I've been talking with a lot of fellow cleantech investors lately, and we all commiserate about how busy we have been so far this year.

I think this is tied to a couple of things. First, as of the beginning of the year, it seems like just about every startup hit the fundraising trail. And secondly, the sector is maturing, and so a much greater percentage of these startups are investable as compared to in the past: strong management teams, good revenue prospects, attractive markets, etc. So it's a really good problem to have as an investor, to be overwhelmed with intriguing dealflow. It's a good sign for the sector, and a sign that it's a great time to have capital to deploy as an investor.

But what's curious is that a lot of investors I speak with have been more busy with existing portfolios than with incoming dealflow. It's interesting, because it feels like cleantech markets and startups are on an upswing. So it's not like the spring of 2009, when cleantech investors were more focused on their portfolios than on new deals out of necessity, since the world had basically come to a crashing halt. That was damage control and triage time.

Instead, I think the universe of cleantech investors is seeing a lot of progress in its portfolios, which is good. But because of the lean times over the past couple of years, their portfolio companies also need an infusion of capital to keep growing. 

And right now, new outside lead investors are still hard to come by. We're seeing progress among cleantech VCs in terms of their own fundraising and fund closings, which bodes well for later on. But for now, there remain few investors with significant new capital, and thus few doing many new investments in the sector, and meanwhile, LPs remain highly skeptical. 

So cleantech VCs see promising signs out of portfolio companies, but they lack outside lead investors because few are available. And so they feel like they should continue to support their startups themselves. Why stop backing a company that's making progress?

The problem is, many of these investors are themselves out of capital. And even for those with dry powder, there's a healthy reticence to do internal-only fundraisings where no outsider prices are around. So they do a smaller-than-needed bridge round instead, kicking the can down the road, putting a convertible note into a company in the expectation of a new, larger round of financing in the second half of the year. It's a pretty standard and appropriate decision for such circumstances, where the company needs more financing, has made progress since the last round, but would have trouble pricing a round at the current moment. A textbook decision, if such textbooks existed.

But unfortunately, I just see a whole lot of these bridges going on right now. So while each one is an appropriate decision under the specific circumstances of each company, I do fear that in the aggregate there won't be nearly enough new lead investors in 2H12 to support so many bridges. Will these be bridges to nowhere? And what happens to these companies if the bridge doesn't lead to a new outside-led equity round?

Entrepreneurs that have taken in bridges in the first quarter should be looking at their existing investors and developing backup plans. Figure out which existing investors have dry powder and think about what an insider-led round should look like as a Plan B. Still, outside pitches lead in 2H12 as Plan A, but be prepared for it to be a crowded market chasing few outside leads. And plan ahead, in tight coordination with those inside investors who aren't themselves tight on capital.

And for companies and investors still thinking about doing a bridge financing intended to lead into a new outside-led financing in the second half of the year -- be careful. It's looking like the second half of the year will be better than the first half of the year, so hope for the best. But there's a possible capital supply and demand imbalance looming as well, so plan for the worst.

Today's guest post comes from Oliver Guinness of Clearpoint Ventures. In recent posts, we've talked about the need for re-examination of various venture capital investment models and how they've been applied to the sector. Oliver and his colleagues' take on the sector is an interesting version of the old "evolution vs. revolution" debate. As such, I asked Oliver to write up their investment approach in his own words. Enjoy!

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When we launched Clearpoint Ventures a couple of years back, we used Steve Blank’s “Customer Development” methodology to come up with an alternative strategy for investing in cleantech. We knew the energy and building sectors were extremely different from those sectors venture investors were used to investing in, so a different approach was probably needed. The notion that you can go way upstream, find cutting-edge technologies and rapidly bring them to market in these sectors was, and continues to be, extremely challenging!

We made two tenets core to our investment thesis:

1.       Innovations in the energy and building sectors tend to be adopted in a more evolutionary than revolutionary way; and

2.       Customers are generally seeking solutions, not just products or technologies.

Of course, the first tenet isn’t in line with the focus of a typical venture strategy because it lacks the word “disruption” or “revolutionary” and the second speaks to more of a “consultative” approach, something VCs tend to avoid as well. However, despite this divergence from typical venture capital criteria, we felt enormous opportunities existed for a different approach, and we feel they are even bigger today.

We call our strategy “Clean Economy” as opposed to “Cleantech,” and based upon our core tenets, it is decidedly focused on the lower-tech, service and IT-enabled service companies operating in and around alternative energy, energy efficiency/management, and green building. While this segment of companies has largely been underserved by investors, if you look at the portfolios of many of the traditional cleantech funds, you’ll likely find one, perhaps two “Clean Economy” companies in each of them. You’ll also realize: 1) they are the ones gaining traction faster; 2) they are achieving incremental industry change with disruptive business models, as opposed to disruptive technologies; 3) they tend to be more capital-efficient; and 4) they generally have or had M&A exit optionality. (This last point is the primary area of focus of this post, and another criterion incorporated in our Clean Economy strategy.)

Some examples of what we would call Clean Economy companies include: SolarCity, Opower, Airbnb, Clean Power Finance, and OwnEnergy (one of ours). (Note: another term being used for a subset of these companies is “CleanWeb,” which refers specifically to those companies operating at the intersection of IT and cleantech -- those that use the cloud, software and big data to enable an innovative business model.) Clean Economy companies operate in smart grid, project development, efficiency, analytics, recycling, water, green building, finance, etc.

