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Cleantech VC:  The LP perspective, pt 1

Rob Day: October 28, 2008, 3:59 PM
On this site we've occasionally enlisted fellow VCs and other market participants in a "five questions" exercise, to help share other voices from around the industry, but one voice that's been lacking here (and, for the most part, elsewhere) has been the perspective from the limited partner community in cleantech venture capital. As a reminder, limited partners (or LPs) are the investors who give capital to venture capital funds to invest on their behalf.  They can be institutional investors, family offices, individuals, etc., but in all cases they are essentially the VCs' "customers", interacting with and evaluating which funds to back, etc.  So they're a pretty important stakeholder in this whole asset class of ours, and yet typically they're quietly in the background while bloviating (read: blogging) VCs hog all the limelight. I thought it would be useful to begin getting the LPs' perspective here on the site.  And the first victim volunteer kind enough to step up to the plate is Danny Zouber, a Partner in Piper Jaffray's Private Capital Team.  In 2005, Piper Jaffray launched the first US-based cleantech private equity "fund of funds," and they've been analyzing energy and cleantech firms even longer than that.  Danny's been an investor that I've enjoyed chatting with and getting insights from for a while now, especially since he has such a strong and deep focus in this sector.  So I asked Danny if he'd answer a few questions for readers, and he kindly agreed:
1. How is the current economic crisis affecting cleantech LPs like your group? We continue to see strong demand from our investors but we are starting to see some denominator effect that is limiting their ability to make any new PE commitments. 2. How do you see the current economic crisis affecting cleantech VCs? Investments in capital intensive companies relying on the free flowing credit markets and a near-term IPO as an exit are going to be in trouble. We saw many companies that had great technology but only worked as an investment with large amounts of cheap debt. We would expect to see some write-downs in that area. On a positive note, the current economic crisis will present a great opportunity for late stage VCs with capital at the ready as valuations are likely to contract over the next several quarters. 3. What excites you about cleantech venture capital right now? There are several things that excite us about Cleantech. We continue to be very pleased with the investments our “pure-play??? managers are making. In many cases they are finding great late stage companies that have been bootstrapped to date. Many of these companies have a reasonable amount of revenue and are proprietary investments. We also get excited about how broad the space is. I have seen great diversification across alternative energy, water, batteries, green building, lighting, waste to gold, etc. Lastly we get excited about how global the opportunities are. We have made investments in the US, Canada, China, Europe, and Israel. Each adds diversification to our portfolios and brings something to the table like water expertise out of Israel or battery technology out of China. 4. What attributes are you particularly looking for in fund managers right now? Experience, deal flow, ability to add value/grow business, late stage focus, no/low tech risk. We are still very much focused on the “pure-play??? managers. As we have a diversified VC FoF as well as a CT FoF we see much more promise thus far from our pure-play managers. That is not to say the generalists aren’t working hard to get up to speed but for now from a deal flow, industry knowledge and overall experience we like the “pure-play??? managers much better for CT investment. 5. What’s next for Piper Jaffray’s Private Capital Team in regards to cleantech? We will continue to build what we believe is the best cleantech fund of funds business worldwide. Having been looking at CT managers since 2003 and launching the first US based CT fund of funds in 2005, plus an affiliation with a leading global Cleantech investment bank, we think we are positioned well. We are actively investing out of our Cleantech Co-Investment vehicle. A couple of our recent investments are Ecore International and Miles Electric Vehicles. ECORE manufactures and markets innovative, sustainable products and solutions for the construction, consumer, commercial, industrial and sports and leisure markets worldwide. We believe Miles will be the first 4-door electric car sold in the US for the masses.
We'll continue to bring in perspectives from the various cleantech VC participants in future posts, including from other LPs, so stay tuned...

