Greentech Media: Cleantech Investing
A Tale Of Two Cleantechs
Two years ago, I heard today, at the NVCA Annual Meeting the Cleantech session had 200 participants.
At today's, it had around 30.
And yet I walked away very encouraged. Why? Because in a room that probably had something like 200 or so collective years of cleantech venture experience, so many smart minds were focused on the basic question that we're wrestling with these days: "What will the next wave of cleantech venture capital look like?"
The panel session quickly turned into a full-room discussion on the subject, with lots of fodder for future columns (I'll get to them eventually, I promise). But perhaps the biggest takeaway for me from the conversation was Josh Green's suggestion that there will be two separate cleantech categories. "Energy/Industrial", and what I'll generally call "Market Reinvention" (while continuing to think of a better way to describe a wide range of consumption-facing business models and technologies -- suggestions welcomed).
"Energy/Industrial" would be the cleantech that many VCs and others seem to instinctively think of when they think about "cleantech": Hardware innovations, production processes, physical innovations. And this always seems to be what VCs gravitate toward. If you get more than two VCs together in the same room to talk about "cleantech", I guarantee you that within 5 minutes the conversation will have skewed over into the difficulties of getting venture returns from materials science or bio-chemistry innovations. (It was fun to watch the cleanweb investors like Mitch Lowe from Greenstart smile and go silent when that happened today.) There are a lot of reasons for this dynamic, including that many of the original cleantech venture investors came out of such hard-engineering disciplines, as well as the fact that cleantech markets are inherently about the physical world and thus there's no escaping the significant needs for such physical world based innovations. But clearly, a lot of venture investors, LPs, pundits, etc., tend to have a primary image of "cleantech" as being all about this subcategory, not just sometimes about this subcategory...
And the other category, as regular readers will no doubt recognize, is about business models and system integration (sometimes financial-oriented, sometimes web-oriented, sometimes software and controls oriented, sometimes deployment-oriented, sometimes just plain services). In large part, these are innovations focused on accelerating the adoption of the increasingly-attractive physical innovations and other resource efficiency improvements that the last decade of cleantech venture capital has done so much to bring about. They can create competitive advantage through proprietary IP, but as often they utilize brand, network effects, captive value chains, etc. to create their competitive advantages.
The point of the conversation, as it dwelled on this division, is that these two subcategories are really very, very different. Very different in terms of the skills required by the entrepreneurs and investors; different in terms of capital requirements; different in terms of time to market; different in terms of which strategic partners are critical, and what roles they need to play.
I happen to personally believe (and am investing around the thesis) that the current investment opportunity is in the Market Reinvention subcategory. Because there's a backlog of ready-for-prime-time physical innovations that aren't being adopted nearly as fast as their economic value propositions would suggest, so there are rapid growth opportunities to be found in figuring out how to unleash accelerated adoption.
Indeed, when Cambridge Associates put out a recent analysis of cleantech venture returns, the differences in performance between these two strategies was quite stark. From 2000-2011, they found that the pooled IRRs of bets in "Renewable Power Development" (basically, deployments/finance/etc. downstream of powergen) and "Energy Optimization" (lighting, efficiency, etc) were relatively more attractive at 11.4% and 8.9% respectively, whereas IRRs for "Renewable Power Manufacturing" (at 4.6%) and "Resource Solutions" (at 1.5%) were significantly less attractive.
But the point isn't to argue that one of these subcategories is better or more attractive than others. That will likely be cyclical. If Market Reinvention is successful, in fact, it will create both increased demand for and more rapid adoption of new Energy/Industrial innovations and thus create the opportunity for superior returns there. It's analogous to when corporate America got to a point of prioritization of and dependence upon new IT innovations that CIOs became prevalent -- when corporate America starts hiring "Chief Energy Officers" we'll all be much better off and physical innovations may find more rapid paths to market adoption and exits. And heaven knows, as a society we need much significant progress in these innovation areas -- a need that may well lend itself to tremendous investment returns for investors with the right strategies and in the right market conditions.
No, the point isn't to advocate for one of these subcategories or the other; the point is that these subcategories are indeed very different and thus require very different investment strategies and skill sets. In any rethinking of the cleantech venture category (and perhaps leading to some rebranding efforts), it's important to acknowledge these differences, and indeed embrace them.
1. "Cleantech" is not one opportunity. It is lots of completely different opportunities in completely different markets, built upon completely different technologies. It is more of a lens through which to view a wide range of innovations by entrepreneurs, some of whom may not even consider themselves "cleantech". And that's okay.
2. Not all of these opportunities will be a fit for the venture capital model, with its exceptionally high returns expectations and relatively short time to exit expectations. And the boundaries of that will vary over time. And that's okay.
3. And even within these subcategories, there will be very different strategies and skillsets required. Smart investors will move away from "checklist investing" as so many of us have engaged with in the past ("I still don't have an advanced battery company in my portfolio, let me go get one of those") and start to focus on particular areas (skill-wise and/or market segment focused) where they have particular access and expertise. And that's okay.
Lest we forget, these are markets that add up to trillions of dollars of revenue opportunity per year that are practically screaming out to be overtaken by new, more efficient technologies and market processes. Clearly, only a subset of this opportunity will be applicable to venture capital returns. But even that subset will be hugely attractive, when we can figure out how to crack it open.
Let's go crack it open.
Consolidation In The Intelligent Energy Sector
Consolidation in an industry sector can be a good or a bad sign.
The waves of consolidation in the PV manufacturing sector for example, presaged (when it was vertical consolidation to lock up access to demand for panels) and then highlighted the overcapacity in that industry. Much of the ongoing consolidation upstream in the solar value chain at this point is opportunistic consolidation of IP on the cheap. Not exciting at all from an investor's perspective.
But the looming consolidation in the "intelligent energy" (ie: IT applications in energy efficiency) sector is, I believe, a very different story. One that is positioning the sector to start showing some really exciting growth stories.
There is a paradox at the heart of the building energy efficiency opportunity.
Many venture investors have shied away from the sector because it doesn't lend itself to what they consider "proprietary technology" that has massive scale -- because it is a highly fragmented market, when you get down to ground level. A home in Nevada behaves very differently and has very different energy costs than a home in Connecticut; much less trying to compare either building to an office building in Chicago, or a foundry in Idaho. So the matrix of optimal lighting, HVAC, etc. solutions ends up looking quite different from customer to customer.
And yet conversely, many of the basic solutions do have commonalities; and many customers end up having some of the same space-driven needs in common. That foundry in Idaho does have an attached office that's smaller than, but has similar needs to, that Chicago office building. Those homes both have opportunities to participate in automated demand response programs and voluntary efficiency programs.
As we've discussed here before, one of the challenges for "single solution" vendors is figuring out how to scale up in the face of such a fragmented market. It's tough to navigate through that matrix of potential customers to find the ones that need your particular solution AND have budget, authorization and motivation to act. One solution we've discussed is to cast a very wide net, and harvest the scattered "easy wins" out there.
But an alternative approach is to offer a full solution set. If you have a full suite of solutions, it's more likely that any single customer will have a need you can satisfy. And that's what the looming consolidation in the intelligent energy sector is shaping up to look like. An early mover in this wave, EnerNOC, acquired several ancillary businesses in energy procurement, carbon accounting and wireless demand control for small commercial facilities -- acquisitions with mixed results, but clear intent. And then yesterday's announcement of Nest's acquisition of MyEnergy. These were acquisitions to provide more completeness of offering to customers who want a single vendor to solve their overall energy issues, not just offer one particular solution. They don't complete that aspiration, of course, but they're pointed in that direction.
While there have been and will continue to be opportunistic acquisitions of distressed assets, of course, I believe this is going to be a healthy consolidation wave in this sector. Why? Because the most strategically-valuable acquisitions will be the ones that customers are already experienced with and are proven out in the marketplace, not distressed assets. Acquisition targets that already have some additional strategic value beyond any proprietary technology, such as customer/user networks, brand recognition, etc. This will be real companies buying real companies, and if done right, will end up with even faster sales growth. And in intelligent energy in particular, it is relatively easier (stress: relatively) to integrate different offerings into a consolidated single platform for customers.
What this likely means is that we're going to start seeing the emergence of several acquiring platforms that could eventually challenge the incumbent sleepy technology providers in these markets (the Johnson Controls, Honeywells and Rockwell Automations of the world). These acquirers will increasingly look to offer a full-service solution set to a particular category of customers -- utilities on the one hand, and on the demand side likely different platforms for different major categories like residential, retail, manufacturers, etc. Some solutions will be outright acquired, others will be licensed or otherwise brought into the solution set without an acquisition. But for major categories, the offer will be "one stop shopping" for their energy needs.
