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How to Interpret Q1 Greentech VC Numbers

Rob Day: April 20, 2012, 1:42 PM

Over the past couple of weeks, various deal-trackers have come out with their Q1 tallies for cleantech venture capital dealflow, and it's a bit confusing this time around.

The Cleantech Group came out with its totals (see the great slide deck here), showing that Q1 saw an increase in the number of cleantech deals (from 176 in Q4 to 185), even as dollar amounts went down. Interestingly, they talk up a rebound in early stage (Seed + A) investing, as well.

DowJones Venture Source has a pretty different number reported in the overall tally reported today, showing energy deal counts drop from 30 in 1Q11 to 29 in 1Q12, of which 23 were in renewables. This isn't from the helpful special cleantech tally it always does, but that hasn't been seen yet, so it's just an incomplete data point to include for context.

CB Insights also released its tally of deals, and it showed a different picture -- not only did dollars fall, as shown as well by the Cleantech Group, but further, deal counts fell from 69 in Q4 down to 56 in Q1. CB Insights also shows a significant decline in the number of early-stage deals in the sector, with Seed and Series A deals together falling from 40% of the overall count in Q4, to 17% of the overall deal count in Q1.

What's going on?

I always like to think about this kind of disparity in terms of three factors: geographic differences, definitional differences (i.e., inclusiveness), and thoroughness.

Geographically speaking, a closer look at the Cleantech Group numbers is a bit revealing, in that the topline numbers above were global. In its North American tally the deal count actually went slightly down -- 118 to 116 -- from Q4.  Cleantech Group doesn't break down that region from an early stage vs. late stage perspective in this deck, unfortunately. But we can at least start to rationalize between the Cleantech Group perspective and the CB Insights perspective, in that part of the upward trend that the Cleantech Group saw was actually in other regions, like Europe and Israel.

There's still a big difference between the Cleantech Group's 116 total counted deals in North America, and CB Insights' 56 total counted deals in the U.S. And I strongly doubt that's because of Canadian deals. Also, there's still the matter of the CB Insights tally showing a significant decline, while the region-specific Cleantech Group tally was pretty flat.

Definitional differences could play a very large role here.  Looking into the sectoral breakdowns within the Cleantech Group numbers, one trend they describe is the increased activity in non-energy subsectors. The company saw a nice uptick in water sector deals, for example. Meanwhile, the CB Insights presentation suggests the company perhaps has a narrower definition of "greentech," not calling out water for example, albeit with a big catch-all "other" category. And as well, remember that being named the Cleantech Group means that organization has an incentive to cast a wide net and include a lot of venture-backed companies that, within a broader survey covering multiple sectors, might reasonably be put into other tech categories instead. The Cleantech Group might also have definitional differences around a "venture capital" round, as well. It wouldn't be surprising to see the Cleantech Group have a looser definition of what types of financings to include, again, because it's the company's mission to be inclusive.

In terms of thoroughness, it's always impossible without going deal by deal to truly figure out if one of these professional organizations is just flat-out missing deals. But if CB Insights (the lower of the two totals) was really missing a lot of deals that the Cleantech Group was catching, you would expect CB Insights to miss more of the smaller (and thus less-reported) variety. Instead, looking at its tally of dollars ($763M) in greentech venture deals in the quarter, versus the Cleantech Group's $1.3B total for North America, it would have really needed to have completely whiffed on some really big deals if lack of thoroughness was the reason for the deal count difference. Most likely, the differences are due to the methodological differences described above. As for me, I think highly of both groups' efforts, having tracked their processes over the past couple of years.

So: what do we conclude, meshing these perspectives? It looks like the first quarters saw venture capitalists shifting their focus a bit outside of the popular subsectors of cleantech (solar, energy efficiency, energy storage), and into subsectors that haven't gotten as much attention -- and that sometimes aren't even considered "cleantech" by some definitions. And maybe, an expansion of "non-VC" financings, counted by one group but not the other.

If so, those are really healthy shifts, in my opinion.

