Cleantech venture capital:  The next six months

So much for that economic stability we wistfully discussed last week.

With the economic forecast for the next 18 months looking pretty grim, energy prices have begun to fall sharply, led by oil, which is now back down below $80 per barrel.  While I often point out that oil doesn’t dictate ALL our energy prices (not much of our electricity comes from oil, for example), in this case the causality between oil prices and electricity prices is the same: the downturn reducing economic production and thus consumption of energy.  So I would expect that we’ll see (to a lesser and more delayed extent) traditional energy prices fall across all categories.

In addition, the economic downturn—and in particular the current instability—is probably making it more difficult for any potential cleantech customer to pull the trigger on any large capex item. Even when the purchase of, say, a new piece of clean water equipment would make economic sense (in terms of payback) for a food and beverage producer, they might be putting such decisions on hold until things at least settle down a bit.  However, when things do settle down, such cost-saving opportunities might get even more attention than they were before.  Higher-cost purchases done primarily for “green marketing” purposes, on the other hand, will be a tougher sell…

Here’s one man’s two cents’ worth, in terms of what I expect to see happen in cleantech venture capital over the next six months.  This is just my own speculation, so take it for what it’s worth.  But:

• I think there will be a hiccup in cleantech market revenues, followed by a period of slower growth.  Anyone selling capital equipment will likely see a temporary slow-down in order flow as customers wait for some basic stability to emerge out of what’s going on right now.  Technologies on the production side (i.e., power generation or liquid fuel production) will be hit harder during the slow growth period to come, as lower demand means both an impact on their economic value proposition (example: ethanol costs will be less-advantaged versus gasoline costs) and an impact on them as big-ticket items.  Technologies on the consumption side (i.e., energy efficiency) will be faster to recover if they can be sold as an expense and not as a capital budget item.  Clean technologies will generally do better than other tech sectors—I expect cleantech markets will continue to grow—but growth rates will be impacted negatively.  The recently-passed federal incentives will help with this, fortunately.

• The big growth in “venture capital dollars” flowing into this sector has been led by later-stage deals, with large, high cash-burn, capital-intensive efforts building out capacity with an expectation of an exit (hopefully IPO) in the relatively near term.  E.g., all the recent big-ticket thin film solar deals…  It’s no surprise to see Schott Solar cancel their IPO.  With the exit window temporarily shut and with most of these deals going into technologies on the production side (see the above point about those getting hardest hit), I think it’s likely we’ll see Q4 show a big drop-off in such headliner deals, and thus that the aggregate dollar amounts going into cleantech VC will show a big decline from Q3’s record numbers.  But it’s important to realize that that will mostly reflect just a small subset of cleantech VC deals—the mega-deals, the later-stage deals.

• The more interesting thing will be to watch what happens to early stage cleantech venture deals.  We’ll have to see, but my expectation is that the pace of early stage cleantech venture deals will decline, but not fall off a cliff.  There will likely be some evidence of a bit of a pause as everyone digests this current period of instability.  But the simple facts are that early stage cleantech VCs are investing for exits several years out, not for the near-term.  And they have funds to deploy.  And entrepreneurs continue to come up with good ideas, addressing critical needs and large, growing markets that aren’t going away.  So I think (guess?) Q4 will see a moderate decline in the number of cleantech deals overall, a bit of a shift into earlier-stage investing, and a big decline in aggregate dollar amounts.  And early-stage will be the first to pick back up going forward.  Early-stage cleantech venture capital remains a very attractive investment area.

• As we saw this summer, when the exit window does start to re-open, cleantech will probably lead the way.  When will that happen?  I can’t say.  But I do think that even an economic downturn wouldn’t stop some good cleantech exits from taking place.  Instability shuts the exit window for everyone, but even a recession—if stable—could see some good exit activity, if somewhat less than might have been hoped.

• Nevertheless, I think we’re going to see some big-name cleantech startups implode.  Some companies that have chosen a supernova growth path of high cash burn with the expectation that revenues will quickly ramp up and massive amounts of follow-on funding (via IPO, many hoped)...  Any such companies that needed to see an IPO over the next 6 months are going to be hurting.  Especially those who had taken on large amounts of debt as well.  Some will muddle through.  But I think it quite likely that we’ll see some high-fliers not be able to make it through the next six months, or however long it takes for the later-stage investing and IPOs to pick back up.

• The above points are a mixed bag, reflecting the mixed reality I expect will emerge in our sector.  But I also expect that the news headlines will be pretty merciless.  Because we’ll see some big-name companies hurting, and aggregate dollar amounts fall way off, journalists will over-react and turn into Chicken Littles real quick.  That’s what they do…

• Meanwhile, while I hope it’s clear from the above descriptions that I’m not sanguine about the prospects of such strong market growth in cleantech over the coming period, I do think that cleantech will likely be better-insulated than many other economic sectors.  I expect cleantech markets will continue to grow, if more slowly.  So all those “green-collar jobs growth” efforts that have been pursued out there might start paying dividends even sooner than had been expected…

What we’re generally telling our portfolio company managers is that it is not time to panic.  It’s a time to make sure and manage cashflow carefully, and to focus on providing good economics to customers.  And to plan around a wide range of scenarios, including the possibility that things will slow down in their market pretty significantly for a while.  But since at our firm we tend to favor lower cash-burn investments anyway, no need for radical shifts in strategy, or pulling back on growth efforts.  Fingers crossed…