Controls providers will be well-positioned, if their solutions can be easily integrated into a wide range of other vendors' equipment. Network effects really come to the fore when you're looking to consolidate control of a very fragmented user equipment base onto one platform.
This also likely means that owning the customer relationship, is going to become even more valuable. Those who own the customer interactions are going to want to be such consolidation platforms; startups that can aggregate a significant customer or user base and aren't planning on driving consolidation will themselves become prime acquisition targets.
The rapid proliferation of new, intelligent solutions for the building energy efficiency market has therefore opened up an opportunity for some new, big players to emerge. And for the incumbent providers to also therefore need to drive strategic acquisitions of their own so that their offerings to their customer base also don't develop gaps.
This feels like the launch of an arms race in intelligent energy, in other words. And investors who are building and selling into it should be pretty excited right about now.
Clean Energy Policy: A Three-Legged Stool
As I sit here at the jam-packed BNEF Summit listening to Senator Murkowski express her frustration about unrealistic political rhetoric on energy, I'm reflecting upon all the recent discussion among clean energy advocates here in the U.S. about priorities.
There's a recognition that in this policy environment, at a federal level this sector won't be able to enjoy all the policy support it should. But upon recognizing this the three major camps of clean energy policy advocates immediately fall upon each other, arguing that their camp deserves the most attention and support.
Advocates of deployment argue for implementing today's energy efficiency and renewable energy technologies at scale, as the best way to affect ongoing carbon emissions and build a stronger sector that can provide fertile ground for future generations of technology. Advocates of breakthrough innovation argue that today's technologies aren't sufficient so it's more important to emphasize R&D for the future solutions that can actually be full solutions. And those of an economic bent still advocate for putting a price on carbon as the biggest overall piece of the puzzle, but they tend to be more quiet these days, with a few stalwart exceptions.
They're all correct. But they all too often insist the other camps are wrong.
We need as much deployment as possible of RE and EE today where the economics make sense, and increasingly they do. The bigger the installed base, the more simple cost curve dynamics drive down prices. And the more people employed and making profits off of clean energy, the bigger voice we have in politics. Momentum matters. Forgoing momentum today to attempt an end-around via breakthrough innovation that solves everything down the road seems improbable, and also unrealistically assumes that a weak market with non-existent channels, etc., could even rapidly scale up such innovation when it becomes ready. And as for carbon tax advocates, it's unrealistic to expect a price on carbon to be politically acceptable if the alternatives aren't evidently at scale.
So I'm encouraged to see the efforts of Sens. Coons, Moran, Murkowski and Stabenow and others to put in place policy changes like MLP treatment for renewable energy that could help unlock deployment capital. These and other policy changes are possible (if still not probable) even in this broken political climate, and could make a significant impact. At a local level, movements to promote PACE and EE financing and feed in tariffs are all also welcome. I love the "race to the top" model for state-level energy policy encouragement outlined in the Obama budget. Furthermore, I've also talked here in the past about non-budgetary ways the White House could do a lot more to focus corporate America on making energy efficiency a shareholder-pleasing priority. If something like these kinds of efforts gets momentum, clean energy advocates of all camps should throw their weight behind it, and not whinge about how their individual camp is being left out.
Similarly, we clearly need to support more R&D spending on clean energy technologies. The Obama budget underlines this need and asks for significant more resources -- this may well not happen when Congress gets around to their own budget versions. But again, it's worth all clean energy advocates fighting for, arm in arm. Even among later-stage deployment folks, the emergence of alternative cheaper energy solutions would only enhance future economics. And to be blunt, as human beings we also need this type of breakthrough innovation, eventually.
Finally, we need a price for carbon. I see deployment advocates and innovation advocates pooh-pooh this basic fact way too often, arguing that a patchwork quilt of incentives for their pet priorities are sufficient. And there's a somewhat defeatest attitude presented along the lines of "oh, Americans will never go for that, so stop distracting yourself with the concept." But let's remember that the climate challenge is at its root a challenge of externally-priced damages. When dumping carbon into the atmosphere is free, no one internalizes these externalities and thus any patchwork of policies will find loopholes exploited, key solutions left out, arguments against "government picking winners", etc. Thus, an overarching policy solution is an inevitability, frankly.
Which is where I take issue with the White House (sorry, Mike and David). I agree that a price on carbon is probably unrealistic in this Congress, and I agree that the President's bully pulpit role will be insufficient to change that fact due to entrenched obstacles, and I understand that this White House is looking for battles they can win right now. But that's such a terribly short-sighted perspective on the President's role. Addressing climate change is going to be a decades-long struggle more akin in its political dynamics to civil rights progress than to near-term economic policy debates. And seen through this lens, the President should take every opportunity to simply utter the phrase "There will eventually be a price for carbon emissions". Just say that. Yes, the President talks about climate change and yes there are some good efforts being done by the Administration such as those mentioned above and many others. But eventually we need a price on carbon. And the President of the United States cannot be cowed into silence on that fact, even if it's politically impossible to push any specific legislation during this particular Congress. Repetition of this phrase, by this President and future presidents, helps shape the expectation that it will happen. It keeps the sense of inevitability that powers long-term political fights. It reminds everyone that, even if it's not a top three priority at any given time, it remains a long-term priority. It's too important to leave to patchwork half-solutions and short-term political silence. And just talking about climate change is not enough. People need to hear that there is an inevitable long-term solution. Or the inevitable keeps getting pushed back.
And along those lines, advocates of clean energy innovation and deployment need to stop their own reticence to engage in this inevitability. I've seen studies talking about how, for instance, dollar for dollar a direct subsidy to deployment results in more deployment than a broader carbon tax. Well duh. If all you care about is deployment of certain technologies, then put your dollars directly into that. But a) this type of argument only serves to illustrate how a broader approach to ALL carbon-reducing options is important, because dollar for dollar internalizing externalities will be more efficient for reducing carbon emissions than any subsidy; and b) a price on carbon can be made partially or entirely revenue neutral, and thus "dollar for dollar" should actually serve multiple economic purposes and have even broader benefit. But that's not to argue that a price on carbon is more important than supporting deployment or R&D -- it's absolutely true as well that if carbon emissions were priced but no support was given to emerging technologies or innovations, barriers to entry and lack of R&D capital would slow down necessary progress.
In short, we need all three: Innovation, Deployment and a Price on Carbon. The right answer isn't one or two of these policy areas. Appropriate and comprehensive clean energy policy is a three-legged stool. I recognize that policy advocates are incentivized to be contrarian and thus divisive. And I agree that we can't do everything, so some prioritization is necessary. But please, stop arguing that your leg should be longer than the others. Let's all get behind whichever of the three has a window of opportunity at any given moment. And let's all speak loudly at all times about the importance of all three; now if possible, later if necessary. We're too small of a community to be able to afford being so internally divided and riven with cynicism.
Why Are Utilities Letting Other People Take All the Value?
The traditional utility model is under threat. Industry leaders like Jim Rogers and David Crane are talking about this publicly. It's becoming harder and harder to make profits managing wires that distribute centrally sourced kilowatt-hours to end customers on demand. The aging T&D workforce, new potential significant loads like PHEVs, intermittent and distributed generation sources, an increasingly complex array of technologies on the demand side and on the grid for utilities to be on top of -- it's not surprising that utilities are finding it a daunting challenge to profitably manage their businesses with their existing wires-based revenue models.
But what I'm surprised about is that utility managers and their boards aren't taking advantage of the unique positioning and branding they have with customers, and their big balance sheets, to tackle other emerging profit pools. In fact, they're letting other players come in and chip away at them, even though they are in a strong position to capture a lot of shareholder value here.
Ultimately, I believe that the wires-management portion of the electric utility business will be used by investor-owned utilities (IOUs) to enable other, unregulated profit centers.
There's already a strong history of IOUs running unregulated subsidiaries. This practice has waxed and waned over the past couple of decades, but I've seen IOUs that have run outsourced billing services divisions, energy trading shops, and even fuel cell businesses. In many cases, those unregulated subs weren't designed to take advantage of the market position of the regulated T&D business unit actually managing wires, etc., but there's no reason they couldn't be if structured appropriately.
Let's look at the business opportunities on the demand side right now. Utility customers are looking to take on energy-efficiency projects, distributed generation installations, inclusion in demand response and ancillary services and other load control programs, backup power and combined heat and power systems, etc. But what holds back these activities from scaling up even faster than they are today? Lack of capex, and lack of buyer information (which vendors to work with, which systems actually work, what other options are there, etc.).
What are utilities uniquely well suited to provide to the customers they literally touch, via managing the wires? Financing of capex, and access to buyer information. How?
