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Massachusetts’ big energy efficiency news, and some thoughts on FITs

Rob Day: January 29, 2010, 9:50 PM

Big news today in the state of Massachusetts, where state officials announced a plan to pour $2.2B into energy efficiency measures, including a target of tripling the number of home energy audits, etc.  On a per capita basis, at least, it would put Massachusetts ahead of any other state in the U.S.  A terrific example, a great initiative...  Great to see!  It will make Massachusetts an even more attractive region for energy efficiency startups, tech or otherwise.


On other policy topics... I haven't spoken much about feed-in tariffs here in this column.  For one thing, the economist in me tends to favor simple tax-based solutions rather than mandates or price setting, so I've never seen FITs as particularly attractive intellectually.

But recent conversations with those in the project finance industry have been changing my mind... a bit.

If policymakers want to see big roll-outs of renewable energy technologies, project finance is a vital player.  No matter what incentive scheme is put into place, someone is going to have to pay for the project.  According to New Energy Finance's figures, clean energy "asset finance", at $92B globally, dwarfs the dollars going into venture capital, government and corporate R&D, IPOs and other public issuances, etc.  No matter how many technologies are invented and introduced to the market, unless project financiers are willing to bankroll actual steel in the ground, the new generation capacity will never be built.

As we've discussed on this site in the past, project finance is very different from venture capital and other investment asset categories.  Project financiers typically target returns much lower than what VCs target.  To make that work on a risk-reward basis, the investment must have absolute minimized risk.  This is why there is a big capital gap between the venture capitalists and the project financiers:  The VCs see their role as getting the company to a point where the technology has been successfully commercialized.  The project financiers will wait even further, however, until all details of implementation are completely understood and underwritable. So the VCs will fund only a new tech up through project #1, and the project financiers still see too much implementation risk at that point, and projects number 2, 3, and 4 have a hard time getting built built.

What kinds of risks do they care about?

  • Input / supply risk
  • Technology risk
  • Demand risk
  • Offtaker credit solvency risk
  • Offtake price risk

To address the capital gap, various government policies are there to help juice the returns for investors.  Investment or production tax credits, 48C manufacturing tax credits, etc.  And there are also mandates out there such as renewable portfolio standards.  These certainly help and have their merits.  But they don't really address the above risks.  And even if the returns are enhanced through the incentives and mandates, project financiers are not used to having to assess such risks in this way.

A feed-in-tariff can directly address three of the above risks.  In most applications, the FIT is a requirement for the local utility to purchase whatever power is produced by the targeted technology, at a set price (this is obviously a simplified version of a FIT).  This means that, to a project financier assessing a FIT-driven project, the demand risk is taken care of -- the utility is required to buy the power.  The offtaker credit solvency risk is minimized, since most large utilities are very credit-worthy.  And the offtake price risk is obviously intended to be set.

I've spoken with a few project financiers who say that they are much more likely to invest in a region where there's a FIT in place, than in a region where there are tax incentives, even if the impacts on project IRRs are comparable.  The FIT just creates a lot more certainty for the investor.

Certainly FITs aren't a panacea.  Setting the price right is a challenge and prone to political inefficiency, for one.  The requirement for utilities to purchase power at such a high price also means that they'll have to pass that price along to consumers or otherwise get government support to cover the difference -- it's not a big deal when the volume of FIT-driven power purchases are low in relation to the overall generation mix, but of course the idea is to dramatically drive up that volume, so it can get costly in a hurry.  And it being a politically-driven system, when things get costly there's danger that the FIT price is reduced much sooner than expected by the market.  This crushed the solar market in Spain, and is also happening now in Germany.  It's critical, therefore, that any FIT be designed so that if there are future FIT price reductions existing projects are grandfathered in, otherwise project financiers won't perceive the policy as truly addressing the above risks for any given project.

But if policymakers want to see dramatically accelerated rollout of clean energy generation technologies, project financiers will have to be the ones supplying the lion's share of the capital required.  And if project financiers are to do this, FITs are definitely worth giving serious consideration.

Here's a link to much better thinking on the topic by the good people at NREL.