Unfortunately, we have less clarity around the idea of early stage investments making a rebound. While perhaps the same definitional differences are at work here, it's just too tough to parse that out. And if CB Insights is right and early-stage greentech took another step back, that's not good. Early stage is the lifeblood of the industry, because they are tomorrow's follow-ons, and also it's an indication of investors putting new money into the sector instead of just defending earlier bets.

Here's hoping the Cleantech Group's perspective on this question -- that early stage is rebounding -- is the more representative one.

An Experiment

Rob Day: April 20, 2012, 9:39 AM

Regular readers of this column will know that I often describe non-tech entrepreneurial efforts, like channel disruption and implementation services, as crucial to the next phase of development of the cleantech market. We still need technical innovation, of course, but it's not the limiting factor in this market right now -- actual implementations are. There are now lots of commercially viable, economically sustainable clean technology solutions available for customers, but we need to see buyers start to adopt and implement them. 

Regular readers of this column will also know that I believe VCs have not yet done a great job of tackling this other type of business opportunity, at least in the cleantech sector. "The Next Great Patent" success story is still the typical cleantech venture capitalist's goal, often for good reason, and it's still what most people think about when the term "cleantech" is mentioned. So there's an unmet need to help out the unrecognized entrepreneurs out there who are taking on this big implementation and market shift challenge.

Finally, regular followers of me on Twitter will know that I've been a big supporter of the Cleantech Open, both as a national board member, and as regional chairman of the Northeast program. It's a great accelerator program that every year helps dozens of emerging entrepreneurs get training, perspective, connections and visibility -- and it's also proven to be a great networking platform for more senior members of the cleantech entrepreneurial and investor community as well.

This year, in the northeast region, we're going to try an experiment, tying all of the above together.

We're still going to work with cleantech VCs and the entrepreneurs who want to meet them, of course -- that's been a primary historical aspect of the Open over the years, with Alumni companies having raised over $660M in venture funding to date. Speaking as a VC, it's been a great program to be a part of, quite valuable for the likes of me. For example, this year the national organization has been selected to manage NASA's Night Rover Challenge, and each year we run a Global Ideas Competition, just a couple of examples of how the Cleantech Open has become a great way for technical innovators to help take their ideas to the next level.

But this year, in the Northeast region, we're going to additionally target helping those entrepreneurs who don't see themselves as necessarily being a fit for the venture capital model.

This means that we're going to specifically recruit and highlight the best new "implementation-oriented" business in the region. We're going to change our training program to better suit the needs of these entrepreneurs, too, bringing in additional perspectives and making sure to address the different types of financing these entrepreneurs should be targeting. And we're going to bring in more angels, family office investors and corporate members of the cleantech community here in the Northeast, as mentors and judges.  

There are lots of opportunities out there for engineering students to get advice on how to spin out technical inventions from a university lab and get venture funding. I'm a big fan of all that, and we'll continue to work hard to help those emerging entrepreneurs too, since we've seen great results doing so. But we also haven't seen enough community support, training, connections, visibility, etc. dedicated to helping the other entrepreneurs who are launching businesses that will eventually implement those inventions -- installing solar panels, doing energy efficiency retrofits, building anaerobic digestion projects, launching LED lighting distribution businesses, etc. So this year we're going to build additional features into our program try to start addressing that gap as well. 

If you're an entrepreneur in the Northeast and this sounds like you, and it sounds like we could help, think about applying. This is one of the most effective nonprofits I've ever been involved in, and it's the centerpiece of a vibrant cleantech entrepreneurial community. We'd love to have you join us.

Sovereign Wealth Funds and Large Pension Funds: Stymied by Greentech VC

Rob Day: April 17, 2012, 8:44 AM

Some very, very large check-writers have been getting bigger and more interested in private equity investments. Sovereign wealth funds and large pension funds don't get a lot of attention, but they're huge players in the investment world. And as I've been speaking with several members of that community, two points have come through fairly clearly: 1) many (especially those outside the U.S.) are interested in doing direct investments in the cleantech space, broadly defined; and 2) they feel stymied in trying to do so.

