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Why We Need to Bring Early-Stage Venture Investors Into NextWave Greentech

Rob Day: July 7, 2014, 9:00 AM

Why do we even need to talk about the next wave of greentech? And what is it, anyway?

When I started talking about an emerging next wave of greentech entrepreneurs and investors a couple of years ago, it was admittedly just described as "not what we did during the last decade." It was defined mostly by what it was not. And that was on purpose. In the spirit of figuring it out together, the idea was simply to learn the lessons of what had not worked, and to develop a variety of new strategies with more pragmatic approaches across the board. Hardware, software, internet, service-based models, all of them. A big tent.

Therefore, the term was somewhat vaguely defined.

As we're now exactly one month away from the NextWave Greentech conference, I've been reflecting a bit on some of the lessons learned over the past couple of years. And I think many of these efforts are now converging in a consistent new way of thinking, both for entrepreneurs and investors. It's still a big tent, but one with a consistent theme -- and one that increasingly matches where the overall venture capital community is headed as well.

If your goal is to see more greentech startups get funded and eventually succeed, this overlap with the evolution of the general venture model is crucial. It turns out, the overlap is around a pretty simple theme: capital required to get started, and time required to get revenue.

First, let's grossly over-generalize today's venture model into two broad buckets: early stage and growth stage. Early stage is the classic, romanticized image of venture capitalists who back startups during their initial creative stage. Growth stage is about putting big dollars behind established companies with significant momentum. Both models are alive and well, although in recent years there's clearly been a shift of emphasis and dollars into growth stage.

But growth stage is pretty mercenary, in that it's not very sector-specific. If a startup has an obvious growth and potential exit story, growth-stage investors will back it, almost regardless of business model, technology, etc. Which is all totally fine -- unless you want to see more greentech startups get funded, as growth-stage investors are totally neutral to that goal.

Growth stage is about investing in companies that are already on a clear path to success, but we need to see more startups helped onto that path in the first place. Because of the agnostic nature of growth stage, the funding patterns there are less of an endorsement of "next wave" pragmatism or any other theme, as it's just an aggregation of idiosyncratic stories that happened to finally arrive at an attractive stage for such funders. As such, there's no coherent, evident strategy to inform future entrepreneurs and set them on a pathway to success.

So therefore the more important constituency to engage consists of early-stage investors. And where are early-stage investors trending these days? 

Mark Suster has pulled together a great presentation on this topic, "Why It's Morning in VC." It's a great overview of the industry in general, and he also includes a couple of key factors that early-stage investors are taking full advantage of right now that I want to specifically highlight. First, he points out that the cost of starting a company has dropped by 99 percent since 1995. And second (as also illustrated in this blog post), he notes that the "time to massive revenue is the most compressed in history due to scale and deflationary economics."

Put more simply, early-stage investors these days are focused on businesses that are cheap to get started and quick to get to revenue growth.

In light of that trend, is it any wonder that such investors have shied away from investments into sectors which, according to anecdote and reputation, require a lot of capital and a long gestation period?

So NextWave Greentech is all about showing entrepreneurs and investors that we can indeed tackle these massive market opportunities in ways that are relatively inexpensive and quick to get to revenue. This is possible not only for web- and software-based greentech startups, but also for hardware innovators as well. 

Yes, this focus on making greentech startups inexpensive and fast to market leaves out some innovation areas that simply cannot fit that (nuclear fusion, for example). But across much of greentech, entrepreneurs are working on web, software, service and/or hardware models that strive for these ideals as much as possible. And that's really important, because once we can demonstrate how successful we can be at making greentech quick, nimble and cheap, the early-stage investors will find the overlap they've been needing to see.

So that's why we have the NextWave Greentech conference -- to highlight such efforts, and such success stories. To bring investor attention to the many entrepreneurs already tackling such an approach, to bring LP attention to the investors who are backing such entrepreneurs and to generally inspire more such entrepreneurs to jump in.

I hope to see you all there.

An Intimate Conversation With… FAKEGRIMLOCK

Rob Day: June 26, 2014, 2:15 PM

We're gearing up for NextWave (register today!), and I really wanted to have FAKEGRIMLOCK keynote the conference. However, the fire commissioner said it would be a safety hazard to have a fire-breathing robot dinosaur show up and possibly eat many of the conference attendees, so that idea didn't work.

What's that? You haven't heard of FAKEGRIMLOCK? If you haven't, it just goes to show the continuing (and in my mind, unfortunate) gulf between the IT and the greentech entrepreneurial communities. FAKEGRIMLOCK is a well-known startup robot dinosaur that lives on the internet and punches entrepreneurs in the face until their "fail" falls out. If you're not already following FAKEGRIMLOCK on Twitter, you should -- it's a lot of good advice for fearless entrepreneurs, in a fun format. And he's become an important tech "influencer" (pretty sure he would eat anyone uttering that phrase, however), collaborating with the likes of Eric Ries, Fred Wilson and Brad Feld. And he has authored a fun book of advice for entrepreneurs as well. Oh, and he also makes a bunch of awesome posters and such! 

So as you might imagine, I was pleased when as an alternative to introducing a safety hazard to NextWave, I was granted the opportunity to interview FAKEGRIMLOCK on the topic of greentech entrepreneurship for this column. A dangerous undertaking, but hey, I'm a greentech investor, so I'm used to danger. As you'll see below, he laid down some challenges for cleantech entrepreneurs. And as we gear up to talk about the ways to drive success out of the next wave of greentech, these are challenges to take to heart.

Rob: You usually talk about internet and IT startups, and while there are increasingly a lot of overlapping efforts in the greentech sector, much of the sector remains very separate from the rest of the tech community. What should greentech entrepreneurs learn from internet and IT entrepreneurs, to prevent becoming GRIMLOCK lunch?

