A different take

In my last post, I said some pretty pessimistic things about the next 12 months.

I do want to note that alternative viewpoints are also out there, as well.  Check out Eric Wesoff's take, for example... 

It’s going to get worse before it gets better

I'm at the Cleantech Forum in Boston this week.  As always, a great networking event, they've really honed the model here at the 23rd edition of the series.  For those of you into such things, you can follow various tweets on the conference, including far too many from yours truly, with the #cleantechforum hashtag...

It's notable, however, how few west coast investors are attending this event.  Now, bay area VCs are always pretty loathe to travel outside of the 650 area code, but still, it's clear that even fewer made this trip than would have this time last year.  Why?  Perhaps some travel budgets are smaller, especially for the smaller shops, but really this is instead an indicator that most VCs are just really inactive on new deals and fundraising right now.  If an investor is actively seeking deals and/or LPs, they'll use a conference as an excuse to travel somewhere for networking purposes.  Which means that conference attendance by VCs is a bit of a leading indicator.

It's an important indicator, because cleantech venture capital doesn't seem to have been too badly hit yet.  Not to say things are easy for cleantech entrepreneurs right now, by any stretch.  But still, according to the Cleantech Group's numbers described at the conference today, in Q3 cleantech became the #1 venture capital category, above IT and biotech, etc. (details to follow on that once I get them).  And while there have been some companies that have gone under over the past 12 months or so, most continue to chug along one way or another.

But for the most part, most VC-backed cleantech startups remain net negative on cashflow.  Which means they're going to need either a rapid market pick-up translating into very near-term revenues, or else they're going to need to raise more capital.

My strong sense, watching the reported deals from the past few months, is that a significant portion of those deals that are taking place (and thus are captured in those Cleantech Group numbers) are insider-only rounds.  I wouldn't at all be surprised to see about half of the deals being such.  This means that most of the rounds taking place are not being priced by the market, it's instead just existing investors putting more money into their portfolio investments, likely at flat valuations or unpriced bridge financings.  Anecdotally, I can tell you that most investors are still refusing to take down valuations on their own portfolios, and yet only looking at follow-on deals that are at down valuations. 

These insider rounds, including many more that probably haven't been announced, are what have been allowing cash-burning cleantech startups to survive, in other words. 

And they can't continue indefinitely.  VCs don't have unlimited funds, and many at this point are starting to feel out of dry powder.  They'll only have so much patience and so much capital they can devote to any one portfolio company.  And with VC fundraising on hold, we shouldn't expect to see VCs be refreshed with capital anytime soon.

I'm not trying to sound too doom-and-gloom, we're not talking about some kind of mass extinction event.  Certainly, government support is going to help some companies survive.  And for those companies and investors willing to take a down valuation, there are still some investors out there willing to step in and carry the torch. Even a slight recovery of the credit markets could also help some startups raise non-dilutive growth financing.

But my point is that, while we haven't seen a massive wave of cleantech startups crashing yet, the factors underlying that are drying up.  And so I expect to see many more unfortunate stories over the next 12 months, even if the economy appears to be slowing getting better.  And if the economy twitches back downward... batten down the hatches.

Proving clean technology works

The headline-grabbing news this week is Khosla Venture's recent fund closings, of their $275M seed fund and $800M "main fund".  It's good to see more seed capital available in the sector -- as we've talked about here before, things have probably shifted too heavily toward late stage deals over the past few quarters, leaving a critical funding gap at the seed stage for cleantech startups.  And it's also good, I think, to see such seed efforts split out into a separate fund from later-stage efforts.  In many of the larger recent cleantech funds, seed and growth stage have been conflated within the same fund, which sets up some internal management challenges and also from an LP's perspective makes it tough to find specialized early stage focus.

In the NYT article about the closings, however, I was a bit surprised to see the suggestion that a few million dollars' worth of investment is all it takes for a cleantech startup to prove their technology to the point of being able to secure project financing.  Now note, I'm not going to pick on Vinod for that quote, because I would bet there were nuances to it that didn't pass through the journalist-editor translation.  But it brings up an important point to discuss, nonetheless.

There is in fact a huge capital gap for cleantech startups around early project finance.  In most cleantech startups that will actually be producing anything (as opposed to software-based cleantech startups), building out production or manufacturing capacity is capital-intensive by definition.  To build out a commercial-scale solar fab could require tens or even hundreds of millions of dollars.  Ditto for biofuel plants, for utility-scale solar generation facilities, and for battery manufacturing lines. 

The problem is, project finance is traditionally very risk-averse, and very intolerant of any new technology.  Project finance firms are very good at structuring deals to enable the build-out of large generation or manufacturing projects, as long as they're not taking any technology risk and as long as the construction timeframe and future revenues and costs are very well understood.  That's why project finance will take a much lower expected rate of return than venture capital, because it's correspondingly lower risk.