They are interested in investing in cleantech markets for the same reason you are, Gentle Reader: because the macro trends are too obvious on a global scale to not eventually result in massive market shifts and the emergence of significant new profit pools.

But when it comes to cleantech venture investments, they're largely sitting on the sidelines. Why?

First, check size. Talking with these investors, even in their direct investments, they need to write really large checks compared to what most VCs are used to.  A $50M check can be perceived as too small of a bet to bother with. And so that significantly limits the universe of types of "venture" deals they can invest in.

In other sectors, however, they can dabble in very-late-stage deals where the exit path is obvious and near-term (the so-called "venture rounds" into companies like Facebook at super-high valuations, for example). But of course, in the cleantech sector we haven't seen any of these. Sure, there have been some IPOs, but no obvious blockbusters. So their direct venture investments are flowing into sectors other than cleantech right now.

These large investors also have a hard time getting involved in cleantech venture capital as LPs for largely the same reason. You'd think venture firms would love a $50M allocation from an LP, but many of these LPs have restrictions about being more than 10% to 20% of a fund, as well as about participating in the first close of a fund. Which means, therefore, that they need to be targeting funds that will be several hundred million dollars in size and get to a sizeable first close without them. But that's hard to find among cleantech specialist VCs right now.  And as well, it's not like the existing returns from cleantech GPs have been very impressive to date. So rather than desperately finding ways to squeeze an allocation into a cleantech specialist VC's newest, smallish fund, interested SWFs and large pension funds are instead settling for the cleantech activities of the generalist VCs (those with really big brand names) they've backed. 

One other path would be for these funds to get into project finance investments. Some are, but that's also not easy. First of all, it's likely a different team and different mandate within that investor's organization. Second, there aren't a lot of large-scale cleantech-specialist project finance firms out there, either. So the same problem with cleantech venture capital presents itself: back lesser-branded developers' projects, or go with the traditional energy project finance firms that aren't making renewables central to their activities? And third and perhaps most important, the types of cleantech sectors they can get into through these activities are very limited, usually consisting only of large-scale powergen and production facilities. There remain very few large-scale ways to play energy efficiency project finance, or green agriculture project finance, or even water-related project finance. 

What all this means is that, as frustrating as it might be for entrepreneurs and specialist VCs, there are some really deep pools of capital that are interested in playing the cleantech investment thesis, but that are currently sitting on the sidelines. Which says there will be a threshold effect. We started to see what this might mean in the 2007-2008 timeframe when some of the higher-profile cleantech sectors got frothy and started getting some of these dollars. The cycle's down right now, but it will come back. And when that threshold gets breached, the capital inflows into this sector will explode. 

It's not an 'if' -- but the 'when' remains very much unknown.

A Greentech VC Bridge Too Far?

Rob Day: April 6, 2012, 9:00 AM

I've been talking with a lot of fellow cleantech investors lately, and we all commiserate about how busy we have been so far this year.

I think this is tied to a couple of things. First, as of the beginning of the year, it seems like just about every startup hit the fundraising trail. And secondly, the sector is maturing, and so a much greater percentage of these startups are investable as compared to in the past: strong management teams, good revenue prospects, attractive markets, etc. So it's a really good problem to have as an investor, to be overwhelmed with intriguing dealflow. It's a good sign for the sector, and a sign that it's a great time to have capital to deploy as an investor.

But what's curious is that a lot of investors I speak with have been more busy with existing portfolios than with incoming dealflow. It's interesting, because it feels like cleantech markets and startups are on an upswing. So it's not like the spring of 2009, when cleantech investors were more focused on their portfolios than on new deals out of necessity, since the world had basically come to a crashing halt. That was damage control and triage time.

Instead, I think the universe of cleantech investors is seeing a lot of progress in its portfolios, which is good. But because of the lean times over the past couple of years, their portfolio companies also need an infusion of capital to keep growing. 

And right now, new outside lead investors are still hard to come by. We're seeing progress among cleantech VCs in terms of their own fundraising and fund closings, which bodes well for later on. But for now, there remain few investors with significant new capital, and thus few doing many new investments in the sector, and meanwhile, LPs remain highly skeptical. 

