOs more opportunistically than at the point of a bayonet.  While several of these filings similarly appear to be too early to IPO, perhaps if you view them instead as a public funding event, you can still feel good about the long-term growth prospects for the company.

I expect I'll get angry comments from both sides for making these observations -- from skeptics for daring to suggest that some of these companies have good prospects, and from proponents who'll feel I'm still not giving these companies their due as the next Google. They're probably both right, somehow.

But either way, one thing that's the same as last year is that the IPO window is officially, if slightly, open.  And so it's "Everyone out of the pool!" time. I worry that in the mad rush to IPO, quality control is going to slip, and may have already. And that would once again muddy up the pool for everyone left still swimming: privately held firms awaiting their exit opportunity.

Family Offices: Cleantech Investing’s Next Wave?

Rob Day: June 22, 2011, 9:34 AM

First of all, a congrats to the guys at Greentown Labs for their grand opening last night; the event was a great success.  I wrote about them and their role a while back, and I still am very impressed with how they're bringing a collaborative -- and cheap! -- approach to getting things actually built and implemented, without taking tens of millions of dollars of venture capital to do so.  The startups at Greentown Labs are applying a "guerrilla cleantech" model to what they're doing that really undermines the "cleantech is always capital-intensive" argument I've been hearing a lot of these days from my fellow cleantech investors. So cheers to the guys and gals at Greentown Labs on their big official launch, and also my thanks to them for arranging for Mayor Menino to be the opening act for my speech. (I kid, I kid; the Mayor and his green team, such as Galen Nelson of the BRA, have been terrific supporters of Boston cleantech over the past few years. They've really made a difference.)

But on to the other big news of the day:  The announcement of the Cleantech Syndicate.

When we launched Black Coral Capital a couple of years back, we started reaching out to our fellow family offices, just to learn who was active and who wasn't in cleantech, and to learn from what had already been done.  Our thinking was that since we were going to be doing some investing via models other than 'cleantech venture capital,' we would need to identify like-minded co-investors from outside the VC community.  And while we expected to find cleantech investors in the family office world, the level of activity and latent interest surprised us nonetheless. So many very quiet single and multi-family offices have an interest in investing in the sector, but have limited bandwidth (the one thing family offices appear to have in common is that we're all chronically understaffed) to actively seek out dealflow, and poor connections to others like them (the "quiet" factor again) for diligence-sharing and co-investing.  So by default, many of these family offices were just following along after the VCs, investing in deals the VCs had invested in. Or just being angel-type investors. Or avoiding cleantech VC altogether and focusing just on project finance. Or, frankly, any of a million other things -- it's a loosely-defined category for sure.

My colleague Christian Zabbal here at Black Coral Capital, and Ward McNally of McNally Capital, started talking about bringing together family offices with strong existing activity in cleantech private equity.  This initial inspiration quickly turned into the idea of a formalized group of leading families, dedicated to collaborating in the sector, across cleantech private equity categories.  It's an amazing group, with deep resources dedicated to the sector, deep domain expertise in a number of critical areas, and some early collaborations already underway, so hats off to Christian and Ward and the others who've played a key role in getting this effort up and off the ground.

Family offices are going to play a key role in the next wave of cleantech investing.  I alluded to this in my presentation about cleantech in 2015 a while back. It's amazing to me, when I speak with my fellow cleantech venture investors out there, to discover that all of us are still trying to figure out first principles about how we should do what we do.  Pretty core assumptions are being re-examined, and very basic lessons are still being learned, by a lot of us. And this is after more than a decade of "cleantech" investing.  

The challenge for VCs is figuring out which venture capital models apply to various cleantech sectors, and which cleantech sectors and investments just aren't a fit for venture capital at all.  My sense is that cleantech VCs are concluding that there are large swaths of the cleantech market (though note, certainly not the entirety of it) that just aren't applicable to venture capital models, whether "capital-efficient" or "capital-intensive" or otherwise. Yet that's not to say that these non-VC investments aren't attractive investments, viewed through another lens.  Innovations in business models, instead of proprietary tech.  Investments in implementation, instead of innovation.  Investments in long-term tech development efforts, instead of "growth stage".  These and others are all examples of where many VCs have concluded they can't play.  But if the 'Cleantech Revolution' is ever to become a reality, these are critical market needs, and thus that suggests they'll be attractive investment areas -- at least at some point.

