Over the next few columns I’m going to talk about what I see as a critical set of lessons and paths forward for cleantech venture capital. But first, I thought it would be necessary to set the table by laying out my own vastly oversimplified version of how cleantech venture capital got to this point.
Where to begin? In the 1990s, there were a very few venture investors tackling alternative energy and environmental technologies. They had small funds and invested mostly in hardware plays of some kind. Sectors like solar and electric vehicles certainly didn’t dominate.
Then the dot-com bubble and IPO frenzy happened. This rising tide lifted a lot of boats, including in this sector. There was a one-year spike of venture investments by generalist firms into what would later be termed “cleantech." As the issue of global warming gained attention, and as hype built around technologies like microturbines and fuel cells, it became possible for some rather early-stage companies with high-cost devices and systems to IPO on the basis of some beta sales and a lot of loose talk about big company adoption and such. I still have some of the presentations from that period where the near-term inevitability of a distributed generation future was posited, and I still remember thinking that, as shares of Ballard Power dropped from over $100 to $20, it might be a good opportunity to buy into the hydrogen-fueled future (oops). When I review a presentation I pulled together in 2001 on the future of alternative energy technologies, it’s… entertaining.
This period was very formative for a lot of investors. It established the expectation that the public would welcome IPOs from companies with a compelling vision of a changed energy future. It locked in the perception that the most value in this sector would be generated by innovative hardware solutions. And the collapse of many of these companies also taught investors that costs and customer economics do matter. And that many of these technologies were therefore not ready for prime time.
In the early 2000s, even as the phrase “cleantech” started to come into currency, the number of venture capitalists putting significant investments into the sector shrank significantly. The members of this fairly tight “cleantech club” were either small-fund sectoral specialists, or gratefully welcomed individual partners at generalist funds. I found myself in cleantech venture capital late into this period, and I remember how it felt like a hugely valuable validation whenever a generalist VC would talk about being interested in cleantech... or heck, talk with me at all. It felt like most of the “cleantech club” of investors knew each other pretty well, and were always co-investing with each other (since they had small funds, or were partners at a generalist fund and needed to co-invest with a sectoral specialist to validate the technology they wanted to put money into). This small group of investors continued to focus on hardware business models. Why? Because market-ready hardware like cost-effective solar panels, etc., didn’t really exist yet. So a) without a base of hardware/infrastructure out there, there’s nothing to build other business models on; and b) the threat of commoditization of the hardware wasn’t very acutely felt, when no one had yet to pass the threshold of commercial viability.
The year 2005 marked a significant inflection point. It’s when many more investors started jumping in. I’m sitting here reading through my Q4 2005 Cleantech Group venture monitor, and it’s fun to look back upon that period where more deals were seed or first-round than follow-ons, energy generation technology was only in its second year of being more important than other investment categories within cleantech, and the West Coast was only then starting to be the dominant region for cleantech deals.
Why did the inflection point happen then? Partly due to oil prices breaking through above $50 and heading upwards. Partly because the topic started to be written about more in the public media. And, relatedly, in 2004, energy investments had done well. Visible leaders within the venture capital industry, such as Kleiner Perkins, started to be more visibly active in the sector, with Alan Salzman of VantagePoint declaring that the next Google was going to come from cleantech. And the SunPower IPO certainly helped.
But I think another major factor is that 2004 marked a doubling of the amount of money put into venture capital by LPs. All of a sudden in 2005, big VCs had a lot of money to put to work. And cleantech seemed like a good place to be able to put it. Remember, VC firms typically look to raise funds in 2-year cycles, so when they raise a big fund, they need to put much of that money to work within the next 24 months. So when the VC herd started moving into doing deals in the cleantech sector, they weren’t going to do it in small ways.
So the die was cast. Cleantech was a sector dominated by hardware plays, the few successful exits were perceived as being based upon proprietary intellectual property (as opposed to branding, customer bases, network externalities, or other sources of shareholder value), and now big money was looking to move in. What else could result except a high level of capital intensity as investors looked to develop highly proprietary equipment-based efforts to make commercially viable solar panels, biofuels, batteries, etc.?
