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A Modest Proposal

Rob Day: October 20, 2012, 2:37 PM

"It is remarkable how little concern men seem to have for logic, statistics, and even, indeed, survival: we live by emotion, prejudice, and pride."

- Dwight Eisenhower, in a letter to Winston Churchill


The above quote is very true, and it would appear particularly so right now regarding rhetoric about clean energy policy. Over the past week, we've seen a bunch of op-eds, some fiery, some sober, attacking clean energy policy and its proponents. And of course, then there are lots of reactions from the clean energy community and its proponents, some rebuttals with data, but a few just some form of a primal scream. The issue has become politicized to an illogical level, pundits are making statements that have no thought-out, sensical conclusion, and the entire situation is basically just, well... stupid.

I think it's time for everyone to take a step back and re-insert sanity and fact-based decision-making into how we talk about energy policy. I would propose to both presidential candidates that they pledge to establish a bipartisan commission, with representatives from big business, entrepreneurs, military, public policy, and former legislators, to investigate and then propose a balanced, coherent and comprehensive energy policy to the President. A Simpson-Bowles for energy policy, in other words. Their stated objective wouldn't be just clean energy policy. But it would be to develop policy recommendations that would result in cheaper, more domestically sourced energy, in as environmentally sustainable a fashion as possible, and with a net reduction in the federal deficit. 

A real honest-to-God energy policy for the nation, in other words.

Reading the various op-eds this week, one gets three distinct impressions:

1. A lot of complaints, no solutions.

I didn't have the harshly negative reaction to David Brooks' column this week that some others had. A lot of his logic about the flaws of the Loan Guarantee Program holds water for me. And he acknowledges that climate change is a priority problem for society, and even suggests he would support a carbon tax, even though he admits that cannot pass Congress right now.

But then he just leaves it there.

Either you think climate change is a big problem, or you think it isn't. If you're in the latter camp, I think there's a fairly large body of evidence at this point that says you're wrong, but at least then it's intellectually honest of you to simply favor doing away with green energy policy altogether (leaving aside all the other many policy benefits of supporting the technologies and industry, of course).

But if you do think climate change is a big problem, you simply cannot say that clean energy policy is flawed and then not offer any alternative proposals. That's just negligent. And intellectually dishonest.

2. Way too much focus on small pieces of the energy policy puzzle, used to paint too broad of a picture.

Our current national conversation around energy policy is, like our energy policy itself, highly disjointed. Which then allows grand sweeping attacks and proclamations based upon relatively small facets of the story.

I'm a free-market type by nature. Yes, as I've written before, I agree that the Loan Guarantee Program made a mistake extending what was intended to be project finance support into the grey area overlaps of late-stage venture capital. And yes, at a more general level, I believe that government staffers are always at a disadvantage in making investment decisions versus relying upon the larger private sector, if assigned the same objectives.

But that's a pretty limited set of situations. It's silly to evaluate government "investments" simply on financial returns, because that's never the primary objective of such programs to begin with. If you disagree with the other objectives (which can include jobs, technological leadership, environmental impact, or simply accelerating learning curve effects on the costs of emerging technologies), see point number one above, but also don't ignore them when evaluating the effectiveness of clean energy policies. And there are many other aspects of energy policy that have been very successful even from a returns perspective -- in fact, within the Loan Guarantee Program's project finance investments, for instance. 

The conflation of totally different government policy efforts further exacerbates the issue. A lot of the recent failures of government-backed startups have been the result of economic development programs, not clean energy programs.

Let me tell you about a state that has backed several cleantech startups with hundreds of millions of dollars in benefits, to attract their manufacturing facilities to the state. Yes, the state's name begins with an M.

Yep, you guessed it -- it's Mississippi. The state government under notorious liberal Haley Barbour has shelled out tons of handouts to at least five cleantech startups, to get them to relocate their operations into the state. 

And they're not alone, nor is this a new trend. States have for decades had their Economic Development departments provide heavy incentives to individual companies to try to outcompete other states and attract new facilities, whether those are creating green jobs or non-green jobs. I'm not trying to single out Mississippi, it happens all over. Such as in Massachusetts, with Evergreen Solar and several cleantech startups that got similar packages and subsequently got a lot more negative attention for it. I personally am not convinced of the worth of these types of economic development policies, it always seems to me like classic "corporate welfare" and the type of auction-based bidding where the winner often ends up with buyer's remorse. But it happens all the time, in most states, under Republicans and Democrats alike, and it's got NOTHING to do with clean energy policy.