So cleantech VCs see promising signs out of portfolio companies, but they lack outside lead investors because few are available. And so they feel like they should continue to support their startups themselves. Why stop backing a company that's making progress?

The problem is, many of these investors are themselves out of capital. And even for those with dry powder, there's a healthy reticence to do internal-only fundraisings where no outsider prices are around. So they do a smaller-than-needed bridge round instead, kicking the can down the road, putting a convertible note into a company in the expectation of a new, larger round of financing in the second half of the year. It's a pretty standard and appropriate decision for such circumstances, where the company needs more financing, has made progress since the last round, but would have trouble pricing a round at the current moment. A textbook decision, if such textbooks existed.

But unfortunately, I just see a whole lot of these bridges going on right now. So while each one is an appropriate decision under the specific circumstances of each company, I do fear that in the aggregate there won't be nearly enough new lead investors in 2H12 to support so many bridges. Will these be bridges to nowhere? And what happens to these companies if the bridge doesn't lead to a new outside-led equity round?

Entrepreneurs that have taken in bridges in the first quarter should be looking at their existing investors and developing backup plans. Figure out which existing investors have dry powder and think about what an insider-led round should look like as a Plan B. Still, outside pitches lead in 2H12 as Plan A, but be prepared for it to be a crowded market chasing few outside leads. And plan ahead, in tight coordination with those inside investors who aren't themselves tight on capital.

And for companies and investors still thinking about doing a bridge financing intended to lead into a new outside-led financing in the second half of the year -- be careful. It's looking like the second half of the year will be better than the first half of the year, so hope for the best. But there's a possible capital supply and demand imbalance looming as well, so plan for the worst.

Guest Post: Capital Efficiency and M&A Opportunities

Rob Day: March 26, 2012, 11:10 AM

Today's guest post comes from Oliver Guinness of Clearpoint Ventures. In recent posts, we've talked about the need for re-examination of various venture capital investment models and how they've been applied to the sector. Oliver and his colleagues' take on the sector is an interesting version of the old "evolution vs. revolution" debate. As such, I asked Oliver to write up their investment approach in his own words. Enjoy!


When we launched Clearpoint Ventures a couple of years back, we used Steve Blank’s “Customer Development” methodology to come up with an alternative strategy for investing in cleantech. We knew the energy and building sectors were extremely different from those sectors venture investors were used to investing in, so a different approach was probably needed. The notion that you can go way upstream, find cutting-edge technologies and rapidly bring them to market in these sectors was, and continues to be, extremely challenging!

We made two tenets core to our investment thesis:

1.       Innovations in the energy and building sectors tend to be adopted in a more evolutionary than revolutionary way; and

2.       Customers are generally seeking solutions, not just products or technologies.

Of course, the first tenet isn’t in line with the focus of a typical venture strategy because it lacks the word “disruption” or “revolutionary” and the second speaks to more of a “consultative” approach, something VCs tend to avoid as well. However, despite this divergence from typical venture capital criteria, we felt enormous opportunities existed for a different approach, and we feel they are even bigger today.

We call our strategy “Clean Economy” as opposed to “Cleantech,” and based upon our core tenets, it is decidedly focused on the lower-tech, service and IT-enabled service companies operating in and around alternative energy, energy efficiency/management, and green building. While this segment of companies has largely been underserved by investors, if you look at the portfolios of many of the traditional cleantech funds, you’ll likely find one, perhaps two “Clean Economy” companies in each of them. You’ll also realize: 1) they are the ones gaining traction faster; 2) they are achieving incremental industry change with disruptive business models, as opposed to disruptive technologies; 3) they tend to be more capital-efficient; and 4) they generally have or had M&A exit optionality. (This last point is the primary area of focus of this post, and another criterion incorporated in our Clean Economy strategy.)

