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VC fund fundraising remains depressed

Rob Day: July 8, 2010, 11:09 AM

Just a really quick follow-up on my last post regarding cleantech venture investments... Entrepreneurs need to realize that this is unlikely to change very soon.  Why? Because VCs themselves are still finding it hard to raise new funds.

Dow Jones put out their tally of VC fundraising in 1H10 today, and the headline was "US Venture Fund-Raising Up 13%".  I've seen people talking about how that's great news.  Not really.  Simply look at the very first data slide in their presentation and you'll see what I mean.  The totals are up compared to 1H09 because 1H09 was awful.  The dollar amounts remain way down from previous years, however.  

I said a while back that my guess was 2010 cleantech venture firm fundraising was going to end up being somewhere in between the 50% decline of 2009 and the "normal" level of previous years.  I may have been over-optimistic.

So entrepreneurs, just remember: If the VCs don't have dry powder, they can't spend it.  Be conservative, hoard cash, stay lean.

Cleantech venture capital remains tepid, not hot

Rob Day: July 7, 2010, 8:42 AM

To judge from the headline of the Cleantech Group's Q2 numbers, "Global Clean Technology Venture Investment Increases 65 Percent in 1H 2010", you might think that cleantech venture capital is white hot right now.

It's certainly not as bad as it was in 1H09.  But there are signs in the CG numbers that things remain fairly tepid.  As the press release describes, the number of deals actually went down from Q1 to Q2 (from 192 to 140), for example.

But this is why we ignore headlines, and even dollar totals, and dig into the details, right?

So what are the trends of interest within the broader mediocre activity level in the sector.  First of all, much of the decline in deal count (which, as a reminder, we care about a lot more than any dollar total which can be skewed by a big deal or two) occurred in North America, according to the CG tally.  North American deals plummeted from 128 in Q1 down to 76 in Q2.  Meanwhile, Europe and Israel appear to have had an uptick in dealflow from quarter to quarter.

In terms of sectors, energy efficiency is now officially mainstream for cleantech venture capital investment, being the sector with the highest number of deals tracked (31), topping even solar (26 deals), biofuels (13) and smart grid (11).  Of course, the dollar totals for energy efficiency put that category at the BOTTOM of sectors tracked, but that's exactly why the sector is popular right now, because of its capital efficient attributes.

So in short, yes, when compared to the trough that was 1H09, cleantech venture capital has picked up.  But it's still pretty rocky, particularly in North America.  

My guess is that the dealflow drop-off reflects the fact that so many cleantech VCs are out fundraising right now.  They're in check-gathering, not check-writing, mode.  My gut feel is that many of the insider rounds to arm existing portfolio companies with additional cash are also done by now.

Unfortunately, for cleantech entrepreneurs this means it will continue to be lean times on the fundraising front going forward.

Nikola would be proud

Rob Day: June 29, 2010, 8:37 PM

Tesla went out to IPO today quite successfully.  I was very glad to see the offering do well, at least on the first day. I've seen complaints about it going out too early (as yet unprofitable, and mass market car not due until 2011), but it does seem from the outside like a relatively well-run company with a compelling story. Low risk? Absolutely not. But I'm hoping they do well. Especially because this sector needs more success stories.  LPs have been waiting very, very patiently for more big visible stories like First Solar... will Tesla prove to be one of them?  Time, and stock market investor patience, will tell... 

I reiterate my long-standing tongue in cheek offer:  If the company would simply give me a roadster loaner for, say, two months, I promise them a glowing product review on this website!

But more seriously, I just hope cleantech VCs realize that stories like Tesla, big capex and somewhat still risky at exit, will be exceptions, not the rule. Not to tar Tesla with this brush, but too many VCs have been hoping that their cleantech companies can IPO early, before they're profitable. This isn't 1998.  And it won't be anytime soon.  Then it was sock puppets and eyeballs. This time it's fabs and negative gross margin beta units.

