In many of my recent conversations with colleagues, there's a recurring theme: As a group, these investors are increasingly convinced that the traditional venture capital investment model as applied to cleantech hasn't been working.
In part, this is because there's increasing conviction among VCs and LPs across sectors that the venture capital model overall is broken and needs re-invention. And in part, this is because the exit window has been so tough to hit for so many venture-backed startups across all sectors, over the past decade. So it's not just a cleantech thing.
But even so, with some exceptions the overall body of cleantech VCs I speak with do recognize that there are differences in energy, water and materials markets that mean the mid-2000s Silicon Valley approach to cleantech venture capital doesn't work. To recap some of these which we've previously discussed on this site:
1. The investment models have been too focused on and accepting of capital intensity, without already knowing where the capacity-buildout / project finance capital would come from.
2. There's been too many investments done at valuations that reflect unrealistic growth expectations, unrealistic visions of the endgame being some "winner take all" scenario, and unrealistic hopes for huge IPOs instead of the more likely M&A exit.
3. Too much of a focus on proprietary IP, when so much of that IP is just defending one particular way of producing a commodity.
4. Too much of a focus on the technology, and not enough on the management team's ability to out-execute other teams.
5. Too much focus on just a handful of subsectors (solar, biofuels, transportation, building energy efficiency), when cleantech is really more an overarching investment thesis about looming natural resource scarcity, and thus more broadly applicable to a wider variety of subsectors.
6. Too much capital put in too early in the lifecycle of the company. Putting in a ton of capital after the science risk is removed, under the expectation that now it's off to the races... but then finding that the path of successful productization, scale manufacturing, and commercialization will take longer than expected, which can be deadly when the company has been put into a high cashburn situation.
For all of these reasons, VCs who have invested into the cleantech sector are now talking to me and to each other about hard lessons learned from the past 5 years of investing.
What's interesting right now, however, is to see how differently many of these investors are reacting to these lessons. If you think about it, there are really four basic ways to react to the realization that the traditional venture model as applied to cleantech isn't working.
- You can continue to beat your head against the wall anyway. And there are certainly numerous investors out there doing just that. They may talk about doing things differently, but at the end of the day their investments in 2011 will look much like their investments in 2007.
- You can narrow down your view of cleantech so that you're only investing in the sectors that look very much like other sectors you're more used to. For example, narrowing down to only investing in internet and electronics-based sectors within cleantech. And there are many investors, predominantly among the generalist VCs who had dabbled in cleantech, who are doing exactly this. They don't want to say they're abandoning cleantech, but they do say they're really focusing on familiar-looking areas. Which helps partially explain the current high level of interest in "energy efficiency" as a category, because so much of that is IT-based. This makes a lot of sense, but is kind of where most of the herd is headed right now, and also it's a bit unclear still how a "Netscape Moment" can emerge out of these investment categories.
- You can run screaming for the hills and abandon the category altogether. And this is definitely happening across the generalist venture landscape as well. Rarely is it being done overtly, but in many cases it's been a quiet retreat as cleantech teams get purged from big-named generalist venture firms. And it's happening to a lesser extent among LPs, although it's tough to tell how much of this is just due to a general pullback of LPs from venture capital altogether. But the net result is the same -- fewer specialist firms able to raise their next fund, and fewer cleantech specialists within generalist funds, so fewer cleantech venture investors overall.
- Or you can try to invent new approaches to venture-stage investing that would better apply to various categories and stages of cleantech investments. This is where family offices and angels have the advantage of flexibility over institutional VCs and corporate VCs who have specific mandates and pre-approved investment strategies. But even among these latter categories I'm hearing some interesting thinking from some of my cleantech investor colleagues out there.
All of the last three reactions have their merits, and I'm sure the first reaction has its defenders as well. Nevertheless, I think there is a continuing shakeout happening among cleantech venture investors that will continue for some time forward. And I think there will be a community of investors who redefine how they engage with cleantech so that it's really more about the core, familiar technology than about the market opportunity.
But I'm also excited to see what this fourth category, the re-inventors, will be coming up with and introducing over the next couple of years. I've seen a few new ideas brought to my attention, but not one that I would say has obviously got it figured out yet, including my own nascent ideas for new approaches. But I continue to be impressed with the level of thinking I see being applied to this challenge, and think we'll see some intriguingly different approaches being tried over the next year or so. Some won't fly at all. But some will. And we'll look back on this 2009-2011 period as having been very formative for the next wave of cleantech "venture capital".