Feed: Greentech Media: Cleantech Investing - AggScore: 82.2

What’s Going On With Corporate Investors in Cleantech?

Walt Frick posted a good rebuttal to the Wired "cleantech bust" article recently, in which he points out that venture dollars going into the sector remain high.

This is true, but as one of my fellow panelists at the Kellogg PE/VC conference yesterday pointed out, a lot of those dollars are simply follow-ons into existing investments. And furthermore, corporate investors have really been filling the gap recently.  One lawyer I spoke with recently who sees a lot of cleantech transactions told me that over the past 12 months, most transactions he's seen have included a strategic investor as the predominant "new money" in the deal.

It's clear that many large corporations have determined that there will be growth opportunities in emerging clean technologies, and at a time when many corporations have been hoarding cash they are thus able to put some money at work in venture investments in the sector. This is very encouraging for the sector, of course.

But corporate venture investments have a history of piling on at the end of cycles. Does this current wave of investments portend bad things for the cleantech venture sector, given the lagging indicator they've often been?

The alternative optimistic view says that "this time is different," because various clean technologies are reaching a point of maturation where they are "ready for primetime" -- and this just happens to be at a point in time where corporations have capital and VCs don't. And in addition, the generally horribly ineffective channels for clean technologies mean that large corporate partners do indeed have value to add, as opposed to other "bulges" in corporate venture investing, where they were just buying late into the party.

At the risk of saying "this time is different" (famous last words), I do tend to believe this latter, optimistic view. Mostly because I don't see a lot of evidence that corporate venture groups are dramatically overpaying to buy their way into 'hot' companies. Indeed, I see a lot of bargain-hunting and serious evaluation of underlying technologies instead of just momentum investing among corporate VCs. I do believe that many large corporations have determined that clean technologies will be strategic growth areas for them over the long run, and that this is a buyer's market, so it's an opportune time to forge some relationships, investment-oriented and otherwise.

But even if so, there's still a significant disconnect going on.  While these corporate venture groups are investing in growth opportunities, the operating units within these larger companies are adopting cost-saving clean technologies as slowly as ever.

A long, long time ago, a colleague and I wrote about four different ways "sustainability" can be used to create economic value for large companies. The first is simply to help ensure "right to operate" -- that is, avoiding major environmental screw-ups. The second is as a means of identifying cost savings via waste reduction. The third is adding new products with resource-efficiency advantages, and the fourth is redefining the entire business. (You can learn more about this framework here.)

Corporate venture groups are primarily concerned with the third of these opportunities: new add-on businesses. But there's a huge opportunity in the cost-saving category that is being missed by these same companies.

I see a lot of industrial energy efficiency startups right now, for example, that are having a hard time getting large corporates to act quickly to purchase new lighting, controls, and other systems that would be relatively easy to implement and have compelling ROIs. You would typically think that a two-year payback period is a no-brainer for a corporate operating manager to pitch internally, yet I'm seeing even six-month paybacks not get the traction you would expect. Why? Mostly because these aren't strategic priorities.

The corporate world has shifted a bit so that C-suites are often focused on executing on a top-three set of priorities. And rarely is "make our facilities run more efficiently" one of these top three stated priorities. Without a specific strategic mandate, the plant manager fights an uphill battle getting the CFO to pay attention, and the CFO doesn't want to spend time pushing these opportunities down on plant managers. And then there's the "all the other stuff" dynamic -- plant managers have three priorities themselves: production, safety, and all the other "stuff."  Energy (and other types of) cost savings fall into this distant third category.

I found it ironic that our cleantech panel yesterday was held at the same time as a panel on how PE firms can create additional returns by driving operational improvements at their portfolio companies. Ironic, because we should have combined the panels. Indeed, thanks to efforts such as the Environmental Defense Fund's Green Returns project, PE firms are actually helping drive adoption of resource-efficient technologies pretty effectively within their portfolios.  

That's because they've made it a strategic priority (because it's such low-hanging fruit with rapid returns). But too often I go out and talk with a corporate venture group, and we'll be comparing notes on investment areas of interest, and they make it clear that their mandate only covers revenue growth opportunities -- they have no ability to invest in technologies that could save their company money in terms of cost savings. Even at companies like Wal-Mart that are doing a pretty effective job of making a priority of resource efficiency in their operations, the venture group is forbidden from investing in companies that could become vendors to their facilities.  

This is a major strategic disconnect -- and in my opinion, a mistake. The most direct way to add to earnings per share is to reduce the costs necessary to create the same dollar of revenue. But some of the very same large corporations now investing into somewhat risky cleantech venture capital deals aren't effectively adopting many of the readily available and proven technologies that could save their operations millions in costs. You, Gentle Reader, are a shareholder in some of these companies, no doubt, so how do you feel about that trade-off?

If corporate leaders are indeed serious about driving future returns through investments in cleantech, they need to make sure that's an urgent priority for their Ops managers as well. Cost savings through adoption of new efficiency technologies should be a priority at every large firm.  

If it takes your plant managers nine months to agree to purchase a system that has a six-month ROI, you're doing it wrong.

Large Corporates and Family Offices: A Need to Connect

One thing many cleantech VCs are good at is connecting with large corporations' strategy and venture groups. They regularly chat to compare notes, discuss market trends, share investment perspectives, identify areas of needed investment, opportunities to work with the VCs' portfolio companies, etc. It's a win-win.

I was surprised upon joining the family office community to discover that these groups are (with some definite exceptions) not as good at this. There are probably several reasons: 1) family offices are often already affiliated with some companies that the family owns, dampening the supposed need; 2) corporate strategic groups don't think about family offices because the FOs aren't asking them for money as LPs; and 3) family offices are generally not very good at networking to begin with. There are certainly some FOs that do have good outreach to corporate groups and vice versa, but it remains an untapped opportunity.

I've been meeting and speaking with corporate leaders for the past few months, to argue for a need for much more regular communications between the two communities. The reasons for family offices to more regularly connect with strategics are the same as for VCs. And smart corporate teams are starting to recognize the unique and additive value to holding such conversations with family offices in addition to their existing conversations with VCs.

Why?  

First of all, family offices are much less limited in terms of the types of business and projects they can invest in. They can be more patient and more flexible. This means they'll often be looking at a different scope of opportunities than the VCs might be. Some FOs will be looking at very early, long-development, really-big-upside opportunities that would take too long for VCs to invest in, at least at that seed stage. This is especially true when one broadens the definition of FOs to include very wealthy individuals. Others will be more open to investing in different service and business models instead of the proprietary technology plays that VCs continue to favor (at least in this sector). Still others will be able to invest in project finance opportunities. In one of our investments at Black Coral Capital, we invested as project investors into a pool of capital alongside a venture-type corporate equity investment by a large corporation in the developer of the pool. These are the kinds of collaboration opportunities that corporates miss if they're not engaging with the family office community.

Secondly, despite some instincts to the contrary, the fact that the family office is often tied to other, larger family-owned businesses means that there are other reasons to hold the conversation as a means of building broader relationships than just common investment opportunities.  