And of course, the failure of many of these cleantech startups would have a lot to do with the direct and indirect (ie: price drops in incumbent energy) effects of the macroeconomic downturn. If cleantech startups fail after receiving government support during the worst economic period in living history, there are actually TWO possible conclusions: 1. the policies are flawed, or 2. there wasn't enough support.

If David Brooks or Steven Syre or others want to attack cleantech-supportive policies as having failed, they need to better articulate a) that they're really talking about a small subset of cleantech-supportive policies, and b) exactly how the policy failures are a more impactful factor than macroeconomic conditions, or broader energy policy impacts, etc. And it would help if they would stop conflating long-running economic development policies with the more recent clean energy subsidies.

3. Cherry-picking and misusing data.

I hope someone alerted the Red Cross to the clear violation of the Geneva Convention in this recent Washington Post article about Al Gore's wealth, because the data has been absolutely tortured.

Hey, maybe Gore's wealth has indeed increased 50X during the past twelve years. How is that possibly due solely to his cleantech investment activities? He gives paid speeches. He runs a media group. He gets compensated by companies like Apple, Google, and Metropolitan West Financial for serving as an advisor or as a board member. 

Based upon the investment track records of the groups he's been associated with on the cleantech investment side, it wouldn't be surprising if he's made some money there, if only off of fees -- maybe some carry, maybe not.

But if, predominantly as a cleantech venture investor, he's made $98 million over the past 12 years, we should all tip our cap to the man. Because he would be the ONLY ONE of us to even come close to doing so. Just looking at Gore's various business activities, what makes most sense to you? The reporter who pulled together this horrible piece of "journalism," and its implications of underhanded business and government practices, should be ashamed of this article. It was clearly just a manufactured and strained effort.

I mean, this kind of stuff makes no sense even on its face, and yet this is just one example of a lot of really screwy data being thrown around out there. Romney suggests that half of the companies backed by the Obama administration have failed? Clearly factually wrong. $90 billion in "green pork" says Paul Ryan? Completely debunked by the fact-checkers. Claiming that the ARRA stimulus is largely responsible for driving down the cost of solar panels, as some have done? *Ahem* China *ahem.*

You can't have a rational dialogue about any policy area if everyone insists upon bringing their own cherry-picked and perhaps completely made up "data" to the effort.


Hence my proposal: It's time to wrest back the energy policy discussion -- clean energy policy and traditional energy policy, combined -- into the realm of reality. It's time to pull it back from all this useless partisan bickering. This isn't inherently a blue vs. red thing, both energy and environmental policy have traditionally been non-partisan issues. And it's time to bring together deeply experienced experts from across the various stakeholder groups to bring real data to the table, and to have an open dialogue around what should be done to pursue some shared national objectives, and get both sides to stop using our sector as a political football.

I don't kid myself about any such commission's ability to force through their recommendations. Like with Simpson-Bowles, I would expect the commission's findings to be given lip-service support and then once again attacked piecemeal in partisan-based rhetoric.

But even just establishing such a commission would send a powerful signal of how important it is that we come up with a coherent national energy policy, for security, economic, and environmental reasons. And it would create a "safe space" for a rational, fact-based dialogue.

And who knows, maybe it would actually come up with something that a group of lonely centrist politicians could support.

I think both presidential candidates should be asked to sign on to a proposal like this. And I wish journalists would take such an approach on the increasingly rare occasions when they ask the candidates about these issues.

A Few Things to Note in the SolarCity S-1

Rob Day: October 18, 2012, 7:55 AM

I'm a few days late to this party, but finally took a look at the SolarCity S-1 yesterday. A few things have already been written about the business, so I won't redundantly go into all the discussion of operations, risks, etc. (Even better, read it for yourself.) But here are a few items I'll add in that caught my eye.

First of all, for a business model like this, discussions about cashflow and margins aren't straightforward. Much has been written about this being a high cash burn model -- but you have to look under the hood on that, and then really pay attention to the IRRs of their projects, which is the heart of the business. That's not spelled out in the S-1, of course, but this Woodlawn Associates analysis does a very good job of teasing that out. I'll echo what they say, namely, that SolarCity appears to be getting pretty industry-standard IRRs, from what I've seen in the market. A good data point, but it also suggests there's no magic returns advantage to the company, other than benefits of scale to attract the lower-cost capital.

