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Fundraising Advice for the Seed-Stage Cleantech Innovator

Rob Day: January 28, 2013, 10:55 PM

Cleantech investors are commonly approached by very early stage entrepreneurs. And by "very early stage," I mean garage-based-inventor stage. In many cases they're not directly looking for funding from my firm at their stage, but they're looking for advice on how to raise seed capital.

We all need such entrepreneurs to succeed. Their innovation and enthusiasm is the lifeblood of our sector. And so while it's gratifying to encounter such innovators, it's also frustrating to find that so many are having a hard time getting started. And I have come to believe that in many cases these innovators are having an especially hard time because they're not looking for the right thing. They shouldn't be looking for seed capital, they should be looking for how to turn their idea into a business. The funding follows after that.

Below are some suggestions that I hope will help such innovators turn their ideas into a real business. This is a lot easier said than done, especially on limited capital and during limited available hours. I've been in this position myself, and I know there are real constraints on what can be done. So the most important watchword here is "patience." The below process can go relatively quickly if you have a lot of time and no financial constraints, but it can also be effectively tackled over time, on the cheap and with limited bandwidth. Just don't expect it to happen overnight, or you're not being thorough enough. It's highly unlikely that these antiquated, slow cleantech markets will move too quickly and pass you by while you're prepping; but it's much more likely that if you go out there not yet fully prepared, you won't make any headway. Be patient.

So with that in mind:


1. Attack your own idea. Why won't it succeed?

The general sentiment experts and investors like to pass along to early innovators is that they must be unmitigatedly optimistic, that they must simply will themselves to succeed and refuse to take no for an answer.

True enough. But there's a time and place for everything. And you should shoot holes in your own ideas before someone else does. The best way to do that is simply to ask yourself tough questions and then gauge your answers on your own personal bullsh*t meter.

Questions like:

"Is this a solution in search of a problem, or is this idea of mine generated by a very real customer (i.e., not society-level) problem that they'll pay someone to solve?"

"Is this a good idea but aimed at customers or a market that simply aren't accepting of new innovations?" 

"Is this a good idea but one where it will take more capital to succeed than I can realistically access?"

"Is this a good idea but one where it will take skills and talents that I don't have and can't access?"

"Do I have time for this? Or am I hoping to just hand it over to someone else to execute for me?"

"Do I have any special advantage that means I would be able to succeed at this even if others also have the same basic idea?"

"Is this something that someone in a national lab or in Silicon Valley or at a university is probably already doing?"

If you end up losing faith in this particular idea, that's still a victory, as long as you then work hard to develop another winning idea. But hopefully what you find is that you have a revised idea you truly believe in, and you're now completely honest with yourself about the obstacles to bringing it successfully to market. I'm a big believer in optimistic entrepreneurs, but there's a difference between optimism and fooling yourself.


2. Decide if you are going to develop a component, or a full solution.

This may seem like a value-laden question, but I really don't mean it that way. These are two equally legitimate pathways.

Is your vision that your innovation is incorporated into other people's products or systems? Are you looking to license it for others to manufacture? These can be financially-successful and commercially-successful paths, requiring much less capital in many cases, than the decision to take on building out a full solution. Are you a battery management innovator who will license an innovation to Tesla, or do you want to take your battery management innovations and use them as the basis for building a new Tesla? The reason to figure this question out for yourself in the early going is that it will dictate a lot of other choices further on. For example, many innovators too quickly assume they need venture capitalists to back their effort, and yet VCs typically want to back full solutions with lots of capital, not capital-light component development and licensing plays...

Generally, I would urge keeping things very simple as a first-time entrepreneur. First-time entrepreneurship is ridiculously hard, and many entrepreneurs find better success their second or third time around after a lot of lessons learned. So to borrow a concept, think of your first entrepreneurial effort as the task of putting out there a "Minimum Viable Entrepreneur" and then failing a lot very quickly so that you can iterate quickly. That's a lot easier to do if the business you're trying to start is as simple as possible. To innovate around a battery pack and license it to an automaker requires several skills. To successfully launch a brand new automaking company requires ten times as many different skills areas. 


