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Much easier said than done

Rob Day: October 26, 2010, 3:20 PM

It's well understood that one of the most critical skills a venture capitalist must have is knowing when to walk away from a portfolio company.

I've heard this aspect of the job described in terms ranging from coldly mercenary to grudging acceptance and regret.  But regardless, no one bats 1.000, so at a certain point you need to cut your losses.  Sometimes the decision is easy, it's effectively made for you.  But in many cases VCs are faced with tough decisions about portfolio companies that went sideways but still have a chance and "just need another round of financing to turn the corner".  The problem is, very few companies do ever turn that corner, so the VC has to decide if it's a smart investment decision to put more money in.  It's one of the toughest parts of the job, both in terms of analysis and in terms of emotions and relationships.

Unfortunately, I'm not sure cleantech VCs have been willing to make these tough decisions, at least up until recently.  A year ago I did a quick little analysis of North American venture rounds during the past decade, divided the companies into three basic categories:  Exited successfully, visibly collapsed (or bad exit), or just still hanging around.

By far, the biggest category was in the "just hanging around" part of the pie chart.  This was true REGARDLESS OF WHAT INVESTMENT STAGE, seed/early or "last money in".

That speaks most of all to the lack of exits.  But it also says there were a lot of companies that were hanging around in portfolios, and maybe had made some progress but not nearly as much as had been hoped when the investment had been done.  Yes, there've been more companies that have been going under recently, but still... Especially when one considers the evidence that a lot of cleantech VC rounds being done over the past few quarters were insider-led, it suggests a lot of companies that have gone sideways are being propped up by their investors, rather than those investors cutting their losses and walking away.


First of all, a lot of investors have seen this lack of progress as being due in part to the macroeconomy.  If we can hang on, the theory goes, when the economy picks up then so will we!  The problem is, I don't see a major economic rebound anytime soon, do you?

Second, a lot of these companies have been still in the tech development stage.  As gets talked about all the time, in subsectors like solar, biofuels, etc., it takes years to go from the lab to the market.  As long as the company is still hitting technical milestones, why walk away?  I've seen some investors get pretty ruthless about what they do when a company misses its technical milestones, but in 2007 there were a lot of pre-revenue investments into companies that remain pre-revenue, and are still being supported by their investors with follow-on financings (albeit often having to run a lot leaner than they'd expected).

Third, there's an increasing wave of recaps and repricings.  I'm seeing it more and more in the dealflow I review that companies that spent millions of dollars trying to introduce something to the market hasn't made as much progress as hoped, and hasn't wanted to just give up, so they've gone out to raise more money but have recognized they'll need to do it under pretty cram-down valuation conditions.  In this case, their existing investors may actually have walked away, but the company would still be in the "just hanging around" category in my analysis.  

Fourth, and relatedly, there's still a lot of interest in cleantech among investors.  So even as the investment pool has dried up a bit (and will continue to do so as GPs run out of dry powder), those reboot rounds are still happening.  As an investor with capital to deploy it's just so tempting when you see that company you've followed for a few years and never wanted to pay the exorbitant price that it was raising money at, and here it is now at a more reasonable price.  So these companies are finding some price elasticity, and the ones willing to drop their price, if they've made any progress at all, are often finding SOME investment dollars to keep them going.

And fifth -- and this is important -- the GPs know they're going to need to fundraise soon.  And they don't have many positive exits, so they also don't want any smoking craters in their portfolio.  I don't think funds are doubling down on bets they know are losers simply to paper over losses, but I do think it's skewing some decision-making on the margin.  So they give the company enough money to keep floating, and hope for the best.  Especially if they can arrange non-dilutive financing (ie: government grants and such) and significantly scale back costs (ie: personnel) in the meantime.

This will end, tho.  There's only so much "floating" VCs will be able to support out of their existing funds, and then the tough decisions will have to be made.  And while the few investors with significant capital to deploy are scrambling around grabbing bargain-priced low-hanging fruit, many companies with otherwise decent stories to tell are finding it really hard to raise capital.  And that non-dilutive financing isn't going completely away, but the meat of it is already served and somewhat digested.  

We're already seeing a wave of startup failures, some that are pretty big-named.  We're going to see more, as cleantech VCs are increasingly forced to finally make these tough decisions.  Frustratingly, some of these failures will be good companies making good progress that just ran out of capital and couldn't raise more.  But the companies and funds that DO make it through this period, history suggests, will be very well positioned down the road.