So, why is capital efficiency and M&A optionality important? Well, we all know that the IPO window is erratic, that less than 8% of venture-backed companies IPO (Dow Jones), and that M&A exits generally dwarf IPOs, both in total dollars and numbers of deals (though if you’re able to IPO, multiples can indeed be much greater). However, the below graph and tables point to another interesting point: not only do most “cleantech” companies (those that are big tech or infrastructure companies) generally require more time and capital, very early on, they have valuations that limit M&A exit optionality. It's IPO or bust! That is problematic so long as the IPO market continues to act as it has, and I’m not sure anyone believes we’ll ever “Party like it's 1999” again. That said, many of the mega-sized cleantech funds have specifically targeted companies in which they can plow tens of millions of dollars in hopes of achieving multi-billion dollar valuations at exit -- to make their return numbers go around, out of necessity, and because they’re looking for, and trying to build, the “Google of cleantech.” Good for them I say; however, optionality is still critical to achieving liquidity when needed. Yet the valuations of those companies generally preclude them from exiting in the cleantech “M&A exit zone” because at their B or C round, they’re likely already priced out of that market and/or because they are still far from commercialization (something buyers tend to demand in the energy and building sectors, while in other industries like IT or pharma, buyers frequently purchase pre-revenue tech or biotech companies).

As Matt Nordan of Venrock outlined in his “State of Cleantech Venture Capital 2011,” the average cleantech company that IPO’d raised $120 million pre-IPO over five rounds over eight to nine years. That’s capital-intensive! The graph below (data from CleanTech Group) shows how that $120 million stacks up against the average and median cleantech M&A exit.

Sources: CleanTech Group; Matt Nordan – Venrock

Also note the sectors of the latest cleantech IPO filings and the amount of additional capital being raised.

Compare that with the list of the most active buyers of cleantech companies, and their sectors of focus:

Source: CleanTech Group

Finally, why is this ultimately important? Time and targeted returns! A 2X to 3X multiple over four to six years (average M&A exit) has the same IRR as a 7X to 8X multiple over nine years (average time to IPO) (Dow Jones). Thus, in my mind: Clean Economy strategy + M&A exit focus = opportunity for strong, comparable venture returns, with less tech and time risk, and of course, less capital. And the added benefit of optionality. You can still swing for that IPO fence if you want to take on more risk… and try and “Party like it's 1999.”

(Note: You may be saying to yourself, 'But those big infrastructure companies require that kind of capital, and we need to fund them in order to change the way we generate and consume energy.' Well, the big venture funds will thankfully continue to work at it, but they need more collaboration from strategics, governments and other investors to succeed. I’ll leave that topic for someone else to tackle.)

In the last couple of posts we first looked over the past 15 years of cleantech venture capital, and then we looked at the various ways to generate VC-type returns in the sector -- and concluded that some of those models are being over-applied and others are being under-applied.

Within the sector, I'm starting to see some investors who get this kind of thinking and are building new types of efforts accordingly.

This harkens back to some of what I laid out a while back in my presentation "Cleantech Venture Capital in 2015," particularly the theme-driven builders and the "lean cleantech" players. We're now starting to see them emerge.

Here are a few examples I've noticed and am tracking:

1. Scott MacDonald and Whitney Rockley are two long-time veterans of the cleantech venture sector, and it appears they're launching a new effort they're calling McRock Capital.  And given their backgrounds, it's interesting to hear they're really focusing in on one particular area within the sector, which they're calling "Intelligent Infrastructure." Basically, the sensors and M2M communications to make things like the smart grid and such work effectively. They are focused on building companies that make existing assets in established industries smarter. It’s about smart data and smarter systems. They are taking advantage of the data tsunami that is already migrating into established industry. These companies are scalable and capital-light. These two both were investors in RuggedCom, which was one of the early success examples of this kind of opportunity, so it's interesting to see them doubling down and focusing on a particular theme like this. And, per the last column, you can see how such investments can become standards and enjoy some positive network externalities when they work well.  

2. Spring Ventures, led by Sunil Paul and Nick Allen, have been championing a "cleanweb" trend recently. If you haven't seen Sunil's slides from SXSW, it's worth checking them out, although they lose something without his voiceover, I'm guessing. But the "cleanweb" concept is pretty interesting, in that many of its examples speak to the lack of good channels in cleantech and seek to address them. Some of the cleanweb examples out there are a bit too "webby" for me, but then again I'm a curmudgeon when it comes to such things, and I'm open to being wrong on that point. I admit, when I first heard of Zappos, I thought it was a terrible idea, for example, so I'm eager to see how this develops. Certainly the recent wave of "cleanweb hackathons" have impressively brought out a lot of entrepreneurial passion among the web crowd that needs to be brought into the cleantech sector, and we're looking forward to doing one here in Boston soon.  

3. It sure seems like the cleantech investment universe is starting to shift towards a place where SJF Ventures has been for a while now.  The firm has been investing in tech-enabled services in the cleantech sector, and avoiding capital intensity and upstream techs. It turns out that SJF Ventures has been able to generate some pretty decent returns while doing so, even though it hasn't gotten nearly the attention heaped on the bigger-named investors who are throwing a lot more capital at the "next big patent."