Secondly, the company really is growing impressively. It's basically been doubling installations every year since 2009. Again, I think that's not that unusual for this market -- solar financing is simply exploding right now. Part of that is simply the power of this type of financing model to unlock consumer buying decisions; part is the significant drop in solar panel and other costs, but a relatively unnoticed factor is the drop in the cost of customer acquisition over time.

You would expect there to be an inflection point in any small but fast-growing market where customer acquisition costs go down over time simply because customer awareness breaks through some kind of threshold and then customers need less education, etc., to want to make a purchasing decision. Interestingly, however, for SolarCity, there are indications that from 2009-2011 the cost of customer acquisition stayed flat. A simple calculation of sales and marketing spend per MW booked stays pretty constant during that period, coming in at between $250-$300 per. This is a curious lack of advantage from scale at the company, and if these figures are indicative of the industry as a whole, it is even more curious.

But I'm seeing a pretty important shift in the marketplace over the past 18 months or so, to really focus on reducing the cost of customer acquisition. Lots of innovative approaches either via technology (remote assessments) or economies of scope (turning to roofers, energy auditors, etc. as lead generators). I think we'll continue to see these costs driven down over time as better data mining and direct marketing capabilities are introduced to the market. And that's more important than you might think -- as Woodlawn Associates points out, SG&A costs per Wp for SolarCity averaged $0.48 over the past few years, with sales and marketing being something close to two-thirds of that spend. When we're all enamored of solar panel prices falling below a dollar per peak watt, reducing the implied $0.30 per Wp in sales and marketing costs would be important for continuing to accelerate the growth of this market. 

It's an under-appreciated aspect of the solar market for sure -- I recently was told by an insider about how frustrated even Secretary Chu got a couple years back, when he started learning about how important installation, etc., costs were to solar power competitiveness, and that simply reducing the costs of panels wouldn't be sufficient.

But in light of all that, it's striking to see that in the first half of this year, SolarCity's sales and marketing per MW booked dropped by something like a third, to under $200 per. And it's not because the projects got bigger -- a similar drop is seen on a per-customer basis (from $5,356 per new customer in 2011 to $2,399 per new customer in 1H12). Is that a sudden materialization of the market shift I describe above? Or is it the result of SolarCity's "SolarStrong" program with the military, and similar aggregated sales that might require less effort per home booked? If the former, that's great news. If the latter, you have to wonder if it's a bit of an aberration, at least for SolarCity. The truth may lie in the middle somewhere.

Finally, the company's recent venture financing history is pretty fascinating. At least to me.

At first blush, the company's $81M Series G raise earlier this year was at a shocking valuation. The implied valuation appears to have been something in the neighborhood of $1.9B (fully diluted).

But before all you solar entrepreneurs get stars in your eyes all over again, note the fine print on the bottom of page 137:

"Each share of Series G preferred stock is initially convertible at the option of the holder into one share of our common stock. Pursuant to the terms of our amended and restated certificate of incorporation, upon the closing of this offering, each share of Series G preferred stock will automatically convert into a number of shares of common stock equal to the quotient obtained by dividing (A) the original issue price of $23.92 per share by (B) the product of (i) the public offering price in this offering (before deducting underwriting discounts and commissions), multiplied by (ii) 0.6. However, in no event will one share of Series G preferred stock convert into more than approximately 2.47 shares or less than one share of common stock as a result of this conversion adjustment mechanism. As a result, the outstanding shares of Series G preferred stock will convert into no more than 8,372,072 shares and no fewer than 3,386,986 shares of common stock."

So the valuation was high on paper, but there's a pretty significant ratchet attached to it. And by my simple calculations, this implies that down to a post-IPO price of $16 per share (note: much lower than the $23.92 per share paid by the Series G), they lock in a 67% return -- as long as the price remains that high at the point where any lockup expires. That's not a bad return, and locking it in with this ratchet makes the high Series G valuation much less relevant than it might appear. Indeed, the share price would have to fall back down below the Series F price of $9.86 per share before Series G starts losing money on an investment where they purchased shares at more than double that.

Venture capital terms like this always fascinate me, and it may be a good lesson for other late-stage investors in the sector, if they're not already deploying this kind of strategy. It's a good lesson in how to give a high valuation and still get a good chance at a decent return.

But it's not a panacea, and I'll note one important implication of this kind of arrangement: It adds pressure for this to be the last round of financing into the company before an IPO (barring possibly just re-opening the Series G if needed), and it puts the company into an "IPO or bust" situation, as far as some very important investors are concerned.