Utilities have big balance sheets, thanks to all of their T&D assets. They can tap into that to get very low-cost capital, which they could then offer as financing to interested customers. If done through an unregulated sub, they couldn't maintain an exclusive financing opportunity to customers -- naturally, other third-party financiers would also be hitting up these same customers. But utilities have a primary advantage of likely lower-cost capital because of the balance sheet, and also more accessibility to customers. On-bill financing has demonstrated that it can be dramatically more effective at unlocking customer purchases than third-party leases and other third-party financing -- customers just find it much easier to pay their financing fees on their existing utility bill. It's not another vendor or a new relationship, it's a bill they're already used to paying each month. IOUs could conceivably make significant high-margin, very stable income by becoming a financier to customers for demand-side projects, or, in a lighter form, by charging a fee to third-party financiers who want to offer customers "on-bill repayment" via the utility billing system. Even in a competitive financing market (so as to not take unfair advantage of the natural monopoly of managing T&D wires), utilities could have enough competitive advantages to grow big businesses here.
Utilities, thanks to their brand and existing connections with customers, are well positioned to be a more effective channel for solutions providers. They have the data to be able to show customers how a specific project would affect their energy spend. Plus, utility-approved vendors and systems (akin to Rockwell Automation's Encompass program) would be given more credence by end-users who don't have time to do an exhaustive investigation of all of the proliferating options available to them (which would make it easier for the utility T&D department to better manage all the more variable inside-the-meter load and generation effects). Utilities could even leverage new or existing unregulated service/channel subsidiaries to compete for this work themselves.
What's necessary? IOUs would need to have a major strategic shift, away from treating the distribution of kilowatt-hours through managed wires as being their primary profit center. They would need to embrace that the grid will be the source of kilowatt-hours of last resort in many cases, and stop trying to make their margin off of the kilowatt-hours thus sold. They would need to embrace that the ability to have that T&D role with end-consumers is worth much more than that, because of the above-named businesses, and bring in strong managers to launch/expand such unregulated subs -- and let them take senior leadership positions within the utility, which as yet never seems to happen. And they would need to educate PUCs as to how this ends up lowering costs for ratepayers, without endangering reliability.
So clearly, it won't happen soon.
But it's going to happen to them if they don't get out in front of it. They need to eat their own lunch before someone else does. And it wouldn't require any major regulatory shifts. So I'm surprised I haven't seen more IOUs starting to talk about a future business model that looks more like the above, rather than just lamenting that the existing business model is in trouble. This could actually be a big win for the shareholders of IOUs, but for now, such shareholders must instead just sit back and watch as other financiers and startups (and increasingly, bigger companies like NRG) take advantage of IOU inaction.
A Roundup of Recent News
It's been quite a while since we did a roundup of recent news items here on the Cleantech Investing blog, but a few smaller news items have caught my eye and are worth discussing.
First of all, some housekeeping issues -- at my firm, we have made the decision to change the name of our firm to address a surprising amount of confusion out there in the marketplace. After receiving numerous business plan submissions addressed to "Black Corral Capital," we've determined it makes sense to change the firm's name to match apparent expectations. Of course, by that logic we also could have renamed the firm "Blackstone" or "Black Rock," but those are already taken. As we believe strongly in partnering with the best entrepreneurs and following their lead into new investment opportunities, it became awkward to be constantly replying to investment submissions with corrections about our company's name. So we've decided to make the change. Please adjust your contact databases accordingly.
Furthermore, we and many other investors in this sector have begun to rethink the "cleantech" phrase as a good descriptor, as it appears to now be out of favor among limited partners and Sand Hill Road types. Unfortunately, many other potential phrases have also become stale or are just silly, and it's even been suggested that the simple term "green" is now too politicized. So a big hat tip to Walt Frick of BostInno for recently coming up with the very pithy "Sustainnovation Greenruption" moniker. It finally captures all the key aspects of the investment thesis at work in this sector, and also should be difficult for extremist politicians in Congress to politicize, because it is so challenging to pronounce. At Black Corral Capital, we now will be shifting our communications to incorporate this new descriptor for the sectors and subsectors we seek to invest in.
Now onto some news items that caught my eye recently:
- Surprisingly quietly, Tesla announced plans to purchase Nest. Terms were not disclosed, but it does make some strategic sense. They tend to have the same customer base anyway, so this allows the combined entity to capture more "share of wallet" among those buyers and hopefully up-sell them to entire newly built green homes designed around Nest thermostats, organic grocery deliveries via self-driven Tesla roadsters, etc. The rumor is that the merged company will be renamed to "TEST" (a combination of the two existing names) as part of a marketing strategy they're internally referring to as the "CleanTEST," which sounds to be something like a Klout score but based entirely upon how much discretionary income you spend on pricey, fashionable clean energy devices. At very least, public scoring of this kind should motivate additional personal purchases by Silicon Valley VCs.
- Not to be outdone, Fisker is supposedly in final negotiations to acquire the assets of the short-lived Tucker automobile company. In a cashless transaction, naturally. Efforts to combine the companies' names appear to be a major sticking point, however.
- Former executives of Advanced Equators have begun fundraising for a new effort geared around "crowdsourced big data demand response". According to this blog post, the pitch to potential investors involves raising funds to build the IT infrastructure to aggregate DR capacity at the investors' own homes and offices, simply by tapping into their potential capabilities to adjust dimmable lighting when signaled to do so by a phone call from one of AE's many, many, many associates. According to an AE spokesman, "By investing a minimum of $1,000, investors who certify that their net assets are over $1 million can buy into this program, where they are in control of the profits of the enterprise by dimming their own light bulbs. We think there are a lot of dim bulbs out there, and we plan to take advantage of them by selling this 'verified' capacity to utilities and recycling all revenues into future growth (and management fees). Eventually, this IPOs, of course." Details on how individuals can invest into the "Energy Suckers Fund" can be found here.
- According to this article, A123 has renamed itself B456. I like this change. The sustainnovation greenruption sector has long lacked strong branding and marketing skill sets, but moves like this are an encouraging signal of change in this regard.
I wish I could also include news of forward progress toward comprehensive federal energy policy, but then readers would probably just assume this was a silly April Fool's Day post, and we wouldn't want that. So for now, here's to all the greenruptors out there. Keep on sustainnovating.
[Editor's note: Rob asked us to post this tomorrow but since it seemed to include sensitive information of a timely nature, we decided it would be prudent to publish it today instead, as a public service.]
When’s That Next Wave Coming?
We recently held a one-day retreat for all of our portfolio CEOs at Black Coral Capital, and it was a really energizing affair. Rather than a day of stale presentations, we created lots of opportunities for our CEOs to compare notes with and look for ways to work with each other, and it was just terrific to be a fly on the wall as all those smart entrepreneurs chatted / cajoled / brainstormed / opined. Just great fun to watch. It certainly helped that all of our companies are in a revenue-growth phase, so they had lots of common points of discussion. And of course, they all had one shared investment partner to complain about with each other...
But to kick off the day I gave a little update on the sector from the investor's perspective. Here's some of what I presented to the group:
We expect that 2013-2014 will see another wave of shakeouts in commodities like biochemicals, electricity storage, etc. There's too many solutions being commercialized right now by high cash-burn startups for the market to absorb in time, some shakeout is inevitable.
But we also think 2013 will see the first data points of success of the "next wave of cleantech investing" -- especially rewarding business model innovation over technical innovation. Thus, we expect LP dollars will start flowing back into this huge macrotrend opportunity, starting in 2014-2015. In the meantime, however, capital will remain scarce. According to Prequin, 2012 was the worst year in more than half a decade for VCs looking to raise cleantech funds, with aggregate capital raised down to $2.8B from $6.1B in 2011 -- part of a downward trend that has continued since 2009.
I also found it interesting to compare our inbound dealflow composition during 2H12 with the reported consummated deals in the market, as reported by the Cleantech Group. In a way, we can assume that the dealflow we see at our shop generally reflects what's being shopped around the broader market, so differences between what's being shopped and what's actually garnering investments might point to gaps and tensions in the market.
Fascinatingly, the dealflow we saw matches up really tightly to the deals that got done. As illustration, 13% of the deals we saw were in the solar space, and Cleantech Group reported that 13% of the reported deals those two quarters were in solar. Similarly closely matched levels in sectors like energy efficiency, biofuels and biochem, agriculture, materials, etc. This suggests that, at least at a sectoral level, there isn't that much divergence between where the entrepreneurs are and where the checks are being written. Of course, in such deal counts an insider-led follow on counts the same as an outside-led round, and trends within subsectors (such as toward downstream solar) aren't available in this data, and it's very susceptible to apples to oranges comparisons for a number of reasons... but it's still a fascinating comparison. If the VCs are actually moving away from some cleantech sectors and into other "new" ones, leaving entrepreneurs behind, you can't see that in this data. At very least, they're still backing their old bets, generally speaking.