WHAT LEARN? EVERYTHING.

GREENTECH THINK LIKE OLD, FAT, DYING COMPANIES. THAT DUMB. UNLESS GOAL IS TO FAIL.

LEARN FROM STARTUPS THAT WIN:

1. BUILD WHAT MARKET WANT, NOT WHAT WISH THEM WANT

2. START SMALL AND SCALE, NOT START BIG AND FAIL

3. IF NEED ARTIFICIAL ADVANTAGE FROM GOVERNMENT OR REGULATION, YOU DOING IT WRONG

EVEN IF GREENTECH, IF NO CAN BUILD VERSION THAT WIN IN GARAGE OR TINY LAB WITH HANDFUL OF PEOPLE, BIG LAB AND TEAM NOT GOING TO HELP YOU.

DO THAT, MAYBE HAVE CHANCE OF NOT BE LUNCH. NO GUARANTEE.


Rob: While there are software/internet-based startups in greentech, many entrepreneurs in the sector are innovating around hardware. Sometimes very big, capital-intensive hardware (almost GRIMLOCK-like, in fact). How can such entrepreneurs still “Win Like Stupid” if they’re tackling efforts like that?

BIG, EXPENSIVE HARDWARE DUMB IDEA. WHOLE POINT OF STARTUP IS SMALL AND NIMBLE KILL BIG AND SLOW. START BIG AND SLOW JUST FORMULA FOR GET KILLED BY SOMEONE SMARTER.

ME, GRIMLOCK, OBVIOUS EXCEPTION. ME SMALLEST AND MOST NIMBLE GIANT ROBOT DINOSAUR OF ALL.

FIND WAY TO MAKE HARDWARE SMALL AND NIMBLE. EVERYONE SAY THAT STUPID AND IMPOSSIBLE. THAT WHY YOU WIN WHEN IT HAPPEN.


Rob: I have the impression that energy/water/resource markets, unlike much of internet/IT, remain largely controlled by big, old dinosa…, er, sorry, incumbent companies, such as utilities and the like. Any words of advice for entrepreneurs on how to deal with markets that aren’t exactly welcoming of innovation?

ME NO ASHAMED OF BE DINOSAUR! ME, FAKEGRIMLOCK, HAVE PRIDE IN SELF. ESPECIALLY PART OF SELF THAT NOT COMPLETELY LAME LIKE OBSOLETE COMPANIES THAT CLING TO LIFE BY STAND IN WAY OF PROGRESS. ME NO CLING! ME NO CARE ABOUT PAST BECAUSE BUILD OWN FUTURE! JUST LIKE EVERY STARTUP.

BUT THAT ENOUGH DINO PRIDE. ME ANSWER ABOUT MARKETS.

WAIT FOR MARKET TO WELCOME INNOVATION SAME AS GIVE UP AND QUIT NOW. STARTUP KICK DOWN DOOR AND SHOVE INNOVATION DOWN MARKET'S THROAT. MARKET ALWAYS HATE NEW IDEA UNTIL IT BURN ALL THE OLD ONES TO THE GROUND. BUT NO CAN BURN ANYTHING DOWN UNTIL BREAK IN.

HOW YOU BREAK INTO MARKET? SIMPLE. ALL MARKETS HAVE HOLES. BUILD THING FIRST, THEN LOOK FOR HOLE? YOU DUMB. VERY SMALL CHANCE YOUR PRODUCT SHAPED LIKE EXISTING HOLE.

INSTEAD FIRST FIND HOLE IN MARKET. THEN BUILD THING TO FIT IT. CHANCE OF FIT ALMOST 100%.

THIS LIKE IPHONE. APPLE NOT BUILD IT THEN FORCE EVERYONE TO WANT IT. NOT EVEN STEVE COULD DO THAT. APPLE SAW IPHONE SHAPED HOLE IN WORLD NO ONE ELSE DID, BUILT IPHONE TO FILL IT. THAT WHY IT WIN.


Rob: In our sector, we like to say that we’re tackling some of the world’s biggest needs and therefore some of the world’s biggest market opportunities. And indeed we’re seeing a lot of great market growth now in areas like solar, electric vehicles, and smart lighting. Yet thus far, innovators even in these high-growth areas have had a hard time getting rewarded for all the value they’ve created. What needs to change?

HUMANS MOSTLY SELFISH AND LAZY. EVERYONE WANT TO SAVE PLANET UNTIL IT COST THEM SOMETHING.

BEST WAY TO SAVE PLANET IS MAKE IT COST LESS THAN NOT SAVE IT.

WANT EVERYONE TO BUY ELECTRIC CAR INSTEAD OF ONLY RICH HIPSTERS? MAKE JOY OF OWN ONE MORE THAN PAIN. FOR EVERYONE.

WANT EVERYONE TO GET SOLAR PANEL? THAT HAPPEN WHEN BUY ONLINE, PLUG IN WALL, PAY FOR SELF IN 1 YEAR IS ENTIRE PROCESS.

ALWAYS ASK WHAT IS REASON NO ONE WANT YOUR THING. THEN REMOVE REASON. OR BUILD SOMETHING ELSE.

UNTIL THAT HAPPEN, GREENTECH STAY SMALL, LOW MARGIN, HARD TO MAKE MONEY.


Rob: VCs went big into greentech during the past decade, and it didn’t work out well, at least the way it was tried back then. Now few VCs will even touch anything labeled “greentech” at all, because it’s “too hard." Any words of wisdom for these VCs, and for the entrepreneurs pushing ahead even while VCs back away?

WHEN GREENTECH START ACTING LIKE STARTUP, VCS COME BACK. LONG AS GREENTECH ACT LIKE OLD DYING BIG CORPS, VCS STAY AWAY.


