Now that energy efficiency is all the rage in cleantech venture circles (note to cleantech VCs: don't pitch LPs on your firm being "differentiated" because you target capital efficient businesses...), investors have been particularly attracted to the energy efficiency plays that appear to be at the intersection of energy efficiency and information technology.  The hope being that these investments would scale like an IT play, but be accessing the large market opportunity in energy efficiency.

The majority of such investments I get approached on, however, are simply information gathering and presentation tools.  A dashboard, either for the home or for a larger building, showing the user how much energy is being used and at what cost.  The idea being that the user, armed with the information, will better manage their energy use and generate savings that pay for the information tool and then some.

There's plenty of evidence that this does work.  I've talked with everyone from homeowners to big real estate managers who have used such systems and recommend them to their peers.  There's some body of studies which show that such information does result in real energy savings, on average.  But not much.  O-Power, for example, talks about 3.5% savings.  Not knocking that -- aggregated, that adds up to a nice amount of saved energy.  

But the problem for investors is that each customer is only willing to spend a very little amount to get those meager savings.  Aggregated, it might be a big deal.  But for each individual customer, even for large buildings, it's just not that much.  Alex Taussig has a nice recent post which includes some useful stats on typical office buildings, where he calculates that a 15,000 square foot US office building would on average spend around $30k per year on electricity.  That's a pretty small building, even if it's "typical", so let's look at the per square foot average electricity spend as around $1/yr.  So for a 20 story, 400k sqft downtown office building you're looking at around $400k per year in electricity spending.  Applying that O-Power metric of 3.5% savings means an annual savings of only $14k.  For a very large building -- that same building would consume about the same electricity as over 500 homes.

And how much of that $14k can an information services provider capture from that customer?  Probably well less than half.  So the vendor has to put a lot of sales effort into winning a very large building over to their information service, all to get less than $10,000 per year in revenue.  Not to mention the fact that the most likely customers to be interested in a service like this are also the ones most likely to already be running an efficient building, so the potential savings are probably less for the otherwise early adopters.  And don't forget there's a very sizable portion of the market that just won't care, either because they have tenants who pay the energy bills, or because they simply can't be bothered.  Alex preaches in his post that the vendor must bring their costs down in order to make their margins at that level.  But even if the margins as a percentage of sales are nice, how difficult will it be to add them up to something attractive in the aggregate?

Don't get me wrong, that commercial building energy information service (CBEIS) can be a very good business to own, and a useful tool for the building owner.  But from the venture investor's perspective, it's going to take a long time to scale up a business like that to something that would generate compelling returns, if that's the only service and customer benefit the system offers.  Plus, how defensible will it be when other companies increasingly offer the same thing?  I talked to one customer who's thinking about dropping one of these CBEIS vendors in favor of a pretty similar interface his utility is now offering for free...

For these reasons I increasingly think about building energy information as being an unimpressive investment opportunity by itself.  But I also think of it as being a critical enabler for significant additional services and products that can be then offered to the building owner, made possible thanks to the availability of the information.  I'm not that interested (as an investor, at least) in one of the cool-looking "home energy displays" that are being offered out there.  But if it was a loss leader to pull people into a social networking/ online shopping play based around communities of energy-conscious consumers, that might be potentially interesting.  And I bet Comverge and EnerNOC would be very interested in a residential energy information company that offered such a display but ALSO cost-effectively enabled the homeowner to participate more easily and effectively in a demand response program, via integrated controls and an easy integration into as many enabled devices as possible inside the home. 

And turning the information into action is really the key.  Automation is what will drive savings in these fragmented building energy efficiency markets.  And it's also what's going to make new energy efficient equipment be more attractive to customers, because automation will be what allows the customer to take full advantage of the efficiency-generating features of the new equipment.  A challenge for new types of equipment is that customers aren't used to doing the new activities they can do with it, but that are what drive the efficiency gains.  Automation solves that. 

A great example is news that came out today about Digital Lumens, one of our portfolio companies.  They released a story about one of the initial customers for their intelligent lighting systems that has saved 87% on their lighting bill as a result.  About 1.7M kWh per year, or enough to power 200 homes.  Some of that savings is because LEDs are an efficient lighting source in general.  But a large part of the savings results from DL's automated controls system that makes sure the lights are being used only when and where needed, taking full advantage of the unique features of LED lighting.  DL's CEO Tom Pincince wrote up a nice column about it, check it out.  

Obviously that's a specific story I'm more than happy to share.  But I hope it serves as a good illustration of my bigger point.  If all Digital Lumens was doing was gathering information about lighting and sharing that information with the building owner, would these savings result?  No.  But with the embedded intelligence and automation included in the system, such information allows the building owner to set up the settings for the system and drive some really serious savings.  