The age of hunter-gatherer cleantech venture capital is over.  When I started out in cleantech venture capital six years ago there were still plenty of unexamined subsectors, but by this point I don't know many subsectors that haven't been at least studied by multiple investors.  We're now deep into the age of both cultivators (ie: those who look for steady, if unexciting, returns) and big game hunters.  As always, big game hunters get the visibility (ie: press coverage).  But to over-extend the analogy, over time the farmers provide most of the nutrition, er, returns.

But seeing Tesla do well does help the exit window for others, including the many less sexy companies out there tackling our many energy problems. Today's performance is proof that investors are still hungry for compelling cleantech stories to back.  Of course, A123 did well immediately after the offering as well.  But I, and most other cleantech investors, are hoping that we see a nice sustainable story from this one.  It certainly is a fun one.  As a sector, not just as individual investors, we need to put some numbers on the board.

Some random cleantech VC thoughts and aphorisms

Rob Day: June 25, 2010, 8:43 PM

Been away on a major travel binge, so apologies for a download of a bunch of randomness that has accumulated over the past few weeks.  So, in no particular order:

1. Selling even millions of dollars' worth of a Gen 1 product at zero or negative gross margins doesn't count as "Commercialization".  It's just a large beta test.  ...Yes I'm talking to you, thin film solar and solid-oxide fuel cell industries. 

2. Tom Pincince, President and CEO at my portfolio company Digital Lumens, is also a former Forrester Research analyst.  And he has some pretty interesting predictions on LEDs.  Definitely check them out.

3. VC/PE funds often pass on great deals.  And know it.  Constantly-shifting internal firm dynamics often mean they just can't write checks to a company they like, for reasons having nothing to do with the potential worth of the investment.

4. The U.S. Senate advocates of climate change legislation continue to place the wrong emphasis, imho.  They have attempted to craft a law that would have significant near- to mid-term climate impact but still be politically and economically palatable.  But the (short) history of market-based environmental regulations suggests that timing isn't nearly so important -- people get out ahead of regulatory impacts as soon as they see a clear signal.  So pass a law this year to significantly price carbon... in 2020.  The net-positive economic changes will start hitting much earlier anyway, and the painful economic changes will be pushed out beyond most politicians' career half-life. 

5.  I talk about venture investment decisions for the most part on this site.  But that's different from career decisions.  Were I someone looking to choose a career right now, becoming an expert in building energy efficiency commissioning and retrofits would top my list.  So much latent demand, and much of it will have to be labor-intensive... and impossible to outsource overseas.

6. The single biggest missing need in cleantech?  Great sales leaders.  I've been searching for them for a while now, and yet have found very few.

7. The cleantech IPO candidate pool continues to look weaker and weaker.  Strong hype can't overcome negative margins and high cash burn -- at least in the absence of a pre-existing stock market bubble. But I do think there are a lot of great companies waiting in the wings for a second wave... if the market conditions allow it.  And if the market forgives this decade's first batch of cleantech IPOs for having a few belly-flops.

8. If you care about climate change, stop conflating natural gas and oil.  Yes, they both often come out of the same holes, and have the same players.  But not really.  There are "oily" and "gassy" producers (to borrow the parlance of Wall Street), and the communities are fairly separate as far as I can tell.  And as this great MIT study shows, any serious effort to combat climate change will need to embrace the substitution of coal and oil with natgas, at least over the near- to mid-term.  Yet environmental rhetoric and federal legislative proposals around climate change continue to significantly subsidize coal but treat natgas production the same as oil production.  That's a mistake.

9. The more time I spend driving up and down the east coast, the more I appreciate the train.  And the more I appreciate crowd-sourced real-time traffic applications for GPS navigation devices...

10. To anyone who was attempting to take a late-morning nap in my hotel in DC on wednesday, my apologies for undoubtedly waking you up by screaming so loud when Landon Donovan put that ball in the net.  Go USA!