Rob: Do you have any favorite greentech startups or products/applications, and if so, why?

NO. ALL OF THEM TOO MUCH PAIN VS GAIN FOR THIS DINO. THEM SHOULD FIX THAT.

(RD note: I'm pretty sure FAKEGRIMLOCK was manufactured in a factory lit with Digital Lumens intelligence, but I'm not certain)


Rob: When will greentech entrepreneurs know that they’ve “made awesome”?

WHEN EVERYONE DESPERATE TO BUY PRODUCT BECAUSE IT AWESOME, NOT BECAUSE IT GREENTECH.


Rob: Anything I didn’t ask you, that I should have?

PROBABLY. IF YOU ESCAPE INTERVIEW ALIVE, MAYBE ME TELL YOU WHAT.

RUN NOW.

 

Fortunately, I managed to escape alive (for now), so you'll still be able to see me up on stage on August 5th at NextWave. More importantly, you'll see a lot of smarter and more photogenic people up on stage, and in the networking breaks. So be more awesome -- and be there.

The State of Cleantech Entrepreneurship in 2014

Rob Day: June 17, 2014, 1:25 PM

As the time approaches to get serious about NextWave14 (coming up in just a few weeks!), I thought it would be a good time to take a step back and review how the overall "sector" is doing right now. And by and large, it's a happy picture.

The markets are booming

I put "sector" in quotation marks above because we all know that this is really a collection of a wide variety of markets and applications gathered under a consistent investment thesis. Cleantech isn't a sector; it's a lens for finding big opportunities across sectors.

But across many of those markets right now, we're seeing amazing growth continue.

The above statistics are just a short list of relevant market stats -- markets for new technologies and business models in other areas like water, food and transportation are all growing quickly as well. And let's not forget, the market opportunities are perhaps even bigger for the developing world.

Ten years ago, I remember a lot of optimism about the potential for exciting market growth in cleantech. Now that's a reality. It's very exciting to see. As McKinsey recently stated quite plainly: "The world is on the cusp of a resource revolution."

The big corporates are jumping in

From fuels to smart buildings to storage to transportation, there's never been more serious corporate interest in the next wave of technologies and business models. 

As I recently pointed out, a large proportion of the growth-stage cleantech venture deals now being done include -- and sometimes are even led by -- corporate investors. Anecdotally, I've seen a surge in proactive outreach from corporate strategy groups and business unit leaders to the startups I work with on a regular basis. 

Even more exciting, at least to me, is seeing some of these big companies start to redefine the markets they're in and gear up for emerging market battles that once would never have been dreamed of. 

  • David Crane declaring that NRG is heading "down the path toward a distributed-generation-centric, clean energy future featuring individual choice and the empowerment of the American energy consumer"
  • Google getting into home energy automation, and reportedly gearing up to distributed energy management
  • Industrial automation giants are realizing that energy automation is a crucial part of what their customers expect
  • Automakers are busy partnering with, or copycatting, Tesla
  • And encouragingly, the big "cleantech giants" like First Solar, Tesla and SolarCity are themselves partnering, opening up new markets and making acquisitions. Our sector is no longer dependent solely upon outside/incumbent big companies "waking up" to the opportunities in the space.

The venture investors aren't paying attention

I recently wrote about the dearth of early-stage VCs and the abdication of growth-stage VCs which are leaving many of the best startups to be invested in by corporates, foreign-based investors and other non-traditional investors like family offices. 

It's frustrating, but perhaps not that surprising in light of the highly mediocre returns such investors saw from their earlier forays into the sector, and the high-profile losses some have experienced. Oh, and Solyndra. Always with the Solyndra.

But that's not what NextWave greentech investing is about; that's last-wave thinking, driving while staring at the rearview mirror. And there are some early encouraging signs that LPs are starting to put some money back into the sector. And that mainstream VCs are perfectly willing to invest in adjacent areas, as long as the opportunities are business-model innovations and not explicitly "cleantech" (because "we don't invest in cleantech"). 

This sector is totally sidelined right now by the venture investor community. But that's got to be temporary, an aversion based upon labels more than market reality. There's no way so many smart investors will continue to pass up on the growth opportunities so obviously illustrated above. What's needed to bring back early- and growth-stage capital is a stronger pattern of exits. 

Fortunately...

The exit paths are clearer

The IPO window is open again for cleantech startups. SolarCity, Silver Spring, Aspen Aerogels, Opower, BioAmber, Control4, Marrone and several other companies are rumored to be lining up to IPO as well. 

Besides IPOs, acquisition activity is also heating up. The most obvious example is Nest, but others include ecoATM, Climate Corp., Novaled, Silevo, Zep, and many others. We're starting to see acquisitions as corporations pursue the expansion strategies described above. And even more encouraging, we're starting to see strategy-driven (as opposed to opportunistic) vertical and horizontal consolidation in areas like solar and water

All of this is boosted, of course, by increasing mainstreaming of these technologies on Wall Street and the overall strong recent performance of the sector there

The politicians in D.C. are still being stupid, but there's state-level progress

In D.C., they're still blocking bipartisan, moderate, smallish energy bills. Okay, forget them and their inability to govern. There's some hope that the newly announced EPA regulations will encourage more investment in clean technologies, but it just seems pretty indirect to me. Whether you are for or against the regs, they're not really relevant to my day-to-day work as a cleantech investor. 

But the much more interesting political conversations are happening at the state and local levels. Perhaps the best indication that we're winning on a number of fronts is that the state and local political backlash is ramping up -- nothing says "scared incumbents" like a bunch of deep-pocketed, regional efforts to obstruct innovation. Or scary talk about "death spirals."