Thirdly, that family offices aren't looking for LP dollars means they will be able to express a different perspective than many VCs will in the same situation.  No one ever provides a 100% objective perspective, but at least in these conversations the corporate team is talking with a professional investor who's not trying to sell them on investing in their next fund.

So should corporate strategy teams start reaching out broadly to the family office community?

Unfortunately, if you know one family office...you know one family office. No two are alike. There are an estimated 3,000 or so single-family offices of significance in the U.S. (BTW, here's a useful primer). But many aren't going to be as valuable a connection as they should be for the corporate team.  

Most family offices aren't in the business of doing direct investments into applicable companies. Many have wealth preservation, rather than wealth creation, goals. When they refer to doing "alternative investments," they may simply mean they're allocating dollars into hedge funds in addition to mutual funds. Very few family office gatherings revolve around the challenges and trend-spotting involved in direct venture and project investing.

Many family offices have simply been passive co-investors with big-name venture and private equity firms. I'm not going to criticize that strategy (in this column, at least), but for the purposes of this discussion it's enough to note that the corporate teams will get more insight from talking with the lead institutional investors these FOs are following.

And fewer still family offices do direct investments into cleantech. Starting from 3,000+ applicable single family offices, the number of FOs doing direct lead investments into cleantech private equity is bigger than you might think -- but it's certainly a very small subset of the 3,000+.

All of which is why we co-started the Cleantech Syndicate a couple of years ago (along with over a dozen other family offices, plus our friends at McNally Capital). We found it was best to aggregate a bunch of these rare entities upfront and build relationships across the teams, rather than wait until we had specific co-investment opportunities and then had to go seek them out in this opaque community on short notice.

Which speaks to the need for corporate teams to be very targeted in their outreach to the family office community. My message to the corporate teams I've been meeting with recently has been, "You should do more to engage with family offices and high net worths. But you should do it selectively, using these specific criteria." There's no magic here, there's just some simple catching up to do to get conversations between corporates and FOs up to par with existing conversations between corporates and VCs. It's worth doing. But it's important to do it right.

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Allow me to hijack this space real quick for something different.  An old colleague of mine reached out and is doing something very cool, so I offered to let him write a blurb about his efforts to share with all of you.  Enjoy!

"I'm writing about an exciting education program my organization, The Keystone Center, runs around the country called the Youth Policy Summit (www.youthpolicysummit.org). We take groups of students to analyze a tough public policy problem, like water scarcity, climate change or childhood nutrition.  We teach the students to analyze the different facets of the problem, including the political, social, economic and technological, as well as different stakeholder views from industry, advocacy groups and government regulators. We provide the students with mediation and negotiation training.

"Students meet with adults from these different stakeholder groups, and then assume the roles of these players as they work to find consensus-based recommendations. They take their suggestions back to their communities and to local legislators and business leaders. More importantly, we have worked with past sponsors to identify future interns and workers.  We truly feel that we are creating the leaders of tomorrow's workforce.

"We have conducted 22 summits over the past eight years, and have found that students care passionately about sustainability, and are passionate about energy and water issues whether they are from rural Appalachia, downtown Detroit, or the Upper East Side of Manhattan. The program trained 125 future entrepreneurs last year, 80 of whom were non-white. They are now entering college with a newfound vision to make the world more sustainable, and to seek opportunities in science and technology to help us get there."

Anyone out there who wants to get involved or support this effort should feel free to track down Jeremy Kranowitz at the Keystone Center (www.keystone.org).

“How Do I Get a Job in Cleantech Venture Capital?”

Around this time of year, the amount of inbound requests for coffees and "picking your brain" chats is always pretty overwhelming, as business school students and others start thinking about how they would love to be a cleantech venture capital investor.

I wanted to write down a few thoughts for such folks in case they would be helpful. Unfortunately, much of what I have to give is simply tough love. Because it's very, very hard to break into cleantech venture capital. When you account for the few specialist teams out there still actively investing in the sector, and then further account for the number of such firms that are hiring any new associates, I would estimate there are probably only one to two dozen new positions in the industry each year for anyone who doesn't already have deep experience. At most. Last year I think it was even less than that. There's at least 10 very interested job seekers for every one available entry-level cleantech venture job, and probably many more.

So with the caveat that no matter how smart you are, the numbers are stacked against you, here are some suggestions:

1.) Think hard about why you want to do this type of job.

I know one of your b-school classmates spent their summer interning with a venture firm and has been quietly lording it over everyone else; don't fall for their swagger. It's not the most direct pathway to achieve your goals, whatever they are.

If your goal is to make money, go into project finance or hedge funds or buyouts or Wall Street.  

If your goal is to make a significant impact on the cleantech industry or on the environment or such, go into a large company and work to make them more green. There, even a small shift makes more of an impact than most cleantech startups ever do.

If your goal is to find yourself doing a lot of exciting entrepreneurial things, go be an entrepreneur.  

If you're looking for job stability and an easy work-life balance, you're definitely barking up the wrong tree.

Venture capital is simply not the best way to accomplish any of those goals. Be honest with yourself about what you really want to do, and also don't fall for the Sunday New York Times-type hype about how VCs are heroes of the innovation world. That's a carefully crafted image some VCs have put out there, very much on purpose, but the true heroes are the entrepreneurs and the corporate managers who go out on a limb to work with entrepreneurs. They actually make stuff happen -- they're the ones to really be admired. There are lots of more impactful (albeit less heralded) ways to accomplish your goals than being a VC, I can pretty much guarantee it.  Don't get me wrong, it's a really fun job if you can land an opportunity in the field -- I love it with a passion that grows the more I time I spend doing it. But I can also tell you that if you want to be a cleantech VC for somewhat romantic and unresearched reasons, you probably won't be a good one anyway.  

And don't think that if you get an entry-level job in cleantech VC your future is secured. It's an up-or-out type of industry, and for the most part, the associates end up going out instead of up. There simply aren't enough openings at the partner level to sustain even the number of justifiable advancements, and it's hard to do well, so there are a lot of folks who find they don't like it or can't cut it. It can be a good springboard into other things, often entrepreneurial endeavors, and can be a very educational experience, but don't fight for an entry-level VC position and then think you've pegged your career for the next 40 years. Heck, venture capital as we know it may not be around 20 years from now -- it's a broken model.  Do you really want to fight to get into a shrinking club?  

In other words, don't go after a cleantech venture job unless you're deadly serious about it.

2.) Network, network, network. But don't just do quick calls and coffees. Do something meaningful.

Yes, there's no substitute for networking your way into a venture capital gig. VC firms typically don't advertise when they're thinking about hiring a new associate, so it's often a matter of right place/right time. One strategy is to watch for announcements of firms that have done first closes on a new fund. That often is a trigger for new investments, and perhaps some changes to the existing team (either up or out), and thus maybe they'll be looking for someone to bring on board. So start with such searches -- but don't be satisfied just talking to someone there.

No one gets hired into a venture capital firm because they impressed one of the partners there over a coffee or during a phone chat. And disappointingly, VCs also don't talk to other VCs about how they're hiring a new associate or such. It just doesn't come up very often. So the idea that a VC you talked to will follow up with you, out of the dozens who chatted with him/her, to let you know about another firm that's hiring an associate is a pipe dream.