More on the Massachusetts innovation gap

Rob Day: June 13, 2010, 9:30 PM

I got a lot of feedback on my last post comparing Massachusetts with California in terms of Research, Innovation, and Commercialization of clean technologies.  One respondent, my friend Jay Fiske of Wakonda Technologies, was so knowledgeable and thoughtful in his take that I asked him to write it up as a guest blog post.  So... Enjoy!


In his most recent post, Rob Day asks why the West Coast seems to be better at commercializing cleantech research than the East Coast.  

It's a great question.

As a former cleantech venture investor with the Massachusetts Green Energy Fund and as Vice President of Operations for Wakonda Technologies -- a company developing high-efficiency, flexible, low-cost photovoltaics for the mobile power and building-integrated solar markets -- I have been privileged to meet and work with a wide variety of scientists and engineers developing clean energy technologies.  

Perhaps one of the biggest differences between the East Coast and West Coast is cultural.  In my experience, there are many university professors who have no interest in commercializing their research.  The knowledge gained from their research is the goal - they are pure intellectuals: "a person who places a high value on or pursues things of interest to the intellect or the more complex forms and fields of knowledge, as aesthetic or philosophical matters, esp. on an abstract and general level."  Thanks to for that one.  

Academia -- at least the East Coast version with which I have the greatest exposure -- is a different place than business.  Many academics seem to compete on who is smartest, who has the best paper, and who was published in which prestigious journal.  Money rarely comes into the credibility equation for academics, unless you're speaking with business school professors, and typically, one doesn't find innovative energy technology in business schools.  

Maybe the difference between the coasts stems from the fact that many universities in the East came into prominence before the industrial revolution when intellectualism was the goal, while many universities in the West came into prominence after the industrial revolution when commercialization was the goal.  

Clearly, I'm stretching here.

Frankly, the "East Coast vs West Coast" debate is an interesting discussion, but the bigger concern I have is US vs India vs China.  

Which regions will thrive because they are continuously developing innovative technologies and forming companies around them, and which regions will struggle to build or maintain a robust economy because innovative firms are formed elsewhere?  

When I was recruiting for a senior scientist position at Wakonda, I reviewed about 130 resumes from PhD's from various prestigious universities.  An astounding 70% of the candidates I reviewed were born in India, China, or Russia.  I guarantee you that not all of these highly-qualified individuals will find jobs in innovative materials science firms in the US such as Wakonda.  Many will go home and start or join innovative firms there.  

In addition to the incredible labor pool being developed in India and China (and to some degree, Russia), much of the manufacturing base has shifted to these regions, which greatly facilitates innovation.  If a company's manufacturing line is housed in the same facility that houses R&D, their "clockspeed" for implementing innovations will be much greater than firms where those capabilities are separated by 10,000 miles.  

So, is it time for Rob Day to move to Shanghai?

Maybe not quite yet.  I think there will still be opportunities to build great companies from East Coast research -- the amount of scientific talent in the Northeast focused on energy is indeed incredible -- and I am hopeful that we will see more efforts to fund the bridge from basic research to commercialization.  However, I agree with Rob's implied point that perhaps we in the East Coast shouldn't be beating our chests too hard and should be a bit more paranoid about the competition.  However, I would shift the focus of our paranoia to China and India and not worry so much about California.  

Massachusetts’ cleantech challenge: Turning Research into Innovation

Rob Day: June 6, 2010, 12:38 PM

Apparently, June is Innovation Month in New England.  So I thought I would write a bit about one of the perplexing things about cleantech investing in New England.

Now, every region ends up being a bit self-centered at times, and New England is certainly no exception.  But it's a commonly-held and oft-stated position among those involved in energytech innovation in this region that "Massachusetts is THE world-class center of research in energy and clean technologies".

