As has been mentioned in this column, while cleantech startups have been booming, Sand Hill Road investors have been largely on the sidelines. But over the next year or two, that will change (in fact, the shift may already be quietly underway). Generalist VCs have been staying away from the sector because of LPs' views of "cleantech" (thanks a lot, 60 Minutes), but LPs are increasingly under pressure to shift away from traditional energy and resource plays into cleaner alternatives. And the smart investors in Silicon Valley and elsewhere are never ones to stay away from clearly growing market opportunities, as many "cleantech" markets are starting to become.
So there will be a shift back into these opportunities. This has happened before. In the early to mid-2000s, a small niche investment sector sometimes called "cleantech" witnessed a big influx of generalist VCs. We all know how that turned out in the end, but how did it begin? What did it look like?
I believe we can draw lessons from the last cycle to speculate about what will be different this time and what we can expect. It won't be exactly like the last time around; some key factors have changed since then.
New label -- or no label
It's pretty clear by now that the phrase "cleantech" is on the outs, deservedly or not. Even many sectoral specialist investors are busy relabeling themselves, or scrambling to make it clear that they never actually used the phrase in the first place. Being tired of explaining that my investments don't include solar panels and biofuels, I may do that myself, just to make life easier.
Generalist VCs aren't going to be any different, even when they starting finding opportunities that might fit the label. There will likely be two approaches:
1. Some will simply not bother with a new label; they will just be doing what they already do. Cleantech opportunities have always been cross-functional and cross-sectoral, anyway. The non-labeled crossover is already underway. Generalist VCs are investing in food, in transportation, in solar and energy-efficiency financing platforms -- all while never referring to them as "cleantech," or using any other umbrella label. This is entirely appropriate. Returns are returns.
2. Some bigger firms, seeking to engage specific LPs' interest in alternatives, may set up some side funds or even specialist teams (albeit unlikely early in the cycle) to focus on investment areas that fall comfortably into the ways such LPs already view things. Labels out there in the LP universe that I rarely hear VCs talk about yet are "sustainability" or "ESG," for example.
At a certain level, labels don't matter. A fragmentation of a wide range of investment areas that have always been artificially bundled together isn't a bad thing, if it means more focused investment strategies and more efficacious groupings of opportunities into logically connected "buckets". We're already seeing a broad divergence between investors who continue to look at upstream, tech-heavy innovation bets, and those who are increasingly looking at more "virtuous cycle" driven businesses engaged in implementation, development, financing, controls and intelligence, etc. Further divergence into market-expertise driven groupings may make it impossible to capture everything under a single umbrella term. And that's okay. Let's just assume that from now on when I say "cleantech" I am using it for the sake of simplicity, and expect there to be a bunch of different ways everyone actually describes it for themselves. But just anticipate that cleantech investments will be on the upswing even as "cleantech investments" are not, if you catch my meaning.
New investors will look for momentum
During the last cycle, when generalist VC firms started assigning team members to cleantech, I would get a lot of calls from these VCs looking to compare notes -- a fun and productive part of the job of being an investor in a collaborative industry. What was striking was that as I would start describing the pretty wide range of investment opportunities I was looking at, these new entrants would always refocus the conversation into solar. Why? Because solar had the most obvious momentum. So that's where they wanted to start.
Some great investors have made great fortunes by investing into concepts that didn't already have obvious momentum. But that's not where the majority of the venture capital industry is these days. And so, with some justification, the generalist VCs will probably zero in on the subsectors that already have a lot of action going on.
Note a couple of key things: First of all, "action" doesn't necessarily mean "evident success stories." Although that never hurts, it's sufficient to demonstrate that a lot of other investors are jumping into a subsector in order for the new entrants to want to do the same. That's how we ended up with so many me-too solar panel manufacturing and biofuels startups, even before any of them had successfully exited. Second, because many of these investors will want to make a big bet on a play where they have a significant ownership, "backing momentum" shouldn't be read as necessarily meaning that the new entrants will back the existing startups that have gotten to a growth stage -- if the last cycle is a guide, many of them will want to find their own stories within the overall concept.
