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How I’ve Failed

Rob Day: October 28, 2011, 9:17 PM

I've heard it said that venture capital is an apprenticeship business, that it takes about seven years for a VC to become a proficient investor.  As I now get close to my eighth year investing in the cleantech sector, that aphorism resonates with me -- especially as I look back at the many ways I've failed so far as a cleantech venture investor.

I've been taking the opportunity to take a retroactive personal look at my investment patterns, at what I think has worked, and at how I've failed. I'm not talking about failed investments per se. I've had my share of those, but I'm really talking about failures in the sense of "Wow, that didn't work out according to plan."  In some cases, these investments have worked out okay over time.  In some cases, they're still being worked out.  

More experienced investors may shake their heads at some of these lessons as being pretty obvious. Agreed. I'm sure I'm fairly unoriginal in how I've screwed up over the years. But just in case it might be helpful to readers out there, I thought I would write a post exploring some of these experiences in general terms. Certainly, these are root causes of failure that I've identified over the past few years and that I am proactively seeking to avoid going forward.

Out of respect for those involved, I don't want to get into too many specific examples; besides, I'm trying to identify general causes of personal failures, not just isolated incidents or individuals or bad luck. The general lessons I've taken away from these failures are:

1. Don't attempt bank shots.

I've talked before in this column about how, particularly in the broad and multivaried cleantech sector, it can be smart for entrepreneurs to tackle a single niche first, own it, and then expand to the broader market from there. I continue to like that approach.

However, what I've found doesn't work, at least for me, is to attempt bets that require significant additional evolution of technology and offerings in order to expand beyond that niche -- plans that, to be successful, require accomplishing one difficult task, only to then have to take on another completely different difficult task.  

A concrete albeit frivolous illustration from well before my actual venture career: In 1999, after the IPO of Webvan, the idea of a capital-intensive grocery delivery business started coming under criticism, but I convinced myself I knew what the real plan had to be. After using groceries as the way to pay for building out that costly delivery infrastructure, Webvan was going to pivot from there to solving the overall "last mile" ecommerce problems. At the time, every delivery made by a FedEx or UPS truck cost an arm and a leg, and also required a signature. But if people are already scheduling their food deliveries around when they're home, I rationalized to myself, then that delivery service can also perform ecommerce fulfillment.  So I bought some shares, because I knew the real secret plan for Webvan was to cannibalize FedEx's lucrative delivery business. It's embarrassing to look back on it, but I then had the opportunity to briefly meet George Shaheen and hit him up with my theory, whereupon he politely but pretty directly told me I had no idea what I was talking about. I sold those shares right quick. Today, if you come visit me in my office, you'll notice a yellow Webvan box under my desk.  It's handy.  But it's also a good reminder to keep things simple and straightforward.

Unfortunately, that's not the only time I've made the same mistake since then. So as I look back upon such examples, I try to differentiate between a "niche-to-big-market" opportunity, which doesn't require developing entirely new competencies, technologies, offerings, etc. to make that transition, versus a "bank shot," which does.  Bridgehead and then expansion? Good. Pre-identified necessary pivot? Too complicated. Nonetheless, pivots will have to happen in many cases as circumstances change. But from day one, if I'm not seeing a simple success story, I've simply been fooling myself.

2.  Keep peeling back the layers; no shortcuts.

Again, this should be pretty obvious. Still, it amazes me how many venture investors -- myself definitely included at times -- just simply haven't dug deeply enough into the investment opportunities they're pursuing or the portfolio companies they're working with. This I consider to be my least excusable source of failures, and the most painful to admit to myself and others.  

I've failed in a couple of examples to do my own diligence, instead relying upon the work of existing investors in the company, or co-investors with particular experience in a technical area. It's not that being a passive follower investor can't work out sometimes; generally, people in venture capital are smart and diligent. But I never should have taken that approach, given that I generally don't like to invest where others are already active. And it's bitten me a couple of times when I took other investors' word for it, simply because of their resume or stature or the pedigree of their firm, without recognizing that they were also inexperienced in that sector or not going deep enough on this specific opportunity.

