Obama at MIT

Had the honor of being invited to Obama's speech at MIT today.  Thanks to the Clean Economy Network and the Renewable Energy Business Network, we were able to bring 50 local green businesspeople to the event (thanks, CEN!).  You can read the transcript here and some coverage here.

The President got a few demonstrations of technology MIT researchers are working on, before giving the speech, and then he spoke for 15 minutes or so to an auditorium full of 750 students, green entrepreneurs, researchers, cleantech investors, politicians, and other key stakeholders. 

A few points from his speech that particularly stuck out for me (paraphrasing):

• Energy tech innovators and entrepreneurs are this generation's pioneers.  Pioneers made this country great -- they expanded our boundaries, took us to the skies and to the moon.  Now energy tech pioneers are expanding our horizons in a new direction.

• There is a global race going on among countries vying to be the hubs of the next great energy technologies, and the country that wins this race will be the global economic giant of the 21st century.

• Energy is a security issue as much as it's an environmental issue.  The Department of Defense has said that reliance upon foreign oil endangers American security.

• We're going to need to use all domestic sources of energy we can find.  So we also need to find efficient ways of using our coal, oil and natural gas resources, not just solar and wind et al. 

I put up some pics on Flickr, for those interested.  It was great to see so many strong cleantech entrepreneurs and innovators in one place (fantastic networking, I might add).

Whether you're "fer" or "ag'in" the individual in your political persuasions, it was great to see someone in that high office have such a strong commitment to seeing cleantech continue to grow and thrive, and with a broad perspective on what cleantech means.

Why the story matters

Just stumbled upon this article in Wired with the blaring headline that EEStor is worth $1.5B!

The writer starts with Zenn Motor's market cap of $169M today, points out they own 10.7% of EEStor, and that Zenn isn't going to be selling their own vehicles anymore, and VOILA! If you give zero value to the rest of Zenn Motors, divide $169M by 10.7%, thus EEStor is worth an implied $1.5B!  Amazing!

Or, you know, the market could be valuing Zenn at $169M, and that stake in EEStor at $0. Because Zenn is still going to be selling things, just not fully manufactured cars, and it's unclear when or if EEStor is going to be producing profits.

Or anything in between.  So what we can tell by the math in the article is that the buyers of ZNN.V are valuing EEStor somewhere between zero and $1.5B.

Okaaaayyyy...

Even if retail investors are truly valuing Zenn based solely upon their minority stake in a "secretive" (as in "telling everyone they can that they're secretive, while releasing a steady drumbeat of news about supposed milestones being achieved") startup, what does the vaguaries of pricing of a thinly-traded stock on the Canadian Venture Exchange really tell us?  Even proponents of efficient market theory have to admit that such prices might easily get a tad skewed by a few over-exuberant day traders...  Which I think is the point of the author, to give him his due, calling it a "questionable milestone".  Still, the headline loses that nuance.

This is after I just saw another article on EEStor (on the site Tonic, which for some reason seems to be infatuated with this one company) where the writer states "Many electrical engineers say it's not possible to make an ultracapacitor."  Uh... no.  Many electrical engineers say it's not possible to build a cost-effective ultracapacitor along the lines of what EEStor is trying to do.  But ultracapacitors are already a fairly big industry.  They're already in many products in your home.  They already exist, Tonic.

The writer of the Wired article is an EV vet who appears to be trying to poke some holes in the EEStor story.  The writer of the Tonic article is clearly infatuated with the possibilities if the EEStor story is true.  All of which is totally fair, albeit questionably edited.

But the problem is that when the headlines blare like they do, and the story about the story becomes so dominating, it really hinders the efforts of other entrepreneurs in that space.  There are numerous other ultracapacitor startup efforts out there.  Many of which hold great promise for improving the cost and performance of ultracaps so they can start to play a significant role in energy storage -- not necessarily obviating batteries, much less gasoline altogether, but in important roles nonetheless.  But many of you, gentle readers, won't have heard about those efforts.  Because of one company getting all the attention, positive and negative.  And that's not helpful.  Over-hype and controversy drives away investment, it doesn't bring it in.  It makes it more difficult for anyone in the sector, not just EEStor, to get government support or venture investment or corporate partnerships.  So we all miss out on innovations that should be commercialized, as the baby is thrown out with the bathwater.