Cobalt Biofuels and GOTV

Rob Day: October 26, 2008, 3:47 PM
This week saw only one announced cleantech venture deal.  Things have gotten suddenly very sloooowwww out there... And this week's deal requires a mandatory: (self-promotion alert)... Cobalt Biofuels, a developer of technologies for the production of biobutanol, announced a $25mm Series C co-led by LSP and Pinnacle Ventures, and including participation by new investors Harris and Harris, and existing investors VantagePoint Venture Partners, The Malaysian Life Sciences Fund and @Ventures.  For more information on what Cobalt's up to, see this article. Since that was the only deal over the past 5 workdays, let's do some GOTV. First, Get Out the Vote!  Google Maps has put together a really handy site to help you find your voting location -- check it out, and make plans to be there on 11/4. Next, Get Out the Venture (Capital)!  There are a lot of good events coming up, and the conference season has been compressed this year thanks to the election, so that November between the 4th and Thanksgiving is very crowded.  One event to check out is GTM's inaugural Greentech Innovations conference in NYC on the 17th and 18th, with lots of companies presenting... Other news and notes:  Thomas Friedman's latest thoughts on cleantech...  Here's a write-up on the Dow Jones Alternative Energy Innovations conference...  Finally, BlackLight Power was on our minds two years ago, and they're back in the news again.

MIT Elevator Pitch Contest

Rob Day: October 20, 2008, 7:09 AM
There's a lot of uncertainty right now about how the global financial turmoil will affect cleantech VC over the near to medium term.  I've seen news stories (mostly looking at backward data) talking about how cleantech has been insulated from the downturn, and I've also seen news stories suggesting the sector is about to drive off a cliff ala Toonces. So in the current context, it was a real joy getting to be one of the judges for the energy track of Saturday's MIT Elevator Pitch Contest.  A bit of a different format from the many other bplan contests I've judged in the past -- in the EPC, we blitzed through over 20 presentations in under an hour, as each student/entrepreneur had 60 seconds to make their best pitch and then the three judges got to ask 2-3 quick follow-up questions.  The presenters in the energy track weren't all from MIT, but were all students, typically grad students either at the business school or in labs somewhere, and often representing a team with a mix of both. What made it so fun for me was how impressive many of the ideas were.  Granted, we didn't get a chance to dig into the details, but in terms of seeing a couple of dozen young entrepreneurs who've come up with some potentially exciting and lucrative and innovative business concepts, it was quite encouraging to see.  And a great variety of details -- from nifty combinations of distributed computing with heating/HVAC to waste-to-energy to ultracaps, while solar and fuels were represented, the breadth of innovation was terrific. So while the sector seems like it's going to slow down a bit here over the near term, at the innovation stage things looked really healthy this weekend, at least. Meanwhile some more numbers came out and confirmed that Q3 was pretty solid for cleantech VC in the midst of a general VC slowdown.  VentureSource tracked 583 US financing rounds totaling $7.3B in the quarter, of which 32 financings were in cleantech, totaling $1.1B.  Obviously the cleantech totals were dominated by a few huge deals, which was a consistent message across the other tallies we discussed a couple of weeks ago as well.  But in this VentureSource survey it's still remarkable to see 5.5% of deals but 15.1% of dollars attributed to the sector.  It's also remarkable to see that the Cleantech Group tracked 77 US cleantech deals while VentureSource only tracked 32.  Then, too, the Moneytree survey came up with 73 cleantech deals in the quarter...  It remains very difficult to tie together the various data trackers in the sector... Deal announcements were pretty slack over the past week.  A sign of things to come?  We'll have to see.
  • GTM's latest Funding Roundup here.
Other news and notes:  It is well worth reading this "tough love" column from Neal Dikeman, cautionary words for VCs in the sector...  And here's a good article regarding the Transmission capacity constraints holding back growth in wind power.

Ocean power:  Attractive and challenging

Rob Day: October 15, 2008, 3:42 AM
I had the pleasure of attending a briefing on GTM's new ocean power market report last week. In their report, the authors make a compelling case that ocean power (wave power, tidal power, etc.) is poised to see rapid market adoption, eventually taking a significant role in the green energy generation mix.