Some examples of what we would call Clean Economy companies include: SolarCity, Opower, Airbnb, Clean Power Finance, and OwnEnergy (one of ours). (Note: another term being used for a subset of these companies is “CleanWeb,” which refers specifically to those companies operating at the intersection of IT and cleantech -- those that use the cloud, software and big data to enable an innovative business model.) Clean Economy companies operate in smart grid, project development, efficiency, analytics, recycling, water, green building, finance, etc.

So, why is capital efficiency and M&A optionality important? Well, we all know that the IPO window is erratic, that less than 8% of venture-backed companies IPO (Dow Jones), and that M&A exits generally dwarf IPOs, both in total dollars and numbers of deals (though if you’re able to IPO, multiples can indeed be much greater). However, the below graph and tables point to another interesting point: not only do most “cleantech” companies (those that are big tech or infrastructure companies) generally require more time and capital, very early on, they have valuations that limit M&A exit optionality. It's IPO or bust! That is problematic so long as the IPO market continues to act as it has, and I’m not sure anyone believes we’ll ever “Party like it's 1999” again. That said, many of the mega-sized cleantech funds have specifically targeted companies in which they can plow tens of millions of dollars in hopes of achieving multi-billion dollar valuations at exit -- to make their return numbers go around, out of necessity, and because they’re looking for, and trying to build, the “Google of cleantech.” Good for them I say; however, optionality is still critical to achieving liquidity when needed. Yet the valuations of those companies generally preclude them from exiting in the cleantech “M&A exit zone” because at their B or C round, they’re likely already priced out of that market and/or because they are still far from commercialization (something buyers tend to demand in the energy and building sectors, while in other industries like IT or pharma, buyers frequently purchase pre-revenue tech or biotech companies).

As Matt Nordan of Venrock outlined in his “State of Cleantech Venture Capital 2011,” the average cleantech company that IPO’d raised $120 million pre-IPO over five rounds over eight to nine years. That’s capital-intensive! The graph below (data from CleanTech Group) shows how that $120 million stacks up against the average and median cleantech M&A exit.

Sources: CleanTech Group; Matt Nordan – Venrock


Also note the sectors of the latest cleantech IPO filings and the amount of additional capital being raised.

Compare that with the list of the most active buyers of cleantech companies, and their sectors of focus:

Source: CleanTech Group

Finally, why is this ultimately important? Time and targeted returns! A 2X to 3X multiple over four to six years (average M&A exit) has the same IRR as a 7X to 8X multiple over nine years (average time to IPO) (Dow Jones). Thus, in my mind: Clean Economy strategy + M&A exit focus = opportunity for strong, comparable venture returns, with less tech and time risk, and of course, less capital. And the added benefit of optionality. You can still swing for that IPO fence if you want to take on more risk… and try and “Party like it's 1999.”

(Note: You may be saying to yourself, 'But those big infrastructure companies require that kind of capital, and we need to fund them in order to change the way we generate and consume energy.' Well, the big venture funds will thankfully continue to work at it, but they need more collaboration from strategics, governments and other investors to succeed. I’ll leave that topic for someone else to tackle.)

Some Examples From the VC Front Lines

Rob Day: March 16, 2012, 10:00 AM

In the last couple of posts we first looked over the past 15 years of cleantech venture capital, and then we looked at the various ways to generate VC-type returns in the sector -- and concluded that some of those models are being over-applied and others are being under-applied.

Within the sector, I'm starting to see some investors who get this kind of thinking and are building new types of efforts accordingly.

This harkens back to some of what I laid out a while back in my presentation "Cleantech Venture Capital in 2015," particularly the theme-driven builders and the "lean cleantech" players. We're now starting to see them emerge.

Here are a few examples I've noticed and am tracking:

1. Scott MacDonald and Whitney Rockley are two long-time veterans of the cleantech venture sector, and it appears they're launching a new effort they're calling McRock Capital.  And given their backgrounds, it's interesting to hear they're really focusing in on one particular area within the sector, which they're calling "Intelligent Infrastructure." Basically, the sensors and M2M communications to make things like the smart grid and such work effectively. They are focused on building companies that make existing assets in established industries smarter. It’s about smart data and smarter systems. They are taking advantage of the data tsunami that is already migrating into established industry. These companies are scalable and capital-light. These two both were investors in RuggedCom, which was one of the early success examples of this kind of opportunity, so it's interesting to see them doubling down and focusing on a particular theme like this. And, per the last column, you can see how such investments can become standards and enjoy some positive network externalities when they work well.  