Family offices typically don't have nearly as many restrictions as venture capital firms and other institutional investors.  We often don't have defined fund lifespans, which eases the pressure to find relatively quick exits.  We may not need an exit at all, but instead can back long-term company growth that will yield ongoing cash flow to owners.  We often won't have VC-type IRR targets, but instead are looking for alpha -- sometimes that will mean VC-type targets and VC-style investing, but it can also include lower-return, lower-risk investments like project finance.  And we can wear multiple hats and play hybrid roles.  

Family offices have always had this kind of flexibility -- and it's desperately needed in the cleantech sector right now.  But without a network of like-minded investors, the challenges of deal sourcing and co-investing with limited team bandwidth has often pushed family offices into the existing institutional investor boxes.  

But that's why the Syndicate is, to me, a very exciting development.  It turns the question on its head.  The question is no longer, 'What parts of cleantech are applicable to the established venture capital and project finance models?' 

Now we get to ask, 'What are the right investing models for cleantech private equity?' We don't have all the answers yet. But it's very exciting, and fun, to have like-minded partners with which to tackle this question.

Top-Tier Entrepreneur Talent and Cleantech Startups

Rob Day: June 13, 2011, 9:01 AM

The single most significant reason my firm passes on venture-stage investment opportunities is because of management teams.

I've heard some cleantech investors say things like, "All I care about is the technology; I can replace the team."  That may be a valid approach, but it's just not ours. In cleantech, it's as yet unproven that the technology is really the single biggest determining factor of investment success.  The innovation may be special today, but with the innovation cycle outpacing the commercialization cycle in many cleantech sectors, quite often today's breakthrough innovation is next year's also-ran. There are a million ways to turn photons into kilowatt-hours, for example, and it's unclear there's one single best way.  Furthermore, it seems like the more disruptive the technology and/or business model, the more resistant the market is to adopting it, and also the more capital-intensive it will be to develop it, so the "best" idea often will not win out -- at least within any firm's investment horizon.  Plus, if you look at the history of cleantech successes, many of them ended up with a very different technology and/or business model than that which with they started out.

All of which suggests that cleantech investing requires even more emphasis on entrepreneurial talent than perhaps in other sectors, even in an asset category like venture capital where the investors already regularly tell themselves it's "all about the team".

The problem is that management team talent has been, on the whole, thin in the cleantech market.  This shouldn't be surprising -- it's a relatively new area for venture-type innovation and entrepreneurs, plus unlike some other sectors like IT, there are fewer large, aggressively innovative incumbent companies that spin out entrepreneurs-in-waiting.  So while there certainly is some top-tier entrepreneurial talent in cleantech, more often I run across management teams with promise but lacking in honed entrepreneurial skills.

So when we pass on an investment opportunity because of the management team, it's usually not because we're convinced that that management team can't possibly pull off the challenge in front of them. It's not a vote of "no confidence." Rather, it's usually because we feel like they still have the steep part of their learning curve ahead of them, and we don't have the bandwidth and assurance that we could ourselves drive a top-grading of that management team in a timely fashion. Despite what those other investors may think, upgrading management teams is hard for investors.  It's disruptive, distracting, and in some cleantech sectors it can be really hard to find the right candidate with both domain expertise and great entrepreneurial skills.  It can take forever, and delays can be fatal. Plus, the more unique the innovation is, the harder it is to find a new CEO who's the right fit, since by definition you're looking at a smaller pool of available, knowledgeable managers from established companies.

Again, it's not that we don't believe those management teams can succeed.  It's because we place such a high bar on the management teams we partner with, given that we say no to at least 99 out of 100 opportunities.

Our firm is not alone in this.  Time and again I've seen cleantech startups that have had trouble raising funding despite having a good idea, and I can tell it's because investors like us have also been intrigued but ultimately have passed because of the team.