But while state-level policy battles on cleantech are a mixed bag right now, there are encouraging signs of solutions going forward. Massachusetts just demonstrated how utilities and solar companies can collaborate for a win-win solution, for instance. California's encouragement is providing a great early entry point for energy storage innovations, and New York and Connecticut are two other states where smart policies are providing cost-effective encouragement of cleantech adoption.

And this isn't strictly a "red state/blue state" thing. Polls consistently show that voters in all states want more access to distributed, clean energy and energy efficiency. So pragmatic state-level leaders across parties are figuring out ways to promote this access, some more quietly than others. It's not a unanimous trend, but it's a clear trend at the state level.

The startups are stronger than ever

Most importantly, five years after a major economic downturn that put the sector on its heels, the cleantech startups that survived are now quietly doing quite well indeed. I can observe this firsthand in our own portfolio, where revenues across the companies we work with continue to grow quickly. And because my firm also at times acts as a limited partner, I can see it in other investors' portfolios as well.

Many startups that survived through lean times are now poised for growth. And startups that were better positioned because of lower capital burn, or launched after the lean times with smarter business models, are doing quite well indeed. Cleantech startups are healthier than ever.

We're seeing a widespread adoption now of business model innovation entrepreneurship in this sector: new service models; downstream startups taking advantage of all of the cost declines upstream; and new financial-based models that profitably merge new innovations with project finance, where there's deep appetite right now for yield. Cleantech startup models are smarter than ever.

And for those startups fortunate enough to be backed by deep-pocketed and dedicated investors, there's a lot of expansion opportunity in such fast-growing markets. When I talk with entrepreneurs in the sector these days, they're often no longer "playing defense." They're hungry to grab the opportunities they see in front of them. Cleantech startups are more aggressive than ever.

In short, there's a lot to be excited about right now in cleantech entrepreneurship. The state of the sector is mixed, mostly because the investors are slow on the uptake. But everyone else can see quite clearly that the next wave is here. When the capital does inevitably come back, this sector (however it's labeled) is poised to take off.

Looking forward to talking about this with you, and hearing a lot more success stories, at NextWave14!

Smart Investors, Not VCs, Are Funding Growth-Stage Cleantech Startups

Rob Day: June 5, 2014, 12:00 PM

Sign up for NextWave Greentech! Seats are filling up quickly, and it sold out last year.

***

A couple of weeks ago, I wrote up an analysis of early-stage cleantech venture rounds so far this year. I came away with the conclusion that very little was happening, except for in cases where a startup could perhaps be considered "cleantech" but was actually funded for entirely different reasons. Basically, that there are very, very few early-stage cleantech venture funders right now.

So I wanted to look at growth-stage financings in the sector (North America only) to do a similar "analysis" (read: lots of SWAGs and judgment calls, so treat accordingly) to see if the picture looks any different.

It does look different, and in some interesting ways. But the picture is only a little bit happier than it is for early-stage funding, it turns out. Basically, U.S. venture capital firms have taken their aversion to the cleantech sector to completely irrational levels, so that while there are definitely growth-stage financings happening (because there are strong, fast-growing companies in the sector), they're not being done by VCs.

But I overgeneralize. Let's look at some specific trends.

1. Yes, there are growth-stage financings to be found in the sector

After knocking a few deals out of the dataset I was using because of a lack of fit (e.g., due to stage, size, sector, or the deal just being a final closing on a 2013 financing round), I was left with 55 transactions. Fifteen of those were just pure insider rounds with no new money identified, so we'll subtract those from the tally. But even still, that's 40 or so cleantech startups that were able to attract significant investment from new investors so far this year.

If you can build a strong company with demonstrated growth and solid forward market potential, smart investors don't care if you're "cleantech." They just like viable growth investments, period.

2. It's all about the corporate dollars

Somewhat impressively, eighteen of the funding rounds I identified had some significant new corporate investors as the primary new money in a deal. In a fair number of these cases, the corporate investors were even listed as the lead investor.

That's unusual, because corporates and their affiliated VC groups typically have not wanted to play the role of lead financial investor in a round. In many cases, the corporate entity has strategic reasons to invest at almost any price, so they prefer to leave the actual pricing and structuring of the round to the VCs coming in alongside them. They also may be restricted internally in their ability to take on board seats, etc. So to see so many corporate investors playing a lead role right now is quite notable.

And the overall proportion of deals including significant new money from corporates is fascinating as well. It's high, and it speaks to the clear market opportunities here. Large corporations see cleantech (using the term broadly; in most cases, they would define their specific interest more narrowly) as a huge market opportunity that is strategically important to them to be involved in. They want exposure to the fast-growing startups in the sector. This is a huge validation point for the market overall.

So to see so many growth-stage deals where corporates are the ones having to step up to lead, knowing that's not their comfort zone, is quite an indictment of the venture community. It means they're giving up on the VCs. 

Furthermore, in many of the other deals where corporates didn't lead but were significant new investors, it looks like they were the only new investor. So there appears to be a pattern right now of insider VCs setting terms on new financing rounds to enable non-lead corporate VCs to make an investment. Again, this isn't the typical path for how "venture investing is done."

I've seen a fair amount of this dynamic anecdotally -- in some specific cases, corporate investors have decided they really want to put money into a startup and actively pester VCs in their network to put in a term sheet so that they can do so. Distressingly, even that sometimes seems to fall on deaf ears, and so the insider VCs must step up themselves to make it happen. 

3. No real clear pattern of sector preferences

I didn't really see any striking pattern of some sectors being clearly more in favor than others. The investments ran the full gamut of cleantech subsectors. Perhaps there was a slight emphasis on electricity storage, but for the most part, what seems to be attracting investment is a strongly positioned startup, rather than what subsector it's in. Per the point above, corporate partnerships obviously are important, in addition to (or in some cases, it seemed, as a proxy for) revenue growth, but that was hard to quantify.