4. Among investors who are going to continue to invest in proprietary technologies at early stages, they'll need to have some kind of special access to innovations and a strong focus on capital efficiency, particularly during the early stages of their investments. Along these lines, I've really enjoyed getting to work with the Israel Cleantech Ventures team as an LP.  As specialists in Israel, they see everything in that innovation-rich region. And I've watched as the team has carefully cultivated their bets to help them get to critical proof points without requiring nearly as much capital as such efforts seem to require in other more heavily-invested regions. This is an example of theme-driven builders of a geographic type.

Will these efforts succeed? I can't say. But I'm watching them all with interest, as efforts resembling some of the ways I expect the broader cleantech venture capital community to evolve over time.

In my last column, I rushed us through my take on 15 years of cleantech venture capital history. Because if we're going to look at the path forward, we need to understand how we got here in the first place. I would also refer everyone to Matthew Nordan's great four-part take on the state of cleantech venture capital from a little while back, particularly Part 2, where he argues that cleantech has performed at par with the overall venture capital category.

To which I would say: nuts to that.

It's not that I in any way wish to slight Matthew's smart analysis; it's a must-read. But if the conclusion is that cleantech has been at par with other sectors simply because on average it has returned capital? We can do better than that. As an asset category, venture capital is supposed to be out at the end of the risk-reward curve, and thus should generate outsized IRRs. But just how to do that in cleantech -- that's the as-yet-unanswered question.

So what will generate big returns for any venture capital investment? Growth, obviously. And profitability. And a high earnings or revenues multiple at time of exit. And a timely exit at that. Pretty simple, right? Buy cheap, grow quickly, sell high. Except all of us investors have seen plenty of good business ideas that don't fit this profile. And we've also all invested in businesses that we thought would produce this, and didn't.

Looking at the history of venture capital and when it has made exceptional returns, I will overgeneralize and argue that those periods saw investments in companies and products that had the following "success conditions":

1. Low customer acquisition cost. 

2. Each new customer makes the overall offering even more valuable -- the so-called "virtuous cycle."

3. High margins.

These are all connected, and are tied to other aspects as well: big markets; solving customer pain points; customer economic value propositions; etc. But at the end of the day, it boils down to investing in companies that will grow quickly and be very profitable (at least on a gross-margin basis). This is what acquirers, including public equities shareholders (i.e., via IPO), will pay through the nose for.  

Otherwise, the ball never gets rolling downhill. The technology being offered is one of many such options and doesn't stand out in any way. And thus customers have a lot of choices and won't buy quickly. Such customers also won't pay a lot for what you're offering. And an acquirer will have lots of choices and also won't be willing to pay up. It's not a recipe for venture success.

So what kind of strategies can create the right type of situation? I can count at least six ways. There may be more, but here are the categories I've seen.

1. Sustainable cost/performance advantage through proprietary IP, plus subsequent scale-driven cost economies

This is clearly where most cleantech venture dollars have been deployed to date. It's basically the First Solar model of cleantech venture capital. Unfortunately, these types of situations appear to be quite rare. They require such a significant IP advantage, plus a fast-growing market that no one else was clued into in time, that you get a significant (two-year?) time window in which to establish a scale advantage and really press it home. It's clearly possible, but it's infrequently successful. More often, even if the technology does catch on as quickly as hoped, commoditization and margin compression happens more rapidly than expected. Thus, you get the current patterns we're seeing in upstream bets in biofuels, solar, LEDs, lithium ion batteries, etc. And VCs keep placing more such bets in these and other subsectors. Personally, I'm starting to despair of seeing venture-type returns anytime soon from the "next big patent" investment strategy in this sector. There would need to be many earlier and more lucrative exits for these companies for it to be successful. And, somewhat unfortunately, these efforts tend to be pretty capital-intensive even before it's clear whether the company truly does have a differentiated technology. Succeeding here will require a management team that is technically brilliant, and great at building hype and raising capital.

2. Info centralization

This is the idea that, by getting out into a marketplace early (perhaps as a media play, or via a SaaS-based model or some other way of controlling data flow), a company can become a central repository for market data (costs, customer patterns, etc.) and then the value will flow from there. One problem is that it requires grabbing market share very quickly. This means basically giving away value for free, unless there are other compelling reasons for customers to adopt the service or product ahead of it becoming that dominant info repository. And the problem with giving away value for free early on is that it's pretty much an Underpants Gnomes business strategy. It's tough to later convert the original offering into value that customers will pay more for, since they're used to getting it for free, and the other sources of value from the gathered information are promising but only hoped-for (in the web sector, they've basically settled on ad revenue as the answer). This is certainly one possible business model to create the previously cited success conditions, even if we haven't seen too many examples yet of it producing outsized returns in cleantech (until Greentech Media IPOs, that is!). And because it requires building out a loss-leader offering before getting into the value-harvesting opportunities from the gathered information, this can also be a somewhat capital-intensive play, albeit much less so than proprietary hardware technology development efforts, of course. 