Yep, that’s right…

Rob Day: January 25, 2010, 10:18 AM

... a $350M Series B for Project Better Place.  At a pre-money of $900M.  And bear in mind, this doesn't include additional financings that have gone into the company's regional subsidiaries, such as in Israel and Australia.

This should really mess up the Q1 cleantech VC tallies when they come out!  Because as longtime readers already know, the headlines are driven by dollar totals, not deals.

And we've already got some head scratching results now to think about as Q4 totals continue to come out.  Last week saw the release of the MoneyTree survey (US tally from PricewaterhouseCoopers, the National Venture Capital Association and Thomson Reuters), and the results were a little bit at odds with what we'd seen from other early counts we've discussed so far (here and here).  Dan Primack at PE Hub described the cleantech results as "particularly sluggish" and I'd have to agree.

The MoneyTree "cleantech" tally showed 2009 to be way down from 2008, with $1.9B into 185 deals showing a decline of more than 50% in dollars and more than 30% in total deals.  In their tracking of first institutional dollar rounds (seed or Series A, mostly), they showed a more than 50% decline in the number of deals in "Industrial/Energy" from 2008 to 2009. 

Contrast that with tallies like Wesoff's at GTM, which showed much less of a decline in dollars, and in fact a slight increase in the number of deals, from 2008 to 2009.  What happened?

It's tough to say, but here's my guess as to why such different results are seen.  First of all, I don't blame it on any significant error by any of the analysts -- what we've found in the past when we've seen such different numbers is that it's about methodology and definitions and not any major goofs.  And so one obvious definitional difference is that Wesoff's tally is global, whereas MoneyTree and ChubbyBrain are both US-focused.  Perhaps international financings helped make up some of what looks to have been a significant drop-off in US cleantech venture financings from '08 to '09.

Secondly, there are usually big differences in inclusiveness (ie: what's a "cleantech" deal, and what's a "venture capital" deal) between the sectoral specialists and the generalists.  Wesoff counted Synthetic Genomics' $300M multi-year commitment from Exxon, for example, in his tallies.  Willing to bet that the MoneyTree tally doesn't include that one.  And then there are always time-based distinctions (timing of dollar flows versus timing of announcement, etc.) that come into play.

So those factors might explain the differences.  What's nicely consistent with what we've seen before is that the 2009 US quarterly cleantech deal total numbers in the MoneyTree survey generally match up well with the "green" category deal totals in the ChubbyBrain survey.  And in the MoneyTree numbers we again see that Q3 2009 was a bit of a blip, it wasn't that Q4 wasn't really a weak quarter as has been generally reported, but instead the quarter fit the pattern of a weak 2009 overall.

Particularly worrying, however, is that the MoneyTree data suggests early stage financings really fell off, as noted above, from 2008 to 2009.  It would be one thing if the 2009 low deal and dollar numbers were mostly driven by delayed follow-on financings, as we've talked about before.  But to see the early stage financings fall off so much suggests even more underlying weakness, and suggests even more limited dealflow for growth stage investors even if/when things do pick back up again.

So far in Q1 we're seeing a lot more dealflow and dollars, even leaving aside exceptional examples like PBP's announcement this morning.  But with the increasing likelihood of a double-dip in the macro economy, these MoneyTree numbers are pretty sobering.



Best wishes to Ray Anderson

Rob Day: January 22, 2010, 2:29 AM

Am en route back to Boston from the Clean Tech Investor Summit, which took place in an incredibly soggy Palm Springs, necessitating a lot of diverted and canceled flights.

Despite the problems participants had getting to and from the event thanks to freakish weather, it remained the very well-attended, hyper-networking, content-laden event I remembered from the last one I went to, four or five years ago.  A great event for catching up with fellow cleantech investors on the left coast (and not a few east coasters made the trip out as well).  I will attend again for sure.

