The two kinds of disruptive clean technologies

Almost all VCs will say that they look to invest in “disruptive” technologies—new products or systems where the value proposition is so markedly better in comparison to the incumbent choices that the market will have little choice but to go with the new option.  Venture capital, needing to see rapid growth potential, naturally needs to see such opportunities, so it’s easy for VCs to say that they’re looking for Disruptive Technologies.

But VCs mean different things when they say this.  And in cleantech, the differences between what I’ll call Compatible Disruptive Technologies and Incompatible Disruptive Technologies are, perhaps, even more stark than in other sectors.

Compatible Disruptive Technologies (let’s create an acronym and use “CDTs”) are those that offer significant economic disruption, but without necessarily disrupting value chain relationships (at least at first).  They are the solutions that dramatically reduce costs versus the status quo, but still go to market through the same channels, and could fit nicely into customers’ facilities/ habits/ lives without too much of a mental or behavioral shift.  They offer such a cost or other economic advantage, however, that they are still “disruptive” versus incumbent approaches within their targeted portion of the value chain.  And often, the hope is that once they get into the market in a traditional way, they will further disrupt the rest of the value chain in some fundamental way.

Incompatible Disruptive Technologies (okay, okay, “IDTs”...)  are those that blow up value chains.  To be successful, they must have compelling economic value propositions as well, or no one would go through all the trouble.  But to be successful, they also require some pretty fundamental shifts in value chains.

Some examples might help break through all the ex-consultant lingo…  The differences between these two kinds of disruptive technologies can be found in most cleantech sectors.

• Hybrid vehicles are CDTs—you’re still filling up at the gas station.  Fuel cell powered vehicles are IDTs—you’re filling up with hydrogen from some as-yet unknown retailer or home option.
• LED-based lightbulbs with edison screws are CDTs—you can screw them into your existing sockets.  Lighting fixtures designed around LEDs, with the diodes integrated into the fixture itself, and other LED-only features (like specialized lighting controls) built in, are IDTs—no more sockets, you’ll throw out the entire light fixture before the bulb ever burns out.
• Thin-film solar panels in traditional format are CDTs—still a roof or ground-mounted panel, even if it’s cheaper.  Building-integrated PV could be IDTs—when roofers or general contractors can just slap products in place, who needs solar installers?

As with all jargon-y business concepts, readers are free to dismiss the distinction as non-existent, or to dismiss the specific examples above… But regular readers of this column will easily be able to point to recent cleantech VC deals that fall into one or the other category.  Anyway, charging ahead:

The markets that cleantech is targeting are huge, and resistant to change.  So in this investment sector perhaps more than any other, the investment choices between backing CDTs and IDTs are clearer.  And so you get very divergent investment strategies, where two very smart VCs may take entirely different approaches to how they invest in this sector.

Those VCs backing CDTs argue that it’s tough enough to break into the market with new tech in energy, water, etc. markets even when you’re offering little disruption and a compelling value proposition.  They point to the failure of previous “big idea” IDTs.  For example:  in the late 1990s, it was pretty much an accepted given by many observers and investors that by about 2008 or so we would be living in a “DG world”, where microturbines and other distributed generation technologies, in a deregulated electricity market, would have dramatically changed the way utilities ran their businesses and their wires.  Well, that hasn’t really played out yet, and being early looks an awful lot like being wrong, as they say.  So CDTs are seen as the way to go, because revolutionary changes in the market aren’t necessary in order to get initial market traction.  There’s an installed base of OEMs and channel partners who can integrate the new tech in easily to their existing businesses, and/or an installed base of systems out in the field where the new products can simply possibly be slotted in.  And earlier market traction means an earlier track record, more opportunities to demonstrate low remaining technology risk, and thus a more rapid path to broad commercialization and exit.  To grossly over-generalize, in comparison to IDTs, CDT plays can drive to earlier cashflow breakeven, they can therefore be more capital efficient, and still offer very big upside returns if the innovation catches on quickly.