4. Investors from "outside the box"

In cases where it wasn't a corporate investor leading the round, it wasn't a cleantech VC, either. I only counted four deals out of that entire dataset where a cleantech VC was an outside lead in the round.

Instead, the leads came from the family-office and high-net-worth-individual communities. Or they were more mainstream private equity players with no particular cleantech or VC activity focus. Or, interestingly, they were PE firms from overseas -- four of the deals were led or co-led by China-based PE firms or corporations, for instance.

That's right -- so far in 2014, you're as likely to get a term sheet for your U.S.-based cleantech growth round from a China-based investor as you are to get it from a U.S.-based cleantech venture firm.

All this confirms for me that the capital markets for cleantech venture capital are just completely irrational right now. Few cleantech-specific venture firms of any stage preference can raise new funds from LPs, so they're not writing checks themselves. And generalist VCs won't touch the sector with a 10-foot pole -- even while large corporate players are eager to make investments (and therefore, ostensibly, acquisitions) in the sector, and even while investors who aren't as subject to the negative stigma around "cleantech venture capital," such as PE players from overseas and family offices, are all happy to put money to work into growth stories regardless of sector.

I can understand VC pullback from the cleantech sector to a certain extent, given the lame returns and bad reputation previous investments in the sector earned. I can understand a fair amount of skepticism toward the sector among Silicon Valley VC types. A pullback and rethinking and skepticism have all been warranted, for sure, given past experiences. But c'mon, people -- we're five years into this negativity cycle. We're now seeing success stories and real exits. We're now seeing lessons learned. And quite clearly, we're seeing a significant number of fast-growing companies. The next wave of cleantech is here now -- for anyone who cares to look for it.

Don't give me excuses about capital intensity. VCs with big funds to deploy have always loved an excuse to put a big check behind startups with obvious momentum. Don't give me excuses about "long gestation periods," because we're talking about just the growth-stage companies that would be at the tail end of any such development period anyway. And don't give me excuses about "unclear exit paths," because obviously there are lots of engaged acquirers in the marketplace, as well as recent evidence that cleantech companies can enjoy the current IPO window just as much as non-cleantech companies can. 

Basically, if you are an investor who is insulated from concerns about the supposed "cleantech crash," then you're happy to put money to work behind the many fast-growing startups in the sector, because you don't care about the sectoral label. But if you are still carrying around that "cleantech crash" reputational burden, you won't touch the sector even when the deals look attractive. In my experience, many of these VCs won't even take a first meeting, not even to learn about how the sector is evolving. This is very obvious and counterproductive herd behavior, much beyond what investor logic should dictate. There isn't one contrarian generalist VC firm out there, ready to reap the benefits of ignoring everyone else's irrational investment fears, and focusing on fact-based investing?

Really?

Tell me how this makes sense.

Could Cleantech Lead the Democratization of Venture Capital?

Rob Day: May 29, 2014, 12:36 PM

Did you buy your ticket to NextWave 2014 yet? You didn't? Get on that! It sold out last year, so don't wait until it's too late this year.

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

In my last column, I ran through recent numbers and showed that there are very few early-stage venture capital check-writers in the cleantech sector right now. By the time you peel out startups that wouldn't think of calling themselves "cleantech," follow-on rounds reported as first rounds, and stuff that's just not a fit, the numbers dwindle down to only a very few deals at that stage.

But there's good news. Crowdfunding seems to be providing some success stories out there.

FINsix, a cool company with power electronics innovations, raised its Kickstarter funding target in less than 12 hours.

Embue is another Boston-area cleantech startup that's just launched a crowdfunding campaign and already has 55 backers.

And heck, even this crazy idea apparently raised $1.4M via crowdfunding.

Limited partners may not be providing the capital for early-stage VCs to put money into cleantech right now, but the general public is still entranced and ready to put money to work behind cool and/or planet-saving ideas, sometimes as angel investors, and certainly in the form of donations or prepaid revenue through these crowdfunding platforms.

For a few years now, an argument has been made that such crowdfunding will "democratize" the venture capital industry. Essentially, venture capital has always been a fairly exclusive investment category, out of legal necessity, because it's a private equity asset category and thus restricted (in its indirect forms, at least) only to a small subset of high net worth individuals (at least in theory) and larger institutional investors like pension funds. But at the same time, venture capital firms have shifted to larger funds, which means shifting toward later stages -- and needing to write bigger checks even at earlier stages. And as always, professional VCs have mostly been looking for a very small number of opportunities that fit a pretty unique set of very lofty expectations.

Angels could in theory fill the gap left by the VCs that are exiting stage left, and that does happen to some extent. But in reality, too many angels just try to out-VC the VCs, funding the same kinds of companies. And aside from great platforms like AngelList, they're hard to find outside of the 3 Fs (friends, fools and family). Government grants and small business loans can be helpful, but they are also hard to access and typically pretty restricted in their application.

Basically, the idea is that crowdfunding, especially as now further enabled by legislative changes, could fill in the early-stage funding gap. But it's been slow to happen. Oculus was one success story (blowback aside), but many early-stage VCs in the tech sector appear able to hold their own, cherry-picking the best early-stage startups and backing them to the exclusion of -- or at least alongside -- crowdfunding. The democratization of venture capital is happening, but perhaps not as quickly as some may have expected.

Looking back at cleantech, the VCs have mostly headed off to greener pastures (pardon the pun). This has left the field wide open for crowdfunders, who now can not only avoid negative selection bias, but can actually cherry-pick the best startups themselves without much competition from reputationally advantaged VCs with bigger checkbooks. 