A particular treat for me was that a lot of the content was somewhat of the "life goes full circle" variety, hearkening back to my days in the "business sustainability" world as a young researcher at the World Resources Institute.  Met up with a former colleague from WRI, got to say hi to one of my favorite pundits and experts in the business Joel Makower (who was actually the original inspiration for this blog, nearly five years ago), and got to hear from some of the visionary leaders who had been among the original inspirations for the "green is good business" type of research I did way back when -- including Amory Lovins, and Ray Anderson of Interface

So I was shocked to then see tonight that Ray Anderson has announced he is going into treatment for cancer.  Over a decade ago, when CEOs were only paying lip service to green business practices, Ray and Interface were re-defining their entire business in ways that reduced waste, improved the company's profits, and launched them into a leadership position in their market segment, all by taking green business practices very seriously.  The Interface example -- along with other early examples of profitability from green thinking -- were why I went off into the business world with entrepreneurial intents. 

Let me tell the story in overly short form, and as I remember it (so: it may not be 100% true, but it's pretty close): Interface was an industrial carpet company.  Like other industrial carpet companies, they viewed their business as selling carpet.  That's it.  It was a highly competitive, low margin industry where differentiation among competitors was difficult.  In having to think about the company's environmental vision for a speech, Ray began reading The Ecology of Commerce by Paul Hawken (another formative figure for me).  And Ray had an epiphany -- that all the massive amounts of waste being produced in carpet manufacturing was financial waste as well... and as this insight triggered more sustainable-minded thinking at Interface, they began to redefine themselves as not being carpet manufacturers, but instead as being in the service business, providing floorcovering for their customers.  So began Interface's really signature effort -- modular carpet squares, enabling not only for customers to keep new-looking carpet all the time without replacing entire carpets, but also allowing Interface to take back worn carpet and better recycle it into new product.  Interfaces revenues grew.  So did their margins.  And customers were happier for it.

If you want to see what we were thinking about this and other examples of win-win green business leadership a decade ago, you can find more here.  It's a bit outdated by now, but the principles are still sound. 

1.  Environmental responsibility can be important preserving the right to operate.  At very least, avoid acting so environmentally irresponsibly that your company gets hammered in the court of public opinion (or for that matter, real courts).

2.  Pollution and discarded materials = waste and financial cost.  Companies pay for inputs, and increasingly often they pay for waste disposal.  So any pollution and waste reduction goes straight to the bottom line, even if the products and services don't change.  And this isn't just true inside your company, you have to look at the entire supply chain and downstream customers.

3.  Look for opportunities to increase revenues by greening your products and services.  It can be a good differentiator that helps capture market share.  Just ask any real estate developer how they feel about LEED certification these days...

4.  Redefine your entire business about what the customer really wants -- and find other ways to satisfy those needs that are on the right side of natural resource trends.  In other words, get out in front of the inevitable Schumpeterian creative destruction that's going to happen (or is already happening) to resource-intensive industries and business practices.

These days, most companies get #1.  Many now get #2 (which is progress from back then).  Increasingly, #3 is something some companies are taking seriously.  But #4 remains untouched by most large companies...

The really great thing about having since moved into the world of cleantech venture capital and private equity, is that now I get to support entrepreneurs who are jumping straight into #4.  The startups that will end up grabbing market share from those current corporate giants who quickly are becoming corporate dinosaurs.  And I never would have ever headed in this direction if it weren't for inspirations including (but definitely not limited to) Paul Hawken, Amory Lovins, Joel Makower, Matt Arnold, and yes, Ray Anderson.  Some of those guys won't remember me...  but I sure remember them, with gratitude.

So please join me in sending best wishes to Ray.


Major change in the cleantech VC industry… and over-experienced investors?

Rob Day: January 20, 2010, 11:53 AM

We're going to look back upon 2010 as a time of major change in the cleantech venture industry.

I haven't heard yet of many established specialized cleantech venture firms scaling back, but it will happen, starting this year.  Certainly there have been a few of the more fledgling efforts to create new specialist firms that have floundered due to the bad fundraising environment over the past 18 months.  And now we're seeing scale-backs at generalist firms (such as Atlas Venture, and Polaris which PE Hub is reporting is raising $500M for their sixth fund, versus $1B for their last one).  As generalists shrink their funds, some are doing more cleantech, but many are going "back to their core" in IT, etc. 