EEStor is working hard to get their story out there, that's their right.  But I often wish reporters and editors would spend a bit more time rounding out their knowledge by talking with industry insiders before publishing breathless copy.

Okay, so it’s broken.  Now what?

I've been having a lot of conversations with cleantech investors lately, and it's clear there's an emerging "consensus" (as much as you can ever get true alignment in such an industry) that the traditional venture capital model applied to cleantech isn't working -- at least in how it's been applied to date. 

To recap, we have seen billions of dollars this decade put into venture capital and "venture capital" deals in energy tech in particular, but not only have there been relatively few exits, many VC-backed cleantech companies have been way behind in their promises regarding commercialization and adoption.  Cleantech VCs have been more effective at making headlines than at making returns.  And there continue to be clear capital gaps at crucial development stages, including seed stage and "first commercial-scale project" financings.

In talking with a wide range of investors over the past few months, it's clear that there is still lots of optimism that there will be strong returns from venture-type investments in this sector.  After all, these are phenomenally huge markets, and they have phenomenally huge unmet needs.  Significant change is expected, and VCs are supposed to profit from significant change.  Exits have clearly been held back at least in part by the overall macroeconomic situation, which nipped several IPOs in the bud through no fault of the companies or their investors.  And there's clear long-term govermental support putting wind into the sails of the industry.

All of which is great, but in talking with these investors they also acknowledge that no one's yet proven out a successful investment model for the sector.  And so, in true hive fashion (everyone thinks they've arrived at the thought independently, but we all are influenced by each other's thinking), I keep hearing that the model is "broken" and solutions need to be found.

Okay.  But what solutions?

Some say that the problem isn't with either cleantech or with the traditional venture capital model, but instead that they don't overlap as often as VCs would like to think.  So, they say, applying IT investment models to IT approaches in cleantech (automated building energy management, carbon accounting SaaS offerings, etc.) is the way to go, not putting hundreds of millions of dollars into capital-intensive renewable energy generation.  Limiting the scope of cleantech venture investing, in other words, to just a subset of the overall energy, water and materials market.  I've argued for this approach at times myself.  However, it does beg the question:  Then how DO we expect to see these renewable energy technologies get to market?  Are the investors putting money into those sectors wrong?  Perhaps VCs are unintentionally, as some have said, simply taking pension fund money and investing in these capital-intensive technologies for society's benefit, but without good overall likelihood of venture-type returns?  Or perhaps not, the exits just haven't happened yet but they will? But that's not an answer to the question, that's just a diagnosis and another set of questions.

Some say that the key is, given long gestation periods, being late-stage investors and coming in after significant technology and commercialization risk is taken out of the company.  Which is a very smart approach except: a) Everyone else is having the same idea, driving up prices for late-stage investments; b) Being only late-stage in capital-intensive development efforts starts to look more and more like some kind of project finance, not venture capital; c) We're seeing ample evidence that there's still plenty of execution, scale-up, and market risk even at these later stages; and d) If everyone's investing late-stage, who provides the funding to bring the companies to that stage of development?

Some, albeit fewer, argue that the way to play cleantech is instead to go quite early and really swing for the fences.  Acknowleding the long gestation period of truly breakthrough ideas in the sector, the idea is to adopt a longer investment horizon, but to raise the bar in terms of the returns potential an investment might have:  So to paraphrase, don't go for the traditional 10x in 5 years, go for 20x in 10 years.  But it's unclear how LPs will react to such an approach, and if you think accountability is low on investments done with 5 year horizons... Furthermore, what about the other 99% of good cleantech innovations that don't qualify as having such dramatic potential?  Not everything can be "the next Google", after all.