THAT'S an energy efficiency story that's scalable.  So for energy efficiency entrepreneurs, the lesson is this:  Don't just show your customers what their energy situation is.  And don't just show them what they could do to improve their energy situation.  Actually do it for them, in as automated and low-cost a way as possible.  Yes, that's incredibly more difficult to pull off.  But that's what it will take to start having some dramatic market impact.

As you pull into the parking lot, the grit of crumbling asphalt crunches under your tires. No shade trees or white curbs in this parking lot, just lines on tarmac, narrow spaces, and an unfiltered summer sun.  You get out of your car and look up at the tall, nondescript brick building, and head toward the effectively unmarked entrance, a metal door that makes you remember public schools from years ago.  A train rattles by on an elevated track directly behind the building, picking up speed as it carries its daily delivery of bankers and lawyers downtown. A few other people amble into and out of the building, but it's far from busy.  This isn't one of the newer generation buildings with retail on the ground floor and offices above, this is an old-school office structure through and through, and you can tell most of the tenants have been here for years.  Some random service providers, maybe a social services agency.  There's an elevator around the corner from the entryway, but you know it might take longer to wheeze its way to the fourth floor than walking up the stairs.  So you walk up and, catching your breath, you walk around a bend in the linoleum-tiled hallway and enter an office lit only from the windows to either side, the lights having been turned off to save electricity except for in the small area occupied by the people you're there to meet.

And you think to yourself, "This is EXACTLY what incubators should look like."  Open space, easy to divide up and then redivide up as needed.  Inspirational views, past some urban sprawl, of Nahant and the sun's twinkling reflections off Massachusetts Bay.  Low rent, but laid out for collaboration and activity.  Yes, it's a relatively new space and thus pretty empty, prompting inevitable jokes with the entrepreneurs about wintertime and The Shining.  But this space isn't designed for aesthetics.  It's designed to be a platform for thinly-capitalized entrepreneurs to get something up and off the ground.  Just around the corner from a commuter rail stop and multiple restaurants, places to sit down and have a coffee.  Productivity first and foremost, with no frills or wasted cost.  A fingertip hold, a small but effective place for a rock climber to latch onto as they scramble up to the next level.

Welcome to the Cleantech InnoVenture Center (CIVC) in Lynn, Massachusetts.  A new space launched by North Shore InnoVentures, about 20 minutes north of downtown Boston.  Housing, at first, a couple of tenants just getting started.  And they're both in the energy efficiency space.  Naturally.

Energy efficiency, specifically regarding buildings and homes, is where the bootstrap cleantech entrepreneurs are going these days.  Launching an energy efficiency startup doesn't require any breakthrough technology, or MIT-based pedigree.  It doesn't require major capital outlays just to ante up, just entrepreneurs willing to work for cheap.  And the market opportunity is huge, yet still clearly waiting for that new business model and unique approach that will unlock all the ROI that has been ignored by building owners for decades -- simply making their offices, stores, homes, etc. less wasteful.

As the capital markets have dried up, cleantech VCs have paid more and more attention to energy efficiency.  While on a dollar basis it remains behind solar and biofuels et al, energy efficiency now has the highest number of deals as a subsector, according to recent tallies by the Cleantech Group.  In part this is because VCs do see the opportunity here, the obvious customer economics, the entry of many more smart entrepreneurs, the ties into IT and internet models that have worked well in the past.  But in part this is because the VCs are now all about "capital efficiency", that buzzword du jour.  Really, VCs nearing the end of their fund life, and seeing little opportunity to raise a new fund, are looking for those 1 or 2 final deals in the current fund to only use up a small amount of capital.  I overgeneralize.  But you get the drift of what's going on.

The problem is, the same challenges that kept VCs out of energy efficiency back when solar and biofuels and EVs were hot remain solidly in place.  Tough to find truly defensible IP, since even a patentable approach to saving energy will face a multitude of competitors using entirely different IP but going after the same wasted kilowatt-hours.  And most energy efficiency startups aren't using patentable approaches to begin with.  Plus, customers remain really reticent to adopt even "no-brainer" services and technologies.  Payback periods of 2 years or better often aren't enough to convince a factory manager or hospital facility manager to take on the risk that some new energy efficiency system will negatively impact the lights, or comfort, or productivity, or simply will just generate complaints they don't want to have to deal with.  And few "network externalities", the positive feedback loops that drive internet users to all want to flock to the same websites and tools.  Furthermore, since so much of energy efficiency is in the service offering and implementation, that's just typically a mismatch for VCs unless they see strong existing market momentum they can jump on board with.  

