2010 may be looking up economically (although I'm personally feeling like we're headed for a double-dip, but let's stay optimistic), and yet 2010 may not be as happy a fundraising environment for cleantech startups as many would hope.

Why?  Because there's a lag between when venture firms raise their capital and when they can deploy it.  And 2009 was the worst year for VC fundraising since 1993, according to the NVCA (note: link opens pdf).

Only about half as many funds successfully raised money as we've seen in other years of the past decade.  And the dollar amounts dropped similarly.

VC funds are typically raised in a fairly consistent two to three year cycle.  So when you see a drop-off like this, it means a lot of firms pushed off fundraising until things picked up.  Which means there are a lot of firms that were due to raise funds in 2009 that instead decided to wait.

These firms will have to go out and raise new funds soon.  The cycle can only be pushed so far out for many funds, before their internal dynamics get squeezed.  Fund fees typically decline over time, meaning that the operating budget for the firm goes DOWN if they don't raise a new fund.  So unless they're going to start shedding staff, either the delaying firms will need to raise new funds in 2010, or the GPs will have to take pay cuts.  Probably a mix of all of the above...

The easing denominator effect for LPs and other LP dynamics probably means that GP fundraising will indeed be easier in 2010 than in 2009.  But even if all goes well (and I'm not saying it will), it'll still mean a lag time before those new funds get up and running.  Meanwhile, all these firms are running out the string on their last fund, and many are thus out of dry powder and unable to do many, if any, new deals (most will be reserving capital for follow-ons with existing portfolio companies, fortunately).

So what does this mean for entrepreneurs?  The trickle-down effect doesn't look good right now.  At least for the first part of the year, it will mean it's still very tough to raise outside capital.  Expect to see yet more insider rounds and bridges.  And expect to have to take a lot more meetings (the GPs will need to be seen as still being "in the game" so they'll still take meetings) before you land a funder.  Follow the money, and watch who's actually doing NEW deals (not just follow-ons into their existing portfolio companies), they'll be the best targets.

Quick reminder:  If you've been missing the dealflow notices that used to appear on this column, they've moved over to Twitter so they can be timelier (and a lot less work).

Anyways, many thanks to all the readers who participated in this year's CI Reader Prediction Survey.  We got lots of good responses, and there's a lot of agreement out there about the coming year, surprisingly to me.

In terms of survey participants, it appears to have been a good mix of entrepreneurs, investors, corporate managers, and service providers, with a smattering of researchers, government/NGO types, and others thrown in.  Lots of entrepreneurs and investors.  Geographically, more than 80% of participating readers are in North America, but Europe, Asia and the Middle East also had a presence (I'm very, very disappointed in you, Australia).

So what do readers predict?

1.  In terms of North American cleantech venture deals, Q1 through Q3 2010, readers expect it to be a moderately good year.  Two-thirds of readers expect that the number of venture deals will grow, but by less than 50%, compared to 2009's same period.  Over 25% expect the number of deals to remain about the same.  Less than 5% thought the number of deals would drop, and less than 5% thought the growth would be more than 50%.

2.  In North American cleantech venture dollars, same period, it was about the same picture.  7% thought the dollars would actually drop, 24% thought they would be about the same, 62% thought they would grow but by less than 50% year on year, and 7% thought they would grow by more than 50%.

3.  There was a bit of a more bullish take on global clean energy private equity (which is mostly in project finance).  4% thought the global dollars going into these projects would fall, 21% thought they would be about the same, 49% thought they would grow but by less than a third.  And interestingly, more than a quarter of readers thought they would grow by more than that. 

4.  I asked that, if 2008 was the "year of solar" and 2009 was the "year of the car" in cleantech, what would 2010 be known as?  Readers pointed to a lot of favorites, but by far the top two vote earners were a) Green buildings and building energy efficiency; and b) Smart grid.  Both got votes from more than 40% of participating readers.  People are really down on solar -- it only beat out wave power and agriculture, with votes from 3% of participating readers.