3. Becoming a standard

This is also where a lot of cleantech venture dollars have gone. And it's been a successful strategy for hardware investments in the history of venture capital. The idea is that if you create a widget, component, product, etc., that becomes an industry standard within a larger business ecosystem, everyone will have to use you and thus you not only grow quickly, you also become an expensive acquisition for someone. It's the idea of creating a monopoly at one segment within a larger value chain. It worked for semiconductors, it worked for medical devices, it worked in some telecom bets. 

Big challenge, however: It only works if it's either mandated from a regulatory standpoint, or if the customer base is homogenous and amenable to being standardized fairly quickly. The former scenario hasn't materialized as some had hoped in energy industries; the latter is possibly true for utilities, but many other customer types in cleantech are much too fragmented, and even utilities are slow and not as homogenous as you might think. Nevertheless, this is clearly the primary hoped-for source of returns in the smart grid, as well as other efforts built around controls and M2M communications (as well as efforts like Project Better Place). And there's some early evidence it can succeed, if the management teams are exceptionally good at building solutions for a particular market niche and using that as their initial beachhead customer sector, and if the market they're selling into is primed for rapid adoption.

4. Building a valuable brand

Venture capitalists backed P.F. Chang's and Jamba Juice. You can't patent a lettuce wrap or a smoothie. Cleantech VCs would never have made those bets. But outside of the cleantech sector, investors have realized for quite some time that successfully building a well-regarded brand can result in strong investment returns, simply because of the power of the brand itself to drive low customer acquisition costs and higher margins. But we haven't seen too many of these efforts in cleantech venture capital yet. I would argue that Tesla and Fisker are venture-backed efforts that have primarily pursued this strategy for venture returns (mixed in with some technology angles as well, of course, but still).  Nevertheless, it remains a relatively untapped business strategy in cleantech markets.

5. Marketplace externalities

I name this late in the list not because it's not a potentially valuable approach, but because it clearly builds upon a couple of the earlier strategies. But over the past two decades, it has become an obvious truth that if you can become a dominant marketplace, you can generate good returns by benefiting from the virtuous cycle of customers and vendors increasingly needing to come to you. And I would argue that, in many cleantech markets, being a "dominant" player doesn't necessarily mean anything close to >50% market share. Customers and vendors are both so scattered and diverse in many cleantech markets that even just being a standout marketplace would likely result in the virtuous cycle effect kicking in. Even still, the challenge of getting to the appropriate level of critical mass, however low it may be, has stymied every effort to create new cleantech marketplaces that I've seen.

Even more challenging for "marketplace" efforts in cleantech, in my mind, is that we lack the necessary standard ways of relaying product performance in ways customers can use. Have you tried to buy an LED bulb on Amazon? It's a horrible experience. And looking at more commercial and industrial markets for LED lighting, I've now seen how many lighting fixture vendors really play around with (i.e., lie about) their product performance specs to a level where the average customer would find spec sheet comparisons, etc., to be a bewildering exercise, and thus something of a non-starter. We will see successful physical and/or ecommerce marketplaces established for cleantech markets. But to get there, we'll need to see someone standardize product performance info.

6. Customer access/building a new channel

As mentioned, these can be very fragmented markets. And the (often 100-year-old) channels in these markets, to put it bluntly, suck. They don't know how to sell the new innovations, nor are they incented to. The lack of good VARs in cleantech is something I've talked about before, and it remains a screaming unmet need in many cleantech markets, especially given the vendor disinformation factor I allude to above. The opportunity to build a new channel model in residential energy efficiency is one major reason we invested in Next Step Living a few years back, just to name one example. When they're now in thousands of homes each year as a trusted energy advisor, that opens up all sorts of opportunities to help bring these customers new innovative products and services. And at that company we're now seeing the proof of how valuable that access is, and how quickly it can scale. So without going so far as to be a marketplace, simply having access to a large number of customers has a lot of value in these markets where channel disruption is so badly needed.

But a separate version of the same "capture the customer" dynamic is often being attempted in more hardcore B2B markets like biochemicals, where upstream tech innovators selling into concentrated customer clusters will attempt to lock them up early on, via JVs and the like. I didn't want to break this out as a separate item, because it's kind of a different flavor of both customer access and becoming a standard, but the theory is that if a startup vendor can gain early entry into several key members of an oligopsony (and fortunately, there are a few of these in cleantech markets), they can box out followers. Again, however, we haven't seen too much evidence of this eventually turning into venture returns in cleantech, unfortunately. But you can see the potential for it to happen -- just not very often.

There are other ways to generate returns, of course, and these are not mutually exclusive categories, but these six approaches are the ones I see attempted by cleantech VCs that are clearly aimed at venture-type IRRs (versus lower-risk/lower-reward investment strategies). All of these six or so strategies are designed to build rapidly scalable businesses with valuable exits, and all are being tried in cleantech, to varying degrees. Unfortunately, what I see is that the strategies least likely to meet the three success conditions described above are also the ones being attempted most often. And despite scant evidence of high success rates in these strategies (such as the "next big patent" approach), cleantech VCs keep looking for those types of plays, and pouring huge amounts of dollars into them. All of these are valid approaches. However, it seems like the balance is out of whack. To date, it seems like the only real attempt at innovation by cleantech VCs in terms of their investment strategies has been to keep doing the same thing, just later and bigger.