Also, I've certainly found my early efforts at management team diligence to have been pretty disappointing in retrospect. Pattern recognition, spending a lot of time with the management team, and references are all necessary, and I carried out those tasks. But I no longer believe they are enough. So at Black Coral Capital, we have adopted deeper management team evaluation methodologies that get into much more detail on an entrepreneur's prior experiences, successes, failures, lessons learned, demonstrated patterns, etc. And we've learned to look not just at the CEO, but also at others within the senior management team, depending upon the stage and size of the company.  Where we've shortchanged this process, we've come to regret it. When we act as LPs, in fact, we also deploy similar approaches to assessing the senior partnership team at venture firms we are considering backing.  

There is another place where lack of depth has hurt, and it's also surprising to recognize, because it's typically after the investment is made. But it's a basic human conflict-avoidance instinct, I've found, that causes many investors to not dig into areas of cognitive dissonance in the boardroom. The CEO says something, it doesn't quite add up, but no one calls him or her on it, especially in a group setting. Often, it's because to do so appears to be micro-managing, overly detail-oriented, and potentially antagonizing the CEO (particularly with founders). But I've learned a lot over the years from watching experienced investors in the boardroom, especially those who've learned to recognize when they feel a little tickle of cognitive dissonance, even over something seemingly minor or overly detail-oriented, and then keep scratching at it until they resolve it. And I've learned to really appreciate CEOs who understand the value of a board member who gets into the details -- and who welcome it instead of feeling threatened by it.

These things are just too damned important to gloss over, and even minor things that don't add up sometimes end up revealing bigger issues. The lack of consistency between development timeframes on two slides in the board deck can end up eventually revealing major unvoiced schisms between senior management team members. The lack of detail about an important partnership discussion can end up having been an early indicator that the discussion is not gaining traction. The glossed-over miss on margins can end up leading to a critical and as-yet-unplanned conversation about possible competitive threats. And those are just a few examples.  

3. Value the team more than the technology.

I know there are investors out there who vehemently disagree with me on this point. And I respect that; I can see both sides of the coin. But in cleantech, more often than not, I think the balance is skewed toward my perspective.

If you look back on the relatively short list of cleantech venture capital success stories to date, they most often weren't successful with Plan A. The original idea -- and in some cases even the original technologies -- were discarded along the way as the market, company and circumstances evolved. These are the unplanned pivots I referred to above. Especially given that there are often many different ways to accomplish what the startup is attempting to do (turn photons into kilowatt-hours; free up capacity upon demand; turn biomass into liquid fuel, etc.), it's unclear whether there will ever be any "killer apps" in cleantech. Well, maybe there will be, but I think the odds are against any particular technical innovation being so mind-blowingly brilliant and unreplicable in any way that it will lead to success despite a mediocre team.

During the early part of my career, I often worked with management teams that I decided were "good enough," and I saw it as my job to help them elevate their performance to a high level, justifying this on the basis of the price to be paid for getting a chance to pursue an investment thesis I really liked. After all, many of these teams were first-time entrepreneurs, and they can't be expected to instantly be great, so perhaps by collaborating with them we could all learn together how to make it work out.  

This isn't completely flawed thinking. VCs are supposed to add value to the teams they partner with -- in fact, that's one reason for entrepreneurs to partner with VCs in the first place.  And all entrepreneurs, successful or not, are first-time entrepreneurs to start off. I am certainly not suggesting that only repeat entrepreneurs can be successful. Instead, you have to look at the core skills and attributes of the entrepreneurs and assess their ability to tackle the specific challenges they'll face in this particular effort -- whether they're a first-time entrepreneur or not.  And what I've found is that too often in my early career I knew the team had gaps, but I felt that I and other investors could help fill those gaps via advice and connections and, possibly, new hires. That rarely worked out.

For one thing, I'm still learning how to be a truly value-added investor, and also I'm not there every day on the front lines like the management team is.  And for another thing, some gaps can indeed be filled, but others are prohibitive. Furthermore, such approaches are really labor-intensive and difficult to scale as an investor.

More recently, even with an affirmed commitment to only working with top-tier entrepreneurs, I've had experiences doing investments where, going in, we knew a CEO hire would need to be made. We only did that with full disclosure and buy-in from the existing management team, and we have experience as a team on such efforts, so it seemed like a role we could play. But this is, of course, really hard. Especially in cleantech, where at this point in the sector's development, you're often bringing in a CEO hire from outside the sector, or simply fishing in a shallow pool of entrepreneurial talent because the specific subsector you're hiring into hasn't seen much entrepreneurial activity before now. We've found great CEOs in these situations, but only after long, painful processes that hindered the investment's performance.   