Unicorn hunting season

Rob Day: October 20, 2010, 9:45 AM

Kind readers, by popular demand (and out of personal necessity), I'm going to start writing these columns a bit more infrequently and certainly with more brevity going forward.  Or at least that's the plan...  What's making me (and other investors) so busy right now?  Turns out right now is a pretty interesting time in our market.

I'm realizing that I've never been more overwhelmed with interesting dealflow.  When I look at the log we keep at my firm of incoming deals, the aggregate number of deals is only slightly up versus what I've historically seen.  But the deals that are coming in are harder to say "no" to at a cursory glance, on average.

For the six years I've been a cleantech investor, I've had in mind a mythical creature type of deal I would be most interested in.  A unicorn of sorts -- not to be confused with black swans, which are always in season for some (although I suspect some are bagging regular old swans painted black... but I digress).

This "unicorn" deal would be a compelling business offering with:

1. A top-notch team

2. Said team holding a very pragmatic approach to how to bring a technology/ product to market and get early sales traction

3. Said team having a strong focus on keeping cash burn relatively low (see point #2 above)

4. No-brainer customer economics

5. Attractive markets

6. Existing sales and/or key market partnerships already in place

7. Reasonable valuation expectations

8. Good exit prospects within a reasonable timeframe

9. An exciting "big picture" story with lots of upside

In the past I've been guilty of stretching on some of the above points in selecting deals, because of falling in love with an investment thesis, or a team, or a deal opportunity. Live and learn. But basically, the above list (plus other criteria that would be more subsector-specific) has always knocked quite a few deals off the table right away.  And after all, the odds are an investor will say "no" to at least 99 deals for every one they say yes to, so it's all about managing limited time resources.

But right now the unicorns are stampeding right at us.

The influx of strong entrepreneurs into the sector is starting to bear fruit.  I meet with many more companies on their second CEO already, or where the founder is an experienced CEO, versus in the past.  And these entrepreneurs are bringing a less over-optimistic, much more sober approach to the massive grinding-it-out exercise that is bringing a successful startup to market.

The economic collapse appears to have "scared straight" a lot of entrepreneurs as well.  Much more of a focus on managing cash burn. We're seeing $10M follow-on rounds that would have been a $50M follow-on ask 3 years ago.  And practical approaches to finding early entry market niches and grabbing early revenue, rather than attempting to build the entire macro-vision of a massively reinvented market, etc. etc., all pre-revenue.  Not that folks are giving up on the big dreams.  Just that folks are realizing how important it is to succeed one step at a time.

Much more active corporates that are now more seriously partnering with startups in a variety of ways, but with some substance to the interaction.

And of course, valuations are still a mixed bag, but flat rounds remain the new up round.  Lots of down rounds, recaps, and generally reasonable valuation expectations.

It's not universally true, of course, but all of the above is more often true of the deals I'm seeing these days.  Which makes it a lot tougher to turn them down quickly.  Which keeps me and my colleagues pretty busy.  Which is great.  Except for blogging.

How to approach investors with a component idea (components part 3)

Rob Day: October 7, 2010, 3:26 PM


In the last post I walked through questions entrepreneurs need to think through, research, and thoughtfully answer before attempting to turn a component-level cleantech innovation into a business.  And a natural next question is, "but who will fund this?"

It's perfectly okay if the answer is "hey, we're going to make a component and then sell that component or license it to OEMs."  But if so, you need to choose your potential investors wisely (in this case, probably angels and smaller venture firms focused on such business models, rather than the NEAs and Kleiners of the world).  And regardless of where you do believe you need to draw the boundaries for your future business, you need to show investors you've answered all of the above questions.  

  • Talk about the 20 conversations you've had with downstream customers and partners, providing quotes and other evidence that the pain points are real, and that they would be eager to try out solutions like yours.  
  • Show you understand all the complexities upstream of you -- for example, if you're a waste-to-energy company, show you know how complex waste stream procurement and materials handling is, and that you have concrete and pragmatic (and cost-effective) plans for addressing those concerns.  
  • Show your work -- explain your rationale for why you've drawn the boundaries where you've drawn them.  
  • And be forthright about skillsets and capabilities you know you'll need to add to be able to succeed -- the right investor won't mind knowing they'll have to be "value-add" in helping to address these gaps, as long as they know you see them as gaps too.