Some investors are implicitly pursuing a momentum approach -- backing high-profile startups in high-profile sectors, putting a lot of effort into P.R. activities to further raise the profile of the startup, using that to bring in corporate partnerships and government support, and thus creating seemingly unstoppable momentum toward an exit.  It's almost (note: I'm clearly using hyperbole here) as if the underlying startup's technology and economics don't really matter.  One big challenge for this approach is the ephemeral nature of P.R. and momentum-building, it's easy for journalists, pundits, etc. to get very skeptical very quickly and turn against a company that has been over-hyped.  And more damaging, in the pursuit of visible evidence of rapid progress, these investors often encourage the companies to take on a high cash-burn model.  Which, when (not if) things go a bit sideways at some point, can be deadly.

I'm also seeing some efforts to create more overt "hybrid" approaches, combining (or at least setting up in parallel) VC, project finance, and middle-market buyout strategies.  But these are as yet mostly ill-defined, and it's unclear at the end of the day what's different from what's already de facto being done today by big VC funds, aside from the additional clarity of returns and risk expectation.

And of course a lot of other intriguing new ideas as well, there is some innovative thinking being developed out there, sometimes in places you wouldn't expect.

But despite all the ideas, so far, few proven answers.

Stay tuned...

The view from the trenches

I've talked a bit on this site about the ways the traditional venture capital model does and doesn't fit with cleantech. 

It's been said that 93 percent of startup financing comes from individuals and not venture capitalists.  Does that mean that 93% of startups are bad ideas?  No, it just points out venture capital is only a very narrow approach to successful entrepreneurial investing.

Many strong businesses are being formed right now that traditional venture capital won't go after, because it's not a proprietary technology play or otherwise a fit for the type of profile VCs look for.  In the teeth of these economic times, these entrepreneurs are forging ahead and getting things off the ground.  And from the perspective of jobs growth and building a robust "clean economy", these businesses will make even more of an aggregate impact than the solar, et al, startups talked about by big-name investors or profiled in the New York Times.

I thought it might be good to give a voice to the experiences some of these entrepreneurs are having out there, on the ground.  So, as a start, I've invited Steve Sherman, COO at GreenChoice Bank, to share a bit about what he's seeing out there:

We’re opening a brand new bank (within the banking world, it’s called a “de novo” bank) that we believe will finally give people a reason to feel good about their financial institution.  Based in Chicago, GreenChoice Bank will be one of the first “green” community banks in the whole country.  At our core, we’ll be a traditional community bank, with all of the products and services, and high level of customer service, that one would expect from a local bank.  But we also have a mission of sustainability that informs every aspect of the bank’s organization—from our initial location in the LEED-Platinum Green Exchange in Chicago (http://www.greenexchange.com), to a back office that is as sustainably built and as paperless as possible, to a set of advantaged loan and deposit products that reward our customers for their green choices (i.e., lending to green technology and green businesses). 

As you would expect, starting a bank is not an easy process.  About 2 years ago, we recognized there was an opportunity to create a “back to basics” kind of community bank with a unique point of differentiation through our green mission.  Last spring, we assembled an exceptional management team and Board of Directors, raised our seed capital, and put in an application for a federal bank charter.  The approval process is excruciating – the whole team underwent full background checks by the government, our business plan got pressure tested and challenged, and we generally had to jump through a lot of hoops to show them we’re serious and we’re the right people for the job.  After almost a full year of scrutiny, we received our approvals from the federal regulators.  Most bank groups don’t make it through this process, particularly in this environment, so this is a huge vote of confidence for the quality of the team and our plan.

We are working hard to get our doors open in the first quarter of 2010.  To be able to do so, we had to meet the regulators’ minimum equity capital requirements, as well as hire our staff, set up the operations, and get our location ready for business.  The operational piece is particularly challenging, though we have a great partner in Fiserv, one of the largest providers of bank core processing systems in the country.  Over the next few months, we will be setting up all the software, designing all of the bank products, and training our staff to use the system so we can open accounts, take deposits, set up loans, etc.  The great thing about outsourcing our systems, though, is that as a brand new bank, we’ll still be able to offer best-of-breed “green” technology to our customers including all the online banking and billpay (Fiserv owns Checkfree), image-based check processing, and remote deposit capture so you can deposit checks from your desk.