The only way you get hired into a venture firm is by impressing them with your ability to actually add value, either to portfolio companies, or to the diligence process. Here are a few networking-your-way-into-VC dos and don'ts:

DON'T try to impress a VC with a couple of general investment theses you've come up with. They've been doing this for longer than you have, they've seen several companies fitting that thesis already, and have already been all over it six ways till Sunday.  

DO pick one subsector you're going to get super-smart about and dive into it. I still remember a b-school student I knew several years ago who decided he would become an expert on building-integrated PV.  He ended up in an operating role instead of an investing role (see point #1 above), but I still periodically catch up with him. If you want to stand out because of what you know and who you know, stand out as a specialist, not just a clever person.

DON'T ask for "thoughts and advice."  It's often a waste of time for both of you.  

DO ask for quick thoughts about specific companies you bring to the table, especially if they're in a subsector you're trying to become a specialist in. An investor is much more likely to give you tactically valuable information if you ask them for specifics instead of generalities.

DON'T ask them to refer you or intro you to their colleagues if they don't already know you well. Venture capital is a reputation-driven industry. No one wants to get a reputation for having sent time-wasters to go bother other investors.

DO ask them if they know of any firms that are about to close on a new fund but may not have announced it (as per the above).

DON'T try to impress a VC by bringing them a startup they likely already know about. If you found out about the startup by reading about it somewhere, the VC already knows about it. If you bring them a stealthy or super-early effort, maybe that will elicit some interest, but it better be a really promising company and not just a fellow b-school classmate's whimsy.

DO get to know VCs by putting significant time into supporting efforts they'll care about -- activities like the MIT Energy Conference that will be bringing in VCs. Even better is getting involved in nonprofit efforts that cleantech VCs are involved in, either professionally or on the side. Find any excuse to spend some quality time with the VC over a shared task, in other words, instead of just a quick coffee and some bland advice.

DON'T criticize a VC's investments. If you really have something to get off your chest, do it with appropriate caveats.

DO see if there are ways you can deliver some real value through a dedicated project. Offer to do a market map. Offer to do some specific biz dev research for a portfolio company. And best of all, intern. An internship is your single best pathway into VC, at least for young professionals.

Show the VC how valuable you are; don't expect them to get that on the basis of a brief interaction and a resume, or to hire you based upon your unproven potential. The great thing about the DO items listed above is that they also position you for other fun roles besides VC, leveraging the same experiences and knowledge and networks you've built.

3.) Expect contradictory advice.

Aspiring VCs often go to established VCs and ask them for advice as to how best to become a VC. Since "don't bother" or "be lucky" aren't very satisfying answers, the VCs give advice as best they can, but it's often very contradictory, leaving the aspiring investors even more confused. Why?

First of all, there is no standard path into venture capital. Everyone got there via a unique path.

Secondly, since there's no right way to do venture investing, there's no right way to break into venture investing. VCs who are former entrepreneurs will tell you to go be an entrepreneur. VCs who are former investors of another type will tell you to go get some other investing experience. VCs who are former consultants will tell you to go prove your value by doing market maps or doing some specific business development research for a portfolio company.

In general, I think former entrepreneurs do have a better shot at becoming VCs -- and then at being good VCs. So much of the role involves networking with entrepreneurs, knowing the challenges of being an entrepreneur, and being able to provide value to entrepreneurs. So an entrepreneurial background is a very useful thing, more useful than being a consultant or a banker.  

And who knows, you might decide you like being an entrepreneur better anyway; who cares about going over to the dark side and becoming one of those meddling VCs?

4.) Have a Plan B that you pursue just as actively, in parallel.

Be prepared for your quest to network your way into a VC role to take a long time, and very likely to end without you getting such a role, since the odds are stacked so heavily against you.

The smartest thing you can do is have another plan (or even more than one) that you pursue in parallel that you would also be excited about. Create options for yourself.  

Many VCs find themselves in the career by accident, having stumbled into it along the way. In fact, that's what happened with me -- I started doing some project work for a cleantech venture firm as a way to get smart about what entrepreneurial opportunities I could identify in the sector, and ended up getting hooked by the venture capital work instead.

So go out there open-minded.  Look for activities you can do that will build deep knowledge in particular areas, and rich networks across investors, entrepreneurs and experts And then you'll find a good way to leverage those assets one way or another. If by networking with and working with VCs you find an opportunity there, grab it.  But if you find a really rewarding entrepreneurial experience for yourself instead, grab that and run with it.  

The twisting road may bring you back that way later on anyway.

12 Predictions for ‘12

'Tis the season for making year-end predictions, and even though I'm clearly not very good at it, I got dragged into doing them a while back. So here are some for 2012. Enjoy these with the appropriately sized grain of sodium chloride.

Looking Back on 2011 Cleantech Investing Predictions

It's been a tumultuous year for a whole lot of folks, and the cleantech market has been no exception. As we near the end of 2011, I thought it would be good to look back on how our predictions from a year ago turned out.  

Here's what I predicted last December:

1. The cleantech venture capital shakeout will become more obvious.

I'd say this has been true. At least to entrepreneurs seeking financing, especially early stage. A few of us in Boston were recently trying to figure out who's still actively investing in the sector in this region -- and it was a shockingly short list. I suspect the same is true in other regions as well.  Score: +1.

2. 2011 will be the Year of Energy Storage.

Turns out this was pretty correct. Energy efficiency still showed a lot of dealflow, solar continued to get a lot of dollars, but energy storage rose up to challenge both subsectors. Seems like this will be a longer-term trend as well, given all the companies at an early stage that have taken in funding over the past couple of years -- and are likely to be taking in even more dollars in the future.  Score: +1.

I said the runner-up subsector would be LED lighting. Anecdotally speaking, feels like this was also about right. It's a hot sector that looks set to continue to heat up (no pun intended).

3. 2011 will be a moderately up year for cleantech venture dollars and valuations.

The dollars prediction was about right, at least through Q3, and I'm guessing Q4 will also be an up quarter when we see those numbers. The valuations prediction was very wrong, however. Tough to find data on this, but I've met with a lot of entrepreneurs who've talked about there being significant valuation downward pressure these days. Half credit only on this one. Score: +1/2.

4. A major geopolitical event will spike oil prices above $120/barrel.  

Nope, wrong. But that's because the global economy remained so bad. Certainly we had plenty of geopolitical excuses for oil price spikes this year. Score: +0.

5. There will be an energy law passed in the U.S., but it will be very patchy and incomplete.

Nope, not even that. The frustration continues. Score: +0.

6. A couple of big venture-backed cleantech IPOs (valued over $1.5B) will happen, but still no blockbusters.

Not so much. The cleantech S-1 backlog continues to grow. Score: +0.

7. Family offices and other non-traditional investors will become a critical source of funding for cleantech private equity.

This has turned out to be pretty correct. But while family offices have indeed stepped up with more activity and visibility, the true non-traditional investor "heroes" filling the capital gap have been corporate investors.  Score: +1.