The findings also served to reinforce in my mind, however, just how challenging this sector and others like it are for venture capitalists.

Venture capitalists don't back entire markets, we invest in individual companies. So even when there is an attractive market such as this one, choosing the right company to partner with is critical. And thus comes one of the major challenges for this market segment: The fact that there are so many wildly different approaches being used to capturing power from waves and tides.

This is a point that the GTM report really drives home. They've done a terrific job of segmenting out the market and the early players, by technology and form factor. We see efforts using linear generators, rotary generators, floating devices, underwater devices, single large units, distributed smaller units… If you can dream it, someone’s trying it. Unlike in wind power, where the large three blade horizontal axis turbine has now become the standard format, what's clear is that there is no standard format yet in ocean power.

Furthermore, it seems the only thing these various approaches have in common is that they are capital intensive. In other words, they are all going to take a lot of venture capital or other financing to build prototype systems, and much more to fully commercialize their systems.

A variety of approaches to a big problem and a lack of an existing industry standard isn't by itself a big problem for VCs, in fact it can be an opportunity to back the company that eventually defines the standard. And certainly some venture capitalists aren't put off by capital intensity, in fact some may even find it attractive, based upon where some investors appear to be putting their money these days (although it's not my own favored approach). But when you have such an unclear market development path, and each bet is going to require significant amounts of capital before the investor learns if it'll be a dead end, the combination of these two factors takes it very difficult for venture capitalists to get comfortable around any individual investment. To invest tens of millions of dollars in the development of large prototypes and initial systems, only to find the market has gone in another direction, is not going to make a VC’s limited partners very happy.

Note that this is another example of where the needs of venture capitalists diverge from the needs of society. The growth of an ocean power market could potentially be a great win for green energy, so the GTM report was very encouraging to see. Furthermore, at this stage, having such a variety of approaches is very healthy, and bodes well for the industry’s ability to find an eventual winning solution. Finally, as we've seen in wind power, capital intensive clean energy technologies can still be very profitable for entrepreneurs and project financiers once the technology reaches a critical point of maturity. But expect VCs to mostly wait on the sidelines until there’s more standardization around a couple of key form factors. The current capital gap, therefore, would be better addressed by government and other funding sources.

Venture capitalists have made and will continue to make bets in ocean power, I’m just painting a picture with broad brush strikes here, so read these generalities accordingly. And some of the venture bets made in the sector will end up as winners, so I'm not trying to shut the door on an entire sector – in fact I already have one portfolio company which is developing solutions that could be applicable to this market.

I'm just using this as a good example of one attractive cleantech market that nevertheless presents a challenge for venture investors.