We think that the economy is starting to level off but it will be a long and slow recovery.  The downturn is having two impacts on our business.  It is actually great for the opportunity we are targeting—the credit crunch has caused most banks to stop lending, so to come to market with a clean balance sheet and a willingness to lend is huge for us.  However, the flipside is that it is also a much tougher environment for capital raising so our sales cycle has been a little longer than it would have been a few years ago. 

This isn’t necessarily a typical venture capital technology play but it's an example of a business that is going to be creating jobs and providing support (in the form of capital) to sustainably minded businesses in our economy.  The economy desperately needs community banks who are willing to take care of the smaller businesses and entrepreneurs who fall through the cracks of the big guys.  The big banks and big businesses are the ones who often drag the economy into a recession, but it’s the smaller guys who can help create the jobs and bring us out.  You can read more about us at http://www.greenchoicebank.com.

Thanks, Steve!

Depends on how you look at it, I guess

The initial takes on Q3 cleantech venture funding have come out over the past few days, and really, you can interpret them however you want.

The tallies are so far pretty consistent (haven't gotten most of the tallies, or even most of the details quite yet). They show that Q3 saw more dollars going into the sector than Q2, but that Q3 2009 was way down in comparison to Q3 2008.  Not really surprising, actually.  Things have been picking up a bit, and 3Q08 was a pretty high quarter.

Eric Wesoff's always useful tallies for GreenTech Media totaled up $1.9B in 112 deals globally.  Of that, solar, biofuels and other fuels made up nearly $1.1B and 46 deals, once again dominating the scene.  Big deals Eric tracked included Solyndra ($198M), Synthetic Genomic's funding commitment from Exxon ($300M over multiple years), Tesla ($82.5M), and Serious Materials ($60M).  As always, Eric and I have very different interpretations of the stage data.  He points to his tally of 35 Series A and seed deals and proclaims "a marked trend of a return to early stage deals".  I look at it as 77 late stage versus 35 early stage deals and still wonder how the top of the funnel is going to continue to be filled for late-stage investors.  But on the other hand, we both wonder if the VC model still works in solar... 

Over at the Cleantech Group, they tracked $1.59B in 134 companies worldwide, also with solar and fuels dominating the tallies.  While they celebrate the A123 and other IPOs, they also note that cleantech M&A was down a bit from the previous quarter.

New Energy Finance (note: link downloads pdf) pointed to a bit of a decline from Q2 to Q3 in terms of overall global investments in renewables.  But within that, they show that venture capital activity in the sector did increase. 

So what have we learned?  Don't believe the overly pessimistic ("things are way down versus a year ago!") and optimistic ("things are up on Q2!") headlines.  Instead, it's pretty much just a confirmation of what we have already been feeling and talking about here -- things look to be getting slightly better, but still far from the high-flying days of early 2008.  That's probably a good thing...

In a completely different note, fellow Bostonian cleantech investor Jon Karlen of Flybridge has launched a new blog, check it out!

A123: A deeper look

Many cleantech investors were cheered by the successful IPO of A123 this past week. 

I noted a very interesting column on PE Hub (sub req'd), by Lawrence Aragon, one of the finer private equity journalists out there.

(We need to caveat all this by acknowledging that it's unlikely much of the VCs' returns have been realized yet, there's typically a lock-up period.  So here's hoping the market valuation holds up.  Still, Lawrence's approach of using current valuations is still quite useful for our illustrative purposes...)

Lawrence takes a look at estimated investment totals and returns for major VCs in the company, and concludes that these investors didn't produce "a huge return", because the major holders only got like 4x or 5x.  But let's look at that a little deeper.  One thing that really struck me about Lawrence's column is that his assumption seems to be that these were all venture investments, and that therefore if you don't get a 10x you didn't get a "high voltage charge" for "venture investors". 