2. Spring Ventures, led by Sunil Paul and Nick Allen, have been championing a "cleanweb" trend recently. If you haven't seen Sunil's slides from SXSW, it's worth checking them out, although they lose something without his voiceover, I'm guessing. But the "cleanweb" concept is pretty interesting, in that many of its examples speak to the lack of good channels in cleantech and seek to address them. Some of the cleanweb examples out there are a bit too "webby" for me, but then again I'm a curmudgeon when it comes to such things, and I'm open to being wrong on that point. I admit, when I first heard of Zappos, I thought it was a terrible idea, for example, so I'm eager to see how this develops. Certainly the recent wave of "cleanweb hackathons" have impressively brought out a lot of entrepreneurial passion among the web crowd that needs to be brought into the cleantech sector, and we're looking forward to doing one here in Boston soon.  

3. It sure seems like the cleantech investment universe is starting to shift towards a place where SJF Ventures has been for a while now.  The firm has been investing in tech-enabled services in the cleantech sector, and avoiding capital intensity and upstream techs. It turns out that SJF Ventures has been able to generate some pretty decent returns while doing so, even though it hasn't gotten nearly the attention heaped on the bigger-named investors who are throwing a lot more capital at the "next big patent."

4. Among investors who are going to continue to invest in proprietary technologies at early stages, they'll need to have some kind of special access to innovations and a strong focus on capital efficiency, particularly during the early stages of their investments. Along these lines, I've really enjoyed getting to work with the Israel Cleantech Ventures team as an LP.  As specialists in Israel, they see everything in that innovation-rich region. And I've watched as the team has carefully cultivated their bets to help them get to critical proof points without requiring nearly as much capital as such efforts seem to require in other more heavily-invested regions. This is an example of theme-driven builders of a geographic type.

Will these efforts succeed? I can't say. But I'm watching them all with interest, as efforts resembling some of the ways I expect the broader cleantech venture capital community to evolve over time.

The Six Ways to Create Venture Capital Returns in Cleantech

Rob Day: March 13, 2012, 12:38 PM

In my last column, I rushed us through my take on 15 years of cleantech venture capital history. Because if we're going to look at the path forward, we need to understand how we got here in the first place. I would also refer everyone to Matthew Nordan's great four-part take on the state of cleantech venture capital from a little while back, particularly Part 2, where he argues that cleantech has performed at par with the overall venture capital category.

To which I would say: nuts to that.

It's not that I in any way wish to slight Matthew's smart analysis; it's a must-read. But if the conclusion is that cleantech has been at par with other sectors simply because on average it has returned capital? We can do better than that. As an asset category, venture capital is supposed to be out at the end of the risk-reward curve, and thus should generate outsized IRRs. But just how to do that in cleantech -- that's the as-yet-unanswered question.

So what will generate big returns for any venture capital investment? Growth, obviously. And profitability. And a high earnings or revenues multiple at time of exit. And a timely exit at that. Pretty simple, right? Buy cheap, grow quickly, sell high. Except all of us investors have seen plenty of good business ideas that don't fit this profile. And we've also all invested in businesses that we thought would produce this, and didn't.

Looking at the history of venture capital and when it has made exceptional returns, I will overgeneralize and argue that those periods saw investments in companies and products that had the following "success conditions":

1. Low customer acquisition cost. 

2. Each new customer makes the overall offering even more valuable -- the so-called "virtuous cycle."

3. High margins.

These are all connected, and are tied to other aspects as well: big markets; solving customer pain points; customer economic value propositions; etc. But at the end of the day, it boils down to investing in companies that will grow quickly and be very profitable (at least on a gross-margin basis). This is what acquirers, including public equities shareholders (i.e., via IPO), will pay through the nose for.  