Investors backing IDTs, on the other hand, say things like “if you’re hunting elephants, you need to bring an elephant gun.”  They argue that if you really want to end up backing the huge success stories in cleantech, you need to back the plays that will revolutionize entire markets.  That’s the way to not only back big-growth market opportunities, but also importantly to CAPTURE the market opportunities.  When you’re the one who organizes the coup d’etat, in other words, you’re usually the one who ends up in the president’s mansion.  Sure, it’s riskier.  Significant capital will need to be deployed not only to develop the technology, but also to educate and proselytize the market, and to build momentum even ahead of market entry (ie: PR, key market and policymaker relationships, etc.).  But with greater risk comes greater rewards.  And besides, if we’re going to move quickly enough to change the world in the timeframe necessary to adequately address climate change, etc., we’re going to need to move beyond what’s easy.

No one knows which strategy will produce higher returns.  It might be possible to succeed wildly with either approach.  It’s certainly possible to fail with either approach.  Really smart investors are lining up behind both strategies, and some are trying to build portfolios with a balance of both.  But it’s an important distinction to have in mind when reading about the latest deal—pay attention to who was involved, and how the deal was structured, and the patterns will emerge.

Here’s another pundit’s take on the same general topic.

Speaking of the latest deals:

• Stirling engine/ solar concentrator startup Infinia has raised a $50mm Series B, after raising a $9.5mm Series A last year.  New investors GLG Partners and Wexford Capital participated in this latest round of financing, alongside existing investors Vulcan Capital, Khosla Ventures, EQUUS Total Return, Idealab, and Power Play Energy LLC.

• Dan Primack at PE Week Wire had two scoops on Friday:  Battery developer Lion Cells has apparently raised a $12mm Series B with participation from return backers Battery Ventures and Nth Power, following on their 2006 Series A.  And in the green building materials space, Apex Construction Systems has brought in $16mm of a $22.3mm Series B, with backers including DJF Element, Nth Power and Emerald Technology Ventures.

• Pythagoras Solar has raised a $10mm Series A, led by Israel Cleantech Ventures, and including participation by Pitango Venture Capital and Evergreen Venture Partners.  More from Israel Cleantech Ventures on the deal here.

• Ed Gunther has a post up describing how Cool Earth Solar, which had previously been bringing in bridge funding, is now going to be announcing an “initial closing” on a $21mm Series A round of financing.  It’s unclear how much of that round is actually signed on at this point.  [2/19 update:  Jonathan Shieber at VentureWire is reporting that the company has actually raised a total of $21mm to date, and may take in a total of $26mm for the round.  He reports they’re also looking to bring in $10-20mm in debt.]

• Impax Asset Management has invested GBP 4mm into waste treatment startup New Earth Solutions.

• Efficient lighting vendor Lumenergi has raised a two-tranched $7.5mm round of financing, from Low Carbon Accelerator and Noventi.  The first $3mm tranche appears to be at an $11mm post-money valuation, and the second $4.5mm tranche appears to be at a $25mm post-money step-up.

• VentureBeat revealed that hybrid drivetrain startup Adura Systems has raised an undisclosed round of strategic financing from wind farm developer New Frontier Renewable Energy.  Very interesting to see a wind developer investment in a hybrid vehicle technology startup described as a “strategic round”.

Other news and notes:  Planktos, we hardly knew ye...  Cree’s acquisition of LED Lighting Fixtures will probably bring even more investor interest to the solid state lighting space, since $103mm is a pretty nice exit valuation on a company that probably had something like $2-4mm in ttm revenues...  Richard Branson wants an “environmental war room”...  Solar continues to be white-hot—besides the new deals mentioned above, Moser Baer has announced they’re putting $1.5B into thin-film manufacturing capacity, India’s $7B Fab City is switching its focus to solar, and here’s a WSJ online column on the topic...  A nice interview with Mr. Oz Cleantech, Ivor Frischknecht...  Finally, recently stumbled upon a fascinating Los Alamos presentation on the possibility of underground nuclear power parks—enjoy! (note: link opens pdf)