So take charge yourself.  Entrepreneurs should aggressively upgrade their own teams. The more you can bring in top talent above and around you, the more attractive your company will be to VCs.  And, of course, the more likely it is you will succeed with or without VC dollars anyway.

It starts with the CEO spot.  Often cleantech startup founding teams will have an "accidental" CEO -- a CEO who was the leader of the team that came up with the innovation, or a CEO picked as the most "business-experienced" of the overall team.  But when I describe "top-tier talent," I'm talking about the top 10% of all startup CEOs.  Ask yourself: Are you really already in the top 10% of all startup CEOs?  

--If you think you are, but you are having trouble raising financing, ask some pointed questions of peers and investors you trust to see if you really are as good as you think you are.  Self-awareness is a critical success trait for entrepreneurs, so develop that knowledge.  There may be one or two gaps in your skill set that you can fill or supplement elsewhere on the team.

--If you think you have the potential to be a top-tier CEO, and you'll grow into the role, at the very least find a terrific hands-on mentor to accelerate that process. It can be an early angel investor who's had a track record of working with and identifying top-tier talent, or a successful entrepreneur in your city. Court such people and suck their brains dry (give them equity so they're motivated to help in a significant way).  And even better, work to find a top-tier CEO you can bring on board that you will work with and learn from. Very rarely are CEOs truly top-tier on their first attempt.  You can learn from failure by yourself, or you can bring on someone to make your current startup a success and from whom you will learn how to make your next startup another success with you at the helm.

--If you are self-aware and realize you're not the right CEO for your company over the long haul, start recruiting that CEO today.  Make it a part of your day-to-day job to bring on board the CEO you want and with whom you'll want to work. Network around town to find the CEOs who are most respected.  

"But wait," you may ask, "Isn't there a chicken-and-egg problem here?  I can't bring in that truly great CEO without raising funding, and I can't raise funding without that truly great CEO." 

Good point. It's a challenge -- but there are ways around it.  

You can identify that CEO and bring them onto your existing board or advisory board.  Or you can just have deep enough conversations with them up to a certain point that you can feel confident you can not only bring them on board after funding, but also put investors in touch with them as a CEO-in-waiting. These first two options might be compelling to some investors, since a few may have their own ideas about what CEOs they would want to introduce to the company, whereas others will be comforted by the fact that you've got one already in hand, so you're covering all bases.  

Alternatively (and to my mind, preferably), you can think about raising a smaller round of financing than you would like, from angel/seed investors, so that you can hire that CEO, even knowing they'll need to go out there and raise a new round sooner than you would have hoped.

But basically, one way or another, find a way to top-grade your own team as aggressively as possible. If you can do this, it's a sign of strength and confidence and self-awareness on your part, not a sign of weakness. It can make all the difference between success and failure.  And I'm not just talking in terms of raising VC dollars.

A few other things to bear in mind:

1. I'm focused on the CEO position in the discussion above because it's the keystone position -- a top-tier CEO can attract other top-tier management team members to the team as well.  And it's also the single most important position funders will look at as well.  But the same basic logic applies to other senior management roles.  Top-grade aggressively for all senior roles.

2. Don't feel like you need to have an entire team of top-tier talent today.  You need to have the core of a great team.  But the company will evolve, and so will the needs of the team. Plus, it's always better to run lean than to have an overweight salary structure to support. You don't need an excellent and highly paid VP of Sales and Marketing before you have something to sell and market, to give an obvious example. Investors are used to backing teams with major holes in the management force. Just make sure that the team members who are there -- the core of the future team -- are top-notch. And when talking with investors, be clear about what gaps you see in your management team that you'll want their help in filling.