8. New hybrid investment models will emerge.

Here's what I wrote last year: "I predicted this for 2010. It didn't really happen. But I continue to speak with both LP-backed and non-traditional VCs and PE players who see the need. So I'll double down for the prediction for 2011. And what I'm talking about is the emergence of new models that combine project finance and venture capital; that take innovative approaches to the use of debt and equity combined; and/or investment into the kinds of business models (like services, etc.) that VCs have typically had a hard time backing." Ditto this year. In particular, at my firm, we have started doing this, but nevertheless, it didn't really happen as a broad sectoral trend. Score: +0.

9. "Tech-enabled services" will be the new hot buzzword among cleantech VCs.

At the time, I noted that I shouldn't be predicting buzzwords, but that what I was really predicting was a rise of investor interest in alternative business and investment models in the sector that weren't dependent upon proprietary technology.  And given the rise of activity in IT-based cleantech plays, including the emergence of Sunil Paul's 'Cleanweb' model, I think I was essentially correct. And this trend will continue.  But no, I shouldn't predict buzzwords.  Score: +1.

10. Among U.S.-based cleantech venture investors, they will devote relatively more dollars to international investments.

I haven't seen a lot of data around this, so it's hard to say. But I haven't seen a lot of evidence of it, myself -- so let's put it in the "wrong" category.  Score: +0.

11.  The Washington Redskins will have a winning record.

D'oh. Score: +0.

So looking it all over, a mixed bag of predictions. In such a chaotic year, that's not too surprising, but still: I scored only 4.5 out of 11. Where I missed, it was mostly by being too optimistic. I'll try to do better later this week when I post predictions for 2012.

Congrats on surviving 2011, everyone.  And thanks for reading and for reaching out with your comments and feedback.  That's why I do this: to learn.  It's clearly not to demonstrate superior prognostication skills!

Quick Hits: Boston’s Super-Angels, Nordan’s Smart Thoughts, and More

Been caught up in a number of year-end projects and thus am way behind on topics I've wanted to write about, so here's a quick set of thoughts on a few unrelated topics, Peter King "Monday Morning Quarterback" style:

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Had dinner last night with several of Boston's most active cleantech angel investors (thanks to Bic Stevens for the invite).  No, none of this went on -- just some thought-provoking conversation over a great Italian meal. One thing that struck me, though, was hearing that Boston-area cleantech VCs are now doing only around three or four Series A rounds per year, and yet at that table were angels who had done eight and six deals over the past year themselves.  

This tells me that for cleantech entrepreneurs in this region (and I suspect it's the same elsewhere), angel funding is now the new-normal way to get started. A few cleantech startups here will take in VC dollars as their first dollars, but many more will have to make significant progress on smaller amounts of money before the VCs will jump in with their multimillion-dollar checks. I suspect this is doubly true for first-time entrepreneurs, as opposed to entrepreneurs who've already got a relationship with a VC or three.

So for emerging entrepreneurs out there, don't automatically build a plan/pitch requiring a $5M or even $2M Series A to get started. Have at least an alternative plan in your back pocket that allows you to make progress with $250k to $500k. And start figuring out how you can network your way into the local angel community.  

That isn't as easy as it should be, despite the good efforts of Bic and others like him. So one takeaway for me is that we need to work even harder to make the Cleantech Open Northeast a venue for regional entrepreneurs and angels to get to know each other.

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Matthew Nordan is one of my favorite cleantech VCs, not least because he's "wicked smaht," as they say around here.  If you haven't read his recent four-part evaluation of the current state of cleantech investing, do so.  

I find myself largely in agreement with Matthew's points, and in fact have already stolen a couple of his charts for various purposes. So rather than go through the entire four-part series in detail with just a lot of "amens" from me, here are some quick thoughts and reactions, for what they're worth:

1. This is one of the better illustrations of the decline in early-stage cleantech investing I've seen. It basically shows that Seed/Series A activity has fallen off by about half -- driven, of course, by the general retrenchment of cleantech venture capital and exacerbated by the continued shift to later-stage investing by VCs. Angels and even corporates are filling that void somewhat, so the picture must look even more dire for cleantech venture capital firms.  The pendulum may be starting to shift back, but still -- it's striking.

2. I disagree with the illustrations by Matthew and others that extrapolate past patterns of capital needs to project future capital needs into later-stage investments in the sector and say there's a huge gap. I understand the logic of it, and it may end up being right. But we're seeing a real shift in the industry. Fewer of the early-stage companies will "graduate," and in some cases rightfully so. Just because all those companies will continue to burn cash, doesn't mean investors should continue to feed them more cash. I'm already seeing a decline in the number and amount of follow-on deals and dollars VCs are willing to put into their companies, except in the case of clear winners -- "pruning the tree" is happening more strictly and earlier in VC portfolios, somewhat out of necessity. Plus, there's a definite shift away from capital-intensive investing in the sector. So while Matthew's basic point is still right -- even as the VCs shift to later stages, there's still going to be yet more need for later-stage capital -- I disagree that it will happen nearly to the extent projected here. Matthew and others who do this type of projection essentially send an implied message: "Hey, there's lots of need for later-stage funding; jump in and fund a fab!" I would tell investors, "Hey, be really careful about being the 100th institutional investor to jump into late-stage cleantech investing, and be especially careful about funding construction of a fab and expecting venture-type returns." There is room for both perspectives alongside each other.

3. Matthew compellingly illustrates that cleantech venture returns haven't underperformed returns for the entire industry, that there's no "cleantech returns gap."  I agree.  But what I really take away from his analysis is that venture returns have sucked across all categories, cleantech and non-cleantech. I don't find the cleantech fund returns he describes to be particularly compelling, as a group. The median IRR in that group he shows is negative.  And yes, that's on par with VC returns across all sectors over the past decade. Still, I wouldn't want to back an index of cleantech venture funds based upon this performance -- and that's essentially how many of the bigger LPs out there will view the question.

4. Matthew's breakdown of the three trajectories is very well done.  In fact, it resonates with a similar analysis I did a couple of years ago that showed even more starkly that "last money in before the exit" rounds have rarely led directly to the anticipated exits, thus necessitating further funding, presumably often at down valuations. Common-holders, even founders who are still in the management team, can be the most hurt in such instances, as the preferred investors have various protections and options available for reducing their pain in down rounds.  And angels and founders no longer in the senior management team get crushed. Of course, in this scenario it's quite common for founders to no longer be part of the management team after that happens. So I think the real lesson learned here is that founders and angels need to be more wary of big upround valuations when times are good. Yes, dilution is a concern, and rightfully so, and so I wouldn't argue for artificially holding down valuations, either. But run really, really lean (i.e., smaller rounds needed) and don't over-hype your company. Because if you raise a really big round at an unwarranted valuation, there will be really big and probably unrealistic expectations -- and you will get crushed when they aren't met. At least, that's how I would think about it were I in their shoes.

Great work by Matthew. Thanks to him for doing this and putting it out there.

