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.