3. Recognize that at this stage, it's all about the customer proof points and the prototype.

You may have a lot of confidence in your idea, but really that doesn't matter much. What matters a lot more is that customers say they want a solution like this when it's ready for them, and that you have some serious prototype that you can show to people and give them confidence in your idea.

You can't learn what you need to learn about prospective customers via web searches. Find people from your prospective customer group, or who work with your prospective customer group, and buy them a cup of coffee and informally tell them about your idea to get their reactions. Don't go straight to the top, go to people who have the time to give you thoughtful answers. Ask them about whether this type of innovation would be welcomed or not (you'd be surprised how many innovators want to sell things to utilities and yet really don't understand why utilities actually buy things, for example). And especially try to learn about what pains and frustrations they experience, that might be relevant to your idea. Building in such solutions can be invaluable. Most of all, leave the door open to follow-up conversations once you have something to show them.

And build that something to show them. To the extent you can with the limited resources you have, build the sucker. Too many innovators go out and seek funding armed only with drawings and computer modeling.

- Perhaps you have to do it at a much smaller scale because of costs and physical constraints;

- Perhaps you have to build something that demonstrates only a portion of your idea;

- Perhaps you need to use mostly off-the-shelf components to show what your envisioned proprietary solution would eventually do a better job of;

- Perhaps you simply are launching a service business and can actually do the service yourself for someone; or 

- Perhaps you are launching a web-based business and your first test site is built using free hosting and web design tools, doesn't look very snazzy, and is built on a very incomplete database

Whatever you have to do, build a version of it that you can show to people. A version that actually demonstrates the potential effectiveness of something, not just an illustrative model or mock-up.


4. Write a business plan.

I know, I know, conventional wisdom now says that writing a business plan is a waste of time and effort. I disagree. Writing a very pretty business plan with lots of jargon designed to impress an external audience is a waste of time and effort. But the actual thought processes behind writing a business plan are invaluable, at least for first-time entrepreneurs.

What this really does for you is it forces you to get down to brass tacks on all of the various parts of your potentially-good idea that you have previously glossed over or just assumed away. Successful entrepreneurship requires many things, but one of those is definitely the ability to execute on an overwhelming number of specific tasks at a detailed level. Especially if you're not a "details person", the forcing function of having to think through the plan of action in a comprehensive and deep way is very useful. 

But do it for you, not for an external audience. Save the high-falutin' jargon for your eventual investor deck or customer pitch (and maybe skip it there, too). Don't worry about the format, about getting the structure just right, or even good grammar. Pick any old suggested template; it really doesn't matter. But take the time to think through your full business in as detailed a way as you can think of, and take the time to write it down, and take the time to keep it roughly updated as you think of areas you forgot or you change your plans. Because when you do go out to external audiences, while you won't show them this document, writing it will be what makes you sound very thoughtful and pragmatic when you pitch your otherwise crazy idea at someone in hopes of them giving you money.

Network with a lot of other entrepreneurs to the extent you can, and try to find a good experienced entrepreneur who's willing to give you regular advice. Consider an accelerator program like the Cleantech Open. Learn good business planning as much as possible from others who've done it in the past, rather than from your own blank slate.

This is not a budgeting exercise. This is a war plan. Numbers are part of that, but it's more about discrete tasks and objectives in a comprehensive fashion. If you're doing it right, you'll likely discover you've been ignoring pretty significant areas of activity that any real business must have... And if you're doing it right, you'll figure out how much money you actually need to raise to make your idea a reality, rather than the typical guessed-at large round number.

Even if your business idea is to get something to a prototype stage and then hand it off to someone else to commercialize, write up the details of that plan, however simple. Because you'll discover it's not so simple after all.