5.  Readers showed a bit more optimism in terms of U.S. cap and trade legislation getting passed than I'm feeling at the moment.  Asked whether we would see enactment of "meaningful" (purposefully vague phrasing, btw) climate change legislation in 2010, 40% of participating readers said yes!  Of course, that means 60% said no...

Here are some of the tips and thoughts readers wanted to share with other readers:

"Stay the course, markets will rebound and investors will start investing again."

"Come to Europe"

"Why haven't we initiated intense policies mandating a reduction in emissions? Adapt or fall to ruin. Businesses have to learn."

"The US gov't continues to derail real momentum in the renewable space. $3.8B to GMAC? Let 'em die and put that money into all of the above; repurpose the workers into something that matters. No action at Copenhagen? Disgraceful."

"Solyndra and possibly Codexis IPOs are likely to be canaries in the coal mine - but tough to see how the canaries make it out alive..."

"I have been and continue to be amazed by the lack of "energy awareness" on the part of normally intelligent Americans. This is a fundamental problem and HAS TO change."

"A more diverse range of investor funds is needed in cleantech (as opposed to one-size fits all structures); as soon as we see an inflow of money we'll see innovations in investment strategies. I think 2010 will see meaningful evolution towards investment vehicles that better match cleantech investment opportunities."

"Investors will lick their wounds from 2008-9 biofuel and solar investment catastrophes, but continue doing deals in cleantech. My magic 8 ball is telling me that entrepreneurs will respond to the challenging investment environment by focusing on building more capital efficient cleantech businesses. I like the software enabled efficiency businesses (green computing, building monitoring & controls, logistics, and industrial logistics sectors) and capital efficient execution companies that wrap up (near) market-ready technologies in new and exciting business models (building and lighting efficiency, transportation, and finance models of these plays)."

And my personal favorite:  "Pyrolysis will explode!"  Not literally, I hope...

We'll check back in at the end of 2010, one way or another, and see how everyone did.  Thanks to all who participated!

Don't forget:  Take the 2010 Cleantech Investor readers' survey.  I'm going to close it over the next day or so, we've plenty of good responses to work with, but the more the merrier.

In case you missed it, among all the other VC predictions for 2010, Peter Hebert of Lux Capital posted a really compelling set on PE Hub (note: link may disappear behind the sub-only wall soon).

I enjoyed all his points, but agreed with some more than others, so in the spirit of dialogue I thought I'd post some of my own thoughts on them:

1.  Venture-backed IPOs rebound smartly, with 50%+ first day price jumps on name brand offerings from Facebook, LinkedIn or Zynga. Among the S-1 clutter, another big beneficiary will be IPOs from smaller, little-known, and speculative-grade companies that also make it out. The visceral response to many IPO filings: Who?

In the cleantech sector, a lot of attention is being focused on Solyndra's IPO.  But in many ways that company is a pretty big exception in comparison to the rest of the sector.  I'm interested to see what other cleantech IPOs make it out this year, and how they do, because they'll tell me a lot more about the potential exit paths for typical cleantech venture investments.

2.  At least one famed VC partnership fractures or sees an orderly wind-down, with insider gossip eventually leaking out. The changing of the venture guard moves full steam ahead, as weak fund performance from the lost decade finally forces LPs to question historic allocations to “franchise funds”.

I do think this is going to happen sooner or later. 

The worst thing anyone ever did for the LP community was to do that famous backward-looking study showing that 1st quartile funds have tended to stay 1st quartile funds.  It was surely an accurate study.  But that study has subsequently skewed LP behavior and thus skewed GP behavior, so that 1st quartile funds are expanding in ways that force them to change what made them so successful in the first place.  Some will pull it off.  Some will just get lucky.  And some won't pull it off.  But this myth that some LPs believe, that the only way to make money in venture capital is to back high-profile top tier funds, will slowly get broken down.

But not this year.  Peter's 2010 prediction might come true if there was more transparency and accountability in the venture community, but even if LP managers were more willing to risk their career on up-and-coming GPs instead of big-name GPs, there still would be the problem that VC manager performance is really difficult to assess and takes years to play out.  Over time, I think Peter will be right.  But it'll be slower shift than he implies.