So what we've seen this decade in cleantech has been the inability of cleantech startups to raise project finance or high levels of leverage for their first or even second commercial-scale facilities.  Even after having "proven" the technology at a pilot plant scale, it's still too early for project financiers to feel they have a good understanding of the construction timeframes and costs for a first of a kind ("FOAK") commercial scale plant.  Also, in many cases the market acceptance is still not locked in, and furthermore the technology will likely not be proven out to nearly the level of confidence that the project financiers would want to see.  So they just don't touch such things.

Thus, for the past few years we've seen venture capitalists stepping in to fund the FOAKs out of necessity.  When you see a $100M+ solar round, for example, there's some working capital and growth equity in there, but the majority of it is going to fill the gap that project finance is unwilling to fund.  It's not really venture capital.  It's quasi- project finance. 

I'm not against this type of activity per se, it can still provide some attractive risk-adjusted returns when it's done creatively.  But it's tough to see how that type of activity can be expected to generate the kinds of absolute returns that VCs are telling their LPs they're targeting, unless there's an opportunity to push a very, very attractive near-term exit afterwords (and there are few such exits right now).  And so when it gets done out of the same venture fund, it's just important to note that it's a bit of a stretch on the definition of "venture capital" as traditionally used.  So be it, rules are made to be broken.

However, what we've seen very clearly over the past 12 months is that such financing will greatly dry up at times.  And a number of high-flying startups have been left high and dry by the pull-back of VCs from FOAK funding.  So it's strange to get the impression from the NYT article that it's fine for VCs to invest in early stage capital-intensive opportunities, because it won't take much capital for the henceforth "proven" technology to bring in project finance to support full-scale commercialization.  FOAKs remain a big gap, one that has already killed a number of promising cleantech startups that had taken in tens of millions of dollars just to get to that point.  What I'm guessing the quote was really intended to say was that non-traditional players like corporate partners, large family offices and government financing can help solve the FOAK challenge, and to an extent that's true.  But it's far from the slam-dunk prospect that comes across in the article.

With $275M to put to work, at around $2M per first-time check, that "seed" Khosla fund must be planning on doing some significant follow-ons (tough to see how they would be able to manage upwards of 100 investments).  And then with the additional $800M in the "main" fund, it's probably a safe bet that KV will have to put some money into FOAKs just like many other VCs have.  Investors may have been advocating for smaller funds focused on capital efficient opportunities.  But there's little evidence such advocacy has really taken hold in Silicon Valley.

Deals from the past week or so:

• WoodPellets.com has raised an $11M Series B, led by Monitor Clipper Partners, and including previous investor .406 Ventures.

• Think Global AS has emerged from bankruptcy and has taken in a capital infusion of around $47M, from investors including several strategics.  Ener1 has put in $18M as part of the financing, in exchange for getting exclusive rights to supply Think with lithium ion batteries, and along with converting $3M in debt is now the biggest shareholder in the company at 31%.

• Utility-scale solar startup Tuusso Energy has raised $2M led by Pivotal Investments, and including Akula Energy Ventures.

• Solar converter startup eIQ has unstealthed and announced $10M in financing from NGEN and Robert Bosch Venture Capital.

• CFX Battery Inc. has closed on $5M of a planned $26.9M round.

• PE Hub reported that li-ion battery startup Seeo has raised $8.6M of new financing, including return backer Khosla Ventures.

• Membrane-based separation startup BPT has taken in a $12M Series B, co-led by US Venture Partners and Pitango Venture Capital, and including existing investors Aurum Ventures and Elron Electric Industries.

• ClearEdge Power, which is developing fuel cell systems for residential applications, has raised a $15M round of financing.

Other news and notes:  Another nobel laureate has come out as a pessimist on fuel cells -- at least "present" ones...  Here's a good list of the recipients of the recently-announced ARRA battery and EV awards...  Finally, if you're going to be in Boston on October 27th, check out the cleantech networking session being organized by PE Hub, featuring five insightful panelists (oh, and yours truly as well).

Two upcoming conferences for entrepreneurs seeking funding

I always hesitate to highlight conferences on this site, since there are far too many interesting ones than I could ever mention, and I hate to highlight some and not others.  However, for entrepreneurs seeking funding, there are two upcoming conferences that haven't gotten a huge amount of attention yet, but could be valuable showcase opportunities for the right startups.

Cleantech startups with at least one woman in a leadership role (at the "C" level) or in a significant position of equity and influence may want to reach out to Astia about their upcoming Silicon Valley conference, which will have a dedicated cleantech track.  The application deadline is Sept. 10th.