In the Boston area alone, I know of at least a half-dozen VCs who were doing cleantech when I moved out here, who are now either not doing new cleantech deals, or had to change firms, or are not even in the venture capital business at all anymore.  There have been a couple of additions to the community in the meantime, but not enough to make up for the exodus.

This means there are potential gaps in the marketplace (early stage cleantech venture capital in New England is starting to seem especially scarce, for example), but in this fundraising environment, not many new efforts are able to launch to fill in the gaps.

Meanwhile, as we've talked about here for a while now, lots of investors are continuing to re-evaluate the way the venture capital model has been applied to cleantech overall.  Some of this will result in new thinking and new approaches.  Some of which will work and some of which won't.

But overall, it just feels like a time of serious transition.

I'm at the Clean Tech Investor Summit on the west coast this week.  It'll be interesting to see how much my Boston-based perspective is reflected in the cleantech venture community out here...  If I can, I'll try to tweet a bit from the proceedings.


And speaking of cleantech investors, here's a good interview with Chuck McDermott, one of my favorite guys in the business.


And speaking of venture capital [total data wonk alert here, read on at severe risk of additional boredom], I saw an interesting article on PE Hub talking about one investor's study purporting to show that venture capitalists with less than 10 years' experience do better -- the implication being that there's a level of experience VCs may get to where they actually become WORSE investors. 

The article says that they examined nearly a thousand VCs' track records, and then looked at the 35 who had produced a "good track record".  Of those 35, the VC who did the study says, "more than half of them have been in the industry for 10 years or fewer".  I love numbers, so this caught my eye.

So first of all, if you look over the track records of 945 VCs and find only 35 with "good" track records... talk about an indictment of the industry. 

Secondly, what proportion of those 945 VCs had been in the industry less than 10 years?  If it's anything close to or more than 50%... have we really learned anything?

And finally, what about the fact that in the beginning of the last decade, a lot of VCs' track records followed the industry's overall collapse in IRRs?  Point being, there may be some underlying factors here having nothing to do with age or experience.

I'd love to see the actual study, obviously it looks interesting but I also have a lot of questions...


Cleantech VCs still heart capital intensity

Rob Day: January 13, 2010, 10:44 AM

First of all, maybe take a minute today to give to the relief efforts in Haiti.  The US State Department is recommending the Red Cross...


Kanellos of GTM posted what I think is one of the more important cleantech VC quotes of the year, citing Bruce Pasternack of CMEA as saying, "I don't know if we'd make a Solyndra-type investment today."  He was apparently referring to the capital-intensity of Solyndra and companies like that, and saying that if another investment opportunity like that came along then CMEA might pass on the basis of that alone.  Kanellos concludes that "The big deals are done."

Kanellos' statement is a bit of an over-generalization, naturally, since he's paid to provoke.  There certainly will be big deals done in 2010, I know of a couple blockbusters in final stages already.  And Pasternack's statement was more about capital-intensive business models and not about single big rounds of financing.  But as a general principle it's right, and it's what we've talked about here for a while now: Cleantech VCs are saying that they're running away from capital intensive business models.  Lots of talk about lessons learned.

Interestingly, that's the conclusion some investors are drawing from a new set of numbers from a group with the somewhat unfortunate name of ChubbyBrain, which has joined the ranks of those doing tallies of U.S. venture capital investing.  I haven't really looked at their numbers before, but I like that they break out "Green" as an over-arching category across technology sectors, and they also provide good details about their methodology as to what deals they count (although they're less clear about how they then define those deals in terms of sectors, etc.).

In their review of their Q4 tally, they conclude that "green investments which are usually a significant contributor to the overall venture totals given their capital intensity fell significantly versus Q3 with investment funding dropping 38% even though deal count stayed steady."  In Q4 they tracked 55 deals totaling $565M, and in Q3 they tracked the same number of deals totaling $913M.  They also break their numbers down in a number of useful pie charts.