Perhaps, just perhaps, cleantech is where the democratization of venture capital will gain the exploitable bridgehead that eventually helps make a real impact on the venture capital world.

These examples suggest to me that all early-stage cleantech startups should at least consider crowdfunding efforts. Not only is it a potential source of some capital (although typically a smallish amount, the example of Solar Roadways notwithstanding), but it's also an important early test of how compelling your idea is and how good you are at selling it.

As FAKEGRIMLOCK so artfully points out, it's fine to fail as long as you do it quickly and try another idea right away. But it can be tough for hardware startups to fail quickly, and many cleantech startups are hardware-based, so failing quickly is tough.

But you can still test your application very quickly by trying to crowdfund it. If you can't articulate a compelling application for your technology, you're not really an entrepreneur; you're just an inventor. If you articulate your application and people won't throw some money at it, then maybe it's not such a compelling application, and you may have some more thinking to do. But if people get excited about your application like they did about FINsix, that's really valuable market validation -- and prepaid revenue. Not to mention PR -- heck, it seems like crowdfunding campaigns get more gushing press coverage than venture capital rounds these days anyway.

That said, it's important not to confuse such validation for technical feasibility, obviously. That's a whole separate challenge, and one you should seek to solve before initiating a crowdfunding campaign for your application (or you could end up pissing off a lot of disappointed people). And don't confuse validation from crowdfunders with customer validation if there isn't strong overlap between the two (such as would be the case with most B2B plays). So this isn't a recommended path for all cleantech startups out there.

But if cleantech could be the place where the democratization of venture capital gains momentum, you should think about getting on board, too.

So Who’s Still Funding Early-Stage Cleantech?

Rob Day: May 20, 2014, 12:34 PM

I'm generally an optimist, and there's lots to be optimistic about right now in the cleantech sector. I've never seen a stronger group of startups in the sector as I see right now, with many fast-growing companies poised to do great things. It's what we're going to be highlighting at the NextWave Greentech 2014 conference on August 5th in Menlo Park -- last year's conference sold out, so get your ticket today so you don't end up on the waitlist like a bunch of disappointed folks did last year.

That said, I have to say I was surprised when I did a little research project recently to figure out who's funding Series A and B rounds for cleantech startups. You see, my distinct impression from talking with entrepreneurs and VCs in the sector was that very little at the early stage was getting funded. But when I looked at the details in a popular deals database, for rounds above $2 million in size, I was pleasantly surprised to see over 60 such rounds recorded so far this year in North America alone! If there are so many early-stage deals getting funded, all's good, right?

And then I started looking through the details.

What I did was to look up all of those deals' press releases and/or Form Ds to see the revealed details. And some caveats here -- it's always very incomplete information (unreported deals, selective information in press releases, etc). But I was interested in a few patterns I found, and I thought readers might be interested in them as well.

So who's funding cleantech startups right now?

1. (Crickets)

As I went through the details, a lot of what was being recorded as a "cleantech Series A" or "cleantech Series B" turned out not to be such. There were a bunch of recorded financings that actually had been initially closed in 2013, or even earlier in some cases, and which had been re-recorded in 2014 because a press release was belatedly put out, or the round had been re-opened for insiders to put more in, etc. Or they simply weren't "green" companies at all.

To be clear, I tried to be inclusive. Even if a round seemed to be an extension of an earlier financing, but it mentioned a new funder, I considered that a new funding -- after all, I've been a "lead" on re-opening a few prior rounds; it's just one way of structuring a new investment but can still reflect an active decision to write a check. And there were a bunch of "Is that really cleantech?" judgment calls, but unless it was pretty clearly not greentech I left it in. A few oil-patch techs got left out, that's it.

And yet by the time I screened out the clear mismatches, I'd knocked out nearly half of the Series A and Series B rounds. I was left with only 36 such financings so far this year.

Importantly, there were no funds that were clearly very active investors at this stage. The only firms that showed up as a major new investor more than once were DBL Investors, and Andreessen Horowitz (more on that below). And there was a long list of notably missing "big cleantech firms": No RockPort. No Nth Power. No Chrysalix. No EnerTech. No Claremont Creek. No Angeleno Group. No SAIL. And yes, no Black Coral Capital (my firm). 

That last one brings up an important point -- the fact that an individual firm didn't appear as a lead investor on a reported early-stage venture round in the first four months of 2014 shouldn't be considered indicative of their individual activity level; deals come and go. I can attest that in our own firm, it's not for lack of effort or interest that we haven't been a deal lead thus far this year, so perhaps that's the same for others as well. 

But in aggregate, it points out that the "traditional cleantech funds" have been awfully quiet lately, especially in the early stages. For many of them, including some listed above, they no longer have the funds to be active lead investors. They're near the end of their fund life, they're husbanding their remaining capital reserves, they need to raise a new fund, and in the meantime, they're taking meetings to stay in the mix, but are mostly just biding their time. And for other firms, including my own, the lure of being able to invest in later-stage companies in an increasingly capital-scarce environment pulls us away from early-stage investment. So when we're overwhelmed with deal opportunities like we are right now, we're definitely skewing toward later-stage companies. I would assume that other firms are as well.

The upshot, however, is that right now there are no "go-to" firms for funding early-stage cleantech startups. For entrepreneurs at that stage, it's a harsh reality.

2. Food is yummy

I actually wasn't expecting to find so many food-related startups on the list, but it was striking how many of them there were once I dug into the details. Out of those 36 reported financings, eight were in some kind of food play that may or may not even be "cleantech" at all. Take FreshRealm, Sprig, Plated, NatureBox, and Munchery, for example. Do these really belong on a list of cleantech venture financings? I'm willing to include them, because the definitions of the category are clearly being exploded. But does this pass the sniff test?