Otherwise, the ball never gets rolling downhill. The technology being offered is one of many such options and doesn't stand out in any way. And thus customers have a lot of choices and won't buy quickly. Such customers also won't pay a lot for what you're offering. And an acquirer will have lots of choices and also won't be willing to pay up. It's not a recipe for venture success.

So what kind of strategies can create the right type of situation? I can count at least six ways. There may be more, but here are the categories I've seen.

1. Sustainable cost/performance advantage through proprietary IP, plus subsequent scale-driven cost economies

This is clearly where most cleantech venture dollars have been deployed to date. It's basically the First Solar model of cleantech venture capital. Unfortunately, these types of situations appear to be quite rare. They require such a significant IP advantage, plus a fast-growing market that no one else was clued into in time, that you get a significant (two-year?) time window in which to establish a scale advantage and really press it home. It's clearly possible, but it's infrequently successful. More often, even if the technology does catch on as quickly as hoped, commoditization and margin compression happens more rapidly than expected. Thus, you get the current patterns we're seeing in upstream bets in biofuels, solar, LEDs, lithium ion batteries, etc. And VCs keep placing more such bets in these and other subsectors. Personally, I'm starting to despair of seeing venture-type returns anytime soon from the "next big patent" investment strategy in this sector. There would need to be many earlier and more lucrative exits for these companies for it to be successful. And, somewhat unfortunately, these efforts tend to be pretty capital-intensive even before it's clear whether the company truly does have a differentiated technology. Succeeding here will require a management team that is technically brilliant, and great at building hype and raising capital.

2. Info centralization

This is the idea that, by getting out into a marketplace early (perhaps as a media play, or via a SaaS-based model or some other way of controlling data flow), a company can become a central repository for market data (costs, customer patterns, etc.) and then the value will flow from there. One problem is that it requires grabbing market share very quickly. This means basically giving away value for free, unless there are other compelling reasons for customers to adopt the service or product ahead of it becoming that dominant info repository. And the problem with giving away value for free early on is that it's pretty much an Underpants Gnomes business strategy. It's tough to later convert the original offering into value that customers will pay more for, since they're used to getting it for free, and the other sources of value from the gathered information are promising but only hoped-for (in the web sector, they've basically settled on ad revenue as the answer). This is certainly one possible business model to create the previously cited success conditions, even if we haven't seen too many examples yet of it producing outsized returns in cleantech (until Greentech Media IPOs, that is!). And because it requires building out a loss-leader offering before getting into the value-harvesting opportunities from the gathered information, this can also be a somewhat capital-intensive play, albeit much less so than proprietary hardware technology development efforts, of course. 

3. Becoming a standard

This is also where a lot of cleantech venture dollars have gone. And it's been a successful strategy for hardware investments in the history of venture capital. The idea is that if you create a widget, component, product, etc., that becomes an industry standard within a larger business ecosystem, everyone will have to use you and thus you not only grow quickly, you also become an expensive acquisition for someone. It's the idea of creating a monopoly at one segment within a larger value chain. It worked for semiconductors, it worked for medical devices, it worked in some telecom bets. 

Big challenge, however: It only works if it's either mandated from a regulatory standpoint, or if the customer base is homogenous and amenable to being standardized fairly quickly. The former scenario hasn't materialized as some had hoped in energy industries; the latter is possibly true for utilities, but many other customer types in cleantech are much too fragmented, and even utilities are slow and not as homogenous as you might think. Nevertheless, this is clearly the primary hoped-for source of returns in the smart grid, as well as other efforts built around controls and M2M communications (as well as efforts like Project Better Place). And there's some early evidence it can succeed, if the management teams are exceptionally good at building solutions for a particular market niche and using that as their initial beachhead customer sector, and if the market they're selling into is primed for rapid adoption.