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I think this is one of the most exciting times in cleantech venture investing that I've ever been a part of. Yes, there are some scary things lurking out there. But while we're seeing the "dabblers" back out of the sector, those investors and entrepreneurs still active in it are really committed to it. And at the same time, I'm seeing a next wave of investors like Nordan and Rachel Sheinbein who are willing to re-examine even core and hard-held assumptions about how cleantech venture capital should be done: in some cases (like Rachel) to re-affirm the existing model, sure, but it's still really healthy and energizing to see the examination being done at all.  

And the dealflow has never been healthier, at least from my perspective.  It's a great time to be investing.

Plus, I really do feel like we're on the verge of a wave of market reinvention that could finally unlock all the value created during the last decade's worth of technology reinvention. If we can finally start to see entrepreneurs introduce new channels and new business models out there, that could unleash a huge amount of latent growth for the sector.

***

The federal government is incompetent and absent on energy policy, but the states have been stepping into the void.  I continue to hear about interesting new policies and programs being implemented at the state level to encourage implementation of clean technologies, even in states you wouldn't think of as being particularly "green" leaning.

But what I'm also starting to see is a wave of attacks at the state level against these policies. There's some real "swiftboating" going on right now, even in states like Massachusetts that have been among the most solid leaders over the past few years -- misinformation campaigns and thinly veiled partisan attacks.

Watch this trend carefully.  

***

I'm headed to the Greentech Media holiday party tonight.  Seems a good excuse to thank them for continuing to put up with my shenanigans and for being a great partner over the past few years.  Thanks, guys -- looking forward to sharing a cup of cheer tonight!

Reinvent the Utility

In the last decade, cleantech venture capital was about reinventing the electric generator.

It's time to reinvent the utility.

Utilities, as currently structured, exist for one reason: wires.  Wires connecting consumers to generators are a natural monopoly, so rather than expecting a competitive market, the market is heavily regulated and overseen by PUCs representing the public's interest. It's true in electricity, just as it's true in wireline communications. Yes, that skews the market, but there's no good alternative in the face of a natural monopoly.

But wires are less important, as distributed generation (so far primarily in the form of rooftop solar, but in the future via other means as well -- Bloom Box, anyone?) catches on. So now retail deregulation plus DG increasingly offers that alternative. Wires are still important, but less important than they once were.

Centralized utilities, as they exist today, are ultimately doomed, as DG and IT will inevitably cannibalize their currently insurmountable advantages. Someone will maintain the wires and connect remote loads and sources, so utilities as we know them won't disappear altogether. But over the long run, today's utilities will have to dramatically shift what they do -- leaving some huge economic rents to be captured by others.

I wish I saw more entrepreneurs focused on driving that shift.  You want to reinvent the energy industry?  Reinvent the utility.  It's an incredibly tough challenge -- but one worth taking on.

What Is “Cleantech 2.0”?

Here's a not-atypical venture capital story:

An early-revenue (or sometimes even pre-revenue) stage venture-backed startup with promising early results wants to make a big splash and run really quickly, so they look to raise a large-ish "growth round".  

To identify a significant new lead investor for the round, they turn to investment bankers with their deeper rolodexes.  The i-bankers only take the assignment because the round will be big enough to provide large enough placement fees to justify their doing the work, versus some other larger transactions they could be working on instead.  For this reason, very few sub-$10 million venture capital rounds get big-named investment bankers placing them.

The i-bankers want to go to the types of large institutional investors in their rolodexes who typically cannot do direct investments into venture capital rounds, because of their check size requirement and other factors. Sovereign wealth funds, "growth equity" funds, pension funds, hedge funds, certain family offices, perhaps an aggregation of individual investors into a special-purpose vehicle, etc.  The i-bankers thus argue for an even bigger round, because then they can potentially bring in these very large check-writers who need to individually write (for example) a minimum of a $20 million check in order to get interested in any direct investment opportunity.  They also usually talk up the company as the best thing since sliced bread, naturally.

Now the round starts to look much larger than the company really needs at that particular point in time.  But that's okay to management and early investors because with these larger check-writers often comes a higher valuation.  If the round size doubled, it wouldn't be surprising to see the ultimate valuation also double, so that dilution for insiders remains roughly the same.  It's not justified that way overtly, of course.  But the existing investors and i-bankers and entrepreneurs all push for this outcome ("no way are we giving up more than x% of the company!"), and the outside larger investors mentioned above often aren't subject matter experts or well-positioned to do a lot of independent valuations and risk assessments of venture-stage companies. And of course, a company with such high growth aspirations must therefore have tremendous exit potential.  The valuation justification follows.  Sometimes the valuation is even established by the i-bankers instead of those actually writing the new checks.  Sometimes it's just that more bidders means a higher winning bid.

Either way, such a high valuation means investors' expectations are sky-high for the company's near-term growth and exit execution.  And they have the additional capital to deploy, so it's time to spend it toward acceleration.  Cash burn goes up.  And yet, not everything can be accelerated by simply spending more money.  Something along the way -- a technical challenge, a scale-up delay, slower-than-expected market adoption, a slammed-shut IPO window -- causes the startup to fail to hit their milestones even with the additional capital deployed.  Suddenly this high-profile company needs more cash, and is in a higher cash-burn situation with a weakened or "sidewise" story to tell.

Time to call in the i-bankers again.  And to start gathering as much non-dilutive government support as possible.  And to push a PR campaign.  And maybe to file an early IPO, as a financing event even if not a liquidity event.

Some such startups work through it. Others don't and flame out quite publicly.  Either way it certainly represents a potential negative selection bias in terms of which companies get the headlines, the big financing rounds, etc.  

This isn't a "good vs. bad" argument, I'm not suggesting that capital intensity never generates returns or is inherently evil, I'm not trying to invalidate i-bankers' roles or certain investment strategies; there's some good justification for a select few companies getting the above-described treatment. Certainly there are some great companies who get attention, government support, high valuations, etc, deservedly.  But there are also many who don't deserve it, as well as great companies who don't get this high profile treatment and its resultant press attention.  Some investors seem to drive their companies into this type of "hype-capital cycle" as a matter of course.

This cycle is what I believe people are implying was "Cleantech v1.0" when they talk about "Cleantech v2.0", as many are these days.  Nevertheless, I have yet to see any consistent definition out there of what Cleantech v2.0 means, other than "not Cleantech v1.0".

But understand -- the "hype-capital cycle" is a venture capital phenomenon.  It is not a cleantech phenomenon.  It happens in any number of venture sectors, to varying degrees.  

In the cleantech sector is where some of the more obvious examples of this cycle have occurred, especially a few years back.  But that should not in any way be used to argue that venture capital investments in the cleantech sector must necessarily look like any version of the above.  If the sector looks skewed toward capital intensity, in large part it's because the financial model applied to the sector has been skewed toward capital intensity, not because of some inherent underlying factor applying universally across the sector.

Cleantech is not capital intensive.  Some cleantech is capital intensive, but not all of it is.  Don't judge the entire sector by the fact that the above type of venture capital story gathered lots of headlines and dollars over the past few years, there are other stories to tell.  And in fact, "small cleantech" may ultimately get much bigger and provide better investor returns than any of the above story.  In other words, it may turn out that "Cleantech v2.0" actually looks a lot like "Venture Capital v1.0"... 