If you are one of those who takes this kind of statement literally, then it probably comes as some surprise to then see that California typically attracts significantly more cleantech venture dollars than Massachusetts, and even New England overall.  I've been part of meetings with investors and other industry participants here in the Boston area where the goal is put out there that Massachusetts should -- especially given its primacy in energy R&D! -- be able to top or at least equal California in terms of cleantech entrepreneurial activity.  And for lack of other trackable statistics, the disparity in cleantech venture capital spending is then lamented as a sign that Massachusetts is "falling behind."

I've been one to say such things myself at times.  Being here, surrounded by so many great researchers in so many varied energy and clean technology fields, really does give one the sense of being in a world-class research cluster that is second-to-none.  And then, as an investor, when I find myself inevitably investing on the west coast, I start wondering "Why?"  

Why do I seem to generally find California a better place to invest in (when I'm wearing my VC hat, versus my other private equity roles), when there's so much innovation around here?  Is it that that's where the dominant amount of cleantech venture dollars are sitting, and therefore more entrepreneurs go there?  Is it something about a disparity in entrepreneurial culture in general between the regions?  Is it just that MIT researchers hate venture capital while many California researchers seek it?  In other words, is there something "wrong" with Massachusetts (from a self-centered VC point of view)?  Or is it simply that California is so much bigger than Massachusetts, in terms of people and economy, so research cluster or not is a moot question?

I decided to take a really quick look into the question.  Starting with cleantech patents.  I wanted to test the theory that innovation is just as prevalent here as it is in California, and started naturally with patents as a proxy.  I couldn't find anyone who had already done this analysis the way I wanted it done (there are some cleantech patent tracking efforts out there, but I can't really get a tangible understanding of their methodologies, and they don't have the state-level breakdowns the way I wanted it), so I went to an online patent search engine and started searching for all published patents from 2007 to the present, with at least one inventor in the searched-for state (CA, MA, and NY).  I didn't scrub the results at all, because I wasn't looking for 100% absolutely accurate totals, I was simply looking for comparisons across regions.  Here's what I found:

As you can see, not only does it appear that California dramatically outpaced Massachusetts in terms of published cleantech patents over the past few years, but MA is even mostly behind New York state as well.  This is pretty damaging to all those Mass-philes out there who claim that this is the dominant place for cleantech innovation.  To put it another way, if you're a cleantech VC, looking at the above tallies, would you rather be in Massachusetts or California? Or even New York state?

Now two big caveats:  First of all not all patents are created equal.  This is just an unscrubbed tally of patents based on very simple search terms, and it might be that the 3 most important photovoltaic patents during this period, from an investor standpoint, were all in Massachusetts.  Or perhaps in NY, for example, a higher proportion of these patents were claimed by large corporate research arms (ie: GE) and therefore aren't accessible to venture investors.  So the above tallies might not tell the full story.  But even still -- there's a wide gulf between the number of cleantech patents published in California and Massachusetts.

Secondly, patents aren't a full proxy for innovation.  They're just a proxy of applied innovation.  For the most part, basic science research results in papers, not patents.  

In fact, I would argue that there's an important distinction between Research and Innovation.  Let me propose a taxonomy of sorts:  "Research" helps uncover basic principles, or invent entire new technology innovation areas.  "Innovation" is the application of those principles to the development of new, commercializable, patentable technology.  And then "Commercialization", the productization of that innovation and the introduction of those products to the market, is where venture and corporate capital is supposed to plug in.

So the answer might be that Massachusetts is indeed a dominant center of excellence for energy research -- but fundamental Research, not patentable technology Innovation.

This is, in fact, what I believe to be happening.  For instance, in the 2007 US Department of Energy budget, California universities and colleges received $100M in DOE support (mostly grants from the Office of Science, very basic research), whereas Massachusetts universities and colleges received $78M, a much closer amount (NY state, btw, received $84M).  And if you could map that out, I bet a 100 mile radius centered around Boston would end up being the top academic research dollar garnering area of comparable size, compared to California and New York state where the research institutions are much more spread out.  It's just one small slice of the cleantech research picture, but it does start to lend some credence to what I and others are sensing anecdotally -- that Massachusetts really is a world-class center of basic academic cleantech Research.