I read a bit of a contradiction in what ChubbyBrain's saying, since they tar all green investments with the "capital intensity" brush but then indicate, as we also saw in Wesoff's tally for GTM, that what happened in Q4 was a significant reduction in average size of cleantech deals.  So what happened?

Pretty much boils down to this:  Q3 saw two massive deals that didn't happen in Q4, Solyndra ($198M) and Suniva ($75M).  Take out those two and the delta in dollar amounts from Q3 to Q4 is largely removed, and yet the deal totals remain about the same. And in fact, if you look at their charts for Q2 through Q4 it's clear that Q3's high dollar total was just an outlier.

Much ado about nothing, in other words.

So once again we learn the same old lesson:  Pay more attention to the total number of deals and not the dollar totals, because the latter gets skewed by one or two deals out of the entire quarter.  And what the CB analysis showed was that the number of deals was "consistent" from Q3 to Q4.

I do really like the pie charts from CB, and am enjoying comparing the breakdowns of dollars versus deals.  So kudos to them...

In any case, there's very little evidence there that cleantech VCs are as of yet putting their money where their mouth is, and pulling away from capital-intensive investment models.  CB appears to have changed their categorizations a bit from one quarter to the next, which is unhelpful, but still they showed about 24 deals in Q3 (nearly half of the Green category) going into "Renewables" and "Automotive Manufacturing", while in Q4 something like two-thirds of the deals they tracked went into either "Energy & Utilities" or "Automotive & Transportation".  A bit of apples and oranges there, but it's consistent with Wesoff's count of 24 out of 82 deals in Q4 (note: global #s, not U.S.) going into solar.  Meanwhile, CB tracked only a handful of deals in Q4 going into Green subcategories like "Internet" and "Software" and "Business Products & Services", which could be expected to be less capital-intensive.

So basically, cleantech VCs are all claiming to be looking for less capital-intensive investments nowadays... but there's little evidence yet of any such trend, other than increased interest in energy efficiency and smart grid.  But even there, the pattern appears to suggest that VCs generally continue to want to big, not lean.


The trickle-down effect

Rob Day: January 11, 2010, 11:39 AM

2010 may be looking up economically (although I'm personally feeling like we're headed for a double-dip, but let's stay optimistic), and yet 2010 may not be as happy a fundraising environment for cleantech startups as many would hope.

Why?  Because there's a lag between when venture firms raise their capital and when they can deploy it.  And 2009 was the worst year for VC fundraising since 1993, according to the NVCA (note: link opens pdf).

Only about half as many funds successfully raised money as we've seen in other years of the past decade.  And the dollar amounts dropped similarly.

VC funds are typically raised in a fairly consistent two to three year cycle.  So when you see a drop-off like this, it means a lot of firms pushed off fundraising until things picked up.  Which means there are a lot of firms that were due to raise funds in 2009 that instead decided to wait.

These firms will have to go out and raise new funds soon.  The cycle can only be pushed so far out for many funds, before their internal dynamics get squeezed.  Fund fees typically decline over time, meaning that the operating budget for the firm goes DOWN if they don't raise a new fund.  So unless they're going to start shedding staff, either the delaying firms will need to raise new funds in 2010, or the GPs will have to take pay cuts.  Probably a mix of all of the above...

The easing denominator effect for LPs and other LP dynamics probably means that GP fundraising will indeed be easier in 2010 than in 2009.  But even if all goes well (and I'm not saying it will), it'll still mean a lag time before those new funds get up and running.  Meanwhile, all these firms are running out the string on their last fund, and many are thus out of dry powder and unable to do many, if any, new deals (most will be reserving capital for follow-ons with existing portfolio companies, fortunately).

So what does this mean for entrepreneurs?  The trickle-down effect doesn't look good right now.  At least for the first part of the year, it will mean it's still very tough to raise outside capital.  Expect to see yet more insider rounds and bridges.  And expect to have to take a lot more meetings (the GPs will need to be seen as still being "in the game" so they'll still take meetings) before you land a funder.  Follow the money, and watch who's actually doing NEW deals (not just follow-ons into their existing portfolio companies), they'll be the best targets.