I think the industry is ripe for some significant change. In the next column, I'll mention a couple of specific managers I see out there who are attempting some different approaches. 

Over the next few columns I’m going to talk about what I see as a critical set of lessons and paths forward for cleantech venture capital. But first, I thought it would be necessary to set the table by laying out my own vastly oversimplified version of how cleantech venture capital got to this point.

Where to begin? In the 1990s, there were a very few venture investors tackling alternative energy and environmental technologies. They had small funds and invested mostly in hardware plays of some kind. Sectors like solar and electric vehicles certainly didn’t dominate.

Then the dot-com bubble and IPO frenzy happened. This rising tide lifted a lot of boats, including in this sector. There was a one-year spike of venture investments by generalist firms into what would later be termed “cleantech." As the issue of global warming gained attention, and as hype built around technologies like microturbines and fuel cells, it became possible for some rather early-stage companies with high-cost devices and systems to IPO on the basis of some beta sales and a lot of loose talk about big company adoption and such. I still have some of the presentations from that period where the near-term inevitability of a distributed generation future was posited, and I still remember thinking that, as shares of Ballard Power dropped from over $100 to $20, it might be a good opportunity to buy into the hydrogen-fueled future (oops). When I review a presentation I pulled together in 2001 on the future of alternative energy technologies, it’s… entertaining.

This period was very formative for a lot of investors. It established the expectation that the public would welcome IPOs from companies with a compelling vision of a changed energy future. It locked in the perception that the most value in this sector would be generated by innovative hardware solutions. And the collapse of many of these companies also taught investors that costs and customer economics do matter. And that many of these technologies were therefore not ready for prime time.

In the early 2000s, even as the phrase “cleantech” started to come into currency, the number of venture capitalists putting significant investments into the sector shrank significantly. The members of this fairly tight “cleantech club” were either small-fund sectoral specialists, or gratefully welcomed individual partners at generalist funds. I found myself in cleantech venture capital late into this period, and I remember how it felt like a hugely valuable validation whenever a generalist VC would talk about being interested in cleantech... or heck, talk with me at all. It felt like most of the “cleantech club” of investors knew each other pretty well, and were always co-investing with each other (since they had small funds, or were partners at a generalist fund and needed to co-invest with a sectoral specialist to validate the technology they wanted to put money into). This small group of investors continued to focus on hardware business models. Why? Because market-ready hardware like cost-effective solar panels, etc., didn’t really exist yet. So a) without a base of hardware/infrastructure out there, there’s nothing to build other business models on; and b) the threat of commoditization of the hardware wasn’t very acutely felt, when no one had yet to pass the threshold of commercial viability. 

The year 2005 marked a significant inflection point. It’s when many more investors started jumping in. I’m sitting here reading through my Q4 2005 Cleantech Group venture monitor, and it’s fun to look back upon that period where more deals were seed or first-round than follow-ons, energy generation technology was only in its second year of being more important than other investment categories within cleantech, and the West Coast was only then starting to be the dominant region for cleantech deals.

Why did the inflection point happen then? Partly due to oil prices breaking through above $50 and heading upwards. Partly because the topic started to be written about more in the public media. And, relatedly, in 2004, energy investments had done well. Visible leaders within the venture capital industry, such as Kleiner Perkins, started to be more visibly active in the sector, with Alan Salzman of VantagePoint declaring that the next Google was going to come from cleantech. And the SunPower IPO certainly helped.

But I think another major factor is that 2004 marked a doubling of the amount of money put into venture capital by LPs.  All of a sudden in 2005, big VCs had a lot of money to put to work. And cleantech seemed like a good place to be able to put it. Remember, VC firms typically look to raise funds in 2-year cycles, so when they raise a big fund, they need to put much of that money to work within the next 24 months. So when the VC herd started moving into doing deals in the cleantech sector, they weren’t going to do it in small ways.

So the die was cast. Cleantech was a sector dominated by hardware plays, the few successful exits were perceived as being based upon proprietary intellectual property (as opposed to branding, customer bases, network externalities, or other sources of shareholder value), and now big money was looking to move in. What else could result except a high level of capital intensity as investors looked to develop highly proprietary equipment-based efforts to make commercially viable solar panels, biofuels, batteries, etc.?

At this point, the sector continued to gain in presence and LP interest. From 2005-2008, venture investments continued to rise, several important cleantech markets started to see significant growth, we started to see some additional venture-backed cleantech companies IPO, and most importantly large corporations started to take these technologies seriously. More capital-intensive investments were made, and few of these big bets going out of business, as an even bigger follow-on was always possible. According to the Cleantech Group, from 2005 to 2008, the average size of a first round in the sector more than doubled from $5M to $13M, and the average size of a follow-on round rose from $8M to $26M.  Biofuels and some other sectors of course were huge recipients of venture dollars, but the real story was solar, which (again, according, to the Cleantech Group) rose from being 15% of venture dollars in 2005 to nearly 40% in 2008.  Several cleantech specialist firms were able to raise very large funds, and generalist firms established cleantech teams.  As the big firms started throwing their weight around, the smaller sectoral specialists stopped being so valued for their experience, and I even heard of some refusing to co-invest with each other anymore because of the stigma attached to being perceived as “just being a little cleantech firm” unable to do deals with the big-brand generalist firms.