In another interesting datapoint, we looked at the stage of development of the companies that approached us for funding in 2H12. Fully 75% of them were at or pre-commercialization. That stands in marked contrast to the significant fall-off the Cleantech Group identified in early stage deal counts (a negative 9% CAGR from 2010-2012). It's getting harder and harder to be an early stage cleantech entrepreneur out there.
Finally, while the Cleantech Group's data suggests that consummated deal sizes have been shrinking over time, we also track how much the fundraising ask was. And since 2009, in our dealflow we have seen remarkable stability in fundraising targets by stage. This suggests that a lot of funding rounds are coming in below target as the asks remain the same size but the reported round sizes drop.
Again, lots of apples to oranges in this data comparison, with possibility of data selection errors as well, so it's important to treat the above as just possibly indicative and far from comprehensive. But the overall picture is pretty clear -- investors don't have as much capital to invest, so deal counts and deal sizes are down, and yet there hasn't yet been any large-scale shift in how and where investments are being done in the cleantech sector, except to veer toward late-stage. Same old, same old.
But I think in 2013 we'll start to see some data points emerge out of alternative investment strategies for the sector. And hopefully that will mean better things for 2014 and beyond. It's certainly a good sign to see some recently announced successful cleantech venture fund closings! Here's hoping these funds and others can help drive the necessary next wave of cleantech investing.
Thoughts on Sales Traction
If you read this column regularly, you know I'm a bit obsessed with this question: Why do many startups in the cleantech sector see much slower-than-expected sales traction after successfully bringing solutions to market?
On the surface, it should be simple. If you bring to the market a solution that offers a compelling economic proposition, given how big the energy markets (etc.) are we should expect to see revenues skyrocket after commercialization. And yet that doesn't often happen. I often mention the company I saw that recently offered a customer a six-month payback period with a proven solution, and it took the customer nine months to say yes.
There are several reasons for the underwhelming post-commercialization revenues growth, of course. In many cases, the products aren't yet ready -- lacking proven reliability, or just being a component and not the full-fledged solution customers need to see before they will readily adopt. And there are market-driven barriers as well, including (but not limited to): The underlying low incumbent energy costs; misinformation in the marketplace; customer risk aversion; mis-designed incentives; etc., etc., etc.
But one other pattern I've seen is a sales approach by the startup that is itself a limitation to rapid growth. It is a "conversion-oriented" sales approach that involves relatively small volume, heavily-vetted pipelines, with sales teams working very hard to close each sale. The sale is heavily education / consultative in nature, and very hands-on.
This is necessary in some situations, but has the inherent limitation that it leads to long sales cycles. And delays in closing deals is the same as losing deals, because of the opportunity cost.
Cleantech startups (aside from those selling to utilities or building large chemical plants, etc.) should consider shifting to a sales process that is more "harvesting-oriented". Shoveling lots of relatively unqualified pipeline into a self-selection sales process. Putting in a lot less conversion effort per customer, and grabbing easy wins and moving on.
This is because of the nature of these markets. Whether it's residential solar installations, or industrial energy efficiency, or any number of other "distributed" cleantech plays, we can all point to inspiringly huge TAMs. Especially once a compelling solution has been developed, the natural assumption is that customers will make the economically rational decision and purchase the offering, once they get a chance to learn about it.
The problem is that most buyers aren't really motivated, often aren't authorized to make unilateral decisions, and certainly are not focused on educating themselves (or even getting educated, for that matter). This means that even when all questions about the startup and their offering have obvious answers (e.g., it's been installed a hundred times, with no reliability issues, reliable economic benefits, and a compelling payback or ROI), the buyers still take months to say yes. I hear it again and again in board rooms, "We're not really losing the deal, it's not competitive, it just didn't close this quarter." Perhaps they needed to do more research on alternative solutions. Perhaps they needed to go to their CFO to get approval. Whatever. The net result is big delays for the startup's revenue growth, as this scenario plays out again and again.
But too often this is presented as an inherent problem that occurs with all customers in these sectors, because of the low urgency of fixing what isn't broken. Instead, I offer that even if only 10% of potential customers already have budget and authorization and motivation to make a decision, these markets are often so large that it's a much better strategy to spread a wide net to catch and harvest those 10%, rather than try to work with the 90% to convert them to a decision.
What this means is that you need 10X the sales pipeline you have. And you need a very low-touch and inexpensive way to both build that pipeline, and quickly harvest as much out of that pipeline as possible. And then move on.
This sounds obvious, motherhood and apple pie. But I see it coming up again and again in these markets, among very smart management teams. It's understandable. Sales at the commercialization stage, when you're first bringing product to market, are always necessarily hands-on as you need to convince the first few customers to take a risk with you. And it's tough to make a hard pivot away from that sales approach. Also, because you're offering a smart solution, customers always sound favorable and motivated; not many people are pitched an obviously smart thing and want to say no to it. But that positive reaction is easily misconstrued as activation, and can fool salespeople into devoting time and energy into a no-win effort, in ways that are hard to qualify until you've already spent a lot of time on it. And certainly, it's tough to wrest salespeople away from trying to convert those high-priority targets at the end of the quarter as they try to hit their targets, rather than go off on another fishing expedition. I've seen this recently at one of our portfolio companies, where the decision to move away from a consultative direct sales approach has been made, and it makes everyone nervous. It's a big shift, after all. But it's a necessary one.
So while it sounds obvious, I just don't see it happening out there like it should. If this sounds like you, if you're falling into a Conversion Sales Trap, consider the following shifts of emphasis:
1. Put even more emphasis on inside sales than you do today, even at the expense of outside sales. Inside sales can cover a lot more ground more quickly. In many cases they can't be the ones to push the ball across the line themselves, but they can often carry it down to the 1 yard line and work with a closing-team of outside sales and sales engineers to punch it in.
2. Focus your outside sales teams on more bizdev-type activities. National accounts and other big wins that are worth the conversion effort.
3. Create a "quick kills" culture that forces time discipline: Only spend time on the easy wins (aside from the bizdev activities described in point #2).
4. Develop and offer free tools that customers find valuable, but that when they use the tools it also flags your inside sales team that the customer is motivated to do something. This is the principle that got us excited to partner with the team at Noesis, for instance, that they were going to roll such offerings out for just this purpose.
5. If the nature of your offering is that a consultative sales approach seems unavoidable, work like heck to simplify the offering, even if it means not being able to serve as much of a TAM. Don't subject your customers to the Tyranny of Choice, it just slows things down. You can expand via other offerings over time.
6. If the nature of your offering still requires a very hands-on sale, you're going to need to put a lot more emphasis on sales via channel partners if you're ever able to rapidly scale. And unfortunately, your channel partners are unlikely to be any better at rapid customer conversions than you are. So you'll need to enlist and manage a whole lot of channel partners for the math to work out.
7. Develop direct marketing programs that are designed to ping high-potential customer pools (e.g., certain types of customers in a certain geography) two or three times very quickly, drive them to action, and then move on having harvested the easy wins. This requires highly targeted and efficient marketing, to keep costs down.
The net result from where I've seen this type of approach (sometimes on purpose, sometimes by accident) is sales cycles that drop from six to eighteen months, down to two to three months. That's huge.
This is not a universal fit, of course, nor is it a black-and-white differentiation of approaches. But I've seen the relevance of this different sales emphasis across many different cleantech subsectors, across both B2C and B2B, across hardware and software.
Here's the good news: Even if you do only harvest 10% of a potential customer pool, that's not your limit, you haven't left money on the table. Because you can go back to them. You go back to the same pool a year or two later, and in the meantime a completely different set of buyers have gotten budget and motivation. And this time they've already heard of you. This approach lends itself well to building self-propelling sales momentum over time, because it also lends itself well to clustering effects such as now are being identified in many of these markets.
I talked with a proven CEO recently who's extended this approach even to a B2B market that requires OEMing a highly technical embedded solution into products with long design cycles -- the classic example of a consultative sales process. "I talk with everyone," he told me. "I talk with anyone who'll talk with me. I quickly figure out if they have a real serious need, and I offer them a solution to that. I don't try to convince them to buy what I've got, I solve their immediate pain. And if they don't have a real serious pain point I can solve quickly, I move on." He's been highly successful with this approach, which is all about opportunistically building momentum while simultaneously taking on longer, strategic projects. "Even if there isn't a way for us to work together today, they'll be there the next time I come through. And sooner or later they'll be at the right place for them to want to buy from me, because no one else can offer them what my company offers. No sales meeting is every really wasted."
Stop trying to convince the customers who nod their heads when you describe your offering but don't move quickly. Start touching a lot more potential customers. Move quickly to harvest the customers who already want to say yes, and move on. And then come back and harvest other customers from the same pool next year as well.
If you want to scale revenues quickly, you're going to have to consider leaving some customers behind.