Smart Grid 2.0

Rob Day: October 13, 2008, 5:58 AM
I noted with some interest Silver Spring's $75mm financing announcement last week -- although it's unclear if this is a new round or just a further extension of their Series C we mentioned back in April.  But regardless of the financial details, it's a big financing for a company in the smart grid sector. The idea of the "smart grid" has been around for some time (as this post from nearly 3 years ago attests...), as the embodiment of the goal of a fully-automated and intelligent electricity transmission and distribution system.  The original smart grid plays, however, were a far cry from this vision.  Instead, they focused on small parts of the overall problem, reflecting the magnitude of the challenges facing any serious upgrade of our antiquated T&D system.  (See these three posts for a bit of the discussion on the topic from 2005, as more background) We're now increasingly seeing venture-backed efforts to bring all these various disparate efforts together, however, into more of a holistic effort focused at giving the utility automated control over the demand in their T&D networks.  This is building off of the emergence of Demand Response as a service for utilities -- negawatts on demand. The initial efforts in Demand Response have been, necessarily, pretty "dumb":  Not very automated, and not very responsive.  A DR aggregator signs up capacity (ie: an office building), and then signs a contract with the utility to free up that capacity on demand.  The utility sees, based upon weather patterns and other data, that they're likely to need that freed-up capacity during some critical period on a bad day, and sends an "alert" to their DR aggregator to trigger a DR event for a specified period (usually a couple of hours).  Then the DR aggregator signals (via email, pager, or just a phone call) to their enlisted capacity owner (ie: the office building's facility manager) that equipment has to turn down during that alert.  The office building owner gets incentives for participating, hopefully no one in the building notices it got a little warmer or dimmer during the alert (or, in many cases, a backup generator is flipped on), the utility pays for a reduction in energy demand which helps them deal with the spike in demand they were expecting elsewhere, and the DR aggregator takes a middleman's cut of the action. But energy usage is much more variable than this set-piece scenario would readily be able to deal with.  This kind of simple DR Alert model works for major, hours-long spikes during hot days.  But not so much for shorter spikes or other types of events going on during the day, affecting a T&D grid which must be kept balanced at all times. The original Smart Grid vendors were offering pieces of the puzzle.  Control systems ("SCADA") that could remotely monitor and control major equipment like transformers.  Advanced power meters that could send data back to the utility without someone having to swing by in person and read the dials, and that could notify of a power outage, etc. Now we're seeing the emergence of Smart Grid 2.0 system vendors, who are looking to put all these pieces of the puzzle together in automated and reactive ways, to keep the system in balance with minimal intervention.  The concept is to tie together a) "smart" (ie: with communications and some automation) equipment throughout a utility's grid; b) data communications across the grid to connect all the equipment with home base; and c) energy automation of some kind within customer premises.  Tying these together is some kind of software-based controls solution for the utility. The original Smart Grid model was just about giving the utility more control over their network, in other words, while Smart Grid 2.0 is about automating the network so that things are kept in balance. Different startups are approaching this challenge in different ways.  Smart meter vendors like Silver Spring Networks are starting at the "gateway device" -- the power meter -- between the consumer and the utility, and using that to provide information and some opportunity for automatic signal-response interaction.  Demand response aggregators are partnering with (and may increasingly acquire) energy management equipment/system vendors so that their initially "dumb" system will be more "smart" over time.  