I suspect this will continue to be an increasing dilemma for entrepreneurs in cleantech.  The innovation cycle is so much faster than the market adoption cycle that people are innovating 3rd generation components for systems that don't really have any sales yet.  So if this column speaks to you, also know you're not alone.

But above all else, don't go to investors and pitch a component as a standalone business for an industry that doesn't yet exist.  Yes, I'm looking at you, photobioreactor designers... 

Drawing boundaries (components part two)

Rob Day: October 7, 2010, 3:12 PM


In the last post I lamented seeing so many entrepreneurs pitching components in cleantech, not fully fleshed out companies.  Then I helpfully mentioned that building a fully fleshed out company is really hard and expensive and often not the right choice.

So what is the entrepreneur to do?  

It's difficult to know exactly where to draw the line between what should be "owned", and what should be left to the rest of the value chain.  But it starts with listening to the customer, and everyone else involved in that industry.  

A. Talk to end users and the people selling to them, and figure out if there's a real pain point here.  Do this more than 3 times, do it 20 times.  And then dig even deeper.  It's not enough to look at market studies, see where analysts say the biggest cost within the value chain is, and develop a solution to reduce that cost.  What do modcos care about besides just cost and efficiency?  The more you understand about the actual details about how the incumbent solutions are deployed and what customers (and OEMs) do and don't like about current approaches, the better you'll understand not only how your innovation might fit into their system, but also who might be interested in trying it out.

B. Figure out where the established handoffs are in the value chain.  When do power supplies actually get selected and integrated into lighting systems?  Is it at the point of installation?  Is it at the point of LED "light engine" manufacturing?  Is it at the point of OEM fixture design? (currently, this is where it is, btw)  Understand that, and you'll understand a natural boundary you might need to incorporate for your own business idea.  If you supply a component, where such handoffs typically involve single-sourcing more complete systems, you're not taking on enough of a market role.

C. Look at where market share concentration occurs in the value chain.  That's where both purchasing and selling power will be most felt.  And also where market penetration will be hardest, if you find you're going to be going up AGAINST such incumbents.  Then ask yourself, in light of the above questions, if you're better off selling to that market chokepoint, or attempting to go around it.  If the former, you will have to work hard to gain a fair price for your component.  But if the latter, you may have to spend significant amounts of money before you even know if you have a chance at success.  One possible solution for going around the OEMs without having to compete with the OEMs is to establish yourself in the market within niche retrofit markets.  It won't scale as quickly, but you'll have a better shot of establishing an early bridgehead in the market.

D.  Get way deep into the details of how your component will actually need to be built into bigger products, and actually used.  What significant changes will this require for your customers (one step down the value chain) and for end users (at the end of the value chain)?  If your innovation requires an OEM to radically change how they do things, that won't happen quickly -- that's one major reason LEDs have been slow to be adopted by existing fixture manufacturers.  And if your innovation requires end users to change their own behaviors, you're going to have to do a lot of service-type operations (education, perhaps owning and operating, etc.) in order to gain market acceptance.

E. Think through whether what you've got is a one-time improvement, or the platform for a series of improvements over multiple products and offerings.  If you've got a single application for your technology, build a business as cheaply as possible and license it out.  If your technology has multiple uses, perhaps it's the same answer but maybe you can build a sustainable, large company around your core innovation and follow on innovations.

You have to think through all this BEFORE you go out to raise capital.  Because the answers you develop will dramatically impact how much capital you need, how rapidly you should be expecting to grow, and thus what types of investors you should even be talking to in the first place.

Some final thoughts in the next post…

Components are not companies

Rob Day: October 7, 2010, 3:11 PM


Yesterday I had the pleasure of being one of the judges of the New England regional finals of the Cleantech Open, an annual nationwide cleantech business pitch competition.  I never get to do as many of these as I would like to, as it's always fun to see entrepreneurial efforts when they're still so new, and these events are also good for catching up with colleagues in cleantech investing (since so many of them also serve as judges).

As I was sitting there listening to the third of three pitches I saw yesterday, I was really struck by an emerging pattern, perhaps most starkly visible to me in that forum but also -- I realized -- prevalent in many pitches I receive these days...