3. Don't think I'm telling you to kick yourself out of your own company! A confident and self-aware founder will know what they're good at and what they're not good at. Several of my portfolio companies have seen founders migrate over time into increasingly specific roles where they continue to shine and be a major force behind the company's success.  A good CEO will also be able to recognize this and build these founders into the right roles for success, if the founders are clearly supportive of such plans. Over time, all startups grow from an early amorphous stage where everyone does a little bit of everything, to more organized and better-defined roles for everyone.  It's a startup, and the odds are stacked against startups. So everyone needs to be pulling at the oars together, and pulling strong.  It should actually therefore be a relief and a joy to find that you get to focus 100% on what critical tasks you're good at and enjoy doing, rather than having to juggle those tasks plus a lot of other tasks that are less comfortable. In other cases, founders know their limitations and phase themselves out altogether. But either way, the more aggressively and early you top-grade your own team, the more you control your own destiny within or beyond your startup.

4. When searching out top talent to add to your team, you don't have to necessarily pick people who are domain experts in what your startup does. Sometimes, that's important. If the CEO is going to be the chief salesperson for the company and the industry is highly skeptical of outsiders, you probably need an industry insider in the role, for example.  But very often, the founding team are domain experts, and what's really needed is simply an experienced, successful entrepreneur at the helm to help make sure the challenges of being a startup -- regardless of sector -- are anticipated and managed as effectively as possible. Poach great talent from other industries, in other words!

I believe our sector is emerging from an innovation-driven phase to an execution phase. But that process requires strong execution by strong management teams.

A Very Important Article About Cleantech Policy in the US

Rob Day: June 3, 2011, 11:19 PM

Take the time to read this Politico article.  It's an important glimpse inside the world of the environmental funding community, and the role the community plays in energy policy.

Just a few quick thoughts and questions:

1. Flooding D.C. with funding on a very periodic basis to support one or two specific legislative efforts is not, um, a terribly effective policy strategy.  

2. "[W]ho spent about 30 minutes with the group before racing out to watch a Chicago Bulls playoff game" ... No comment.

3. By reactively pulling back so hard on funding, environmental foundations are basically pulling the rug out from under many organizations that are only now hitting their stride.  Foundations need to take a venture capital mindset. No early-stage VC thinks it'll take only two years to get their latest bet up and running and proven out. This is especially true for membership-driven organizations, which take a few years to start getting momentum.

4. The environmental foundation community needs to decide whether or not they support market-based (i.e., entrepreneurial) solutions. Otherwise, they end up finding allies in strange places: Carbon cap and trade is being rolled back in New Jersey and New Hampshire by anti-environmental groups, and it is also under attack in California by environmental groups that decry specific attributes of AB32.  Letting the perfect be the enemy of the good is not, um, a terribly effective policy strategy.

5. No U.S. energy and climate policy reform effort will be successful unless it is truly bipartisan.  That doesn't mean having one or two votes from the "other" side; it means a truly bipartisan approach -- which will require compromise and incremental changes, as well as a supportive business voice.

6. When will the cleantech business community step up to speak up as one voice on these issues, instead of relying upon the environmental community and sector-specific trade associations?  Anti-cleantech efforts don't differentiate between cleantech sectors.

How to Raise a First-Time Cleantech Venture Fund

Rob Day: June 2, 2011, 12:13 PM

The economy may be gearing up to double-dip, Congress and state-level governments may be soured on doing anything serious about energy technology and climate change, and LPs may be down on the venture capital category altogether. But I still continue to be approached by smart, motivated investors looking to launch a first-time cleantech venture fund. It's a testament to their enthusiasm and entrepreneurialism -- and to the continued evidence of the long-term business opportunity in these sectors.

But how can these entrepreneurial investors successfully launch a new cleantech venture firm?

My first piece of advice is: don't do it. Seriously, this is a very hard thing to do even in the best of times. Venture capital is overcrowded, LPs are down on the asset category and even the sector, and it's always near-impossible for first-time funds to get traction in any case. So unless you're really a masochist, think about other roles in the cleantech sector that might also be fun and more accessible. This will be hard. It will take years of your life and probably will not work out.

If the last paragraph didn't dissuade you, then ... OK, here are some other thoughts:

I've seen three different pathways for new cleantech venture firms to get up and off the ground.  