How This Cleantech Investment Firm Is Tackling the Next Wave
Just stepped out of a great RFK Compass event, where I took the opportunity to deliver some of my current message to the limited partner community in person. And it occurred to me that, while I've put bits and pieces of the thesis into past columns here on this site, I've never really explained how we at Black Coral Capital are ourselves tackling the next great cleantech investment opportunity -- and you might want to know whether we practice what I preach. I've been reticent to turn out a column that's a blatant self-advertisement, but if you'll forgive me this once, I'll lay out what we're aiming to do and then you can all judge our performance over time...
As background, we started Black Coral around 4 years ago as a blank sheet of paper, trying to answer the question "if you actually wanted to make money in the cleantech sector, what would it look like?" We had a conviction that there was a huge macro-opportunity here, but also a recognition that none of the GPs in the sector (myself included) had yet proven that they knew how to reliably make money investing into these opportunities. We also were fortunate enough to have secure capital in place and didn't need to go out to the limited partner community as a first-time fund.
So we embarked on a period of some experimentation and network-building, to accelerate our learning directly and via others. I come away strongly believing that there will be multiple "correct" answers here, several different strategies that will make money over time (and you can see some of my earlier thinking on this here, which surprisingly has not yet grown stale).
Important additional context for our team in particular, then, is that we have from Day 1 believed very strongly in finding and backing only the very best management teams, using a very rigorous methodology borrowed from elsewhere in the private equity world. And also that we wanted to take advantage of our flexibility, rather than to try to "out Sand Hill Rd." the various Sand Hill Rd. denizens. They're smarter than we could ever be, so we should try to do what they can't or won't.
Over time, this has led us to really focus on tech-enabled and non-tech execution plays, and to avoid commoditization cycles wherever possible (but in fact, where possible to take advantage of them). Our view is that venture capital investments into clean technologies have been very successful over the past few years, in terms of bringing to the market new technologies that are capable, reliable and cost-effective. But that the market hasn't been ready to rapidly adopt those technologies. Thus the adoption cycle remains too slow for capital-intensive, high cash-burn commodity producers to get down their cost curve before they run out of runway, in far too many instances. (And thus, the lack of compelling investor returns in the sector)
So from our perspective, the opportunity now lies in market reinvention. Figuring out how to accelerate how people buy, sell and deploy these new technologies, in scalable ways.
This requires a new type of investment thinking, at least as applied to the cleantech sector (although it's really old-hat in some other venture investment sectors).
It means focusing on new business models, not solely on breakthrough technology innovations.
It means finding strong executing teams as a first-cut investment criteria, not as a secondary consideration after sectoral thesis and proprietary IP ownership.
It means being perfectly okay with "stealing" good ideas that are already well-understood from other sectors (e.g., web-based marketplaces) where they are applicable and adaptable to these change-resistant markets.
It means finding world-class teams who are tackling difficult market adoption challenges, with technology or non-tech solutions; and those solutions cannot be "but we can make it cheaper than anyone else" as the major point of differentiation.
In many cases it means finding teams that have developed advantaged innovations, but who then seek to control their own destiny; so they themselves deploy those innovations downstream (i.e., embedded controls vs. standalone) rather than trust that a market will emerge downstream smart enough to value and reward them for their efforts, at least in the near term. Bundling their innovations into a full market-ready solution, in other words.
It means being open to growing, and then using that scale to drive new innovation into the marketplace; not the other way around.
And it means sometimes being a "VC," sometimes being a project finance investor, and sometimes investing in entirely different business models and investment structures than either of those two approaches would typically back.
It also (along with the make-up of our team) steers us away from opportunities with major science risk, because what's the point of going through all the trouble of vetting a high-execution team if execution isn't really in their control anyway ("sorry, but the bugs died in the test tube").
A lot of the market is shifting in this direction over time, and certainly various parts of this approach are already being deployed by various firms out there. Everything I describe above is in fact where VCs have made a ton of returns over the years, in other sectors (think about how the dot-com revolution was really market reinvention surfing the wake of a prior wave of IT/telecom hardware commoditization).
But in cleantech, I don't see this approach being deployed comprehensively, consistently, and in practice the same way we do, so we don't yet see any existing investors for us to simply dovetail behind. So we'll continue to focus most of our efforts on our direct investments versus our LP activities, at least for the time being.
And while it remains early days, our early results have been quite positive. While I of course can't divulge many details of our portfolio performance to date, I can tell you that across our entire portfolio last year we saw revenues grow 84% year over year. We don't have the ultimate evidence yet in terms of a lot of realized exit activity, but we feel we are at least helping great entrepreneurs build solid businesses and we are hoping that helps lead to strong results.
But we shall see. Apologies for the self-advertisement post here, but rather than simply describe parts of our thesis I wanted to lay it all out one time. Because now it's time for us and others tackling the reinvention of cleantech investing to start not only showing some results, but showing our work along the way, so that everyone out there has a framework for understanding the results over time.
And to be clear, I think there are other really interesting and potentially valuable (and completely different) approaches being attempted out there in the marketplace. I've seen some really smart approaches to backing "black swan" proprietary technology R&D efforts; to project finance; to subsector-specific efforts; etc. I would encourage these other investors to also lay out their theses (here's one!).
Because I think we're going to start seeing some compelling but early data points about the validity of these new approaches to cleantech investing, and we all need to understand the frameworks underlying them or it's going to simply appear as some randomly-generated success stories in a sector otherwise still dominated by v1.0 type thinking (amidst a lot of continued v1.0 shakeout).
Let the cleantech investing revolution begin. And let it be
The Cleantech Investing Summit I Would Like to See
Stopped by the Cleantech Investor Summit out in Palm Springs this week -- meant to stay through for the entire event, but Nemo forced me to scurry back to Boston on an earlier flight.
Ira and his team always do a terrific job of running that event, it's always a good networking opportunity and they get big names to come speak. And Tesla test drives, of course.
But it seemed to me like yet another missed opportunity. With so many cleantech investors and their ecosystem partners under one roof, it would have been great to see more exploration of the emerging "next wave" of cleantech investing strategies. Instead, most of what was presented was what I call "old Cleantech VC": capital-intensive upstream technology bets.
Until recently, such investments really defined "cleantech venture capital," in the eyes of GPs, LPs, the media, and entrepreneurs. But over the past couple of years we've seen the emergence of a few different takes on the sector, and it's time we had a major industry event really explore these kinds of strategies.
I would love to see a full-day event where a few innovative investors were given the platform to present their strategies and analyses in short plenary talks. Matthew Nordan to present some of his quantitative research into cleantech venture returns and key success factors. Sunil Paul to present his Cleanweb thesis. Whitney and Scott at McRock Capital to present their intelligent infrastructure focus. Sarah Wood to discuss her efforts working with family foundations to promote program-related investments (PRIs). US Renewables Group to present their more project-finance oriented approaches. And yes, one of my colleagues at Black Coral Capital to present our market-innovation (vs. tech-innovation) approach and our collaborations with other family offices. As just some examples among others.
In between these presentations, there could be presentations by some of the startups and established companies that are touchstones and early examples of these approaches. From bigger companies like Tesla and EnerNOC and SolarCity to earlier stage companies like Noesis and Sidecar and Propel. They could present their businesses, but especially their capital strategies and how they look to interact with cleantech investors in the new era.
We're all working hard to reinvent cleantech venture capital, with an eye toward returns-producing investment strategies. And there won't be one right answer, there will be several, it seems to me. But at just about every industry conference I go to these days, most of what's discussed is the old paradigm, with companies that were funded that way but couldn't get funded that way today.
That's not looking forward, that's looking backward. And I think our industry would be well-served at this point to have a real forward-looking event, so we can kick-start more of the necessary conversations about what's next. Those conversations, plus some good results starting this year from these new approaches, would be what would unlock LP interest in the sector. And that's necessary, because it's the LP community's utter disinterest in cleantech right now that's the limiting factor.
I've never seen better entrepreneurial teams in cleantech. I've never seen more interesting, pragmatic business plans. The underlying markets are growing strongly and seem poised to continue to do so. The large corporates seem more serious than ever about getting into cleantech with strategic intent. The one missing, and yet vital piece is the venture capital dollars, and if the LPs aren't giving any capital to the VCs, the VCs can't put any money into this next wave of startups.
We're not going to fix that by fixating on the old paradigms of cleantech investing. So it would be great to see one day that gets a lot of attention focused on potential next paradigms for cleantech investing.
Fundraising Advice for the Seed-Stage Cleantech Innovator
Cleantech investors are commonly approached by very early stage entrepreneurs. And by "very early stage," I mean garage-based-inventor stage. In many cases they're not directly looking for funding from my firm at their stage, but they're looking for advice on how to raise seed capital.