5. Find your team.

I've found that many innovators are pretty self-aware and know of several key skills areas they don't have and will need to bring on board. But they really don't know what to do about that. It's difficult to impossible to build a team by recruiting people you don't know, before you raise money. And yet most innovators, especially first-time entrepreneurs, don't have an a priori team around them. So many innovators punt on this and simply tell themselves (and prospective investors) that they'll hire senior people into various roles after getting capital.

The problem is, unless you have identified full- or part-time managers for crucial areas, it's hard for any investor to write a check. They want to know the team they're backing. So punting is ineffective.

The answer is to rely upon all the networking you've been doing from the above steps. As you've been talking with prospective customers and partners, and with other entrepreneurs, see who can get to be passionate about your idea. If you need other skills you haven't encountered yet, figure out where those people network and go there, looking for good listeners. With those people, meet with them several times if they're willing, and if you see a good mutual fit, try to soft-recruit them. By which I mean get them fired up about joining your effort when you get funding, so that you can bring them into your pre-funding planning process, and also tell prospective investors about them.

You'll need full- or part-time managers for all the really critical tasks. But there are a lot of other necessary but not as critical areas of entrepreneurship, so also recruit advisors/mentors who can help you know what to expect but aren't anticipated to put in more than an hour or so every other week. And don't forget -- you'll also need someone to do all the actual work. If you're going to CEO this effort, you'll end up spending a lot less time in the lab yourself.

Remember, you're potentially trapped with these people for 10 years or so. So don't fool yourself about your skills gaps, their skills gaps, or that you might quickly discover you can't stand each other. Again, be patient and let relationships develop over time in an iterative way.

You don't need a full team before launching your business, but knowing more of the pieces than just you alone is part of the necessary planning and credibility-building you need to do before approaching funders.


6. Approach funders.

Aha, finally we're to the point of this column, right? I hope that's not what you're thinking, and if so prepare for disappointment. Getting funding is a result of building a great (albeit fledgling) business, not the other way around, and I hope that the above steps are helpful in that regard.

But at some point you'll likely need some capital. So in this period where early stage venture capital is hard to find, where should you look? In all likelihood, the underwhelming answer is grants and local angels.

At this point you hopefully know how much capital you need to take your idea to the next step, and hopefully it's not a huge amount. So note that for anything under $1M, venture capital is likely not a good fit. Even early stage VCs typically don't want to write a bunch of smallish checks out of >$100M funds, because it's a lot of management overhead for them. And there really aren't that many early stage venture capital deals done in any case, versus the number of good ideas out there, so just the numbers game alone says that VCs are likely not your best source of startup capital as a first-time entrepreneur who doesn't already have a relationship with any VCs. Never say never, but grants and angels are most likely the way to go.

And for both of these capital sources, focus mostly on local targets, because they tend to really focus in on their regions. There are actually a lot more grant opportunities at the local level than you might think, but many innovators focus just on the higher-profile national opportunities (like ARPA-E, etc) that get a lot of attention. But I've worked with grant-making bodies from Massachusetts to North Dakota and I can tell you that many states have some kind of entity with a small (<$1M check) capacity to support early stage entrepreneurs and/or technology innovators -- it may not be a cleantech-focused entity, mind you. Furthermore, there are often resources attached to universities, as well as non-profits like MassChallenge and the Cleantech Open, who have some limited financial resources for program participants/winners.

If you need millions of dollars to make your prototype, you're probably not thinking creatively enough. And if you don't need millions of dollars for this first step, do a lot of research to find what local grant-making resources there are that are available to you.

And angels are all around you as well. There are angel groups all over, and online. Without doing the above process it may be difficult to break through the noise to get the attention of angels even when you find them; but with a credible plan your task is to network to an angel investor (or three) who share your passion and your vision for the business. Don't just fire off an executive summary to an angel group email address, use LinkedIn and other resources to figure out individual angels and go talk to them. Even when they're not a fit (which is likely), ask them about other angel investors you should track down. Don't ask them for an endorsement or even a referral unless they want to do so, because investors of all stripes are wary about burning relationship capital in this way when they don't really know someone that well. But just good solid leads for you to track down are quite valuable.