3.  A large, non-traditional investor enters the venture fray, boasting a very long fund duration (~20 years) vehicle focused on science and technology. Commence discussion on whether the traditional 10-year fund life makes structural sense for early-stage life sciences and energy investments.

There's a lot of merit to this concept.  But what kind of non-traditional investor, besides the family offices that have been doing some of this already, or a large private equity or sovereign fund with little early stage venture experience? 

And if it's a returns-oriented investor, what does such a long timeframe do to IRRs?  What's described here is, at least at first blush, a recipe for higher risk and lower IRRs (because of the holding period).  Not sure we'll see someone jump to do that on more than a token basis, or possibly as a one-off fund done by a traditional VC for marketing purposes as much as anything...

Cynicism aside, I do think there's a kernel of something important in Peter's point, and given more space to write about it I'm sure he'd fill out more of the details he's got in mind, but the devil will be in those details.  A new structure would need to be developed so that capital outlays were kept very low for the 1st half of the fund, and also not have burdensome fees (ie: low cost or subsidized staffing), yet still bring a lot of resources to bear in helping these companies.  I know institutional investors who are noodling on this, but I haven't heard any concrete answers yet.

4.  Stealthy cleantech companies unveil. After years of intrigue and speculation, not to mention tens to several hundred million dollars invested, several energy technology companies finally lift the curtain and introduce themselves to the world. Will the emperor be wearing clothes?

Yep, will be a fun year...

5.  Spike in biotech M&A. December 2009 served as an excellent indicator of what’s to come, with more than $1 billion returned to venture funds through the acquisitions of Acclarent, Calixa and Gloucester. Expect this month’s JP Morgan healthcare conference to play host to the industry’s ultimate speed dating session.

I think there will be a spike in cleantech M&A as well.  If the economy continues to track upward, even if not dramatically so, big buyers will start looking for bargain opportunities -- and after such a rough patch for startups, there will be some of those available.  Also, some big players will look to acquire smaller startups that have gotten inside tracks on major government dollars. 

6.  Semiconductors regain luster. After years spent languishing as pond scum in the VC pool, the public market chip rebound finally extends to its capital-starved, private brethren. Expect several IPOs and profitable M&A for some of the largest revenue generators.

This is potentially true for all the highly capacity-driven cyclical tech sectors.  Of which there are several in cleantech, naturally.

7.  Solar failures litter VC landscape. Schumpeter’s gale of creative destruction blows through the 250+ private solar companies. A handful of heavily-funded solar PV and CPV companies flame out, while sector leaders like First Solar consolidate their market position.

I could be wrong, but while I do expect a bit of a solar shakeout, I don't expect it to be so dramatic. 

It's tougher than you may think for someone like First Solar to grab smaller companies' techs and successfully integrate them into their products, so the idea that one of these companies will go on a big horizontal integration spree is intriguing but tough to pull off, unless what the acquirer pays for isn't technology but is instead advanced sales bookings, etc.  However, vertical integration is something we'll likely see more and more of. 

And certainly a bunch of solar companies will go splat.  Some will be the ones that had a smallish tweak as their core innovation and have been spending money like they wanted to be a standalone competitor to First Solar or SunPower.  Some will be the ones that just got too far out ahead of their skis, were spending money expecting an IPO in 2009, and then the economy came to a screaming halt, and so they're in trouble but they just haven't completely wiped out quite yet. 

But while I think there will be some high-profile examples of both types of flameouts in the solar sector, and while I do think sooner or later VCs have to pull back from putting so much capital into this space, I think plenty of those 250+ private companies will be around in 2011.  I know too many sober entrepreneurs in the sector who now understand the need to be capital efficient, are focusing on their core innovations, and are planning for a few lean years.  That doesn't bode well for future gargantuan exits for their investors, because these companies will end up being smaller and more interchangeable than their VCs had hoped.  But it doesn't mean 2010 will see a huge wave of "solar failures".  That would require a regulatory retrenchment ala the early 1980s, and instead the opposite trend seems to be taking place.

So on this one, Peter and I are in agreement at a high level, but I would differ in tone.