We all need such entrepreneurs to succeed. Their innovation and enthusiasm is the lifeblood of our sector. And so while it's gratifying to encounter such innovators, it's also frustrating to find that so many are having a hard time getting started. And I have come to believe that in many cases these innovators are having an especially hard time because they're not looking for the right thing. They shouldn't be looking for seed capital, they should be looking for how to turn their idea into a business. The funding follows after that.
Below are some suggestions that I hope will help such innovators turn their ideas into a real business. This is a lot easier said than done, especially on limited capital and during limited available hours. I've been in this position myself, and I know there are real constraints on what can be done. So the most important watchword here is "patience." The below process can go relatively quickly if you have a lot of time and no financial constraints, but it can also be effectively tackled over time, on the cheap and with limited bandwidth. Just don't expect it to happen overnight, or you're not being thorough enough. It's highly unlikely that these antiquated, slow cleantech markets will move too quickly and pass you by while you're prepping; but it's much more likely that if you go out there not yet fully prepared, you won't make any headway. Be patient.
So with that in mind:
1. Attack your own idea. Why won't it succeed?
The general sentiment experts and investors like to pass along to early innovators is that they must be unmitigatedly optimistic, that they must simply will themselves to succeed and refuse to take no for an answer.
True enough. But there's a time and place for everything. And you should shoot holes in your own ideas before someone else does. The best way to do that is simply to ask yourself tough questions and then gauge your answers on your own personal bullsh*t meter.
"Is this a solution in search of a problem, or is this idea of mine generated by a very real customer (i.e., not society-level) problem that they'll pay someone to solve?"
"Is this a good idea but aimed at customers or a market that simply aren't accepting of new innovations?"
"Is this a good idea but one where it will take more capital to succeed than I can realistically access?"
"Is this a good idea but one where it will take skills and talents that I don't have and can't access?"
"Do I have time for this? Or am I hoping to just hand it over to someone else to execute for me?"
"Do I have any special advantage that means I would be able to succeed at this even if others also have the same basic idea?"
"Is this something that someone in a national lab or in Silicon Valley or at a university is probably already doing?"
If you end up losing faith in this particular idea, that's still a victory, as long as you then work hard to develop another winning idea. But hopefully what you find is that you have a revised idea you truly believe in, and you're now completely honest with yourself about the obstacles to bringing it successfully to market. I'm a big believer in optimistic entrepreneurs, but there's a difference between optimism and fooling yourself.
2. Decide if you are going to develop a component, or a full solution.
This may seem like a value-laden question, but I really don't mean it that way. These are two equally legitimate pathways.
Is your vision that your innovation is incorporated into other people's products or systems? Are you looking to license it for others to manufacture? These can be financially-successful and commercially-successful paths, requiring much less capital in many cases, than the decision to take on building out a full solution. Are you a battery management innovator who will license an innovation to Tesla, or do you want to take your battery management innovations and use them as the basis for building a new Tesla? The reason to figure this question out for yourself in the early going is that it will dictate a lot of other choices further on. For example, many innovators too quickly assume they need venture capitalists to back their effort, and yet VCs typically want to back full solutions with lots of capital, not capital-light component development and licensing plays...
Generally, I would urge keeping things very simple as a first-time entrepreneur. First-time entrepreneurship is ridiculously hard, and many entrepreneurs find better success their second or third time around after a lot of lessons learned. So to borrow a concept, think of your first entrepreneurial effort as the task of putting out there a "Minimum Viable Entrepreneur" and then failing a lot very quickly so that you can iterate quickly. That's a lot easier to do if the business you're trying to start is as simple as possible. To innovate around a battery pack and license it to an automaker requires several skills. To successfully launch a brand new automaking company requires ten times as many different skills areas.
3. Recognize that at this stage, it's all about the customer proof points and the prototype.
You may have a lot of confidence in your idea, but really that doesn't matter much. What matters a lot more is that customers say they want a solution like this when it's ready for them, and that you have some serious prototype that you can show to people and give them confidence in your idea.
You can't learn what you need to learn about prospective customers via web searches. Find people from your prospective customer group, or who work with your prospective customer group, and buy them a cup of coffee and informally tell them about your idea to get their reactions. Don't go straight to the top, go to people who have the time to give you thoughtful answers. Ask them about whether this type of innovation would be welcomed or not (you'd be surprised how many innovators want to sell things to utilities and yet really don't understand why utilities actually buy things, for example). And especially try to learn about what pains and frustrations they experience, that might be relevant to your idea. Building in such solutions can be invaluable. Most of all, leave the door open to follow-up conversations once you have something to show them.
And build that something to show them. To the extent you can with the limited resources you have, build the sucker. Too many innovators go out and seek funding armed only with drawings and computer modeling.
- Perhaps you have to do it at a much smaller scale because of costs and physical constraints;
- Perhaps you have to build something that demonstrates only a portion of your idea;
- Perhaps you need to use mostly off-the-shelf components to show what your envisioned proprietary solution would eventually do a better job of;
- Perhaps you simply are launching a service business and can actually do the service yourself for someone; or
- Perhaps you are launching a web-based business and your first test site is built using free hosting and web design tools, doesn't look very snazzy, and is built on a very incomplete database
Whatever you have to do, build a version of it that you can show to people. A version that actually demonstrates the potential effectiveness of something, not just an illustrative model or mock-up.
4. Write a business plan.
I know, I know, conventional wisdom now says that writing a business plan is a waste of time and effort. I disagree. Writing a very pretty business plan with lots of jargon designed to impress an external audience is a waste of time and effort. But the actual thought processes behind writing a business plan are invaluable, at least for first-time entrepreneurs.
What this really does for you is it forces you to get down to brass tacks on all of the various parts of your potentially-good idea that you have previously glossed over or just assumed away. Successful entrepreneurship requires many things, but one of those is definitely the ability to execute on an overwhelming number of specific tasks at a detailed level. Especially if you're not a "details person", the forcing function of having to think through the plan of action in a comprehensive and deep way is very useful.
But do it for you, not for an external audience. Save the high-falutin' jargon for your eventual investor deck or customer pitch (and maybe skip it there, too). Don't worry about the format, about getting the structure just right, or even good grammar. Pick any old suggested template; it really doesn't matter. But take the time to think through your full business in as detailed a way as you can think of, and take the time to write it down, and take the time to keep it roughly updated as you think of areas you forgot or you change your plans. Because when you do go out to external audiences, while you won't show them this document, writing it will be what makes you sound very thoughtful and pragmatic when you pitch your otherwise crazy idea at someone in hopes of them giving you money.
Network with a lot of other entrepreneurs to the extent you can, and try to find a good experienced entrepreneur who's willing to give you regular advice. Consider an accelerator program like the Cleantech Open. Learn good business planning as much as possible from others who've done it in the past, rather than from your own blank slate.
This is not a budgeting exercise. This is a war plan. Numbers are part of that, but it's more about discrete tasks and objectives in a comprehensive fashion. If you're doing it right, you'll likely discover you've been ignoring pretty significant areas of activity that any real business must have... And if you're doing it right, you'll figure out how much money you actually need to raise to make your idea a reality, rather than the typical guessed-at large round number.
Even if your business idea is to get something to a prototype stage and then hand it off to someone else to commercialize, write up the details of that plan, however simple. Because you'll discover it's not so simple after all.
5. Find your team.
I've found that many innovators are pretty self-aware and know of several key skills areas they don't have and will need to bring on board. But they really don't know what to do about that. It's difficult to impossible to build a team by recruiting people you don't know, before you raise money. And yet most innovators, especially first-time entrepreneurs, don't have an a priori team around them. So many innovators punt on this and simply tell themselves (and prospective investors) that they'll hire senior people into various roles after getting capital.
The problem is, unless you have identified full- or part-time managers for crucial areas, it's hard for any investor to write a check. They want to know the team they're backing. So punting is ineffective.
The answer is to rely upon all the networking you've been doing from the above steps. As you've been talking with prospective customers and partners, and with other entrepreneurs, see who can get to be passionate about your idea. If you need other skills you haven't encountered yet, figure out where those people network and go there, looking for good listeners. With those people, meet with them several times if they're willing, and if you see a good mutual fit, try to soft-recruit them. By which I mean get them fired up about joining your effort when you get funding, so that you can bring them into your pre-funding planning process, and also tell prospective investors about them.
You'll need full- or part-time managers for all the really critical tasks. But there are a lot of other necessary but not as critical areas of entrepreneurship, so also recruit advisors/mentors who can help you know what to expect but aren't anticipated to put in more than an hour or so every other week. And don't forget -- you'll also need someone to do all the actual work. If you're going to CEO this effort, you'll end up spending a lot less time in the lab yourself.
Remember, you're potentially trapped with these people for 10 years or so. So don't fool yourself about your skills gaps, their skills gaps, or that you might quickly discover you can't stand each other. Again, be patient and let relationships develop over time in an iterative way.