So while energy efficiency is on the rise among cleantech VCs, it's still really tough for most energy efficiency entrepreneurs to think about VCs as being their initial funding source.  Speaking for myself, I see lots and lots of great entrepreneurs and great ideas in the sector.  But BECAUSE of that, and given all of the above challenges, it's tough for me to think about funding one of these efforts until I see proof of execution:  Customer traction, repeat business, proof of savings, significant revenue.

But how do the entrepreneurs get from just getting started around a table at the CIVC, to that point?  If VCs aren't going to go in so pre-revenue into energy efficiency as they'd done in the past with solar et al, who will help the entrepreneurs get through the first couple of years of operation?

Energy efficiency is where angel investors are really going to shine.  Angels, and efforts across the country like the CIVC.  

I took a quick look through the most recent Pepperdine Capital Markets survey recently.  It's still a work in progress, but it gets better each time.  They're still not getting enough participation from the venture community, or from New England investors, and they still need to better segment the answers from VCs so that the interesting answers from the few big-name firms don't get lost in the reported medians of so many pretty small shops.  

But the survey illustrates nicely exactly how important angel investors are going to be to energy efficiency.  It shows their strong inclination to investing in companies within 30 miles of where they live.  Service-oriented energy efficiency startups are going to be very local, at least to get started.  The survey shows that angels are really reliant upon formal and informal angel groups, and energy efficiency entrepreneurs come from the same professional networks these angels are coming from -- not just from highly technical research institutions.  And it shows that, while VCs may be forced to target what they consider "capital efficiency" right now, angels are ALWAYS having to target it, since a median $25k check can only go so far.  

So it's not surprising to see that, out of all the various cleantech segments, angels identified energy efficiency as the top area they're targeting for future investments.

This is great news all around.  It's great news for energy efficiency entrepreneurs that cleantech was the fourth most popular sector for angels (out of 18 choices), and that energy efficiency was the top choice among those seeking to do cleantech deals.  It's great that so many angels see their role as being Seed and Series A investors.  And it's really helpful for VCs that angels and facilities like the CIVC are there to give these companies the boost they need to get to the revenue stage where VCs can finally get themselves comfortable with the other challenging aspects of these startups.  

One lesson learned for angels and places like the CIVC is that they really need each other.  

CIVC and other local incubators, finding themselves inundated with interest from energy efficiency entrepreneurs just getting started, need to be thinking about angels as being the most likely funders of these companies.  Too many, I've found, focus too much on hunting for a VC to bring their capital and notoriety, instead of focusing on the investors who will be the right fit at this stage.  These incubators need to reach out to local angel groups and establish relationships with them, hosting angel-only events, providing the market context and data that angels always hunger for, bringing these groups these deals early and often.

And angels need efforts like the CIVC to be able to make sure that their $25k checks, even when matched with other angels, go as far as possible.  CIVC is just one illustration of the kind of effort that's happening in similar spaces all over the country, across the midwest, the southeast, etc.:  Efforts to promote entrepreneurship as one point of leverage as the U.S. economy tries to lurch into recovery and growth.  So angels need to be reaching out to such regional incubators, and directing these companies their way.

As these companies establish themselves in the marketplace, they'll graduate out of the incubators.  And they'll eventually raise more money, if necessary, from larger check-writers who see the momentum and now want to jump on board.

But angels, and to a certain extent the CIVCs of the world, are going to play a critical role in launching the energy efficiency innovation sector as it enters a high-growth stage over the next few decades.

You're a DC politician.  You want to do something to promote jobs growth.  You want to do something to make a reduction in carbon emissions more feasible and rapidly implementable.  And you'd love the idea of being able to give some kind of tangible value to your constituents.

Thus, Home Star is born.  The idea would be that homeowners would (either directly in the form of a voucher, or via overseeing programs, or via tax credits) get significant financial credit toward the cost of accredited home energy efficiency retrofits.  Stopping up air loss, improving insulation, upgrading appliances, etc.  It's not rocket science, but it takes someone pretty knowledgeable to do it right.  And it can save a ton of energy and dollars for homeowners.

We've known about the potential savings for a while.  The White House recently put out a report showing that residential energy efficiency retrofits on a mass scale could save homeowners $21B per year and reduce carbon emissions by 160 million tco2e per year.  The problem has been getting homeowners to actually DO it.  Left to their own devices, many homeowners balk at the up front costs involved, and don't know where to start finding a good retrofitter to work with.  So the savings don't happen.