Interestingly, in this subcategory we find many of the rounds led by decidedly non-cleantech venture capital groups like Andreessen Horowitz. So they're not considering these to be cleantech startups either.

Regardless, it's clear that food is in. VCs are stuffing their faces with food delivery startups in particular. I would go so far as to suggest there's a mini-bubble in food delivery startups and food logistics startups right now.

3. Don't call yourself a "cleantech" startup

Out of the 36 "cleantech" Series A/B financings I counted so far this year, only eight were led by VCs I would consider "cleantech investors" in any way. And I was being inclusive in making that determination. I'm not talking about just pure-play cleantech venture firms; I'm also including investors whose websites in any way mention the sector, even in vague terms.

Cleanweb startups were invested in by "online marketplace" investors.

Food startups were invested in by "consumer and brand" investors.

And the list of leads included a fair number of what were clearly just "right connection at the right time" investors.

"Cleantech" is out of favor. "Clean energy" is out of favor. And yet these are massive markets. So there will be lots of ways to attack these markets. Some of these approaches will appeal to mainstream investors like Andreessen Horowitz and others, who see business models that are familiar to them and mega-sized markets being targeted via those models, and would never have selected a company because it was a cleantech startup. So therefore I found on the list startups like Granular and Twice. Do you think their investment pitch ever mentions "cleantech" or anything like that?

Heck no.

We are all broadly attacking natural resource scarcity, and that can be done directly or indirectly. It can be done any number of ways that take advantage of the 3 Rs (reduce, re-use, recycle) which also yield economic benefits. Furthermore, markets like solar on rooftops are exploding like few markets have ever grown before. Natural resource scarcity is a massive mega-trend revealing massive mega-markets.

So if your business is at all addressing this mega-trend and these mega-markets, be encouraged that you are right in the thick of a really big economic transformation. But don't describe yourself as a cleantech company. Describe yourself in a way that speaks to the fact that you're offering a new marketplace, or a new financing platform, etc., that happens to be aimed at a multi-billion dollar market in desperate need of reinvention. Oh, that's the energy market? How interesting...

I honestly don't consider this to be a retreat, on the whole. "Cleantech" was always a thesis much more than it was a sector. And I really could care less how an investor finds a winning investment, whether it's via looking for new marketplaces/tools/brands/etc. across markets, or via an interest in the particular market the marketplace/tool/brand is in. A few years back it was fashionable to declare publicly that "cleantech is a temporary description" and that " cleantech won't exist a few years from now" because it would be an underlying concept subsumed into other categories.

We're now at that point, it's pretty clear. And that's a good thing.

4. To VC or not to VC: That is the question

Out of the 36 rounds I looked at, eleven were led by corporates, family offices, high net worths or other non-institutional venture capital investors.

Between them and the rounds led by smaller regional (and thus ostensibly more omnivorous) VCs, they covered most of the funded early-stage startups that one would consider to be more obviously "cleantech" startups. Remember, many of the rest of the startups on the list were on the margins of "cleantech" anyway.

If you're a cleantech entrepreneur, your first instinct when looking to raise venture capital will be to go to venture capital firms, because they're the most visible funders. And yet, my distinct impression looking over this data and reflecting upon what I'm seeing in the market is that there are lots of VCs still taking meetings, but few checks are being written. So instead of taking a narrow approach to raising a Series A with VCs, keep focusing on angels and bigger check-writers who look a lot like angels. Or get strategic partners you already have a relationship with to write a check, call it a "venture round," release a PR, and move forward. Clearly, that's what some of your peers are doing.

I would guess the number of North American "cleantech" venture firms willing to actually lead a Series A or Series B is probably only around ten or so right now. Which is pretty sad. But sad or not, plan accordingly.

I'll try to do another look at later-stage funding sometime soon. I expect a slightly happier storyline there. In the meantime, if you care about greentech, come join us at NextWave14 as we celebrate and highlight the increasing number of success stories in the sector. Successes should breed successes, so let's talk about them.

 

Venture Capital, Family Offices and the Drive for More Cleantech Success Stories

Rob Day: April 22, 2014, 11:00 AM

A while back, I wrote about the role “impact investors” could play in funding the next wave of cleantech startups. This week I had the opportunity to sit in on a conversation between several such investors from the family office community and some of the smartest generalist VCs still investing in the sector. It was a fascinating and educational afternoon.

The gist of the conversation revolved around one basic idea: how impact investors and VCs can work together to drive more successes in the sector. Because such successes (“we need ten Teslas, not just a couple”) would bring a lot more mainstream investors and entrepreneurs into the sector and feed a new wave of cleantech commercialization. It's a great conversation to have.

Let’s take a step back and look at the “traditional” role of family offices and other similar types as investors in the startups backed by mainstream VCs. To understand the relationship, it’s important to understand how many such family offices are organized. Theytypically don’t have large staffs -- the investment decisions are made by a very small team, which often includes a member of the family itself. They typically cover a very broad range of investment asset categories, too: One day it’s evaluating hedge fund managers, another day it’s considering a set of publicly traded equities, and a couple of times a year there may be consideration of a “venture capital” round. I’m overgeneralizing here (after all, the old joke is “if you know one family office, you know one family office,” and certainly our own firm is a clear exception to this broad characterization, as are many others). But it’s a good enough model to use for this discussion.

With a family office like this, even very smart investors at such groups don’t have the bandwidth to do significant research into every investment opportunity, to do full diligence, or to learn the ins and outs of how various asset categories behave. So the idea of such groups being “lead investors” in a select few venture capital investments is difficult to fit with the above model. There’s certainly some of that that goes on. But by and large, such groups end up being followers more often than leaders.