4. Building a valuable brand

Venture capitalists backed P.F. Chang's and Jamba Juice. You can't patent a lettuce wrap or a smoothie. Cleantech VCs would never have made those bets. But outside of the cleantech sector, investors have realized for quite some time that successfully building a well-regarded brand can result in strong investment returns, simply because of the power of the brand itself to drive low customer acquisition costs and higher margins. But we haven't seen too many of these efforts in cleantech venture capital yet. I would argue that Tesla and Fisker are venture-backed efforts that have primarily pursued this strategy for venture returns (mixed in with some technology angles as well, of course, but still).  Nevertheless, it remains a relatively untapped business strategy in cleantech markets.

5. Marketplace externalities

I name this late in the list not because it's not a potentially valuable approach, but because it clearly builds upon a couple of the earlier strategies. But over the past two decades, it has become an obvious truth that if you can become a dominant marketplace, you can generate good returns by benefiting from the virtuous cycle of customers and vendors increasingly needing to come to you. And I would argue that, in many cleantech markets, being a "dominant" player doesn't necessarily mean anything close to >50% market share. Customers and vendors are both so scattered and diverse in many cleantech markets that even just being a standout marketplace would likely result in the virtuous cycle effect kicking in. Even still, the challenge of getting to the appropriate level of critical mass, however low it may be, has stymied every effort to create new cleantech marketplaces that I've seen.

Even more challenging for "marketplace" efforts in cleantech, in my mind, is that we lack the necessary standard ways of relaying product performance in ways customers can use. Have you tried to buy an LED bulb on Amazon? It's a horrible experience. And looking at more commercial and industrial markets for LED lighting, I've now seen how many lighting fixture vendors really play around with (i.e., lie about) their product performance specs to a level where the average customer would find spec sheet comparisons, etc., to be a bewildering exercise, and thus something of a non-starter. We will see successful physical and/or ecommerce marketplaces established for cleantech markets. But to get there, we'll need to see someone standardize product performance info.

6. Customer access/building a new channel

As mentioned, these can be very fragmented markets. And the (often 100-year-old) channels in these markets, to put it bluntly, suck. They don't know how to sell the new innovations, nor are they incented to. The lack of good VARs in cleantech is something I've talked about before, and it remains a screaming unmet need in many cleantech markets, especially given the vendor disinformation factor I allude to above. The opportunity to build a new channel model in residential energy efficiency is one major reason we invested in Next Step Living a few years back, just to name one example. When they're now in thousands of homes each year as a trusted energy advisor, that opens up all sorts of opportunities to help bring these customers new innovative products and services. And at that company we're now seeing the proof of how valuable that access is, and how quickly it can scale. So without going so far as to be a marketplace, simply having access to a large number of customers has a lot of value in these markets where channel disruption is so badly needed.

But a separate version of the same "capture the customer" dynamic is often being attempted in more hardcore B2B markets like biochemicals, where upstream tech innovators selling into concentrated customer clusters will attempt to lock them up early on, via JVs and the like. I didn't want to break this out as a separate item, because it's kind of a different flavor of both customer access and becoming a standard, but the theory is that if a startup vendor can gain early entry into several key members of an oligopsony (and fortunately, there are a few of these in cleantech markets), they can box out followers. Again, however, we haven't seen too much evidence of this eventually turning into venture returns in cleantech, unfortunately. But you can see the potential for it to happen -- just not very often.


There are other ways to generate returns, of course, and these are not mutually exclusive categories, but these six approaches are the ones I see attempted by cleantech VCs that are clearly aimed at venture-type IRRs (versus lower-risk/lower-reward investment strategies). All of these six or so strategies are designed to build rapidly scalable businesses with valuable exits, and all are being tried in cleantech, to varying degrees. Unfortunately, what I see is that the strategies least likely to meet the three success conditions described above are also the ones being attempted most often. And despite scant evidence of high success rates in these strategies (such as the "next big patent" approach), cleantech VCs keep looking for those types of plays, and pouring huge amounts of dollars into them. All of these are valid approaches. However, it seems like the balance is out of whack. To date, it seems like the only real attempt at innovation by cleantech VCs in terms of their investment strategies has been to keep doing the same thing, just later and bigger.

I think the industry is ripe for some significant change. In the next column, I'll mention a couple of specific managers I see out there who are attempting some different approaches.