Consumer-facing players like GridPoint, who started out putting batteries together for backup power solutions, are now migrating toward the utility and using these kinds of solutions to offer automated demand response and control.  I've seen any number of business plans over the last year or so which seek to connect energy consuming equipment in the home to monitoring systems -- initially just so the homeowner can get a better handle on their own energy waste, but eventually (such as via smart thermostats) enabling utilities to simply "push a button" and have thermostats dial down across entire service territories. We're still quite a ways from a truly smart grid, much less from this Smart Grid 2.0 vision.  But as the physical grid becomes even more enfeebled and constrained, and the utility workforce gets old and older, it's easy to see how the idea of a fully reactive and automated grid would hold appeal for utilities. To me, the opportunity for a smart solution is clear, but the scope any such solution must offer the utility to be truly useful is quite broad.  As with other enterprise-level solutions, while some incomplete offerings will be adopted by a small set of early users and niche players, to really see broad adoption you need to see a complete umbrella solution so that the grid manager at the utility isn't forced to juggle any number of separate, potentially even conflicting systems.  Such an umbrella solution may come from a startup, but it's more likely to come from someone like IBM -- and in fact, major IT solutions providers like IBM and others are now specifically targeting the smart grid as a future growth area. More entrepreneurial efforts, therefore, will need to offer solutions that fit well into such umbrella offerings, filling in the gaps.  Gaps that can be quite large, in this case, given the magnitude of the opportunity.  To give a concrete example (forgive the self-promotion here, but it seemed useful to make this all tangible), take my firm's portfolio company, Powerit Solutions. Powerit has a system for use by industrial facilities (ie: manufacturing plants) with variable electricity loads, to avoid peaks and to automate participation in demand response events.  Their system detects when a spike in energy consumption is about to happen, and (in ways that minimize impacts on productivity, comfort, etc.) adjusts the consumption accordingly -- so, for instance, a foundry's furnace that doesn't really have to be fired up right that minute gets its activation delayed by a small amount of time.  In a demand response event, the same system helps reduce the facility's energy usage in the same way, moving loads around so that the whole building doesn't go over the necessary threshold but production still continues. What sets them apart is their focus on the specific needs of industrial facilities, which have a broad variety of types of loads, and very conservative managers -- they don't want to save a couple of bucks on their electricity bill if it risks losing much more revenue because of lost productivity.  The company's systems therefore are designed to work in everything from food processing plants to metal foundries to newspaper printing plants, etc.  And to be simple to operate, with good payback periods.  And to make sure that, if all else fails, the Powerit system can be unplugged and the factory operates normally, with no disruption to production.  They're fairly unique in their offering to this market niche.  And it's a pretty critical niche to be so otherwise unaddressed -- industrial energy use is about 27% of electricity consumption in the U.S.  And just one of Powerit's industrial customers can free up 10-20x the capacity that the hypothetical office building could, so each installation is a big hit. Forgive the advert, but I was hoping it would serve as a useful illustration of what I'm describing as Smart Grid 2.0 and how the industry is going to develop.  Because, while Powerit could attempt to use their system to compete with the demand response aggregators like EnerNOC, Comverge, etc., instead they're working with those players, teaming up to sell automated solutions.  And as the Smart Grid 2.0 ecosystem continues to develop, the winners will likely be those startups who find a large niche where they can excel, and who play well with others.