But basic Research.  Not Innovations ready to be Commercialized within a venture capital type time period.  

So let's go back to the original question about cleantech venture capital... In light of the above analysis, New Englanders should celebrate the fact that the region is receiving almost as much attention as the west coast in terms of early stage cleantech venture capital.  I looked it up, and thanks to the Cleantech Group's new data format for members (really a terrific job of data presentation, I absolutely love this new sortable format, kudos to them), I was able to look only at "early stage" (ie: 1st round) financings within each region:

In terms of dollars tracked by the Cleantech Group, the Northeast is only about half of the West Coast, but in terms of number of deals they're actually pretty comparable.  And as long-time readers know, because of the really broad range of capital-intensity across sectors and business models within cleantech, I always say that the number of deals, and not the dollars, is a much more accurate indicator of venture investment activity.  So the Northeast overall is right up there with the West Coast in terms of venture investments in cleantech innovation.

So Beat L.A.! and all that...  Massachusetts can declare (near) victory and walk away happy from this analysis, right?

Sort of.  I actually think what I may have identified is an unsustainable trend in the region.  If the patent-level innovation shows such a wide disparity, but the venture investments and research dollars look much more similar in number, one of three things is happening.

1. New England innovations, on a per-patent basis, are much more valuable than West Coast innovations.

2. New England cleantech investors have been harvesting available patentable innovations at a comparable rate to West Coast investors, but with a shallower pool to work from, so are going to hit diminishing returns much sooner.

3. New England cleantech investors have been more eager than West Coast investors (on average) to put venture dollars into more basic research efforts that are further away from commercialization.

The first one is probably nonsense.  And the second two possible scenarios (which aren't mutually exclusive, btw) are unsustainable.  When coupled with the fact that, anecdotally at least, the Boston cleantech venture capital community is rapidly shrinking and spending a lot of time on airplanes right now, it paints a picture that's less happy looking forward.

In other words, those who want to see a continued vibrant cleantech innovation-based economy in Massachusetts should be pretty pleased with how the region has performed to date, in comparison with California and other regions.  No doubt greatly helped by strongly supportive government policy at the state level. And they should be proud of the world-class energy technology research being undertaken here.  But they should also be concerned about the fact that there appears to be a possible disconnect between the large amount of brilliant basic energy Research being done here, and a relatively low amount of commercializable Innovation development being undertaken.  

To put it another way, there's an important R&D step between fundamental Research and venture-backed or corporate-driven Commercialization of new clean technologies, and in Massachusetts there's some evidence that this Innovation step is a relative weakness, at least when compared to some other top regions (it's not like Massachusetts is an absolute laggard or anything, but you get my point).

Massachusetts needs to be thinking about how to better hand-off all this fundamental science Research to the engineering-based Innovator community (which could be either internal or external to the research's academic setting) that can drive it closer to actual Commercialization.  

Or else the research will go elsewhere for commercialization -- or worse, go nowhere.




Risk vs. Reward

Rob Day: May 27, 2010, 8:49 AM

One thing that non-VCs typically don't have a good understanding of is how different venture investors view the risk versus reward tradeoff when it comes to managing portfolio companies.

How do VCs get compensated, besides salary?  "Carry", a/k/a profit-sharing.  And except in very few cases, carry on an entire fund, not on a per-deal basis.  Everyone in the industry is familiar with the studies that have shown that fund performance is typically determined, at least on the upside, by a handful of deals across an entire portfolio.  In other words, 1 or more really big wins drive all the performance.  And, by the way, 1 or more really big wins really drive a VC's career as well, because of the visibility they bring.  

It all sets up a dynamic where individual VCs, and overall partnerships, are motivated not to try to produce steady returns across an entire portfolio, but instead to try to maximize the slim chance that each deal becomes a blockbuster.