I'm seeing a lot more components these days, not full companies.  Especially in early stage deals.

I'm increasingly getting pitches from entrepreneurs where they have a neat technology, but they either don't realize or don't want to deal with the fact that there's going to have to be a much broader service and product offering in order for that technology to make any sense.  It's great to see someone come up with a very cost-effective photobioreactor for growing algae, for example.  But where's the concentrated CO2 going to come from?  Who's going to dewater and use the algae?  Who's going to monitor and service the bioreactor?  Etc., etc.  In many cases, these entrepreneurs are assuming the eventual emergence of a robust industry around them, but one that doesn't yet exist.  That would be like launching Zappos back when the intertubes was just ARPAnet.

That's not to say, however, that anyone with a component-level innovation needs therefore to weave an entire value chain within one company.  We've seen plenty of that already in areas like biofuels and solar.  And it's expensive, and dilutes any advantages of the core innovation.  I've seen companies that have a "tweak" that improves efficiencies within PV cells, and are looking to build an entire fab and manufacture branded PV panels instead of partnering with existing fabs.  I've seen companies with a proprietary distillation technology try to build entire standalone biofuels production efforts.  Yes, sometimes this is the best way to create capture value -- it can be necessary to prove out the tweak, or perhaps the "tweak" is actually a really critical pain point, or perhaps the company's VCs are pushing them to be bigger (ugh) and more aggressive.  But it shouldn't be a very first option pursued, because it's really hard, and failure in any one part of the rest of such a complex effort can obviate even the most compelling of proprietary innovations.

More on this topic in the next post... 

Some quick thoughts on a recent west coast swing

Rob Day: September 29, 2010, 10:40 PM

I clearly need to come visit the bay area more often.  Not only do I simply miss San Francisco, it's also always a super-busy trip as there are just way too many people to visit with in any single trip.  Maybe 14 meetings in 2.5 days doesn't sound like much to some, but when you consider travel time it adds up to some really full days...

  • No offense to Boston, but I got more high-quality deal leads in a couple of days here in SF than in a couple of weeks back east.  Maybe there's some selection bias at work there, not suggesting any hard and fast ratio or anything.  But the level of high-quality entrepreneurial cleantech energy (so to speak) in the bay area really does trump that in Boston, IMHO.  Not that Boston's a slouch, just that the bay area is that active.  When I left SF in 2007 it felt like, in cleantech, there were more interested investors than kick-butt startup management teams.  Now that feels like it's been reversed.  
  • Solar is really on the outs in the bay area, at least among VCs.  In Boston it's similarly out of favor, but not to such an extent, and I do get the sense that in many cases it's as much because the Boston cleantech VCs are out of funds themselves.  In SF, however, in many of my conversations with investors it was clear that simply being OPEN to doing a solar deal made me contrarian.  Maybe that's my signal that it's finally time for me to do one, who knows... 
  • I sort of sensed it along the way, and as one investor confirmed to me, "late-stage cleantech venture is in a funk."  But interestingly, it seems like early stage cleantech remains pretty active out in the bay area.  That's not to say large, late-stage cleantech venture deals aren't happening, but it became clear from talking to investors that it's a lot harder to get an outside lead investor for such rounds than it used to be.  The lack of predictable and lucrative IPOs really seems to be impacting investor interest in the infamous "last money in before the exit" rounds.  But meanwhile, investors see that the winners in these "mediocre" IPOs we've been seeing tend to be the Series A investors, plus it requires less capital to get in (at least for THAT check).  So there's still strong interest in the Series A rounds... but the definition has drifted a bit, to be less seed-y, closer to commercialization.  Entrepreneurs better have a killer tech, plus proof of productization (not just concept), plus proof of market adoption potential, plus a killer team (VCs always WANT all these, but now it's more of a necessity than ever).  Given all that and a sector that VCs remain hot on, such startups are still getting multiple term sheets.  
  • If there's one overheated sector right now that bucks the above trends, it's energy storage.  Every investor I talked to was excited about one new type of battery or another.  In that category, at least, they were all interested in very early concepts, not late-stage companies already shipping product.  And they were lamenting the fact that the companies they were interested in already had multiple VCs crawling all over them, perhaps with multiple competing terms sheets being thrown at them, at surprisingly high valuations.  I'm not sure why so many investors would be shying away from "capital-intensive, overly crowded" solar to pile into what appears on the surface to be a similarly long-path-to-market, big capex, unclear-what-tech-will-"win" battery space.  But it's happening.  Commercial building energy efficiency SaaS, btw, is also going to be overcrowded within 12 months... 
  • Lots of hand-wringing about the challenges of applying "traditional" venture capital models to cleantech.  But not a lot of true breakthrough thinking, much less activity, in any other kind of investment models.  At least not yet.  All it will take is for one brand-name firm to break from the herd and do a very different type of fund.  Not sure when that will happen, but I wouldn't be surprised to see it happen sooner rather than later.  For the most part, tho, despite all necessary rhetoric about "differentiation" most firms seem to be all going after many of the same markets and techs, using many of the same techniques, and using the same deal structures etc.  

