Dear venture capital limited partners:

I get it.

You were promised that cleantech was going to be the Next Big Thing and it didn't happen. Instead, you've seen the GPs you've backed in the sector have to face a legislative/political headwind, a dearth of big exciting exits, and a number of high-profile flameouts. At this point you're doubtful that there are big returns to be made in the sector and your colleagues are telling you cleantech is a bad place to put capital and so you're pulling out altogether, at least for the time being.

Sure, some cleantech-focused GPs tell you that cleantech hasn't actually performed worse than other sectors for the venture capital category, and they're right, technically speaking. But that misses the point, doesn't it.

As one major LP told me a few years back, the major reason for LPs to put any money into venture capital at all, with its sub-par risk-reward performance over the past decade, is in the hopes of getting in ahead of the next great bubble... and he hoped that cleantech might become that. But that was a few years back -- at this point, cleantech looks very unlikely to become a bubble sector with lots of high-flying IPOs anytime soon. So what's the point of doing marginally better than the barely-returning-capital performance of the overall VC asset category when there's no upside to a particular subsector. Especially when some of the smartest investors in venture capital have seen some major smoking craters in their portfolios in the cleantech sector.

And yes, cleantech venture capital was supposed to save the world. This was supposed to be a feel-good story. Do well by doing good, and all that. But in the meantime bigger resource shifts (namely, natural gas abundance in the US) have led to reduced carbon emissions while also lowering the competitive price targets emerging energy technologies have to beat in order to look attractive. So again, what's the point?

By now, you view cleantech as a low-upside, very difficult, politicized, capital-intensive sector with bad to mediocre returns expectations. And so naturally, you're staying away. Like I said, I get it.

I'm not going to try to dissuade you from any of the above. I think we cleantech VCs took some very questionable approaches to investing in the sector over the past decade, and now deserve your skepticism. But of course I'm not actually a cleantech VC right now, I'm investing out of a family office and don't need to ask LPs for capital and don't have a vested interest in trying to promote one particular investment strategy or another. But I do want the sector to succeed. So for what it's worth, let me just make a few points, in hopes of getting you to take a more nuanced view on the sector...

1. What hasn't changed: In the long run we need some new, efficient solutions

Yes, carbon emissions have gone down in the US thanks to some natgas cannibalization of coal-powered generation capacity. But remember even just a year ago, when natural gas was supposed to be free? It can't possibly go back up, right? So we can't possibly need additional energy resources to support continued economic growth, right?

And even without getting into supply-demand energy arguments, climate change shifts are clearly going to need to be either addressed or accomodated. Because they're real. Just ask your real-asset colleagues what assumptions they're having to make regarding climate shifts when evaluating timber and agriculture resources, or any analyst covering the insurance industry. 

And speaking of which, if we look beyond energy of course there are a host of other resource-related pressures caused by climate change or the commodities boom that will lead to a need for more efficient ways to provide shelter, food and water to humans in the future.

I'm telling you what you already know, sorry. But it's worth noting that there are still some very basic, Maslovian underpinnings to the macrotrends underlying this umbrella investment thesis we've called "cleantech" for the past few years. They haven't gone away.

2. Not every "world-saving" innovation will be a fit for venture capital

I think there was an implicit assumption a few years back that if the solution was audacious and broad enough, it was going to lead directly to an opportunity for VCs to make returns going straight at it. So we need more and cleaner liquid fuels? The direct path to riches is to make them in as proprietary a way as possible. We need cheap solar power? A proprietary formula for making cheap solar panels will result in a big IPO or three. 

Indeed, while there have been some isolated wins in both of these examples, we should just simply acknowledge that a big business opportunity doesn't necessarily equate to a great venture capital opportunity. Capital intensity, risk and timeframes can make it difficult to tackle some major opportunities head-on with a venture capital model and make superior returns. Difficult but not impossible, absolutely. But difficult.

It's entirely possible, in fact probable, that those who create the really big solutions to climate change, etc., won't be able to capture much of the economic rent that they create. That fast-followers, large corporates, governments and others will grab enough value from first-movers that those who expensively created proprietary solutions won't get the returns they deserved for it.

It is what it is. But let's acknowledge it as such.

3. Not every great return in the "cleantech" sector will be world-saving

Re-inventing entire multi-trillion industries is very hard, naturally. But the flipside of that is that making even small dents in those multi-trillion industries can end up revealing multi-billion dollar "niche" and optimization opportunities, and consequently some great returns.