One pathway is what LPs would classically call "emerging managers." These efforts are led by well-established and recognized venture investors with a significant track record at existing firms who break away from those firms and build an independent team, most often full of other well-recognized luminaries. This is what firms like C Change Investments, Silver Lake Kraftwerk, and a few others have done.

The second pathway is the "affiliation" course. These efforts are connected and often co-branded with more established firms.  The more established firms bring some name-recognition, LP connections, deal networks and some expertise, and often some capital and operational support to help get the new firm off the ground. Blackstone's cleantech venture team is an example here, and of course Kraftwerk is, as well (these first two paths aren't mutually exclusive, after all).

The third pathway is the "pledge fund" option. And this is what's really available to those who are launching into this area but don't have the advantages of having been at an established firm with a long track record. To many of those hoping to launch a brand new cleantech venture fund, this is really the only viable option, unless they happen to have a very, very wealthy connection willing to bankroll them. And even then, it can still be the best available path to take.

In this pathway, a small (2-3 partners) group develop their pitch to appeal primarily to a small, specialized subset of LPs. It may be a regional play, or a particularly unique investment strategy, etc. The idea is to have enough of a pitch that is clearly differentiated from the cleantech VC herd that some LPs can fall in love with the concept instead of having to rely upon existing track records. Next, the firm goes out and aggregates a small pool of interested, likely pretty small LPs (perhaps in the range of $100k to $2M), typically high-net-worth individuals, corporations, and family offices rather than large pension funds and other institutional LPs.

But rather than ask these backers to put money into an unproven committed capital fund, the firm brings them fully baked deals and each of the funders decides for themselves whether they will put money into the deal or not.  These backers have "pledged" to invest in the firm's deals, and the shared expectation is that they will, but they don't have to blindly do so.  

In this way, over a few years, the firm establishes a track record. And then, if things go well they can raise a committed capital fund, from existing backers and new LPs, graduating over time to more institutional LP types. This is the pathway one of my old firms took, and over four or five years they were able to raise a fund over $100M.  It was not easy and it wasn't a straight path from start to finish; there were certainly hiccups along the way.  But they were able to do it.

Some other tips:

- I see too many such first-time investors try to go to large institutional LPs for their backing. It can be a helpful conversation if it's for general feedback and advice, but I've almost never seen such LPs back truly first-time investors (even those with "emerging manager" mandates often want to see a track record from another firm).

- Truly challenge yourself on your investment strategy. Now, in my LP role, I get to see tons of different pitches all the time. And they really do blur together. I've been guilty of this myself in the past, and so I know it's true -- what you think makes you differentiated really doesn't. I can almost guarantee that your message is too nuanced, too dependent upon proof of competence (necessary, but not sufficient for raising LP funds), and too jargon-y. Take what you think makes you differentiated and double down on it. Don't go off the deep end. But don't be afraid of turning off some LPs with your differentiated strategy; your goal is to get a small number of LPs to be inspired to actually write checks, not to have a majority of LPs think you're smart.

- Know your customer. All LPs are not alike, first of all, despite my sweeping generalizations throughout this rambling column. You need to make sure your pitch is one they'll be receptive to. Also, make sure you're asking for the right size of a commitment. Many smaller funds will approach larger LPs, thinking that it's easier to ask for a smaller amount of commitment rather than a larger amount. Actually, that's not true -- very often the LP will have a minimum commitment size they can do, and also restrictions about not being more than 20% of a fund (for example).  So if you're talking to a large pension fund about your $50M target fund, and they only write $20M minimum size commitments, there's likely a mismatch. So pre-qualify, do your research, and also don't be afraid to ask lots of questions.

- You will hear "no" a lot. Don't give up; don't lose heart. And if there are LPs you truly believe should be backers of your effort, make sure to keep them somewhat in the loop on all your progress. As long as you don't push too hard, a "no" can sometimes turn into a "yes" down the road. Not often, but sometimes.

This is a down point for the cleantech venture community, but the space will come back. Firms that are able to get such multi-year efforts launched successfully in this environment may well be positioned to take advantage of the upswing to come. LPs are finally starting to loosen their purse strings. So if I didn't scare you off with all the purposeful pessimism up top, good luck!