I've heard a couple of investors say things like, "I care more about the idea, because I can recruit a team around a great idea." That may work for them. But it hasn't worked for me so far in the cleantech sector. 

So I've learned again and again and again what all investors say, and experienced investors really know, which is that it's all about the team. Working with a great entrepreneur is indeed a privilege and an incredible advantage. It's the best part of my job. I love that at our firm, we have lots of flexibility as to what sectors and asset categories we can invest in, because it gives me a lot more latitude to work with phenomenal teams wherever I can find them.  

And it's also why I've made it a priority to work with efforts like the Cleantech Open that serve as "accelerators" for emerging entrepreneurs. I recognize how critical it can be for such entrepreneurs to tap into customers, investors, mentors, etc. Such efforts are so very important to our sector right now.

The three sources of failures I've discussed here are far from the only ones, but they're the three broad categories that pop out for me when I look over the past seven-plus years and reflect on what I've learned from failure. Failure is, of course, inevitable in venture capital. I feel I've actually been pretty fortunate to date in terms of results. But I've also been even more fortunate to have had these experiences, both good and bad. Every year I've looked back and been surprised at how much I've learned over the previous 12 months. I'm sure it'll be the same going forward. Venture capital may be a seven-year apprenticeship business, but I feel like I still have a lot more to learn before I would consider myself truly "good" at this. For now, I hope sharing some of this thinking is useful for someone out there. Or at least entertaining.

Q3: One Last Bloom Before the Winter?

Rob Day: October 11, 2011, 10:39 AM

The Cleantech Group released their Q3 preliminary tally recently, and there appears to be some positive news in there.

In their global count, they saw not only an uptick in the dollars going into the sector ($2.23B in Q3 2011, up from $1.81B in Q3 2010), but also an increase in the number of financing rounds (189, up from 179 in Q2 2011).  Even more encouragingly, the number of Seed / Series A deals went up, so this wasn't just a quarter of insider follow-ons like we've seen at times in the past. The total of 128 deals they counted in North America was a new high for the region, they report, and represented a second straight quarter of deal-count growth. While they point to energy storage as being a hot area, it's important to note that a small handful of large battery- and fuel cell-related deals drove that sector to be a major recipient of dollars. Energy efficiency and solar saw the highest number of deals, and continue to feel like they're still "hot" even if the deal counts in each subsector are a bit down from their highs.

So, some encouraging news. But there were signs of distress as well.

They show average early-round deal sizes declining for a second straight quarter to $6.1M. That remains well off the peak average of over $12M for such deals from back in 2008. The fact that deal sizes are coming down isn't necessarily a bad thing, however. But the Cleantech Group readout (see their whole slide deck here for lots of data goodness) also notes that exits are hard to come by right now. So we're left with a lot of VCs holding existing portfolios, needing to raise new funds, but not having exits from existing funds that they can point to. Perhaps that's the reason why that out of the top 10 "venture deals" they list for the quarter, I count only a couple that had venture firms as their primary investors.

Furthermore, the entire VC asset category is out of favor right now.  As Dow Jones reported yesterday, VC fundraising is way down. Especially hard hit have been early-stage investments, which saw fundraising drop 41% year-on-year. If VC firms can't raise new funds, they can't invest in new deals.

This resonates with the sharp decline in the number of VC firms in the U.S. actively investing, as reported in August by Ernst & Young (sorry, don't have a link; working off a document) across all sectors (not just cleantech). Even as recently as 2008, they counted 911 venture firms making investments, of which 345 made four or more investments per year. By 2010, that number had fallen to 793 total, with only 274 making four or more investments. So far in 2011, that total is down to 564, with only 150 making four or more investments.  

There is a contraction underway in the venture capital asset category overall. And while some LPs still like the cleantech thesis, there's plenty of anecdotal evidence to suggest that this year (even before the Solyndra circus rolled into town), many LPs are generally backing away from the sector. So I would expect the contraction to end up being especially harsh on cleantech VCs.

This isn't to be over-generalized. Certainly, there are VC firms still investing heavily in cleantech, and certainly there are some specialist cleantech VC firms out there able to close on decent-sized new funds.

But in general, it doesn't look like the investors in this sector will be entering 2012 with deep pockets -- especially if a now-expected second recession hits the macroeconomy, further hurting LP allocations and exit pathways.

So while the Q3 results are somewhat encouraging, it will be surprising to see that upward trend continue over the next few quarters.