Cleantech Investing reader predictions for 2010

Rob Day: January 7, 2010, 4:44 PM

Quick reminder:  If you've been missing the dealflow notices that used to appear on this column, they've moved over to Twitter so they can be timelier (and a lot less work).

Anyways, many thanks to all the readers who participated in this year's CI Reader Prediction Survey.  We got lots of good responses, and there's a lot of agreement out there about the coming year, surprisingly to me.

In terms of survey participants, it appears to have been a good mix of entrepreneurs, investors, corporate managers, and service providers, with a smattering of researchers, government/NGO types, and others thrown in.  Lots of entrepreneurs and investors.  Geographically, more than 80% of participating readers are in North America, but Europe, Asia and the Middle East also had a presence (I'm very, very disappointed in you, Australia).

So what do readers predict?

1.  In terms of North American cleantech venture deals, Q1 through Q3 2010, readers expect it to be a moderately good year.  Two-thirds of readers expect that the number of venture deals will grow, but by less than 50%, compared to 2009's same period.  Over 25% expect the number of deals to remain about the same.  Less than 5% thought the number of deals would drop, and less than 5% thought the growth would be more than 50%.

2.  In North American cleantech venture dollars, same period, it was about the same picture.  7% thought the dollars would actually drop, 24% thought they would be about the same, 62% thought they would grow but by less than 50% year on year, and 7% thought they would grow by more than 50%.

3.  There was a bit of a more bullish take on global clean energy private equity (which is mostly in project finance).  4% thought the global dollars going into these projects would fall, 21% thought they would be about the same, 49% thought they would grow but by less than a third.  And interestingly, more than a quarter of readers thought they would grow by more than that. 

4.  I asked that, if 2008 was the "year of solar" and 2009 was the "year of the car" in cleantech, what would 2010 be known as?  Readers pointed to a lot of favorites, but by far the top two vote earners were a) Green buildings and building energy efficiency; and b) Smart grid.  Both got votes from more than 40% of participating readers.  People are really down on solar -- it only beat out wave power and agriculture, with votes from 3% of participating readers.

5.  Readers showed a bit more optimism in terms of U.S. cap and trade legislation getting passed than I'm feeling at the moment.  Asked whether we would see enactment of "meaningful" (purposefully vague phrasing, btw) climate change legislation in 2010, 40% of participating readers said yes!  Of course, that means 60% said no...

Here are some of the tips and thoughts readers wanted to share with other readers:

"Stay the course, markets will rebound and investors will start investing again."

"Come to Europe"

"Why haven't we initiated intense policies mandating a reduction in emissions? Adapt or fall to ruin. Businesses have to learn."

"The US gov't continues to derail real momentum in the renewable space. $3.8B to GMAC? Let 'em die and put that money into all of the above; repurpose the workers into something that matters. No action at Copenhagen? Disgraceful."

"Solyndra and possibly Codexis IPOs are likely to be canaries in the coal mine - but tough to see how the canaries make it out alive..."

"I have been and continue to be amazed by the lack of "energy awareness" on the part of normally intelligent Americans. This is a fundamental problem and HAS TO change."

"A more diverse range of investor funds is needed in cleantech (as opposed to one-size fits all structures); as soon as we see an inflow of money we'll see innovations in investment strategies. I think 2010 will see meaningful evolution towards investment vehicles that better match cleantech investment opportunities."

"Investors will lick their wounds from 2008-9 biofuel and solar investment catastrophes, but continue doing deals in cleantech. My magic 8 ball is telling me that entrepreneurs will respond to the challenging investment environment by focusing on building more capital efficient cleantech businesses. I like the software enabled efficiency businesses (green computing, building monitoring & controls, logistics, and industrial logistics sectors) and capital efficient execution companies that wrap up (near) market-ready technologies in new and exciting business models (building and lighting efficiency, transportation, and finance models of these plays)."

And my personal favorite:  "Pyrolysis will explode!"  Not literally, I hope...

We'll check back in at the end of 2010, one way or another, and see how everyone did.  Thanks to all who participated!