So what this means is that a few subsectors deemed as having the most potential will get very crowded very quickly, which isn't necessarily good for the first-movers who were already there. This is especially punitive for the first-movers who perhaps aimed a bit lower out of capital pragmatism, and have been selling a smaller solution or simply not investing into growth like the new entrants will look to do (see discussion of capital-intensity below). The last time around, it was a good thing during the lean times to have been slow and steady, but when the rush times came, those startups either got overtaken quickly by the Elon Musks of the world, or in many other cases, they tried to rapidly shift to much more aggressive strategies and got themselves in trouble. It's a jarring transition if it's not done right.
New investors will often seek out capital-intensity
This happened last time around and it's going to happen again, because the dynamics of venture capital haven't changed: There's a concentration of capital into a few big firms, and they need to spend the capital quickly so they can raise their next big fund. I'm not suggesting that there was callous disregard of the risks-and-returns math of seeking out capital-intensive opportunities last time around, but at the time, we could all see the effects of the emphasis on making big bets with big-win expectations -- which is clearly what these bigger generalist investors are motivated to seek. Why go to all the trouble of getting smart about a new investment area if you're just going to play too small to make an impact on your fund?
So such investors will once again seek out opportunities where they can put a lot of capital at work relatively quickly and in concentrated form, if things seem to be going well. But I do think there will be a key difference, in that such opportunities will much less frequently be upstream commodity manufacturing. The risks-and-returns math of big centralized capex plays is still frowned upon; there were some seriously painful lessons learned the last time around. And meanwhile, big-check-writers have found that they can still deploy significant capital (at the appropriate stage) behind "capital-efficient" plays such as financing and development platforms (for sponsor equity), B2C product and service plays (to dramatically accelerate marketing and sales), and roll-up platforms.
In short, the last ten years of overall venture capital have demonstrated that any business model can justify taking in significant capital, as long as there's evident momentum to justify it. That lesson will be applied here as well.
There will be a lot of sniffing around -- and then the dam will break
It almost always started with a senior partner at a generalist firm deciding to start paying attention to cleantech. That partner would discuss it with the broader partnership, and eventually get buy-in to dedicate a junior team member (often reallocated out of telecom or biotech, since those were currently out of favor) to the sector full time. There would be lots of coffees. Lots of market maps drawn up. Lots of first-pitch meetings. Some co-investing with specialist firms, mostly to learn or to harvest the more obvious first-mover advantage situations.
Then everyone stops sticking a toe in the water, and all jump in at once. So it was, so it is, so it will be (see exhibit A: food delivery apps).
So what should cleantech entrepreneurs do?
In short, be prepared. Because when the shift happens, it'll happen unevenly and not necessarily in a way that's positive for you. Unless you set yourself up to be the beneficiary of it, entirely on purpose.
1. If you're in one of the subsectors more likely to get the benefit of early attention, start laying the groundwork now. My guess as to which subsectors should be particularly attuned to this possibility? Food and ag (all throughout the value chain), energystorage energy efficiency finance, and anything involving a potential crossover with "sexy" applications like robotics, drones, and 3-D printing. These are all already getting investor attention, and can already demonstrate both momentum and the ability to absorb large amounts of capital as appropriate.
2. Stay pragmatic for now (don't assume early interest means actual checks are near), but have a "go big" plan that makes sense, where you have the right capabilities and opportunities and can dramatically accelerate your growth without major changes to your strategy. This can mean simply having contingency plans to roll out additional financing pools if the capital's available, or a roll-up strategy within your existing market. When the dam breaks, if you're not poised to be one of the anointed "winners" with all the evident momentum, the big backers will find an alternative to you.
3. Ready your mainstream-media PR campaigns. Being a first mover but not loudly talking about it completely undermines your ability to defend that early-mover status when everyone is suddenly talking about your subsector.
All that being said, keep your head down establishing proof points for your solution. If you're early-stage, develop partnerships with key validating large strategics. If you're growth-stage, ready your exit strategy so that you can move quickly as windows develop. But just keep building a great business given the resources you have today. You can't time the market, and the market will move in unexpected ways. Meanwhile, if you're like many cleantech entrepreneurs still plugging away right now, you're seeing your own growth story come together. Be prepared for the turbulence. But steady as she goes for now.