You don't need a full team before launching your business, but knowing more of the pieces than just you alone is part of the necessary planning and credibility-building you need to do before approaching funders.
6. Approach funders.
Aha, finally we're to the point of this column, right? I hope that's not what you're thinking, and if so prepare for disappointment. Getting funding is a result of building a great (albeit fledgling) business, not the other way around, and I hope that the above steps are helpful in that regard.
But at some point you'll likely need some capital. So in this period where early stage venture capital is hard to find, where should you look? In all likelihood, the underwhelming answer is grants and local angels.
At this point you hopefully know how much capital you need to take your idea to the next step, and hopefully it's not a huge amount. So note that for anything under $1M, venture capital is likely not a good fit. Even early stage VCs typically don't want to write a bunch of smallish checks out of >$100M funds, because it's a lot of management overhead for them. And there really aren't that many early stage venture capital deals done in any case, versus the number of good ideas out there, so just the numbers game alone says that VCs are likely not your best source of startup capital as a first-time entrepreneur who doesn't already have a relationship with any VCs. Never say never, but grants and angels are most likely the way to go.
And for both of these capital sources, focus mostly on local targets, because they tend to really focus in on their regions. There are actually a lot more grant opportunities at the local level than you might think, but many innovators focus just on the higher-profile national opportunities (like ARPA-E, etc) that get a lot of attention. But I've worked with grant-making bodies from Massachusetts to North Dakota and I can tell you that many states have some kind of entity with a small (<$1M check) capacity to support early stage entrepreneurs and/or technology innovators -- it may not be a cleantech-focused entity, mind you. Furthermore, there are often resources attached to universities, as well as non-profits like MassChallenge and the Cleantech Open, who have some limited financial resources for program participants/winners.
If you need millions of dollars to make your prototype, you're probably not thinking creatively enough. And if you don't need millions of dollars for this first step, do a lot of research to find what local grant-making resources there are that are available to you.
And angels are all around you as well. There are angel groups all over, and online. Without doing the above process it may be difficult to break through the noise to get the attention of angels even when you find them; but with a credible plan your task is to network to an angel investor (or three) who share your passion and your vision for the business. Don't just fire off an executive summary to an angel group email address, use LinkedIn and other resources to figure out individual angels and go talk to them. Even when they're not a fit (which is likely), ask them about other angel investors you should track down. Don't ask them for an endorsement or even a referral unless they want to do so, because investors of all stripes are wary about burning relationship capital in this way when they don't really know someone that well. But just good solid leads for you to track down are quite valuable.
Think globally, but fundraise locally.
The above steps won't be applicable to many innovators, and many more will already know and be actively doing most parts of it. But in my experience, I run across lots of innovators who really don't know how to get started at turning their good ideas into real businesses, and go out to find funding to support doing so. My point is, that's the wrong order of things. Patiently and thoroughly build your business, even if it has gaps at this early stage, and then you'll be in a much better situation when you write a grant application or pitch an angel investor. Which then allows you to focus on local funders with confidence, rather than casting your net too widely.
Network, network, network. Have strong opinions, loosely held. And be prepared to iterate and have countless conversations before you piece it all together. It's hard, but it can be done, and you can do it, even if you've never done it before.
Lessons From The Past Ten Years: Embedded
As talk of the "internet of things" -- ie: smart equipment via automation and machine-to-machine communications -- continues to get attention, we're seeing more and more entrepreneurs bringing forth some flavor of idea involving energy-focused equipment controls. Smart-home plays, automated load shifting efforts, smart grid software, etc.
From a cleantech perspective, the basic concept is the same: Using automated intelligence, make hardware save energy spend via optimized usage patterns, and then build other value propositions (e.g., preventative maintenance, more granular data, remote sensing, etc) on top of that core value proposition.
As entrepreneurs tackle a variety of sectors and applications with this concept, however, there's one basic question they inevitably have to ask themselves: How embedded do I want my intelligence? Or to put the same question another way, how much do I want my software- and controls-based solution to be residing within specific hardware devices, vs how much do I want to simply ride over a variety of devices with common set of controls and software?
Do I just sell software, separate from the purchase decision of hardware? Do I license software embedded into other OEM's hardware, by partnering with those OEMs? Or do I make my own hardware and sell it, but with my software/controls as the advantaged factor?
As we look across sectors and applications, there is no universally correct answer to these questions. But it is hugely important to answer them correctly, as we'll see below. So let's explore some of the trade-offs and key criteria entrepreneurs should keep in mind when addressing this question strategically.
1. How much technical advantage is gained by tailoring specific controls attributes to specific hardware?
This question has to do both with the complexity of the hardware being affected, and how much of the optimization gains are due to technical hardware operations vs. simpler adjustments to usage.
The more complex and intricate the hardware, unsurprisingly, the more you would expect a customized solution for each specific type (brand, model, etc) of hardware would ferret out additional efficiency gains. With solid state lighting, for instance, the differences in power electronics, cooling requirements, voltage choices (ie: run chips hard or easy), types of sensors, etc. are all variables that can significantly affect the ability of a controls solution to drive efficiency gains. The more tailored the controls to that particular fixture's setup, the more efficiency it can drive. You can certainly drive savings by applying a broadly-designed controls system across a wide variety of lights, but you get deeper savings by designing specific controls parameters for the other specific components and configurations of the fixture or bulb.
World-class leaders in battery control technologies, for example, have gained important advantages. Tesla's future growth, for example, is built as much on such factors as on brand awareness.
Contrast to a smart-home clothes dryer, on the other hand. It's a big energy user, but the specific energy-consuming system is fairly simple and standard. Instead, the energy gains to be made are more about time of use and some other choices around usage patterns. This would be more amenable to a separate, broader controls system that perhaps adjusts more in the home than just the dryer, for example.
2. How much existing, standardized equipment interface is available?
Many existing industrial controls standards already exist in the marketplace, for instance with large HVAC systems, other commercial buildings management systems, or factory equipment. These typically haven't been designed already with energy optimization in mind, but you also often don't need to build controls that are linked to specific components within the equipment, because the existing industrial controls they were designed around provide a "doorway" for energy-optimization software to make targeted adjustments.
On the other hand, in just about all segments there are also small niche industrial controls vendors or even just PLC-based homegrown solutions that have some portion of the installed base. If they make up a large portion of the market, you're going to need fairly customized solutions regularly.
3. Are you targeting applications inside or outside the meter?
Utility-facing smart grid software has to interact with hardware in some way. But there's a lot of legacy hardware out there, a lot of utility resistance against new hardware vendors, and a much bigger scale of project, than typical for energy consumer-side applications. System integrators are also more readily available for utility-scale implementations. Generally speaking, therefore, these factors will drive more non-embedded controls on the utility side of the meter than on the consumer side.
Even on the consumer side of the meter, I think we'll see a shift over time toward more common controls standards, even when embedded into hardware from various manufacturers. But utility-side projects are probably more often large enough to support software-only efforts in this regard.
4. How fragmented and receptive are the OEMs and channel partners to partnering with (and paying) controls vendors?
It's obvious but it's amazing how many entrepreneurs don't really factor this in -- if you're planning on getting your revenues from licensing controls to OEMs, how capable and receptive and scalable are they? You're not going to build revenues quickly if the answers to this question are at all negative.
So, for instance, in the lighting industry some smart entrepreneurs have instead chosen the two other pathways. Some have gone the fully separate software route, designing controls that are intended to be overlayed on any OEM's fixtures. Another, BCC portfolio company Digital Lumens, decided instead to start by building their own fixtures with their own embedded controls, eventually migrating to an OEM-licensing strategy.
Take note of what this implies: The counter-intuitive decision to manufacture hardware as a result of a go-to-market strategy, not the other way around. Per point #1 above, there are obviously operating efficiencies to this stack-integrated approach, but the other relevant factor here is the nature of the channels in addition to the OEMs. In today's lighting market, the channel partners generally don't "get" the economics of lighting controls yet, and in many customer segments there's resistance to paying much for an add-on controls solution (even when the economic value proposition is clear). So embedding the controls into actual hardware and selling the full bundle to customers gives more opportunities to capture the economic value created by the controls, is the theory.
And at least in this case, the theory seems to have held. DL's embedded controls have been installed in 50M square feet, ~10x as many square feet of space as any of the software-only startup contenders over a roughly equivalent period of time. Of course, it's still early days in that industry sector, the full story has yet to be told...
5. How hard is it to make the hardware yourself?
Another obvious one in many cases (why invent a new dishwasher manufacturing company just to sell a proprietary smart-home control system?), but not in all. Contrast EcoFactor with Nest. Both are going after smart thermostat hosted controls in the home, but Nest decided to sell proprietary ones and EcoFactor partnered with an existing smart thermostat manufacturer. Both companies are growing so it's hard to say yet which was the smarter pathway to establishing their controls in the marketplace, but it'll be fascinating to watch the rivalry as it develops.
