Debunking some of the myths around cleantech venture capital
Rob Day: June 30, 2008, 7:24 AM
The myths being thrown around about cleantech venture capital perhaps reached a new height of silliness this weekend, with a NYT article which suggested that cleantech venture capital is responsible for the lack of VC-backed IPOs in the last quarter (also mentioned in this Earth2Tech post).
They reported that some VCs said that"the pipeline for public offerings has dried up in part because of the considerable shift in the industry’s interest in the last three years into 'green' technologies, which was taking time to bear fruit."
That's just plain silly.
It does, however, provide a nice opportunity to discuss a few of the myths (and half-truths) surrounding cleantech venture capital these days, because that silly statement about IPOs rests upon a few key assumptions worth looking into:
Necessary assumption #1: Cleantech venture capital activity has reached such a point that it's "driving the bus" in the sector, so if there are no cleantech IPOs, then there are no VC-backed IPOs.
Look, I know all the media wants to talk about is the excitement around cleantech/ greentech/ energytech these days, and not the "boring" other technology sectors [insert ironic tone here]. But it's not like the entire VC industry woke up three years ago and decided to abandon all other investments. Even by the most generous measures (and they're indeed generous, if you look at the details), cleantech remains less than a fifth of all VC dollars invested in the U.S. And most tallies put the proportion going into cleantech at much lower levels (less than 10%, according to Ernst & Young).
In fact, as we noted before, health care still attracts significantly more venture dollars than cleantech. Not to mention software and IT, internet, etc. Especially when one considers the size of the market opportunity (and with some exceptions in specific sub-sectors, perhaps), cleantech remains a relatively underinvested sector. There are a lot of attractive places venture capital is going these days, and cleantech is only a small part of that.
So how is cleantech possibly driving the overall venture capital asset class?
Necessary assumption #2: Clean technologies take longer to mature.
This falls into the category of "half-truth".
Yes, when compared to a software or internet startup, a biofuels or solar startup will take longer to mature. It just makes sense. The process iterations take longer and require more capital, and the end product can't just be thrown out there into the market before being fully vetted and in some cases certified. Not problems that a Web 2.0 startup has to deal with, for example.
But NO, when compared with many other venture-targeted sectors, and when the entirety of cleantech subsectors is taken into account, it's hard to argue that the entire universe of clean technologies takes longer to mature than the rest of the VC-backed markets.
Since we've already mentioned health care, let's consider that as a contra-example. It's a regulatory-driven market that requires significant time to develop, iterate, and get approval for new technologies. As previously mentioned, it's much bigger as an investment category than cleantech. I'm not knocking that investment category, just asking: Why single out cleantech as being particularly long to mature?
And let's consider the many efforts within cleantech that aren't solar and biofuels -- does energy efficiency software take longer to mature than other software plays? Do solar financing startups take longer to mature than other financial services startups? I'm willing to grant that there are many cleantech segments where the technologies will take a fair amount of time to mature, and that includes a few of the hottest segments in the sector -- but there are plenty of other segments where that's simply not true.
This myth, that cleantech invariably takes longer to mature than other sectors, has been given some credence lately by several high-profile venture capitalists who make that argument publicly. But a) they're usually focused on the longer-gestating cleantechs like solar, biofuels and solid oxide fuel cells, and thus conflating the rest of the market into their narrow view of "cleantech"; and b) they're often referring to specific examples in their early experiences in the sector where they made a bet with overly optimistic expectations around time-to-market, and got burned.
All of which is fair, and smarter investors may disagree with my point of view... but when you see a journalist (perhaps citing a VC) implying there's a consensus that cleantech always takes longer to mature than other tech types, know that they're over-generalizing greatly.
Necessary assumption #3: A sector where the techs take longer to mature means a sector where the investments take longer to exit.
Maybe if all VCs always invested at the same stage in a startup's development, this might hold true.
But it's been clear for some time now that VCs have reacted to the longer gestation periods for solar and biofuels (where most of the capital has been deployed) by shifting later stage. According to the Cleantech Group, while the number of seed and "first round" cleantech venture capital investments actually fell from about 200 total in 2003 down to about 175 total in 2007, "follow on" rounds shot up steadily over that period from 150 in 2003 to 300 in 2007. Later stage venture capital has been driving the growth in venture capital spending in cleantech.
Basically, if a technology takes 3, 5, 7 or 55 years to mature... but the investors don't get in until it's just a couple of years from commercialization... how does that affect the amount of time between writing the check and the exit? The longer gestation period may be a reason why some investors have been moving later-stage, but it shouldn't be a reason for any gap in exits, in other words.
Now, what may have been happening is that even "follow on" rounds into cleantech companies have ended up being further from a point of exit than had been expected by the investors when they did the deal. But what that says is that the gestation period of clean technologies doesn't matter... the VCs' ability to ESTIMATE the gestation period of clean technologies is what matters. And as they've gotten smarter about making those estimations, many have gone later and later in their investments. To the point where now we see the emergence of very large cleantech funds being raised with the explicit expectation of shifting a bit more (as a proportion of dollars spent, at least) into "growth stage" investments.
At my firm, we are early stage specialists in cleantech. But we're not seed stage investors. Because we know that in many sectors it can take longer than expected for the technologies to be developed, commercialized, and adopted by the market. It's just a strategic choice we've made. Other firms are making other strategic choices, and some have chosen to focus more on later-stage investments, especially during this period when exits have been forestalled. Still others (esp. including angels) continue to focus on seed stage investments, filling that pipeline referred to in the article. There's no single uniform timeframe venture investors are targeting, in other words, so the journalistic tendency to paint the entire category as some monolithic herd is a bit misguided.
In any case, there's no inherent reason why, even though solar and biofuels have longer tech maturation periods, that should have any impact on exit timing for venture capital investments. It's not like VCs have been doing only early-stage cleantech investments over the past few years.
Necessary assumption #4: Any of the above assumptions, whether right or wrong, would have any impact at all relative to the overall macroeconomic effects being felt right now.
What makes the NYT article particularly silly is that it flies clearly in the face of available evidence that there are indeed numerous cleantech startups that are primed to IPO as soon as the overall window opens. In fact, as we've talked about before, 2008 was supposed to be the year of the first big wave of VC-backed cleantech IPOs, which are now only being held back by broader market conditions. Investment bankers are saying that cleantech will be the sector that leads the way when the IPO window re-opens. Retail investor interest in the sector doesn't appear to have waned much, as record oil prices continue to make the most visible argument (albeit far from the only one) that the underlying fundamentals are greatly in favor of strong growth in cleantech markets.
So far from being blamed for the IPO "gap" this year, cleantech is being viewed as a potentially critical sector that will drive the next wave in exits.
The simple fact is that the macroeconomic conditions, and the mood on Wall Street in general, is not conducive to IPOs of any color.
So the argument that cleantech is a significant reason for the lack of VC-backed IPOs this quarter is just plain silly. ...although perhaps not as silly as bottled water economics.
Finally, on a lighter note, this cartoon was kind of funny.