So it makes sense to devote some resources to giving it a kick-start, helping to reduce the upfront costs and putting in place programs to help homeowners find trustworthy, qualified consultants to do the work. 

And yet VCs are challenged by this market.  The problem for VCs isn't that this isn't an attractive entrepreneurial opportunity.  It's that they don't see how to achieve a 10x out of it.  Tough to find proprietary, scalable technology-type plays that would result in high value exits.  A couple of companies have been backed in the space by institutional VCs, but even Sustainable Spaces (one of the more visible venture-backed residential retrofitters) is said to be shifting away from service and into IT-based offerings.  There are a ton of home energy monitoring efforts, but it can be tough to see any being truly differentiated from the pack.  VCs are trying to get in through the meter via smart grid type investments, but still, at the end of the day... There will need to be someone actually providing the service part of the solution. 

Home Star would be a great idea, here's hoping it happens.  And if it does, I would expect to see several VCs jump into backing service companies in the sector, following the money.  But it'll be interesting to see how they position such investments in terms of their fit with the traditional VC investment model...

PS: I will be away from blogging capabilities for the next week, so Happy Thanksgiving everyone!

Cleantech investor Sunil Paul doesn't just invest his time and effort into startups, he and a lot of volunteers have also now launched the "Gigaton Throwdown", an effort to answer a huge question:

What would it take to reduce CO2e emissions by a gigaton by 2020?

It's well worth downloading and reading the report at the GT website. 

The report looks at nine different technology areas (ones where cleantech VCs have been putting in a lot of dollars, in most cases) to see what it would take to scale up each one to a gigaton of annual emissions reductions by 2020, including an estimate of how much money would need to be invested in order to make that kind of impact.

• Next generation biofuels ("corn ethanol cannot deliver 1 gigaton of CO2e reductions because of massive land-use requirements," the report states) could achieve the target with an investment of $383B, creating 394k jobs.
• Building efficiency technologies could achieve the target with an investment of $61B, creating 681k new jobs.
• Concentrating solar power could achieve the target with an investment of $2.24 trillion, creating 484k new jobs.
• Construction materials could achieve the target with an investment of $445B, creating 328k new jobs.
• Enhanced geothermal could achieve the target with an investment of $919B, creating 448k new jobs.
• Nuclear could achieve the target with an investment of $1.27 trillion, creating 269k new jobs.
• PHEVs cannot achieve the target by 2020.
• Solar PV could achieve the target with an investment of $1.71 trillion, creating 1.63 million new jobs.
• Wind power could achieve the target with an investment of $1.38 trillion, creating 452k new jobs.

A couple of surprises here -- I would have thought wind power would have been in a better position, given existing low costs, to make a cost-effective impact on emissions reductions.

But the big winner here in terms of cost-effective impact is, unsurprisingly, energy efficiency (long-time readers of this site will know this is one of my favorite investment areas for this very reason).  And the big winners in terms of jobs creation are the service-intensive areas like building efficiency equipment/system installation and solar installation.

A few favorite areas for big venture investment don't end up looking so good, on the other hand.  Remember, this is just one (pretty good) report, and it doesn't have a direct bearing on returns potential in these sectors.  But it's still interesting to juxtapose which sectors would have the biggest "bang for the buck", versus where the venture bucks are going.

Kudos to the Gigaton Throwdown team for a great and timely report.  Hopefully policymakers will read the report -- and hopefully investors will, too.

Had the pleasure of moderating a very interesting panel at Boston University today on smart grid and energy efficiency, including representatives from the State of Massachusetts, NSTAR, GE, BU, and Millennial Net.  Lots of optimism about ongoing pilots and smart grid roll-outs.

And of course, here in this column we've talked quite a lot recently about how the cleantech VC community seems to be much more vocal about targeting capital-efficient energy efficiency and smart grid investments these days.

Except that I took a look at the details in the Q1 2009 Cleantech Venture Monitor (another great job by Cleantech Group's Brian Fan and colleagues), and there's no evidence yet of such a shift.

In their tally, solar remains the big dog, at almost 35% of all cleantech venture dollars in the quarter.  That's just barely down from the ~38% it captured in Q1 of last year, for example. 

Biofuels and transportation (not exactly the poster children for capital efficient investment areas) continue to be other big targets for VC dollars, at ~10% and ~20% respectively. 

And where is "smart grid"?  At under a 5% share.  In the Cleantech Group's methodology, energy efficiency investments tend to be spread across a number of different categories, but even the "green buildings" category garnered only ~10%, about the same as in Q1 2008.

Will we see VCs start to put their money where their mouths are in upcoming quarters?  We'll just have to wait and see.