And then, of course, the global economy came to a screeching halt. This not only meant hard times for many cleantech startups’ revenue forecasts, it also meant a drying up of the LP dollars going into venture capital overall. The period 2009-2011 will be looked back upon as a real dry season for the sector. First of all, on the policy/politics side, it’s been a disaster here in the U.S.: Not only did the hoped-for climate change legislation get royally screwed up by Congress, but also the visible blow-ups by Solyndra and other government dollar recipients has very much chilled political support for the sector overall. And partly as a result, as LPs pulled back from venture capital overall, they particularly soured on cleantech. This means that many cleantech specialist firms weren’t able to raise their next fund, and many generalist firms sent their cleantech teams packing. Furthermore, some of the technology bets made earlier really did start to pan out. Whereas before, there were few commercially viable offerings in many cleantech sectors, now suddenly there were lots, all competing with each other, and driving down margins and prices. Thanks to that, and some significant public investment by China, 2009-2011 was a period of significant and rapid commoditization of many clean technologies.  

Thus, there was a somewhat strange bifurcation of the cleantech venture dollar cycle. Seed and Series A deals were hard to come by, and were skewed toward the new watchword “capital efficiency,” which really meant software-based plays. And yet follow-on rounds, predominantly by insiders, continued to flow into the previous capital-intensive bets, so that overall the sector continued to look dominated by such types of investments. Without angels and family offices stepping into the early stage void, and corporate investors stepping into the late stage void, and government support at all stages, the sector might have seen a real collapse. Instead, thanks to these investors and supporters coming in, as well as VCs’ willingness to continue to back their own bets, the period looked like a “go sideways” period, at least from those outside looking at the data.

For insiders, however, this has clearly been a rough shakeout period. Many startups, in the solar, biofuels and vehicles sectors in particular, have gone under or are in serious trouble. Many capital-intensive bets have run out of steam and investors aren’t there to help like they were before. And there’s even been a shakeout of the investors as well. Multiple smaller cleantech VC firms have gone under, and certainly there’s been a dramatic contraction in the number of cleantech-dedicated investors at generalist firms.

What does 2012 look like so far? A simultaneous accelerated shakeout period, and yet also a rebirth. We’ll start to see more firms finally able to raise their next fund, albeit a smaller one. We’ll start to be able to discern which startups in the crowded sectors like solar and biofuels have staying power, and which ones are going to be crushed by rapid commoditization and price drops and the sudden withdrawal of government support. And we’re going to see the emergence of more new investment models.

So there you go: 15 years of cleantech venture capital in one oversimplified column. Apologies for such a long column, but I wanted to post it all in one piece as a necessary set-up to columns soon to follow, talking about some of these new investment models that I see emerging.  I’ve been writing this column since 2005, and I sometimes lose track of how much things have shifted over that time, so it’s good to review before plunging ahead.

And I hope you, gentle reader, take away one major lesson from the above -- namely, that the “inherently capital-intensive” nature of cleantech venture capital really isn’t so, at least not nearly to the level we saw it become. The uber-intensity of capital spending in cleantech startups was a result of several choices by VCs along the way, based upon perceived lessons and opportunities, and the incentives various investors had. Certainly, the cleantech sector needed to be hardware-focused as recently as five or so years ago. Because the hardware/infrastructure is a necessary precondition for many other business models to follow, just as we saw in the IT and telecom sectors. But by now, if an investor views cleantech as a capital intensive sector where patented technology is the most important source of value, that is their choice. It can be, and has been, but it is not inherently so. Many other markets dealing with the production and use of physical products have been successfully disrupted in non-capital-intensive ways, after all.

More on this topic to follow.

It's not a popular thing to argue right now, but yes, there certainly is a vital role for government in support of cleantech innovation.

Let me start by acknowledging that I absolutely understand and quite often agree with the sentiment that government shouldn't be in the business of venture capital. Market-based policies are, to my liking, almost always preferable to policies where government employees select and fund specific innovators or companies. Thus, the most effective way for governments to support cleantech innovation would be to price in externalities like climate change and dependence on imported energy, and then let the market sort things out.

But that's not likely to happen anytime soon in the U.S.

So in the meantime, how should we view policymakers' efforts to promote innovation and startups that would otherwise languish in today's skewed pricing environment? It's a very complex problem, which I'll illustrate below.

I would propose that an appropriate government effort to promote cleantech innovation will follow three core principles:

1. Additionality

Within the realm of desirable outcomes for the U.S. economy and energy mix, some are already being tackled by the private sector, and some are not.  As a rule, government efforts even in economically beneficial innovation areas shouldn't duplicate the existing efforts of the private sector. In this case, the government should be aiming to fill capital gaps.

This is a lot easier said than done, however. First of all, how do you define a capital gap? It's hard enough to get reliable information about venture funding overall, much less get reliable data about what specific stages and sectors and business models are hard to get funded. Secondly, these capital gaps also wax, wane, and shift as investor enthusiasm for a sector ebbs and flows. Thirdly, in some of these capital gaps, there might be non-institutional investors who are interested in putting in money where the institutional VCs won't, and the capital gap is one of check size (angels writing $25,000 checks when $250,000 is what's needed), not one that's sector- or stage-driven. And finally, there might even be gaps across various efforts within an individual company -- for example, a research project at a venture-backed startup, where the research wouldn't have happened with VC dollars alone.