8.  Energy investors swap wind and solar for abundant natural gas and carbon-free nuclear. Looking to replace a large swath of coal-fired power for base-load electricity generation? Natural gas and nuclear are not just attractive base-load alternatives—they are the only options.

Wind is already scaling up so quickly that many regional grid operators can't handle it.  So discounting wind in this way is overly simplistic.  The problem with wind power isn't cost or ability to build out generation capacity rapidly.  The problem is that there's no way to store the power, so when the wind blows, in some places like Texas and the Midwest grid operators are forced to literally shut down power production.  But I've seen good efforts to address this.

I do agree that natural gas is a seriously overlooked option if you're looking for large-scale, rapid shifts in the powergen (and transportation) mix.  But nuclear capacity won't be fast to develop, no way.  So I think Peter misses the mark a bit here.  But his focus on economics and scalability are quite well taken.

9.  Russian oligarchs and other foreign investors snap up late-stage U.S. tech. DST’s investments in Facebook and Zynga serve as a role model. Let’s hope they encounter more success than the sovereign funds that purchased big stakes in U.S. investment banks.

There are certainly plenty of candidates for this type of investment within the cleantech sectors.  Big checkwriters with less valuation focus could be poised to make a big direct-investment splash in the solar and battery and smart grid sectors in particular.  But see below.

10.  Return of the VC mystique. A counter-intuitive prediction, but one that reflects the above assumptions and data points. A select few IPO grand slams create massive returns and fanfare, sparking a resurgence of interest in the asset class. LPs actually begin to talk about new opportunities in venture capital

I think VC has to be poised for a bit of a temporary uptick as an asset class, everyone is so beaten down right now and VC performance tends to track the economy roughly speaking.  2010 will be better than 2009 for VC fundraising, perhaps significantly. 

But beyond 2010, the sector will continue to contract, there are still way too many managers and way too many dollars in the overall category.  And as far as "mystique" goes, I think that will really continue to be depleted over time. 

Some of the biggest names out there in the venture world have started to risk their brands.  Some are letting bankers use the VC's reputation to push non-institutional investors to do high-priced follow-on rounds into struggling startups, when institutional investors have already passed on the deals (so... what do those institutional investors know that the individual investors don't?).  Some venture firms continue to risk their "mystique" by using their brand to attract LPs into ever-bigger funds and extensions into categories and asset classes where the GPs have little investment experience and will be learning on the fly, which is not a recipe for consistently top-tier results.  And when these top firms risk their brand, that risks the "VC mystique" overall.

I'm a huge fan of the venture capital industry and its role, and am continually humbled by the brains and effort and pattern recognition many VCs show, both the well-recognized and the relatively unheralded investors alike.  These are smart people doing some inspired work.  But I do think the VC mystique is more at risk right now, than poised for a comeback. 

Regardless, kudos to Peter on a really thought-provoking set of predictions!

------------------

Administrative note:  Miss the cleantech venture deal roundups that used to be a staple of this column?  Well, they've migrated over to Twitter, where it's a lot easier to get others to do the work for me.  If you're interested, follow the cleantechvc feed.

Happy new year, everyone!  If you haven't yet done the readers' prediction survey, please click here and do so, it'll take all of 30 seconds.  Lots of good responses so far...

So at midnight on the 31st, the U.S.'s $1/gallon biodiesel tax credit expired because the Senate couldn't get their act together to extend it.  Already, some biodiesel plants are shutting down, hoping for a legislative fix soon so they can restart.  But emphasis on "hoping".

My point isn't to defend subsidies or biodiesel, we've talked about those in other posts, and regular readers know my take on both is somewhat mixed.  No, my point is that if you're a lawmaker and you decide you DO want to incent the growth of an emerging industry by providing tax credits, the very WORST thing you can do is to set the timeframes short and then fail to re-up them in time.

We've talked a lot here about the project finance gap in cleantech, where traditional energy project financiers aren't willing to put money into "new" technologies.  And I put quote marks around "new", because some technologies that project finance remains leery of probably seem old hat by now to readers of this column.  But the traditional project finance model isn't designed to take on much risk at all.  And so it's tough to get project financiers to put capital into building out production capacity when the technology still is being tweaked, or when inputs aren't secure, or when demand isn't secure. 