I really want SolarCity's IPO to go well -- we all have a lot riding on its visible success at this point. But I note how the incentives around the table would be for the company to IPO as soon as possible. And that the company's current cash position suggests they may need additional financing relatively soon. Knowing the caliber of the investors in this company, I trust them to not send this company out to the market before they feel it's really ready for prime time, and as discussed above, there's a lot to like about the story (while also some points of concern, as many have noted). But more generally, we've seen too many cleantech IPOs that clearly went out too early. And it's hurt us on Wall Street, and thus hurt our returns as a sector.

Fingers are crossed this time around. Not only do we as a sector need a win badly, SolarCity also looks a lot more like the kinds of companies I've been espousing (and investing in). So I'll be cheering them on. And if they keep growing like they have been, there's a lot to cheer for.

Lessons From the Past Ten Years: Angels

Rob Day: October 16, 2012, 6:56 PM

Now should be a period of happy hunting for angel and other seed-stage investors looking for new deals. Venture capitalists have abandoned the sector, at least temporarily. The Cleantech Group's early Q3 numbers showed a continued decline in early-stage dealflow, with only 55 early-stage deals tracked worldwide in the quarter. If that number holds upon further review, it would be the lowest such quarter for early-stage deal activity over the past five years. Nevertheless, the entrepreneurs have remained active and in my opinion have brought forth even more investable ideas, more pragmatic approaches with more relevancy for existing markets. So it's wide open spaces for angels and other seed-stage investors interested in getting active in the sector.

But it's a lot easier said than done. As we've talked about often in this column, it's time for some rethinking about how investing is done in this sector, but that requires angels to step out of whatever comfort zone they might already have (if any) in terms of how they've done things in the past. I had the opportunity to speak briefly with a group of cleantech angels earlier today, and I encouraged them to step up to this opportunity. I passed along three general suggestions:

1. Hit 'em where they ain't.

A lot of the angel activity I see in the cleantech sector chases the very same type of investments we've seen VCs do as well. Next-great-patent investing, hardware innovations, etc. After my little talk today, someone came up to me and said I disparaged such investing. Not at all! But my message is "AND." It's time to broaden beyond that type of investing, not be limited to just that one approach. And angels are very well positioned to lead the charge.

Why? For one thing, the best new approaches to market reinvention might not be capital intensive, and in fact might require so little capital to get started that the VCs won't be interested -- VCs typically have a minimum check size they'll write, except in rare occasions. Whether it's a new approach to a service offering, or a web-based marketplace, some of these efforts can get to a market proof point before capital requirements get into the millions.

Also, if done correctly, angels can take a longer-term view on some of the slower-developing tech plays like ocean power or advanced materials or water technologies.  The big caveat is that these can also be more capital-intensive. But there are strategies to deploy in that regard.

In both of the above scenarios, also think more about alternative corporate structures than the traditional preferred equity approach. LLCs can help provide liquidity out of successful cash-generating service companies, for instance. And an LLC can convert to a C Corp if and when VCs look to invest in a company.

2. Work with friends.

This may seem to be at odds with point #1 above, but it isn't. There are resources out there to help validate ideas during investment selection, to provide support to the companies backed by angels, and to help bring in co-investment dollars.

Universities increasingly have entrepreneurship centers. They can be gateways to getting access to technical knowledge, because I guarantee they would like to meet angel investors and to help them. Corporate technology groups also are increasingly looking to connect with angel investors, since corporates may often see technology ideas they like but are too early for them to engage with. Government labs like NREL are eager to help angels get access to technologies and technology experts, as well. VCs, even if they're not investing (or perhaps, especially because of it) are often happy to meet with and compare notes with angels. There's never enough time, but these kinds of resources for market and technology access, and even for dealflow, are available to investors no matter what kind of investment strategy they're pursuing.

And once an investment is made, there are a lot of organizations ready to help. Just here in the New England region, we have the ACTION network of incubators like Greentown Labs; the Cleantech Open Northeast accelerator / training program; the New England Clean Energy Center; the Massachusetts Clean Energy Center; and others. If you back a relatively inexperienced team, send them to participate in some of these programs. If you back an experienced team, see what resources these groups can bring to the table to help minimize capital burn.

And there are an increasing number of cleantech-focused angel groups and family office groups out there. Go find these kinds of groups and get to know them, even if you decide not to join them. All investors in this sector need to find and collaborate with like-minded co-investors, and just to compare notes. 