Think globally, but fundraise locally.


The above steps won't be applicable to many innovators, and many more will already know and be actively doing most parts of it. But in my experience, I run across lots of innovators who really don't know how to get started at turning their good ideas into real businesses, and go out to find funding to support doing so. My point is, that's the wrong order of things. Patiently and thoroughly build your business, even if it has gaps at this early stage, and then you'll be in a much better situation when you write a grant application or pitch an angel investor. Which then allows you to focus on local funders with confidence, rather than casting your net too widely.

Network, network, network. Have strong opinions, loosely held. And be prepared to iterate and have countless conversations before you piece it all together. It's hard, but it can be done, and you can do it, even if you've never done it before.

Lessons From the Past 10 Years: Embedded

Rob Day: January 18, 2013, 9:03 AM

As talk of the "internet of things" -- that is, smart equipment via automation and machine-to-machine communications -- continues to get attention, we're seeing more and more entrepreneurs bringing forth some flavor of idea involving energy-focused equipment controls. Smart-home plays, automated load shifting efforts, smart grid software, etc.

From a cleantech perspective, the basic concept is the same: Using automated intelligence, make hardware save energy spend via optimized usage patterns, and then build other value propositions (e.g., preventative maintenance, more granular data, remote sensing, etc) on top of that core value proposition.

As entrepreneurs tackle a variety of sectors and applications with this concept, however, there's one basic question they inevitably have to ask themselves: How embedded do I want my intelligence? Or to put the same question another way, how much do I want my software- and controls-based solution to be residing within specific hardware devices, vs how much do I want to simply ride over a variety of devices with common set of controls and software? 

Do I just sell software, separate from the purchase decision of hardware? Do I license software embedded into other OEM's hardware, by partnering with those OEMs? Or do I make my own hardware and sell it, but with my software/controls as the advantaged factor?

As we look across sectors and applications, there is no universally correct answer to these questions. But it is hugely important to answer them correctly, as we'll see below. So let's explore some of the trade-offs and key criteria entrepreneurs should keep in mind when addressing this question strategically.

1. How much technical advantage is gained by tailoring specific controls attributes to specific hardware?

This question has to do both with the complexity of the hardware being affected, and how much of the optimization gains are due to technical hardware operations vs. simpler adjustments to usage.

The more complex and intricate the hardware, unsurprisingly, the more you would expect a customized solution for each specific type (brand, model, etc) of hardware would ferret out additional efficiency gains. With solid state lighting, for instance, the differences in power electronics, cooling requirements, voltage choices (i.e., run chips hard or easy), types of sensors, etc. are all variables that can significantly affect the ability of a controls solution to drive efficiency gains. The more tailored the controls to that particular fixture's setup, the more efficiency it can drive. You can certainly drive savings by applying a broadly-designed controls system across a wide variety of lights, but you get deeper savings by designing specific controls parameters for the other specific components and configurations of the fixture or bulb.

World-class leaders in battery control technologies, for example, have gained important advantages. Tesla's future growth, for example, is built as much on such factors as on brand awareness.

Contrast to a smart-home clothes dryer, on the other hand. It's a big energy user, but the specific energy-consuming system is fairly simple and standard. Instead, the energy gains to be made are more about time of use and some other choices around usage patterns. This would be more amenable to a separate, broader controls system that perhaps adjusts more in the home than just the dryer, for example.

2. How much existing, standardized equipment interface is available?

Many existing industrial controls standards already exist in the marketplace, for instance with large HVAC systems, other commercial buildings management systems, or factory equipment. These typically haven't been designed already with energy optimization in mind, but you also often don't need to build controls that are linked to specific components within the equipment, because the existing industrial controls they were designed around provide a "doorway" for energy-optimization software to make targeted adjustments.