So when someone wants to build a biodiesel plant, or a wind farm, etc., and they approach project financiers, a volatile incentive system is EXACTLY OPPOSITE of what you want if you want to encourage broad roll-out of a technology.  And yet in the U.S., Congress insists upon not only relatively short-term incentives that need to be renewed or else lapse, then they regularly fail to meet the deadlines for renewal!

Here's a chart of what such treatment of the Production Tax Credit has done to the U.S. wind industry, courtesy of the AWEA (via Cleantechnica):

Of course, the ARRA included an extension of the PTC -- for 3 years for wind, to the end of 2012.  If you're a project financier, when you're evaluating a wind project, do you have faith that Congress will re-up the incentive by that deadline so that there will be no gaps?

It's all good that we're providing loan guarantees, working on Green Energy Bank legislation, and all that.  But whether the incentives for clean technologies are to be heavy or light, the greatest sin that Congress regularly commits is to create massive instability in the market by working with relatively short timeframes (10 years is a much more appropriate timeframe for such things), and especially to have the default action be a lapse of incentives without official renewal, instead of a more reasonable design which would have a grace period where the default was to CONTINUE an incentive if Congress can't get their act together by the deadline.

Because they rarely seem to be able to do so.

Thank goodness there are almost no revenue-producing algal biodiesel producers out there to be hurt by this lapse, huh?  I kid.  But lest I be perceived as promoting one clean transportation solution over the others, let me also wrap up with this inspired piece of marketing for the Chevy Volt:

Enjoy!

Over twenty participants already in the 2010 CI Readers' Prediction survey, in just a few hours after launching.  If you haven't taken the survey yet, click here to do so.  It's only a couple of quick questions.

The first of the year-end cleantech VC deal and dollar tallies has come out, with GTM's Eric Wesoff releasing his always-useful quarterly review.  Eric has a pretty good write-up on his results, so I won't go over it all here, but I wanted to highlight a few specific things that struck me:

1.  While Eric's blog posting talks about 2009 overall numbers, I'm frankly a bit taken aback to see that his totals for Q4 venture dollars were down at $817M, way down from Q3's $1.9B and even lower than Q1's $864M, which was supposed to be the low point, right?  What happened?  Has there been a quiet train wreck in cleantech venture capital?

Well, it's still a bit early to draw too many conclusions.  A number of Q4 deals that happened may not have been revealed quite yet as the Reg D filings have their deadline today.  And so by putting out his total today, Eric's obviously missed those, to be included in later updates.  Perhaps there are more dollars out there left to be found.

But not THAT many.  Clearly the dollar amounts took a big step back in Q4.  What about the deal amounts?  They dropped, too.  From 117 in Q3 to 82 in Q4.  Again, this tally may increase in later updates.  But it's still a pretty healthy drop.  However, it is NOT as big a drop as we saw in Q1, when Eric counted only 65 deals.

So what appears to have happened is that the size of deals went way down, at least in Eric's tally (to be confirmed when we review other tallies later).  From a mean round size of over $16M, down to a mean round size of less than $10M in Q4. 

Remember what we've seen again and again in the tallies:  That the dollar amounts are driven by big later-stage deals, as much as by the number of deals (I remain amazed that journalists often ignore this basic fact and draw conclusions based only on dollar totals).  So did big later-stage deals dry up?  Or did later stage deals just get smaller? 

Based upon what I'm seeing in the marketplace, I'm wondering if a bunch of the growth-stage companies that would have normally raised money in 2H09 instead pushed such financings into 2010 -- by either running leaner, or taking in smaller bridges or round extensions.  With the funding environment still very unfriendly to startups, but more macroeconomic optimism out there for 2010, it would be tempting to entrepreneurs and their backers to push off a new fundraising for a half a year or more, in hopes of suffering less dilution (ie: getting a higher valuation) as the sector rebounds.  I've seen a lot of anecdotal evidence of this happening.