Let's put some really oversimplified math to it:  

$100M fund, 10 portfolio companies, each with $10M committed.  If each one creates a 2x outcome, that's $100M in return.  But if just one company creates a 10x outcome, then you could only break even with all the others and still come close to creating the same return ($90M).  If you get two 10x outcomes, or one ten-bagger and one 5-bagger, then the VC fund is sitting pretty almost regardless of what anything else in the portfolio does.  

This has a lot of implications for how VCs typically manage their portfolios.  To overgeneralize a bit:

First of all, it explains why VCs would so often pass on investment opportunities with good chances to double or triple their money.  Not that any one as an individual would pass up on the opportunity to double or triple their own money all things being equal, but if you're more motivated to find the 5-10x opportunities you'll pass up on attractive but smaller ones.  I interact with entrepreneurs all the time who have good solid businesses with good growth prospects, and yet they're frustrated at their inability to get VC interest.  Basically, this is one major reason why that happens.

Secondly, it means VCs will spend more time on their portfolio companies that are doing well, versus the companies that aren't doing well.  If they can help turn a 3x outcome into a 10x outcome, that's worth a lot more to them than working hard to turn a 0.3x outcome into a 1x outcome.  Many VCs I know have a hard time sticking to this rule, because at the end of the day as individuals with personal relationships and a sense of obligation they want to help out all their companies as much as possible, but the more hardnosed VCs will admit that this is how they try to spend their limited available time in portfolio management.  I've even heard of some big-name VCs who simply stop showing up for board meetings once the company gets off-track.  

Thirdly, it means that around the boardroom, many VCs will tend to push their companies into riskier situations when it means a better likelihood of an upside outcome.  Let me illustrate:

If the VC starts out with each company having a 30% chance of a 0x, a 30% chance of a 1x, a 30% chance of a 2x, and a 10% chance of a 10x, then if they can shift that to be 50% chance of a 0x, 15% chance of a 1x, 15% chance of a 2x, and 20% chance of a 10x, that can end up being a better odds-weighted return.

But note that, to the entrepreneur, that just became a much riskier scenario.  

How does this play out in reality?  Well, the other day someone was telling me about one cleantech company with two big-name generalist VC firms as investors.  And they were describing how, around the boardroom, there had been major disagreement between the two VC firms -- one wanted the company to be burning several hundred thousand in cash per month, the other wanted the company to be burning more than a million in cash per month.  With the real disagreement being around how quickly to push the company to bring a commercial product to market.  This is a natural outcome of all of the motivations described above, along with an expectation that one way or another these brand-name VCs could attract additional follow-on capital into the company if and when it ran out of cash.

On the other hand, I know that many of the "original cleantech crew" of sectoral specialist VCs, and some other specialist and generalist VCs with lower-risk approaches, tend to want the companies to get to cashflow breakeven as quickly as possible.  And thus they want to keep the company expenses lean.

I typically favor that last approach (albeit on a case by case basis).  I just think in slow-moving cleantech markets, rushing a product to market doesn't have the same likelihood of creating customer uptake and first-mover advantage as is often seen in other technology sectors.  So you can easily put a company in a high cash burn situation to successfully bring a product to market, and still fail.  Venture capital is risky enough, without adding further risk into a company... 

But no one knows which approach is truly best for producing investment returns.  In the boardroom anecdote above, those investors were deeply experienced and VC-savvy (certainly more so than me), and not dumb about cleantech either.  And until we see a wave of exits, no one in this industry will have proven that they know how to consistently make money.  So the right risk/reward tradeoff approach to cleantech venture investing remains a very open question.

However, to those out there urging that major amounts of government dollars be simply handed over to VCs to invest as they see fit... Make sure you really understand and are comfortable with all of the above dynamic, and what its implications would be for the successful commercialization of a broad range of clean energy and other technologies.  I am absolutely a strong proponent of government support for commercialization of clean technologies.  But not as a carte blanche to VCs...