3. Make those companies run really lean.

Whether you're taking on a "capital-efficient" cleanweb opportunity, or taking on a 10-year technology development effort, it's important to try to keep the cash burn as low as possible. Angels simply cannot count upon even their better-performing seed-stage bets attracting follow-on venture capital, as is the traditional path. It's time to plan these investments as if follow-on capital won't be there. 

What does this mean? One of the first things you should help a seed-stage company find is access to grant-identification and grant-writing expertise. State-level grants. DARPA contracts. DOE grants. There are lots of potential opportunities for non-dilutive financing. One key will be keeping these grants from becoming too distracting, but at least right now, it's worth pursuing.

And the other thing is to sacrifice some speed for the sake of cash preservation. Technologist entrepreneurs sometimes think receiving even a small amount of investment means it's off to the races in terms of hiring. That needs to be a very slow-rolled decision, however. 

And finally, early revenue is good. Seek it out. Try to charge for early betas. Try to identify an early-adopter niche willing to pay for a specialized product even while you continue to develop the mainstream offering. Get NRE revenue from corporate partners. Do everything you can get make sure limited angel dollars will be sufficient.


Now is a phenomenal time to be a cleantech angel investor. But it's also a confusing and challenging time, in terms of figuring out how to do it. I hope many will feel it's well worth the effort, because it feels like we're on the cusp of a real transformation of the cleantech investing and entrepreneurial scene. And I think angels have an important role to play in bringing it about.

The Next Wave of Cleantech Investing Is Here

Rob Day: October 8, 2012, 12:00 PM

The next wave of cleantech is here.

The old form of cleantech is dead or dying, everyone agrees. I don't know too many investors out there still looking for capital-intensive ways of making commodities, as marked the height of the pre-2008 cleantech wave (and that I've been guilty of myself in some cases, I must admit). And there will be yet more bad news piled onto our sector thanks to those types of investments. Just this past week I learned about yet another high-profile capital-intensive cleantech startup that is on the ropes cash-wise, and likely to be a bad headline soon. My message isn't that things are about to turn a corner, in terms of the negative tones in the press, in politics, or amongst LPs.

But there's a cadre of cleantech investors and entrepreneurs who are actively rethinking all this. And they're now getting a chance to put that thinking into action.

I'm seeing tech-focused investors looking not only for compelling innovations, but for management teams that are pragmatic about their path to market, and that are relatively (stress on relatively) capital-efficient in how they're going to commercialize their innovations. These "cleanTECH" investors may still be hunting for the next great patent, as before, but they're now doing it in smarter ways.

And I'm seeing more investors tackling information-based cleantech, taking on the next great data challenge and opportunity that is energy and water, and thinking about brands not as something that can be bought with scads of venture capital driven PR, but instead as powerful assets that smart management teams can build in effective ways, organically.

In both cases, it's no longer "build it and they will come" approaches; rather, it's all about the customers, directly or indirectly. And I firmly believe that effective market reinvention and adoption acceleration will mark the inflection point where the pendulum starts to swing back for our industry. Owning the customer is more important than owning a patent. And a great execution-oriented team is more valuable than a great technical innovation.

This next wave of cleantech is less MiaSolé, and more Nest and Next Step Living.

And it's being led by a younger crowd of investors. I got to catch up this past week with the likes of Rodrigo Prudencio, Will Coleman, Matthew Nordan, and others among their peer group -- smart investors blazing a new path. What I heard about what they're up to got me revved up, energized, excited about the next wave. I'm seeing complete rethinkings about how venture capital in this sector should be structured, how investors should make their choices, and how the rest of the ecosystem (especially large corporates) should be engaged. About how to declare "Damn the political torpedoes, full speed ahead." And most of all, about how to grow companies without burning so much capital along the way. High-cash-burn business models have already killed way too many good cleantech ideas over the past decade.

I also got to meet a bunch of entrepreneurs who are working on this next wave: experienced IT entrepreneurs building new marketplaces using tools they already understand well; younger entrepreneurs who are thinking cleverly about how to leverage existing and underutilized capacities in existing markets; and industry veterans who know how to open doors with large corporate customers and have realistic expectations about how to build powerful relationships that unlock doors. Some of these entrepreneurs I already knew well; some were brand new to me. All left me impressed.

There will continue to be blowups out of the last wave of cleantech. They will continue to dominate the headlines over the coming months. But in the background, the next wave is upon us. And I have high hopes for it.