What does this mean? It means that some viscerally underwhelming plays may end up resulting in great venture capital investments, even if they're not radically changing how energy is produced and consumed. Coming up with complicated financial structures for residential rooftop solar can actually turn into big business opportunities, for instance. Helping homeowners get the residential energy information and improvements they've always lacked access to can be a big growth service business. Simply providing previously-missing information to commercial/industrial building owners and managers can help launch a new marketplace for new solutions. These things may not lend themselves to holiday party cocktail conversation like "I invested in an electric vehicle that'll change the world" would, but that's not really the ultimate point, is it.

If you want your GPs to be investing where others aren't, in cleantech that means they'll be investing in some arcane, niche-y and unsexy stuff at times. And so just separate out in your mind the idea that something has to be a Really Big Idea to make great venture capital returns in cleantech. Instead, it comes down to deal size/structure, and real economic value creation, which can happen in some obscure and seemingly marginal areas.

4. If any GP tells you they know how the global climate challenge will be solved, or the "right way to do cleantech venture capital", they're blowing smoke

I see it on Twitter all the time, these debates among investors and pundits about whether the best path forward for society and for investors is heavy-innovation in hopes of a breakthrough that will result in wholescale cannibalization of the incumbent energy industry, or more immediately-feasible efficiency improvements within the current industry structure. Between those like Vinod Khosla and Bill Gates who advocate emphasizing hardcore technical innovation, and those who emphasize figuring out how to more rapidly scale-up the more efficient solutions we already have in the marketplace.

"Yes, please" to both.

So-called Black Swan events happen in any number of industries and are likely to happen in the energy and resource industries over the next couple of decades, sure. But the nature of such events is that no one really sees them coming, and that those who precipitate them don't necessary get any economic benefit from having launched a new trend which others rapidly jump in on. On the other hand, making the current energy/resource scheme more efficient might just be rearranging deck-chairs on the Titanic, in an era when we're already locked into major climate shifts

I personally don't think you can make any money betting against the innovative and self-preservation capacities of the human race. So therefore, you might as well bet on an eventual reversion to a sustainable path forward one way or another, because otherwise what's the point, any other bets are moot. The problem is, you can't just assume one of these pathways (Big Innovation vs. Accelerated Deployment) is better than the other. Or decide ahead of time which pathway will lead to better returns.

So don't...

 

What do these four points together mean for limited partners?

It means that I understand why you have been pulling back from venture capitalists in the cleantech sector. But that I think perhaps it's been overdone a bit at this point.

I've seen many very smart venture capitalists with deep experience in this sector be forced out and into either non-cleantech investment roles, or non-VC roles altogether. I've seen innovative cleantech entrepreneurs who are actively trying to avoid the mistakes of the 2000s, but who can't get the funding to get their ideas into the marketplace. 

If you believe the above four points, you acknowledge that at some point -- now, or later -- there will be some solutions that come to the marketplace with some really strong potential economic gains. And like me (my firm has made several LP commitments, ourselves), you've likely been approached by a myriad of venture capitalists with new and innovative approaches to trying to make returns off of these solutions, be they revolutionary or evolutionary. You can probably see that at some point this sector will get momentum again, in a big way, although in a form that might be different from what you've been told to expect.

Unfortunately, because you and all your colleagues have decided not to put any dollars into cleantech venture capital at all, there's no push to help get this momentum going. There are almost no first-time and/or small cleantech-focused venture firms that can get off the ground and prove out their ideas or not, because they can't get LP funding. The generalist VCs are pulling back even from the 10-20% allocations they'd had into the sector, and losing the experienced investors who could help figure out new approaches at those larger platforms. Some of you are backing a very small cadre of high-profile investors in the sector, but by and large even they are not really trying new investment models, they're just shifting to later-stage investments where sectoral differences don't matter so much. And thereby creating an early stage funding gap that has now reached crisis levels.

So my plea to you is this: Fund some experimentation. Purposefully fund some smaller, emerging efforts -- at big-named firms or at fledgling firms -- to figure this sector out. Help get early promising reinvented strategies out into the marketplace. Place a few smaller, perhaps even sub-scale (from the perspective of your governance requirements) bets that will help support the experienced minds eagerly trying to figure out this cleantech venture capital problem. They may in fact not even call it a "cleantech" focus, amen to rebranding if that's what will help. 

Because I totally understand -- from your perspective, underperformance by the cleantech venture sector is indeed a legitimate problem. But eventually, with a problem as big and important as this one, those who come up with the solutions will end up making phenomenal financial returns one way or another, and their early backers (not the too-late, solution's-obvious-to-everyone backers) will too.

And in the end, no one solves a problem by just sitting on the sidelines and not trying anything.