It's encouraging to see so many investors and industry participants actively seeking to develop a model for Cleantech v2.0.  But to date, it's mostly been defined by what it is not, than what it will be. 

Get Involved

Today, the Clean Economy Network announced a merger into the Advanced Energy Economy, a network of cleantech business leaders and regional organizations. It's been a fun ride to get to this important transition point.

Four years ago, Andrew Friendly and I launched a "Renewable Energy Business Network" chapter in Boston, borrowing from a successful model we'd both seen work on the West Coast, for informal and event-based networking-with-a-purpose among cleantech entrepreneurs and innovators. It caught on very quickly, and we found strong demand for similar efforts across the U.S., so we officially co-founded REBN as a nonprofit, and built up an eventual network of 15 regional volunteer-led REBN chapters in the U.S. and Canada, with thousands of members. It grew so quickly and successfully that we and our thin staff of two part-time, underpaid heroes (thanks, Laura and Helen!) were overwhelmed, and we saw an opportunity to deploy this network for even greater purpose, so we merged REBN with the Clean Economy Network, a D.C.-based nonpartisan organization that had been launched in 2009 to represent the cleantech industry at a national and regional level.

I continued on as co-chairman of the board of the Clean Economy Network Education Fund (a c3), and have spent the past couple of years working with CEN staff and the other CEN board members to help continue to build up that organization and work (sometimes successfully, sometimes not) on clean energy policy. With the launch of the AEE, a well-funded new platform bringing together regional clean energy nonprofits like the New England Clean Energy Council and others, it made sense to combine forces, and so after several months of hard work by a lot of folks in both organizations, today we see CEN and AEE joining together to take the next step. 

My congrats and huge kudos to all the volunteers and staff of REBN and CEN today.  Thank you!

I learned and re-learned a lot over the past couple of years. Regarding federal energy policy, it was a fascinating time to watch the sausage being made (or more accurately, not being made, at least in recent years). I come away more convinced than ever that congressional energy policymaking is deeply and fundamentally broken. Americans overwhelmingly want cheap, clean and domestically sourced energy, but the system isn't putting forward any such long-term solutions. The most logical and straightforward ways to positively shift energy policy have been needlessly politicized and/or overlooked. Egos and a desire for individual visibility too often trump the need for collaboration.

Environmentalists, sometimes claiming to speak for the cleantech community, often pick the wrong battles and pit themselves against the natural political allies of pragmatic cleantech policy, letting the perfect be the enemy of the good. Individual cleantech sector trade associations undermine the overall cleantech industry by fighting over portions of a dwindling pie, rather than banding together to push for effective, broader change. Powerful incumbent energy interests successfully counter any efforts to push for fundamental change, with campaigns of misinformation and overwrought rhetoric. When the U.S. military is saying greater energy independence is a core strategic imperative, and Congress effectively ignores them, you've seen all you need to know about congressional incompetence and impotence on this issue.  All of which is why the role of CEN, and now AEE, is so important for the long run.  There must be a voice, even if for now it often remains drowned out amidst all the noise. 

But more positively, I came away with a great appreciation for the nascent stage of development of our sector, from a basic community-building perspective. Partly because the wave of cleantech entrepreneurs is such a recent phenomenon, partly because cleantech entrepreneurs and innovators are more scattered geographically than you see in software and web entrepreneurship, and partly because "cleantech" is just an umbrella label for a lot of disparate sectors and innovation areas, our sector is only now coalescing.

Cleantech entrepreneurs, be they new to entrepreneurship or just new to the sector, still don't enjoy the same fundamental networking, hiring, visibility, and customer-connection resources that entrepreneurs in other sectors often have access to. Pattern recognition across entrepreneurs and investors, which I believe to be key to the virtuous cycles leading to the success of web entrepreneurship, is hindered by lack of connections and learning opportunities, as water-tech entrepreneurs don't know what solar entrepreneurs are doing, and neither are kept aware of what's new in energy efficiency startups, for example. This is to be expected for such a fairly new and fragmented sector, but it's a challenge that needs to be addressed.

This is what I found so gratifying about co-founding REBN, and why I'm excited to be part of efforts like the Cleantech Open, helping bring entrepreneurs together, and bringing them resources to help build their chances of success.  If you are going to invest and work in the cleantech sector, you need to recognize that this sector is still at a nascent stage of development where we all need to get involved to help build core platforms and community assets that will enable future success for all of us. For one thing, getting involved is the most effective way to build out effective networks and rapidly learn lessons from others' experiences. The most effective networking is done when you're collaborating on something, not just bumping into someone at a single event. It's worth the investment, therefore, to dedicate time and attention to some such effort.  

And there are lots of such non-political opportunities regardless of where you are.  Across the U.S., many states are making clean energy an economic development priority.  Yes, in places like California and Massachusetts, it's pretty visible. But in just about every state I'm seeing these efforts, often in a completely non-political fashion. From North Dakota, to Utah, to Alabama, to Nevada, to just about all over, efforts to promote renewable energy and energy efficiency jobs and innovation are being put in place, and thus are creating opportunities to plug in.

Outside of economic development efforts, the communities are coming together as well -- here in the Northeast, we had a phenomenal regional Cleantech Open program this year, with several dozen startups getting to work with nearly 100 experienced mentors, with the support of forward-thinking organizations like the Massachusetts Clean Energy Center and others, all geared to helping these emerging cleantech entrepreneurs maximize their chances for success. All of this was done via volunteers and sponsors that were coordinated by only one full-time staffer (thanks, Karla!). That's a heck of a community effort; I was deeply impressed to see so many get so deeply involved.  No matter where you are located, something interesting is going on.

So there are lots of opportunities to plug in.  From just easy networking, to active mentoring, to supporting smart regional economic development efforts, to adding your voice at the national level. The most important thing is to pick one or two such opportunities that are interesting and important to you, and then to get involved. I know it's asking an awful lot of overwhelmed entrepreneurs to ask them to devote some of their precious little time to such side efforts. But now's an important time to do so, for the cleantech sector, and also to help build out your own networks and improve pattern recognition -- and to maximize your own chances for success.  One way or another, get involved. It'll pay dividends in the end.  

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Speaking of which, the Cleantech Open Northeast is looking for a new CEO / Regional Director.  If you're looking for an opportunity to work with a lot of cleantech entrepreneurs here in the northeast, and gain visibility and experience as a springboard to being a cleantech entrepreneur yourself, check it out.

How I’ve Failed

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

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

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

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

1. Don't attempt bank shots.

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

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

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

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

2.  Keep peeling back the layers; no shortcuts.

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

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

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

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

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

3. Value the team more than the technology.

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

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

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

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

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

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

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

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

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

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

Q3: One Last Bloom Before the Winter?

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

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

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

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

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

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

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

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

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

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

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

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

Powering Through

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

The Solyndra Political Circus and What It Means for Cleantech

Plenty has already been written by many people smarter than me about why Solyndra failed, and what lessons are to be drawn from it, so I haven't wanted to write about it. I see Solyndra as having been a big but not necessarily dumb bet, one that attempted to bring expensive panels into the market but with the intent of saving costs further downstream in the solar value chain, to provide net savings for flat-roofed customers. That bet obviously didn't work out, for a number of reasons: 1) yes, panel ASPs fell faster than predicted, although everyone should have been expecting them to fall significantly; 2) the downstream channel resisted significant change; 3) some bad luck and bad timing, no doubt; and last and most importantly, 4) execution and high cash burn.  