On the other hand, in just about all segments there are also small niche industrial controls vendors or even just PLC-based homegrown solutions that have some portion of the installed base. If they make up a large portion of the market, you're going to need fairly customized solutions regularly.

3. Are you targeting applications inside or outside the meter?

Utility-facing smart grid software has to interact with hardware in some way. But there's a lot of legacy hardware out there, a lot of utility resistance against new hardware vendors, and a much bigger scale of project, than typical for energy consumer-side applications. System integrators are also more readily available for utility-scale implementations. Generally speaking, therefore, these factors will drive more non-embedded controls on the utility side of the meter than on the consumer side.

Even on the consumer side of the meter, I think we'll see a shift over time toward more common controls standards, even when embedded into hardware from various manufacturers. But utility-side projects are probably more often large enough to support software-only efforts in this regard.

4. How fragmented and receptive are the OEMs and channel partners to partnering with (and paying) controls vendors? 

It's obvious but it's amazing how many entrepreneurs don't really factor this in -- if you're planning on getting your revenues from licensing controls to OEMs, how capable and receptive and scalable are they? You're not going to build revenues quickly if the answers to this question are at all negative.

So, for instance, in the lighting industry some smart entrepreneurs have instead chosen the two other pathways. Some have gone the fully separate software route, designing controls that are intended to be overlaid on any OEM's fixtures. Another, BCC portfolio company Digital Lumens, decided instead to start by building their own fixtures with their own embedded controls, eventually migrating to an OEM-licensing strategy.

Take note of what this implies: The counter-intuitive decision to manufacture hardware as a result of a go-to-market strategy, not the other way around. Per point #1 above, there are obviously operating efficiencies to this stack-integrated approach, but the other relevant factor here is the nature of the channels in addition to the OEMs. In today's lighting market, the channel partners generally don't "get" the economics of lighting controls yet, and in many customer segments there's resistance to paying much for an add-on controls solution (even when the economic value proposition is clear). So embedding the controls into actual hardware and selling the full bundle to customers gives more opportunities to capture the economic value created by the controls, is the theory.

And at least in this case, the theory seems to have held. DL's embedded controls have been installed in 50M square feet, ~10x as many square feet of space as any of the software-only startup contenders over a roughly equivalent period of time. Of course, it's still early days in that industry sector, the full story has yet to be told...

5. How hard is it to make the hardware yourself?

Another obvious one in many cases (why invent a new dishwasher manufacturing company just to sell a proprietary smart-home control system?), but not in all. Contrast EcoFactor with Nest. Both are going after smart thermostat hosted controls in the home, but Nest decided to sell proprietary ones and EcoFactor partnered with an existing smart thermostat manufacturer. Both companies are growing so it's hard to say yet which was the smarter pathway to establishing their controls in the marketplace, but it'll be fascinating to watch the rivalry as it develops.

But of course, it's only an issue because the thermostat assembly itself could be relatively cost-effectively outsourced. For more complex or otherwise costly manufacturing decisions, it's a factor that could skew entrepreneurs toward a non-embedded controls strategy altogether.


Ultimately for all of these software/controls plays, embedded or not, the goal is the same -- to become an actual or de facto industry standard. The decision as to what path to take is primarily one of market entry and early scalability, because the hope for all is that network externalities eventually take over after some critical mass is reached. But this is an important strategic decision for the long run for startups. It affects core and ancillary capabilities they must build into the team. It affects capital needs and revenue models. And as a couple of the examples above show, it can determine whether a startup can outpace the others to become a leader in the race to network externalities, or fall behind and be imperiled. There are other questions to ask when making this decision to embed, license or float above the hardware choices altogether. But the above five questions are ones that we've seen come up repeatedly, across a wide variety of end markets.