Also, here in New England the Fifth Conference on Clean Energy will be taking place on November 12 & 13, at the end of Clean Energy Week.  Selected entrepreneurs will be giving 10 minute investor pitches, and previous participants have raised $80M.

It's still tough out there to raise funds, so I thought I would pass these two lesser-known opportunities along to those interested.

Befuddling patent numbers

I was having a conversation with a European investor today, and the subject of patents came up.  Specifically, the question of which global region is the source of the most clean energy innovation, as measured by patents.

Simple question to answer, right?  Except that my quick googling for the answer has left me completely befuddled.

In the OECD report linked to here (note: opens pdf), specifically on pg. 21, it indicates that in 2005 the EU accounted for 37% of renewable energy patents, with the U.S. and Japan lagging at around 20% each.

In the Lux Research report linked to here, they suggest that the U.S. leads in cleantech patents issued, with 46% of the total for 2006.

And for good measure, in this additional quarterly clean energy patent survey, while they don't track overall regional totals it would appear that Germany regularly falls behind even Michigan when it comes to clean energy patents!

What's going on here??  Is Europe way ahead in clean energy patents, as the investor I was speaking to claimed today, or does the EU's powerhouse Germany fall behind even Michigan when it comes to clean energy innovation?

Color me confused.

In other news and notes:  Here's a great blog on cleantech IP issues...  Here's Kanellos on some other weirdness in the cleantech patent tallies...  Here are some good thoughts from Dan Goldman on the Clean Energy Accelerator Corp...  And finally, congrats to Peter Rothstein on his new gig with the NECEC, where he'll be working on (among other things) a pretty interesting challenge with the Clean Energy Innovation Consortia Project (first task: come up with a catchier acronym).

Cleantech funding poised for an uptake?  Maybe…

Last week, Katie Fehrenbacher opined that cleantech funding seems poised for another big bump in the near future.  She cited a few big recent deals, and some other factors that are potentially encouraging for investors right now. 

For what it's worth, it still seems like most investors are sitting on the sidelines.  The number of companies seeking funding remains high, but even many well-positioned companies are still having a hard time lining up capital.  And I'm not sure that will change anytime soon.  With a few exceptions, VCs continue to have a hard time raising new funds from LPs, and many are scaling back their investments accordingly.  Until the VCs have more visibility into when the LPs' purse strings will be loosened, many are keeping their remaining powder dry.  I don't see any signs of any near-term shift in LPs' willingness to put money into venture capital, and even once that starts to happen, there will be a pretty big lag time before that starts to flow through to actual venture investments.  Also, the early stage is being relatively neglected, meaning that there won't be a healthy pipeline of growth stage companies when the big investment dollars start looking at them again...

The new Deloitte report on global venture capital (note: link opens pdf) seems to back this up.  It shows how two to four times as many investors are scaling back their investments, as those increasing their level of investment (see pages 5 and 6).  And while almost none are shifting to focus on earlier stage, over a third are shifting toward later stage.  That data isn't cleantech-specific, but gives a good sense of the mood among VCs right now. 

Then again, the Deloitte report also shows 63% of investors saying they're going to be shifting their efforts into cleantech over the next 3 years.  So I guess I'm suggesting that, while cleantech remains a relative bright spot, the overall negative market vibe will continue to weigh it down for a while.

Of course, even in this moribund market there are signs of life, and even Katie rightfully caveats her relatively optimistic perspective by noting that the investment levels won't get back to where they were last year.  And it's the summer duldrums, too.  So let's celebrate the few deals and moves of the past week:

• NanoSteel has apparently taken in $8M of a planned $11M round of financing.

• Amyris Biotechnologies has apparently taken in $24.7M of a planned $62M round of financing.  

• Southwest Windpower has taken in additional financing, of an undisclosed amount.  PCG Clean Energy and Technology Fund participated alongside other existing investors Altira, GE Energy Financial Services, NGP Energy Technology Partners, and Rockport Capital.

• Plextronics has completed a $14M Series B-1 financing, led by Solvay North American Investments.  "Several" existing investors also participated.

• Cleantech investors in the news:  Matthew Nordan, co-founder of Lux Research (and one of the first to call the solar and biofuels subsegment bubble), has joined Venrock.

Other news and notes:  Time to get smart about the proposed "Green Bank"...  Finally, hey Richard, give Tennessee some credit!  ORNL, lots of sustainability efforts in the Chattanooga region, lots of cleantech-related manufacturing efforts: the Volunteer State may be a flyover instead of a destination for many software VCs, but certainly is gearing up for the implementation phase of cleantech.