I would argue that much of the pre-IPO capital that was put into A123 wasn't "venture capital", at least in the sense Lawrence seems to mean it.  Let me illustrate what I mean:  If you have the chance to make 2x on an investment over 1 year, would you do it?  Sure, 100% IRRs are pretty sweet.  2x over 2 years, 3x over 3 years are all pretty attractive returns as well, on an IRR basis.  So when Lawrence points to 4x type returns to "venture investors", he seems to be assuming that these were long-term holders, but many weren't.  The Series D was in 2007, for example, and was at an approximate pre-money of $300M. Right now, that return looks pretty good on an IRR basis, even after an extra year's delay past the originally intended IPO date.  North Bridge, for example, was looking at a much higher multiple on their investment before they had to pump in an extra $10M as part of a May 2009 Series F, and while that very late round yielded a much smaller multiple, it was over just a few months, and probably looks great right now on an IRR basis.

So I don't think Lawrence crystalized the point he was trying to make.  However, I think the A123 experience illustrates a couple of important principles at work in cleantech investing today:

1.  I continue to have a hard time thinking about pre-IPO equity investments at pre-money valuations in the hundreds of millions as being "venture capital".  At very least, we need a new sub-category to describe this type of investing.  We have early stage investing, the Series As and Series Bs that are what most outsiders think of when they think of "venture capital" (if at all), typically aiming (read: "hoping") for a 10x return over 5-7 years.  Then you have "growth stage" venture capital, which is later-stage VC investing, aiming for a 5x in 3-5 years.  But as I noted back in that August 2008 post, much of the Series E (June '08, ~$100M raise, approx. $1B pre-money) appears to have been provided by first-time investors.  These investors weren't brought into the raise as "venture capitalists," I guarantee you.  Instead, it's probably best to think about that type of investment as a "mezz equity round".  In other words, the expectations were probably for a 2x in 1-2 years.  That's not necessarily better or worse investing than "venture capital" as Lawrence is referring to.  But it's certainly different.  It means a simple analysis of returns based on multiples is useless if all these types of investors are bundled together.

2.  Growth and even "equity mezz" financing isn't as low-risk as it's made out to be.  It's worth noting that those Series E investors are the ones who didn't make out so well.  Right now it's looking good as A123 trades almost 50% above its IPO price, so if that holds up through their holding periods they may still make out with a 1.5x return.  But the initial offering price appears to have been at just about the same post-money (around $1.1B) valuation of the Series E.  So a zero return at that price. And since my write-up last August after the Series E, apparently investors needed to pony up an additional $99M Series F round according to the updated S-1... and that was at a significant down round valuation (something like $9.20/sh vs. the Series E's $16/sh).

A lot of non-VC investors such as family offices and hedge funds have been brought into these kinds of mezz equity rounds in the past.  The pitch to those investors is, "hey, this company is going to IPO, and you're going to double your money over a year or so -- you can't lose!"  What we've learned about these kinds of rounds in thin-film solar, and now with A123, is that even at that late stage there's still plenty of risk of an exit not happening in the timeframe anticipated, or at a lower than hoped for valuation, or perhaps not at all. 

There's this theory out there that being a very late investor into cleantech is the way to go because the risk has been taken out of the equation.  Do the later investors into thin-film solar companies still feel that the risk of a timely and high-valuation exit was low?  Do the Series E investors in A123 feel like the risk was low in retrospect, after a year of holding their breath amid high cash burn and a down round and no exit window in sight? It worked out for A123.  But so far, for most of the large late-round investors in cleantech, the exits still haven't appeared. We all know early stage cleantech venture capital is risky.  But when I see it said/written/implied that we somehow can conclude with confidence that early stage cleantech VC doesn't make sense because it's "too risky, too long" whereas growth stage is the "smart way to do cleantech", I just shake my head.  And when anyone tells me I "can't lose" on a later-stage investment, I run away as fast as I can, because there's no such thing.

So basically, I look at the A123 IPO and am cheered.  I see it as being a sign of more good exits to come, in a sector that really needs them.  And I believe it shows us something about the shape of cleantech venture investing right now.