You also want to avoid either having these government-directed dollars flowing into the hot new startup (because the program is under pressure to show some 'successes' early on), or a negative selection bias where government dollars are being directed away from the best innovative startups because VCs might become interested. But you do want to see leverage resulting from these efforts, where the government program helps to unlock follow-on capital from the private sector. In other words, VC dollars following government dollars is one indicative metric of a successful program. But government dollars following VC dollars is less so (with the caveat of the additional research project scenario as described above).

How to prove additionality under such complex conditions? It doesn't make sense to attempt to codify a definition legislatively. Rather, the best approach is to to develop flexible processes that are outcome-oriented and provide opportunities for an evolution of the program over time.

2. Flexibility

One of the less-reported but damaging trends in U.S. policy right now is the shift in tactical control from the executive branch to the legislative branch. In other words, lawmakers are writing in too many detailed directives as to how programs should work, instead of stepping back. Because if there's one group of people you don't want designing your management process, it's Congress. Yet that's exactly what's going on. Many of the more public examples of failed energy policy recently were, at heart, driven by byzantine program designs dictated from Capitol Hill, not in the White House or inside the DOE. It's the equivalent of a startup's board of directors going around the CEO to specify how junior engineers in the R&D group should organize their daily activities. Lawmakers should establish goals, provide boundaries and oversight, and then let the implementers on the firing lines figure out the best way to accomplish these objectives.

If lawmakers are to surrender some control over process, however, there does need to be sufficient oversight, as well as a forcing function to make sure the program really does evolve over time as market conditions change.

3. The Voice of the Market

To reiterate, I strongly prefer market-based policies to any effort to have government groups select some specific recipients over others. But if there are some areas where economic imperatives necessitate this latter type of policy, the next best choice is to at least give the voice of the market a major role.

Peer review is one commonly used way to get at this. And if done the right way, it can be quite valuable. But if done wrong, of course, it's useless. A good peer review process will work hard to get a wide variety of knowledgeable technical and market viewpoints, control for potential conflicts of interest, and include force-ranking or other ways of making sure 'grade inflation' doesn't creep in. 

What I haven't seen as much of, but what would also be valuable, would be to have additional reviews done by groups of end-users or customers. This is tougher, and won't be definitive, because quite often customers don't know what they've been missing until they see something in action. But still, for building energy efficiency technology (for example), there should be collective reviews by large building owners who could eventually be purchasing the technology, both within the government system (e.g., let's get the Navy helping ARPA-E select what technologies they'd love to have commercialized for use on their bases) and, of course, really including the private sector owners of buildings. It will be important to avoid inclusion of channel partners who seem like purchasers but really are biased distributors (sorry, ESCOs). It won't be a perfect process, but these programs shouldn't be "build it and they will come" by design -- they should be bringing in the voice of the customer right from the point of selection. And the input and perspective will help all participating startups, even those not selected by the program.

Outside perspectives from market participants can, at least in a wisdom of crowds format, also help identify which areas are truly capital gaps and which aren't. Perhaps doing this on a case-by-case basis would be unwieldy, but at the very least, a large panel of advisors from the private sector could help evaluate the program staff's own identification and definition of capital gaps on an annual basis, helping to validate the strategy while keeping it somewhat flexible. It would have to be a large and diverse panel -- each advisor would absolutely walk in with their own biases in certain sectors and categories, so it will be important to flood out each bias with enough of a crowd of perspectives.

Bringing this all together, I'll throw out there a vision of what this might look like:

• A program given a concrete and ambitious but relatively broad set of mandates in terms of goals (such as $1.00 per watt installed solar cost), with an authorized budget and department home, and some basic parameters around types of activities (grants vs. investments, etc.) and a requirement to demonstrate additionality.
• An oversight committee to review the program's activities on a quarterly basis and strategy/program design on an annual basis.
• An auditor established elsewhere in the government to evaluate adherence and effectiveness of the program on an annual basis.
• A strong manager out of the private sector with a mandate to hire a top-notch team, tasked with designing and running the program.
• Peer review and market input processes so that as much as possible of the program's activities are guided by the voice of the market, while still giving the internal team latitude to use their experience and judgment toward meeting the goals of the program.

Obviously, a fourth unstated principle, therefore, is that this requires a really sharp team. Not a bureaucrat-laden team, but a team of experienced managers with private-sector experience, leavened with smart young technologists and market analyst types. This is the single most important determinant, in my mind, between a successful effort like this and an unsuccessful effort. Groups like ARPA-E and the Massachusetts Clean Energy Center have had leadership like this, and it's a major reason why (in my mind, at least) they've been pretty successful to date. Effective, mission-oriented people have been brought on board by the leadership of each program, and they've found a way to make a positive impact.  

But will that last? I do worry that the crushing nature of politics means that such people will eventually be driven out by partisanship-inspired attacks. I'm not sure that can be avoided (unless anyone has any brilliant ideas on how to remove party politics from energy policy in this country?). So we can only hope that effective businesspeople with tough hides will continue to agree to lead programs like this out of a sense of mission, and that they will be able to continue to inspire strong managers and analysts to come join these teams even though they will have to expect that it becomes unpleasant at times.