Once again, my advice to cleantech entrepreneurs is simple: if you have the opportunity to raise money, do it. And raise more than you think you'll need, so you have enough to last through a "winter season" in cleantech venture capital if that's what 2012 ends up looking like.

Root for that IPO window to re-open, because exits would really help bring back LP interest into the sector.

Powering Through

Rob Day: October 5, 2011, 11:54 AM

The economy is sputtering; VCs and LPs continue to be wary of cleantech; federal government support of the sector continues to be feckless; political rhetoric regarding cleantech is reckless; and the sky is falling (at least where I live -- we had five inches of rain in two hours yesterday).

So why am I smiling and full of cheer this morning?

Because the Cleantech Open Northeast regional final event yesterday and last night (formerly known as Ignite Clean Energy) was an incredible demonstration of the power of the grassroots community that has grown to support and nurture this sector, and of the amazing entrepreneurial energy being directed at our natural resource challenges.

Yesterday, we had more than 30 strong startups from across the New England region gather to present to a collection of judges. Six finalists were selected for a second round of judging, which was public, in front of a crowd of over 200 that had gathered to witness the event. Then an all-star roster of New England cleantech investors and entrepreneurs (including Pat Cloney of the Massachusetts Clean Energy Center, Geoff Chapin of Next Step Living, Gisele Everett of DB Masdar, David Vieau of A123, Tom Burton of Mintz Levin, and Bryan Garcia of the Connecticut Clean Energy Finance and Investment Authority) selected three finalists who are going to go represent New England at the national competition in November.
Congratulations to Arctic Sand, PK Clean and Qado Energy!  
But more important than the results of the competition was what the entire day represented. 
1. A vibrant entrepreneurial community. We had over 70 applicants for this year's program -- 70 real businesses, not just business plans or ideas. Many were first-time entrepreneurs. Across those 70 startups, a wide range of sectors and technologies were represented. The three regional finalists, as Nadia Shalaby of Arctic Sand pointed out to me last night, are all led by women entrepreneurs. And the event ran smoothly, thanks largely to the efforts of a bunch of student and professional volunteers, many of whom got involved because they are or want to be cleantech entrepreneurs themselves. There is a deeply set passion many entrepreneurs have for the cleantech sector, and that passion will carry the sector through this and any other downturns in the future.
2. A supportive community of experienced entrepreneurs and businesspeople.  All of yesterday's contestants worked with mentors. This year, we had over 100 mentors volunteer their time to help these companies. And that plus the rest of the CTO educational program seemed to have really delivered some value to the participating entrepreneurs -- several judges came up to tell me that they'd seen some of the participants several months back, and in the meantime the companies had made leaps and bounds in terms of progress. And the judges themselves were great. In addition to the judges for the evening public event, we had something like 25 additional judges from the investor, entrepreneur and corporate communities, all of whom volunteered an entire day out of their busy lives to come listen to the pitches, grade them, and even more importantly, give feedback. At least here in New England, to have such a deep bench of committed, experienced sector participants is a huge resource. By connecting with this resource, even those Cleantech Open participants who didn't win still gained a lot from the experience and the exposure.
3. Lots of collaboration. In addition to working with the MassCEC and the CT CEFIA, here in New England the Cleantech Open is also working closely with groups like the New England Clean Energy Council and the Fraunhofer TechBridge -- in fact, several ULaunch/TechBridge awards were also announced last night. That kind of overt collaboration stands in stark contrast to the political infighting and territorial grabbing that happens all too often at the national level among environmental and cleantech-oriented nonprofits. Such overt collaboration is, I believe, a critical reason why cleantech regional policies and cluster-building efforts have been so much more effective than most efforts at the national/federal level. Those who truly have a passion for seeing this sector grow and thrive don't need to own it. They work together as partners, and they don't feel the need to make sure they get labels like "co-founder" and get to be the center of attention -- something I've seen way too much of in certain cleantech cluster-building efforts lately. There's no room for power-grabs and other forms of selfishness when we all need to work together to harness and cultivate the entrepreneurial passion in the cleantech sector. We all need to have small egos and dull elbows. In that regard, the collaboration evidenced at last night's event was hugely gratifying.
So while the cleantech sector faces a lot of "headline risk" at the moment, at the grassroots level, we have never seen so much commitment and enthusiasm from both new entrants and experienced leaders in support of the growth of the sector. Last night was a competition, but it was also a celebration -- one that the New England cleantech community roundly deserves.