So that's that.  Should there be an analysis of how the company so spectacularly failed, and a re-evaluation of how the DOE's Loan Guarantee Program has been designed and administered? Absolutely. This was a big loss to investors and taxpayers. I've already discussed my views on the Loan Guarantee Program before in a number of forums: I believe that it addresses a key capital gap in the "valley of death" for cleantech innovations, but wasn't designed well; that it creates negative selection biases; that it is far too bureaucratic in ways that undermines its usefulness; and that it leans too much on a small team to make very big decisions with somewhat limited knowledge and resources. So there's a sober conversation to be had about whether government should be seeking to address that capital gap, and if so, how it should do so.

But apparently, today's hearing on Capitol Hill was a useless political circus and not an honest investigation or analysis -- by either party's representatives. It has become political football. And this may have a significant negative impact on cleantech startups that have nothing to do with the DOE programs or the like.

First of all, Congress is likely to throw the baby out with the bath water. While this particular high-profile program has had mixed success and will likely see some additional "wins" and "losses" going forward, there are lots of other DOE and other governmental efforts that are doing an effective job of providing economic return for investment of taxpayer dollars. But this episode is just going to further politicize cleantech and alternative energy, which is stupid. We need all of the above, in terms of energy choices. There's no compelling reason for anyone to have a philosophical problem with economically viable, domestically produced clean energy. But in an era when some people view energy-efficient light bulbs much in the same way that their political precursors viewed fluoride in drinking water, we can expect that this episode will result in even more political pressure for even the more effective governmental programs to be undermined and assaulted. If nothing else, politicization of the clean energy sector just adds further regulatory uncertainty to the environment we all operate in. And it could filter down to the state level, where to date, cleantech cluster creation has been a non-partisan issue.

Secondly, among LPs who were already increasingly skeptical of cleantech venture capital, this is just going to further dissuade them. I've spoken with a few cleantech VCs lately who are out there raising funds and have spoken with LPs who are uncomfortable with the asset category in general and the sector in particular. When Solyndra is the visible poster child for what "cleantech venture capital" is perceived to be, and then it blows up and becomes a political football -- that's not exactly a recipe for pension fund LP comfort. Of course, Gentle Reader, you and I both know that some of the more compelling investment opportunities in cleantech venture capital look nothing like Solyndra. In fact, the strong shift to energy efficiency among investors in the sector is evidence of this, and information-based cleantech is starting to show some interesting early momentum. Even in sectors like solar that saw the most capital-intensive investing a few years ago, much of the action is shifting to less capital-intensive plays and into other parts of the value chain.  Nevertheless, this episode will make it that much harder for large institutional LPs to allocate resources to the sector, until the shift away from Solyndra-type plays becomes more obvious.

This is all going to make it more difficult for cleantech VCs to raise funding from LPs, and thus it's going to make it harder for cleantech startups to raise funding from either VCs or non-dilutive sources.

The shame of it is that cleantech markets have never had stronger fundamentals. Energy prices remain high. Entrepreneurial interest remains strong. Corporations are doubling down, getting more and more involved in cleantech markets and making investments and acquisitions in the sector. The solar market in the U.S. is a net positive to our trade balance, and the solar market is one of the fastest growing markets in the country, even in the midst of the capital pullback and the nattering nabobs of negativity. The solar industry is not a dog. There are dogs in the solar sector and an overdue shakeout taking place -- but the solar industry is going to be a winner for the U.S. There are already next-generation solar producers who are quietly selling their products and beating today's low panel prices. They're just not making the headlines...yet. But there will be visible U.S. venture-backed solar winners who emerge from this consolidation phase with a lot of room for profitable growth.

Cleantech is at a low point right now. It will come back. The core needs are too severe. The corporate momentum is too significant. The entrepreneurial energy is too inspired. But thanks to this episode with Solyndra and with other shoes yet to drop, the sector may have to develop some successes over the next couple of years in spite of the politicians -- and in spite of the LPs. Eventually, they will come running back to jump in front of the parade once again. But for now, entrepreneurs need to hunker down and run lean and run hard.

Turning the Corner: A Very Difficult Moment for Many Cleantech Startups

You've taken a technology idea, developed it into a product or service, and convinced a few customers to buy it. Now it's off to the races, right?

That's been the prevailing theory behind a lot of expensive growth-round financings in cleantech venture capital over the past decade. But from what we've seen, quite often there's a next step in the growth curve that can be very difficult to predict and to pull off successfully -- transitioning from an initial consultative sales phase into a rapid-scaling standardized sales phase.

It can be hard to get customers for many types of cleantech products and services to try it, much less pay for it. Take energy efficiency, for example -- energy costs for building owners may be one of their top 3 or so expense line items, yet it's rarely top of mind and is often subsumed below other priorities like maintaining comfort and/or productivity. So if you have a new type of efficient HVAC system, no one wants to be the first to buy it and install it, even with white papers and data to show the system will work. The same applies to other cleantech areas like solar panels, smart grid, vehicles, water treatment, etc.

I've run across a few entrepreneurs in the cleantech world who are really good at navigating this early adopter phase to get initial products and services out into the marketplace. These entrepreneurs tend to have a well-honed consultative approach to sales, a very direct relationship-based approach to enlisting customers and convincing them to take a relatively bold step to purchase the startup's solution. They work through a long sales cycle to make the customer feel comfortable that the system will work and that the startup will stand behind it and not let that customer fail. They rapidly iterate their overall solution in response to potential customers' needs and wants. And they help the purchasing manager feel good about their decision professionally and personally.  

All of this takes significant time and effort. So while these entrepreneurs can be pretty gifted at making these first few sales happen, these skills don't necessarily lend themselves to a next phase of rapid sales growth, which can't be so high-touch.

In fact, it is at precisely this point that we've seen a number of venture-backed cleantech startups get themselves in trouble -- often precipitated by raising large rounds of "expansion capital" and then attempting to scale up too quickly.  

The startup may have overly high expectations of the effectiveness of recently enlisted channel partners, for example.  If the initial direct sales required a very consultative approach, sales efforts by channel partners are likely to require a similar approach. And often, distributors and resellers aren't as effective at that, nor can they scale up rapidly themselves, either. I've seen several startups who used early sales to enlist big-name channel/sales partners and then were surprised at how ineffective that partnership turned out to be.

Similarly, the startup may have successfully sold a downstream OEM on including their solution in that OEM's products, only to see the OEM underperform on sales. This has happened in the lighting industry a couple of times, for example, with LED component sales to large incumbent fixture manufacturers. Winning a few SKUs with that OEM is a great first step -- but then no market pull materializes because the OEM isn't very effective at selling the new technology and therefore initial POs to the startup dwindle instead of ramping up.