In the meantime, we can hope to continue to see broader recognition of the need for market-based energy policies that will establish a more even playing field, so that all of the above becomes less necessary. Because right now, it's absolutely critical.

Walt Frick posted a good rebuttal to the Wired "cleantech bust" article recently, in which he points out that venture dollars going into the sector remain high.

This is true, but as one of my fellow panelists at the Kellogg PE/VC conference yesterday pointed out, a lot of those dollars are simply follow-ons into existing investments. And furthermore, corporate investors have really been filling the gap recently.  One lawyer I spoke with recently who sees a lot of cleantech transactions told me that over the past 12 months, most transactions he's seen have included a strategic investor as the predominant "new money" in the deal.

It's clear that many large corporations have determined that there will be growth opportunities in emerging clean technologies, and at a time when many corporations have been hoarding cash they are thus able to put some money at work in venture investments in the sector. This is very encouraging for the sector, of course.

But corporate venture investments have a history of piling on at the end of cycles. Does this current wave of investments portend bad things for the cleantech venture sector, given the lagging indicator they've often been?

The alternative optimistic view says that "this time is different," because various clean technologies are reaching a point of maturation where they are "ready for primetime" -- and this just happens to be at a point in time where corporations have capital and VCs don't. And in addition, the generally horribly ineffective channels for clean technologies mean that large corporate partners do indeed have value to add, as opposed to other "bulges" in corporate venture investing, where they were just buying late into the party.

At the risk of saying "this time is different" (famous last words), I do tend to believe this latter, optimistic view. Mostly because I don't see a lot of evidence that corporate venture groups are dramatically overpaying to buy their way into 'hot' companies. Indeed, I see a lot of bargain-hunting and serious evaluation of underlying technologies instead of just momentum investing among corporate VCs. I do believe that many large corporations have determined that clean technologies will be strategic growth areas for them over the long run, and that this is a buyer's market, so it's an opportune time to forge some relationships, investment-oriented and otherwise.

But even if so, there's still a significant disconnect going on.  While these corporate venture groups are investing in growth opportunities, the operating units within these larger companies are adopting cost-saving clean technologies as slowly as ever.

A long, long time ago, a colleague and I wrote about four different ways "sustainability" can be used to create economic value for large companies. The first is simply to help ensure "right to operate" -- that is, avoiding major environmental screw-ups. The second is as a means of identifying cost savings via waste reduction. The third is adding new products with resource-efficiency advantages, and the fourth is redefining the entire business. (You can learn more about this framework here.)

Corporate venture groups are primarily concerned with the third of these opportunities: new add-on businesses. But there's a huge opportunity in the cost-saving category that is being missed by these same companies.

I see a lot of industrial energy efficiency startups right now, for example, that are having a hard time getting large corporates to act quickly to purchase new lighting, controls, and other systems that would be relatively easy to implement and have compelling ROIs. You would typically think that a two-year payback period is a no-brainer for a corporate operating manager to pitch internally, yet I'm seeing even six-month paybacks not get the traction you would expect. Why? Mostly because these aren't strategic priorities.

The corporate world has shifted a bit so that C-suites are often focused on executing on a top-three set of priorities. And rarely is "make our facilities run more efficiently" one of these top three stated priorities. Without a specific strategic mandate, the plant manager fights an uphill battle getting the CFO to pay attention, and the CFO doesn't want to spend time pushing these opportunities down on plant managers. And then there's the "all the other stuff" dynamic -- plant managers have three priorities themselves: production, safety, and all the other "stuff."  Energy (and other types of) cost savings fall into this distant third category.

I found it ironic that our cleantech panel yesterday was held at the same time as a panel on how PE firms can create additional returns by driving operational improvements at their portfolio companies. Ironic, because we should have combined the panels. Indeed, thanks to efforts such as the Environmental Defense Fund's Green Returns project, PE firms are actually helping drive adoption of resource-efficient technologies pretty effectively within their portfolios.  

That's because they've made it a strategic priority (because it's such low-hanging fruit with rapid returns). But too often I go out and talk with a corporate venture group, and we'll be comparing notes on investment areas of interest, and they make it clear that their mandate only covers revenue growth opportunities -- they have no ability to invest in technologies that could save their company money in terms of cost savings. Even at companies like Wal-Mart that are doing a pretty effective job of making a priority of resource efficiency in their operations, the venture group is forbidden from investing in companies that could become vendors to their facilities.  

This is a major strategic disconnect -- and in my opinion, a mistake. The most direct way to add to earnings per share is to reduce the costs necessary to create the same dollar of revenue. But some of the very same large corporations now investing into somewhat risky cleantech venture capital deals aren't effectively adopting many of the readily available and proven technologies that could save their operations millions in costs. You, Gentle Reader, are a shareholder in some of these companies, no doubt, so how do you feel about that trade-off?

If corporate leaders are indeed serious about driving future returns through investments in cleantech, they need to make sure that's an urgent priority for their Ops managers as well. Cost savings through adoption of new efficiency technologies should be a priority at every large firm.  

If it takes your plant managers nine months to agree to purchase a system that has a six-month ROI, you're doing it wrong.