If so, it's a risky strategy, however.  Because not everyone is convinced the 2010 economy will see a really strong rebound.  And even if things pick up in the overall economy, venture dollars could lag because so many investment funds remain tapped out and need to raise their next funds themselves.  Perhaps 2010 will see the return of high valuations.  But perhaps not.  So it's a bit of a gamble to wait.

2.  Q4 was once again a big month for solar.

Eric counted 24 venture rounds into solar companies.  Compare that with 9 rounds into biofuels, or 5 rounds into his Smart Grid, EE and DR category.  Or two rounds into water tech.

Not much more to say about that.

We'll write up Q4 a bit more when more tallies come out.  Until then, thanks to Eric for sharing these first results!

Okay, gang, you seen my predictions for next year, and you've seen how we all did last year.  Now it's time to make your own predictions about 2010.

Click here to take a very brief survey, to share your opinion on the new year.  It'll only take a couple of minutes, it's only a few questions long.

Take the survey!

And then, to reward yourself, enjoy this funny spoof interview:

Happy New Year, everyone!

About this time last year, I put together a few predictions and readers chimed in with theirs.  How did we all do?

Question 1:  How far will U.S. cleantech venture dollars drop from 1H08 to 1H09? 

I wrote it could be as high as 40%.  I argued that what was going to go completely missing were the mega-deals, and that on a dollar basis at least those made up a significant chunk, around 40% of quarterly tallies. Readers voted for a drop, but totaling less than a third on a dollar basis.

Well, according to the Cleantech Group's tallies, in 1H08 the total North American disclosed venture capital tally was $2.9B, and for 1H09 it was down around $1.6B.  Which is a 45% drop... 

Question 2:  How much, if at all, will the # of U.S. cleantech venture deals drop, 1H08 to 1H09? 

My argument was that the number of deals would probably drop, but by a lot less than the dollar amounts, as investors still did follow-on rounds but backed mostly away from the mega-deals.  I pegged the drop in the number of U.S. deals at around 20%.  Whereas CI readers tended to believe in a drop in the number of deals, but by less than 20%. 

In 1H08, the Cleantech Group counted 136 total North American venture deals.  In 1H09, the total was 139.  So the number of deals was indeed pretty flat!  But obviously the average size per round went way down.

Interestingly, it wasn't because of any significant shift in stage preference, i.e., investors didn't shift back to earlier stage in any significant way.  In 1H08 seed and first round were 32% of the North American total number of rounds, and in 1H09 they were 31%.  Investors still dramatically favored later stage deals.  They just weren't putting so much into them.  In fact, the mean size (sorry, I don't have median readily available) of disclosed "Follow-On" rounds in this data set dropped from $31.1M to $16.5M.

Question 3:  How much will cleantech dollars into China rise, 1H08 to 1H09?

I suggested they could rise 25%.  CI readers agreed with a rise, but were split as to whether it would be more or less than 25%.

We've got a bit of a data availability issue, as CG only started tracking China deals in 2Q08, and so we're missing 1Q08 data.  However, it's enough to show that the dollar amounts did in fact drop -- 2Q08 alone saw $257M, but 1H09's tally was only $170M.

Question 4:  What will be the "hot" sector in 1H09?

Of course, such an undefined question is tough to answer, but CI readers pointed most to energy efficiency and solar as the two most likely categories.  I'd said that solar was going to have to see a retrenchment, and that energy efficiency seemed most poised for growth.

Since the CG's sectoral definitions don't overlap well with my own (they bundle in biofuels and batteries together under the "Transportation" tag, for instance), it's a bit tough to make a definitive statement about how accurate everyone was in their predictions.  However, it is notable that solar dropped from being around 35-40% of venture dollars as it had been throughout 2008, down to a low of 13% share in 2Q09 (before rebounding back up to a 28% share in 3Q09).

Meanwhile, that amorphous "Transportation" category grew to rival the solar sector in terms of share of venture dollars.  So I suppose that means it's a likely candidate for "hot sector", although drilling down into it we see a healthy mix in there of everything from EVs and hybrids to batteries to biofuels.  Still, if 2008 was the year of solar, perhaps 2009 was the year of cars.

In another post, we'll have to do another prediction survey.  This was a pretty useful exercise.