Alternatively, the startup may simply expect the direct sales efforts to ramp up quickly once the market sees its solution in place and working well. But the really difficult thing about many cleantech solutions is that even early sales often don't unleash market pull. It's not as if many purchasers of energy-related products and services are simply waiting on the sidelines until they see something that works. They often see lots of things that work. And yet they also have higher priorities on a daily basis, and they don't have time to sort through all their choices. So simply having successful installations to point to isn't enough to pick up significant sales momentum, at least by itself.

Meanwhile, the startup's investors are pushing for revenue growth, so new sales team members push harder and harder to win any deals they can -- and margins suffer and mission creep leads to overpromising on what can be delivered. I've seen at least one startup in the energy intelligence sector get sucked into projects that significantly drifted away from the company's core technology and competencies, and led to underperformance versus customer expectations. That startup still didn't see rapid acceleration of revenues even with such drift.

And yet, along with the above three types of failure to "turn the corner" and see rapid acceleration of sales, the startup may have significantly ramped up their expenses, to manage channel partners, or to do further product development, or to build out a direct sales force.  But if they overly invest in such capacity and sales remain tepid, cash burn remains high.  Let's be clear -- in all of the above examples, revenues were growing!  But they were growing at a lower rate than expenses were, and the startups got in trouble.  In a couple of cases mentioned above, the startups effectively failed.

So what does it take to make this difficult transition?  It requires standardizing the solution and being very hard-nosed about it. The initial "the Beta Customer is always right" phase needs to give way to a phase where -- as informed by those early customer interactions -- the solutions offered to customers come in a very finite set of options.  

This next phase also requires a very different skill set and sales approach. Instead of winning early sales at any cost, now the sales team needs to feel free to walk away if the customer is asking for too much of a discount, so this now requires a different level and caliber of sales team management, including changing the way sales team members are compensated so that it's not just top-line oriented. Counterintuitively, walking away from tough sales may help accelerate overall sales, if sales team bandwidth is a limited resource and other easier sales opportunities are being missed. This next phase thus requires a very formulaic inside and outside sales process, which therefore requires experienced sales leaders who know how to establish and manage such processes. Sales teams themselves may need to change, to better reflect the skills required for this next phase.

And now is when significant "direct marketing" can be helpful, so that in a very targeted way the next potential wave of customers are repeatedly informed about the startup's solution before the sales team has ever visited. The goal is that by the time a channel partner or sales team member shows up at a customer site, the customer has already heard several times about the startup's solution, the value proposition, and examples of success. They're primed to say "yes," or at least to proffer a faster "no." No more evangelical sales efforts with long lead times.  

Managing this shift also requires significant changes to product management, to logistics and operations, to customer service, and to many other aspects of the business, as well. In short, it's a very difficult transition to get right. Very few management teams, even the ones who managed the early market introduction with flying colors, can successfully navigate this transition without at least augmenting the senior management team to bring in these different experiences and skill sets.

Nevertheless, in many cases there will still be a need for a consultative sales skillset when expanding into new markets with new offerings, so I'm also not arguing that it's inevitable that the startup's leadership has to be changed to manage this transition. I haven't yet seen many examples of cleantech startups dividing the sales management role into two parts -- a leader of the inside and outside sales effort for the solutions that are already established in the marketplace, and a "New Business Development" leader. That model would be interesting to see tried out. But for now, I've only seen attempts to have the chief sales leader in the company manage both types of sales. And I think this is why many revenue-stage cleantech startups have struggled at this phase. Either they are so focused on the rapid scale-up that they lose the ability to identify and enter new market opportunities, and fail to escape out of their early-adopter niches, or they never add the kind of sales leadership more appropriate for rapid revenue scale-up within existing market opportunities.  

And while this transition is probably pretty difficult in any sector, I believe it is often exceptionally difficult in energy- and water-related markets. And it likely will continue to be until the universe of potential corporate customers for new solutions start making energy and water costs their top priority.

NIMBY in My Backyard

When my travel-heavy schedule permits, I try to show up at the meetings for my town's Renewable Energy Committee. They're usually a quiet affair, as the committee is a small group of volunteers who help the town assembly look into issues like energy efficiency improvements to the schools, some renewable energy opportunities, streetlight replacements, etc.

So I was pretty surprised to show up last night to find that instead of the usual four-person meeting, there was a packed room of around 20. Why? Because of recent local newspaper articles suggesting that the REC was about to put up a wind turbine at the town's middle school.

I sat back and just watched, and it was a fascinating look at the tensions that naturally result from efforts to put up local wind projects, particularly here in New England. To everyone's credit, it was a constructive and respectful conversation, even though (judging from the shaky voices and hands of some folks making comments) emotions were running high.  But instead of a fight, it was a very good open airing of facts and concerns all around, aided in large part by the fact that there was no real decision point on the project, which is far from being recommended to the town assembly, much less approved.

But after having looked at a number of wind turbine and wind developer investment opportunities over the past few years, it was my first opportunity to actually sit in a room while one such town conversation was held.

The concerns raised were numerous.

What about examples from towns in Maine, in Illinois, and elsewhere, where people complain about noise, light flickering, and falling property values? In some of these cases, there have been lawsuits. Turns out that evaluating noise and flickering was a mandatory part of the feasibility study, which is still being reviewed. But such concerns are being treated seriously. "People are getting sick!" exclaimed one attendee, but that wasn't really addressed in the conversation except to note that health concerns were naturally also part of the feasibility study.

How big would the turbine be? The analyst had evaluated several options and recommended a 75-meter-tall model, said one member of the committee. "What is that in feet? Please use feet!" another attendee interjected. "It's big," acknowledged one of the committee members, "and that's something we're concerned about."

What's the payback period? Sixteen years, if it is done as a straight one-time investment of capital with no financing.  One software salesman in the audience expressed incredulity that anything like that would be considered, since in the private sector people are looking for 18-month payback periods. And the committee agreed that a 16-year payback was pretty bad and not something they were interested in, but pointed out that there are potential financing options available that could result in lower-cost electricity from day one and would not necessarily require a capex/payback calculation -- all of which is still being learned about and thought through. The town simply may not have the wind resources to make it an attractive project, regardless of neighborhood concerns.

How much town money has already been spent on this?  None. It's a volunteer committee and the feasibility study was paid for by the state.

In the end, everyone there had an opportunity to say their piece, and it was all within the context of this volunteer committee still digesting the feasibility study. For the most part, the concerns raised were valid ones that the committee was also wrestling with. I didn't hear any concerns that were strictly political or anti-green; in fact, the opposite was true -- some in the audience expressed strong support for the goals of the committee even while they were worried about this particular potential project. I thought it was a really fascinating look at wind project siting issues in local communities.  

More broadly, NIMBY ('not in my backyard') issues are not going to go away in the U.S., nor should they just be dismissed as being uninformed or unimportant. These concerns expressed at the meeting last night were for the most part well-founded, thoughtful and understandable. Yet I've seen renewable energy proponents, entrepreneurs and investors sometimes failing to give NIMBYism enough consideration in their processes of idea creation and evaluation. Anyone hoping for a "tipping point" where Americans will eagerly welcome large renewable energy projects in their backyards is probably engaging in wishful thinking.