The two VCs within cleantech

Rob Day: September 23, 2010, 7:44 AM

It's been pretty fascinating to watch how many strong opinions have been expressed over the past couple of days regarding Fred Wilson's "two VCs" post (and then some others pointed at me after my response to his post). So I thought I would paraphrase some of what I heard (note: mostly NOT from Fred, but from others who've piled on) and give some replies.


Rob, are you saying Fred is wrong?

No. I totally agree with Fred that there's an important divergence of two very different approaches to venture capital right now -- the lean VC (put as little capital as possible to work in each company, grow it quickly and as low-cost as possible, and then sell it as early as possible), and the big VC (find winners, give them even more momentum via advice, capital and brand leverage, and drive to as big an exit as possible).

If anything, I tend to favor the lean VC model Fred is clearly espousing. I do think venture capital is due for a re-invention (or a back to basics, as others view it).

I just don't think it's fair to imply (as Fred and many others have done) that ALL of cleantech venture capital falls into the "big VC" category.

To put my point as simply as possible: Fred is right, there are two separate venture capital industries right now. And you can find BOTH within cleantech.


But statistics show that cleantech is more capital intensive than web investing!

First of all, don't try to apply averages (especially in the form of means and not medians, c'mon Techcrunch you can do better) to "prove" anything about cleantech as an overall sector. As we've discussed ad nauseum on this site, all it takes is a small handful of megadeals to totally skew the sector dollar totals, so means are worse than useless, and even median deal sizes will reveal only that 51% of deals are large ones, right? It doesn't prove that there isn't any capital-efficient investing going on within the sector.

Secondly, it's a little tiresome to see all these web and software journalists and investors castigate cleantech in such simplistic terms (maybe they're all too distracted by AngelGate). Don't get me wrong, I like the web (in fact, I'm using it right now!) and have nothing at all against web and software investors, it seems like a compelling set of markets. I don't paint their entire sector(s) as one single monoculture, so I wish they would do the same.

As Tom Pincince, President and CEO at Digital Lumens (and former Director of Forrester Research’s Network Strategy Service) emailed to a few of us: "Cleantech is such a diverse category ranging from biofuel to consumer power portals. We could just as easily lump software into IT and drag in big networking boxes and telecommunications companies."

Thirdly, while some of the rhetoric around "capital efficient cleantech venture capital" is just empty words, I do think there are a number of investors out there putting serious effort and thought into how to do it. So backward-looking data will only tell us so much about what the sector looks like going forward.


How dare you say cleantech isn't capital intensive! Just look at the high-profile capital intensive deals that have been talked about so much!

Just like how I don't think it's fair to paint cleantech with a broad brush and imply it's all capital intensive, nor am I trying to make the argument that all of it is capital efficient. In fact, if you look at the deals done in cleantech from 2006-2008 (ish), much of them were indeed capital intensive.

But I increasingly see attempts to apply the "lean VC" model within subsectors of this market. And even within some of the sectors of the market that are infamous for being capital intensive (e.g., solar).

But making a significant impact on the energy, etc. industries will require some significant capital to be deployed.


Sure, but why does that have to be venture capital in particular?

Venture capitalists are supposed to be focused on returns, not impact. Often they conflate the two, especially when standing on stage at a conference. But it's increasingly unclear that VCs are supposed to be the ones providing all the capital that will be necessary to put significant amounts of clean power generation out