Deal catch-up

Rob Day: October 13, 2008, 3:58 AM
Here are the deals from the past fortnight that we hadn't already talked about elsewhere:
  • See GTM's Funding Roundup for descriptions of deals for Solar Power Partners, Promethean Power Systems, Urbasolar, EcoMotors, Magnomatics, Redwood Systems, ICQ Group, and MyFC.  [10/13 update:  The latest Funding Roundup got posted as I was writing this column, and additionally mentioned Apollo Solar]
  • JinkoSolar, a Chinese PV silicon wafer vendor, has raised a $35mm Series B.  China Israel Value Capital, Shenzhen Capital Group, and Pitango led the round.
  • PE Week Wire is reporting that hybrid vehicle drive train developer ISE Corp has raised $5.5mm of a targeted $25mm Series D round, with Siemens Venture Capital joining return backers NGP and RockPort.
  • Industrial Origami (developer of technology for the efficient production of sheet metal) has raised $17mm, led by Environmental Technologies Fund and including "wealthy individuals".
Finally, here's a good column on how cleantech is benefiting from a good influx of managerial talent from other sectors these days.

Cleantech venture capital:  The next six months

Rob Day: October 10, 2008, 4:13 AM
So much for that economic stability we wistfully discussed last week. With the economic forecast for the next 18 months looking pretty grim, energy prices have begun to fall sharply, led by oil, which is now back down below $80 per barrel.  While I often point out that oil doesn't dictate ALL our energy prices (not much of our electricity comes from oil, for example), in this case the causality between oil prices and electricity prices is the same: the downturn reducing economic production and thus consumption of energy.  So I would expect that we'll see (to a lesser and more delayed extent) traditional energy prices fall across all categories. In addition, the economic downturn -- and in particular the current instability -- is probably making it more difficult for any potential cleantech customer to pull the trigger on any large capex item. Even when the purchase of, say, a new piece of clean water equipment would make economic sense (in terms of payback) for a food and beverage producer, they might be putting such decisions on hold until things at least settle down a bit.  However, when things do settle down, such cost-saving opportunities might get even more attention than they were before.  Higher-cost purchases done primarily for "green marketing" purposes, on the other hand, will be a tougher sell... Here's one man's two cents' worth, in terms of what I expect to see happen in cleantech venture capital over the next six months.  This is just my own speculation, so take it for what it's worth.  But:
  • I think there will be a hiccup in cleantech market revenues, followed by a period of slower growth.  Anyone selling capital equipment will likely see a temporary slow-down in order flow as customers wait for some basic stability to emerge out of what's going on right now.  Technologies on the production side (i.e., power generation or liquid fuel production) will be hit harder during the slow growth period to come, as lower demand means both an impact on their economic value proposition (example: ethanol costs will be less-advantaged versus gasoline costs) and an impact on them as big-ticket items.  Technologies on the consumption side (i.e., energy efficiency) will be faster to recover if they can be sold as an expense and not as a capital budget item.  Clean technologies will generally do better than other tech sectors -- I expect cleantech markets will continue to grow -- but growth rates will be impacted negatively.  The recently-passed federal incentives will help with this, fortunately.
  • The big growth in "venture capital dollars" flowing into this sector has been led by later-stage deals, with large, high cash-burn, capital-intensive efforts building out capacity with an expectation of an exit (hopefully IPO) in the relatively near term.  E.g., all the recent big-ticket thin film solar deals...  It's no surprise to see Schott Solar cancel their IPO.  With the exit window temporarily shut and with most of these deals going into technologies on the production side (see the above point about those getting hardest hit), I think it's likely we'll see Q4 show a big drop-off in such headliner deals, and thus that the aggregate dollar amounts going into cleantech VC will show a big decline from Q3's record numbers.  But it's important to realize that that will mostly reflect just a small subset of cleantech VC deals -- the mega-deals, the later-stage deals.
  • The more interesting thing will be to watch what happens to early stage cleantech venture deals.  We'll have to see, but my expectation is that the pace of early stage cleantech venture deals will decline, but not fall off a cliff.  There will likely be some evidence of a bit of a pause as everyone digests this current period of instability.  But the simple facts are that early stage cleantech VCs are investing for exits several years out, not for the near-term.  And they have funds to deploy.  And entrepreneurs continue to come up with good ideas, addressing critical needs and large, growing markets that aren't going away.  So I think (guess?) Q4 will see a moderate decline in the number of cleantech deals overall, a bit of a shift into earlier-stage investing, and a big decline in aggregate dollar amounts.  And early-stage will be the first to pick back up going forward.  Early-stage cleantech venture capital remains a very attractive investment area.
  • As we saw this summer, when the exit window does start to re-open, cleantech will probably lead the way.  When will that happen?  I can't say.  But I do think that even an economic downturn wouldn't stop some good cleantech exits from taking place.  Instability shuts the exit window for everyone, but even a recession -- if stable -- could see some good exit activity, if somewhat less than might have been hoped.
  • Nevertheless, I think we're going to see some big-name cleantech startups implode.  Some companies that have chosen a supernova growth path of high cash burn with the expectation that revenues will quickly ramp up and massive amounts of follow-on funding (via IPO, many hoped)...  Any such companies that needed to see an IPO over the next 6 months are going to be hurting.  Especially those who had taken on large amounts of debt as well.  Some will muddle through.  But I think it quite likely that we'll see some high-fliers not be able to make it through the next six months, or however long it takes for the later-stage investing and IPOs to pick back up.
  • The above points are a mixed bag, reflecting the mixed reality I expect will emerge in our sector.  But I also expect that the news headlines will be pretty merciless.  Because we'll see some big-name companies hurting, and aggregate dollar amounts fall way off, journalists will over-react and turn into Chicken Littles real quick.  That's what they do...
  • Meanwhile, while I hope it's clear from the above descriptions that I'm not sanguine about the prospects of such strong market growth in cleantech over the coming period, I do think that cleantech will likely be better-insulated than many other economic sectors.  I expect cleantech markets will continue to grow, if more slowly.  So all those "green-collar jobs growth" efforts that have been pursued out there might start paying dividends even sooner than had been expected...
What we're generally telling our portfolio company managers is that it is not time to panic.  It's a time to make sure and manage cashflow carefully, and to focus on providing good economics to customers.  And to plan around a wide range of scenarios, including the possibility that things will slow down in their market pretty significantly for a while.  But since at our firm we tend to favor lower cash-burn investments anyway, no need for radical shifts in strategy, or pulling back on growth efforts.  Fingers crossed...