So unsurprisingly, the relationship between VCs and such family offices has been one where the VCs fund the early rounds, and then FOs and other non-VC investors (corporates, hedge funds, bigger financial investors, PE firms) come in for larger, later rounds. Many of the most famous (and infamous) startups over the past decade of cleantech venture capital ended up with such FOs quietly investing in later-round deals because of this dynamic.

The dynamic relies upon trust and reputation, as well as a hunger for particular theses. Trust is important in the sense that the investors should be confident that what’s being offered really does have a good chance (at least at that late stage) of being a big winner, justifying what is typically a significant “up-round” valuation which very clearly benefits the existing VC investor. Reputation is important in that the venture firms introducing the opportunity have to be worthy of that trust. And certainly, there has to be a hunger for a particular investment sector, which is why the FO is stepping into what is relatively unfamiliar territory.

Right now, cleantech doesn’t possess many of these features, unfortunately. So such follow-up capital has dried up. And the fear expressed by some in the meeting this week was that, lacking follow-up capital, some very promising companies have withered on the vine during this sectoral capital depression.

I also share that fear.

To be clear, I do believe part of the problem is the capital-intensive models of many of the companies that have gotten themselves in the most trouble. Because such “cheap follow-on capital” used to be more readily available, it led some entrepreneurs and their VC backers to put the pedal to the metal and push hard to drive to a big exit. And when the exit didn’t happen as quickly as expected, the company was hemorrhaging cash, and follow-on capital was sought out to rescue it (albeit presented with great optimism, of course). That’s not a story likely to have a happy ending.

But another part of the problem is companies that didn’t let themselves fall into that trap, aren’t burning so much cash in their current form, and yet still need additional capital to take a next step, whether that step is to open up a new commercial-scale plant, to establish their first pool of distributed-asset financing, to expand into a new territory, or something else. And this capital depression is real and impacting even very well-performing companies. I see it in our own portfolio all the time: companies that are growing revenues at really impressive rates still have to work very hard to find follow-on capital, even when successful exits are likely in the near future. These types of stories would be attractive companies for FOs to invest in, especially at this point in time.

The problem from the FO perspective (whether or not “impact investment” is a focus) is differentiating between the two previous stories. This is especially true for an out-of-favor sector, where a rising tide isn’t there to raise all boats. Yet ironically, that’s exactly when smart FO investors could reap the most reward for stepping into the right deals -- if they could tell which ones were the right deals, of course.

What I think many VCs don’t realize is the extent to which many FOs (and other similar types of investors) worry about negative selection bias in terms of the deals they’re being presented. In other words, many tend to wonder, “Why am I getting a chance to invest in this deal?”

As I told the room this week, “Here’s how the family office investor looks at it. 'I’m not going to be smarter than any Sand Hill Road investors on the technology or the market. I’m not going to be smarter than mainstream project finance companies at project finance. I’m not going to be an active hands-on investor with a lot of value to add to the management team. So why am I being approached about this deal? Did other smarter investors already pass on it, or wanted to do it at a lower price, in which case, why should I do this deal at this price? Why me?'” And there’s evidence to support this fear in plenty of examples I’ve seen over the past decade, where FOs are approached sometimes weeks after I’ve seen the exact same deals pitched at VCs, who apparently must have passed before the marketing outreach got to the FOs and such.

At my firm, we looked at the above dynamic and chose to zig while others zag, to do different types of deals in different types of ways, and to figure out how to be active investors who strive for value-add. (You’ll have to ask our entrepreneur partners if we’re pulling that off, but at least we make the effort!) As such, we hope to avoid this negative selection bias trap. But our approach isn’t a fit for many kinds of family offices; we are admittedly rather different.

To get the broader FO community more actively engaged, I believe one key is to figure out what family offices bring to the table that is truly unique and valuable. And with some specific exceptions, for the most part, that asset is flexibility. FOs can invest in a venture capital structure, but don’t have to. Which means that as the startup reaches a point where it could use different types of capital other than very expensive venture capital (such as early project finance, or debt), FOs can play a unique role to make sure that the startup's corporate equity stack doesn’t get too high, and that appropriately priced capital is deployed optimally. And that directly answers the “Why me?” question.

Another key is to have investors who are knowledgeable about these alternative structures lead these follow-on rounds. FOs that are comfortable in that role are pretty rare, but they do exist. Also, an institutional investor with project finance expertise (for example) could help structure that side of the transaction, and FOs could be asked to put money into both the corporate side and the project side. Corporate venture groups are often used as a validation point (although they may validate the technology, but their ability to validate the business model or deal structure is often overrated).

All that said, as cleantech comes back into favor, we’ll continue to see lots of examples of FOs and high net worth investors putting money into follow-on rounds as passive investors. It’s the way it’s worked in the past, and it’s easy to hear it when talking with many such investors who say things like, “Well, if I was going to start investing in the sector, it would certainly be by following [brand-name VC firm], since they’re the ones who know what they’re doing.”

Yes, they do. And they know how beneficial it is to their own returns to find passive investors willing to pay up to support their existing investments. I believe that solving this moral hazard along the lines I’ve described here would help even the most well-meaning VCs, because the knowledge that it exists leaves a lot of FOs sitting on the sidelines. So I was also excited to hear other ideas discussed to resolve this trust barrier as well, from deal structure changes to simply “more transparency.”

If VCs would approach FOs with a clearer idea of why that FO is being approached as a follow-on investor, or if the moral hazard/negative selection bias dilemma could be resolved, it would unlock a lot more activity. And that would do a world of good for helping bring more cleantech innovations successfully to market. It’s the right conversation to have, so I’m glad to have had the opportunity to be part of it, at least for one afternoon. I’m looking forward to seeing how it progresses.