At this point, the sector continued to gain in presence and LP interest. From 2005-2008, venture investments continued to rise, several important cleantech markets started to see significant growth, we started to see some additional venture-backed cleantech companies IPO, and most importantly large corporations started to take these technologies seriously. More capital-intensive investments were made, and few of these big bets going out of business, as an even bigger follow-on was always possible. According to the Cleantech Group, from 2005 to 2008, the average size of a first round in the sector more than doubled from $5M to $13M, and the average size of a follow-on round rose from $8M to $26M. Biofuels and some other sectors of course were huge recipients of venture dollars, but the real story was solar, which (again, according, to the Cleantech Group) rose from being 15% of venture dollars in 2005 to nearly 40% in 2008. Several cleantech specialist firms were able to raise very large funds, and generalist firms established cleantech teams. As the big firms started throwing their weight around, the smaller sectoral specialists stopped being so valued for their experience, and I even heard of some refusing to co-invest with each other anymore because of the stigma attached to being perceived as “just being a little cleantech firm” unable to do deals with the big-brand generalist firms.
And then, of course, the global economy came to a screeching halt. This not only meant hard times for many cleantech startups’ revenue forecasts, it also meant a drying up of the LP dollars going into venture capital overall. The period 2009-2011 will be looked back upon as a real dry season for the sector. First of all, on the policy/politics side, it’s been a disaster here in the U.S.: Not only did the hoped-for climate change legislation get royally screwed up by Congress, but also the visible blow-ups by Solyndra and other government dollar recipients has very much chilled political support for the sector overall. And partly as a result, as LPs pulled back from venture capital overall, they particularly soured on cleantech. This means that many cleantech specialist firms weren’t able to raise their next fund, and many generalist firms sent their cleantech teams packing. Furthermore, some of the technology bets made earlier really did start to pan out. Whereas before, there were few commercially viable offerings in many cleantech sectors, now suddenly there were lots, all competing with each other, and driving down margins and prices. Thanks to that, and some significant public investment by China, 2009-2011 was a period of significant and rapid commoditization of many clean technologies.
Thus, there was a somewhat strange bifurcation of the cleantech venture dollar cycle. Seed and Series A deals were hard to come by, and were skewed toward the new watchword “capital efficiency,” which really meant software-based plays. And yet follow-on rounds, predominantly by insiders, continued to flow into the previous capital-intensive bets, so that overall the sector continued to look dominated by such types of investments. Without angels and family offices stepping into the early stage void, and corporate investors stepping into the late stage void, and government support at all stages, the sector might have seen a real collapse. Instead, thanks to these investors and supporters coming in, as well as VCs’ willingness to continue to back their own bets, the period looked like a “go sideways” period, at least from those outside looking at the data.
For insiders, however, this has clearly been a rough shakeout period. Many startups, in the solar, biofuels and vehicles sectors in particular, have gone under or are in serious trouble. Many capital-intensive bets have run out of steam and investors aren’t there to help like they were before. And there’s even been a shakeout of the investors as well. Multiple smaller cleantech VC firms have gone under, and certainly there’s been a dramatic contraction in the number of cleantech-dedicated investors at generalist firms.
What does 2012 look like so far? A simultaneous accelerated shakeout period, and yet also a rebirth. We’ll start to see more firms finally able to raise their next fund, albeit a smaller one. We’ll start to be able to discern which startups in the crowded sectors like solar and biofuels have staying power, and which ones are going to be crushed by rapid commoditization and price drops and the sudden withdrawal of government support. And we’re going to see the emergence of more new investment models.
So there you go: 15 years of cleantech venture capital in one oversimplified column. Apologies for such a long column, but I wanted to post it all in one piece as a necessary set-up to columns soon to follow, talking about some of these new investment models that I see emerging. I’ve been writing this column since 2005, and I sometimes lose track of how much things have shifted over that time, so it’s good to review before plunging ahead.
And I hope you, gentle reader, take away one major lesson from the above -- namely, that the “inherently capital-intensive” nature of cleantech venture capital really isn’t so, at least not nearly to the level we saw it become. The uber-intensity of capital spending in cleantech startups was a result of several choices by VCs along the way, based upon perceived lessons and opportunities, and the incentives various investors had. Certainly, the cleantech sector needed to be hardware-focused as recently as five or so years ago. Because the hardware/infrastructure is a necessary precondition for many other business models to follow, just as we saw in the IT and telecom sectors. But by now, if an investor views cleantech as a capital intensive sector where patented technology is the most important source of value, that is their choice. It can be, and has been, but it is not inherently so. Many other markets dealing with the production and use of physical products have been successfully disrupted in non-capital-intensive ways, after all.
More on this topic to follow.