The Sky Is Not Falling

Rob Day: January 5, 2013, 10:23 PM

After the Cleantech Group released their 2012 cleantech venture totals this past week, I heard a surprising amount of pessimism out there. I saw the sector called a "bust" and was asked a couple of times if the sector is just plain dying out.

Of course not, c'mon people.

First of all, regular readers of this column probably found very little of surprise in the Cleantech Group's numbers. For a while now we've been talking about how LPs have pulled back from the sector and how that has been forcing VCs to pull back from the sector, and in many cases to go find new jobs altogether. Given all this anecdotal evidence, it shouldn't be a surprise to anyone that the retrospective numbers now back these observations with data. The Cleantech Group's tallies were largely just confirmation of what we already knew was going on (with one exception, lower activity by corporates, which I'll discuss below). But these numbers shouldn't have shocked anyone.

Secondly, cleantech markets continue to grow quickly, with little signs of falling off anytime soon.

Here are some examples I found by cruising through GTM headlines from just the past few weeks:

Similar growth is taking place in many other cleantech markets as well, especially non-energy sectors. These are multibillion dollar markets, often among the fastest-growing segments of the US economy.

It is extremely rare to see such fast-growing markets and not see VCs trying to figure out how to put money at work in them. That's why we're not seeing the end of the cleantech sector for VCs; we're just in period where folks (especially LPs) are still licking their wounds from the past decade's failures and lack of exits. What we're seeing is a big pullback from the 2000s-era cleantech venture investment model, which is understandble. But there are other models now being developed and deployed.

Unfortunately, somewhere along the way someone convinced most of the large LP community that the investment model we saw over the past decade was the only way to invest in this sector. Which means they have pulled away from the sector altogether and thus they're not funding the next wave like they should. But investors who do have capital to deploy -- many of whom are not traditional VCs, but instead investors like family offices and others with more flexibility -- are staying active and will generate some new pathways to returns. Exits such as SolarCity's IPO and ZipCar's acquisition and others to come will help demonstrate that there are alternative high-growth business models in these markets than cutting-edge technology development and commodities manufacturing.

I don't think it'll happen immediately, but there's every reason to believe that as some successes with new investment and business models are seen, the pendulum will swing back and LPs and VCs will eventually jump back into the sector. 

So yes, it's not happy times for cleantech VCs and for cleantech entrepreneurs needing venture capital right now. But we knew that. We didn't need the Cleantech Group's report (very well done media presentation by them, btw) to tell us that.

One trend they note that may come as a bit of a surprise, however, is the decline in venture investment and M&A activity from corporates. In each of Q3 and Q4, for instance, the number of cleantech venture deals tracked by CG as having corporate involvement was below 30, the lowest two quarters since 2008. We've been hearing that corporate investors have been stepping up to help fill the gap left by VCs, but how do we reconcile these numbers with that supposed observation?

It could very well be that corporates are now pulling back from the sector as well. But I'm just not seeing it anecdotally. So alternatively, the numbers may reflect two other factors at work.

1. Corporate venture groups generally prefer not to lead deals. Which means they need a venture deal to be led by VCs. If VCs aren't leading many deals, therefore, that will reduce the number of opportunities for otherwise interested corporates to write checks. Such corporates need to more actively network with other investors besides VCs, if this is the case.

2. Interest among corporates may be shifting from some sectors to others. For instance, chemicals and oil companies that have been funding biofuels startups and projects may at this point have a fairly full dance card and be backing off, whereas other large players in sectors like industrial automation and agriculture may still be ramping up their internal efforts. That would also help explain the lower-than-expected corporate M&A activity, in addition to the low corporate venture activity.

The truth is probably a combination of all of the above. But I keep hearing from corporate managers I speak with that their companies are increasingly viewing clean technologies as major topline growth opportunities going forward, so I would assume that would mean they'll be having to buy their way into these new sectors sooner or later. I'll be watching this particular question carefully in the months to come, because it's a curious (and important) trend.