But of course, it's only an issue because the thermostat assembly itself could be relatively cost-effectively outsourced. For more complex or otherwise costly manufacturing decisions, it's a factor that could skew entrepreneurs toward a non-embedded controls strategy altogether.
Ultimately for all of these software/controls plays, embedded or not, the goal is the same -- to become an actual or de facto industry standard. The decision as to what path to take is primarily one of market entry and early scalability, because the hope for all is that network externalities eventually take over after some critical mass is reached. But this is an important strategic decision for the long run for startups. It affects core and ancillary capabilities they must build into the team. It affects capital needs and revenue models. And as a couple of the examples above show, it can determine whether a startup can outpace the others to become a leader in the race to network externalities, or fall behind and be imperiled. There are other questions to ask when making this decision to embed, license or float above the hardware choices altogether. But the above five questions are ones that we've seen come up repeatedly, across a wide variety of end markets.
The Sky Is Not Falling
After the Cleantech Group released their 2012 cleantech venture totals this past week, I heard a surprising amount of pessimism out there. I saw the sector called a "bust" and was asked a couple of times if the sector is just plain dying out.
Of course not, c'mon people.
First of all, regular readers of this column probably found very little of surprise in the Cleantech Group's numbers. For a while now we've been talking about how LPs have pulled back from the sector and how that has been forcing VCs to pull back from the sector, and in many cases to go find new jobs altogether. Given all this anecdotal evidence, it shouldn't be a surprise to anyone that the retrospective numbers now back these observations with data. The Cleantech Group's tallies were largely just confirmation of what we already knew was going on (with one exception, lower activity by corporates, which I'll discuss below). But these numbers shouldn't have shocked anyone.
Secondly, cleantech markets continue to grow quickly, with little signs of falling off anytime soon.
Here are some examples I found by cruising through GTM headlines from just the past few weeks:
- LED lighting markets continue to grow, amidst a phase-out of incandenscent bulbs and high-profile companies switching over fully to LED lights.
- Q4 solar installations at 1.2GW were nearly 10x what they had been just back in Q1 2010.
- US wind installations were at record levels last year, and the industry just saw the PTC renewed.
- GTM Research expects power utility data analytics spending to top $20B over the next nine years.
- Even lower profile sectors are chugging along -- in the US, geothermal saw its second biggest year since 2005, for instance.
Similar growth is taking place in many other cleantech markets as well, especially non-energy sectors. These are multibillion dollar markets, often among the fastest-growing segments of the US economy.
It is extremely rare to see such fast-growing markets and not see VCs trying to figure out how to put money at work in them. That's why we're not seeing the end of the cleantech sector for VCs; we're just in period where folks (especially LPs) are still licking their wounds from the past decade's failures and lack of exits. What we're seeing is a big pullback from the 2000s-era cleantech venture investment model, which is understandble. But there are other models now being developed and deployed.
Unfortunately, somewhere along the way someone convinced most of the large LP community that the investment model we saw over the past decade was the only way to invest in this sector. Which means they have pulled away from the sector altogether and thus they're not funding the next wave like they should. But investors who do have capital to deploy -- many of whom are not traditional VCs, but instead investors like family offices and others with more flexibility -- are staying active and will generate some new pathways to returns. Exits such as SolarCity's IPO and ZipCar's acquisition and others to come will help demonstrate that there are alternative high-growth business models in these markets than cutting-edge technology development and commodities manufacturing.
I don't think it'll happen immediately, but there's every reason to believe that as some successes with new investment and business models are seen, the pendulum will swing back and LPs and VCs will eventually jump back into the sector.
So yes, it's not happy times for cleantech VCs and for cleantech entrepreneurs needing venture capital right now. But we knew that. We didn't need the Cleantech Group's report (very well done media presentation by them, btw) to tell us that.
One trend they note that may come as a bit of a surprise, however, is the decline in venture investment and M&A activity from corporates. In each of Q3 and Q4, for instance, the number of cleantech venture deals tracked by CG as having corporate involvement was below 30, the lowest two quarters since 2008. We've been hearing that corporate investors have been stepping up to help fill the gap left by VCs, but how do we reconcile these numbers with that supposed observation?
It could very well be that corporates are now pulling back from the sector as well. But I'm just not seeing it anecdotally. So alternatively, the numbers may reflect two other factors at work.
1. Corporate venture groups generally prefer not to lead deals. Which means they need a venture deal to be led by VCs. If VCs aren't leading many deals, therefore, that will reduce the number of opportunities for otherwise interested corporates to write checks. Such corporates need to more actively network with other investors besides VCs, if this is the case.
2. Interest among corporates may be shifting from some sectors to others. For instance, chemicals and oil companies that have been funding biofuels startups and projects may at this point have a fairly full dance card and be backing off, whereas other large players in sectors like industrial automation and agriculture may still be ramping up their internal efforts. That would also help explain the lower-than-expected corporate M&A activity, in addition to the low corporate venture activity.
The truth is probably a combination of all of the above. But I keep hearing from corporate managers I speak with that their companies are increasingly viewing clean technologies as major topline growth opportunities going forward, so I would assume that would mean they'll be having to buy their way into these new sectors sooner or later. I'll be watching this particular question carefully in the months to come, because it's a curious (and important) trend.
Cleantech Investing: 2013 Predictions
First: Several folks asked if I could post my little Christmas Eve twitter poem. Well, Walt Frick was kind enough to do so here. So enjoy, typos and all! And my thanks to Walt...
It's that time of year again! Time for some prognostications of questionable accuracy, as we head into the new year. 2012 was hard for cleantech investors. Will 2013 be a rebound year? This time next year will we be looking back and smiling broadly at our good fortune?
Unfortunately, that's not what I'm expecting.
Our sector is at a pretty low point right now, and while I do personally believe cleantech is just in the "Trough of Disillusionment" and will eventually rebound, there aren't a lot of factors primed to trigger any upswing in the coming months. So 2013 seems like a "go-sideways" year, off of an already low starting point.
In fact, I think the term "cleantech" will continue to become unfashionable, although some (including myself) will continue to use it in very generic ways. But this will be a year where the cleantech sector gets a lot broader, in terms of where the (limited) activity is and who's interested in it, so that'll probably mean a lot of rebranding and proliferation of other terms as everyone tries to figure out their own renewed take on things.
But my track record on these things isn't very good, so don't get either too discouraged or encouraged by the following predictions:
1. U.S. cleantech deal counts will be flat in 2013 (within 10% plus or minus) of 2012 levels, and dollar amounts will be down.
Both venture dollars and deal counts were down in the first three quarters of 2012 (note: link opens pdf) and Q4 doesn't feel poised to surprise on the upside. Even follow-on funding has been down, but mostly it's the initial investments (Series A, etc) that have fallen by the wayside. This is driven by the significant withdrawal of generalists from the sector, and the reality that specialist VC firms are low on capital reserves. More on this below, but it doesn't seem like LPs will suddenly start demanding VCs invest in cleantech or start making big commitments to the sector, at least in the next few months, and there's a lag time between such shifts at the LP level and how deal volumes flow down through the GP level anyway.
That said, with 2012 levels already pretty low, I don't expect a major decline from these depressed levels either. So I expect a flat year for deal counts. I do think the shift toward smaller follow-ons and more capital efficient first rounds will continue, however, so even with deal counts staying the same I expect dollar amounts to continue to decline. Remember: I always say to look more at deal counts as an indicator of VC interest in a sector than the dollar amounts.
Note that I'm not making any prediction about international venture activity in cleantech. That's because I find the deal tracking outside of North America to be pretty squirrelly still, and I also cannot guess what's going to happen in some of those other markets. Generally speaking, Europe will continue to be an economic mess, BRICs will continue to grow and thus drive demand for "all of the above", and MENA will continue to diversify. To what extent, and to what effect on cleantech? I have no idea.
2. Agriculture-related investments will be the next "new new thing" area for venture investments.
I don't quite know how to quantitatively define this, but I think 2013 will be a big year for venture investments in the agriculture / food sector, generally speaking. Most VCs I speak with now talk about this as being one of the sectors they're spending a lot of time looking at, and that often results in significant visible dealflow months later.
It would have been easier to forecast a big year for cleantech-related IT and web investments. But while I do think we'll see a lot of noise out of the "Cleanweb" sector in 2013, everyone can already see that coming. I didn't want to just be the 20th person to suggest 2013 will be "The Year of Cleanweb/ Cleantech IT". Whereas I do think Ag/Food might surprise some folks, so I'm highlighting that sector instead.
Interestingly, not all cleantech deal tallies include agriculture in their tracking, so it may or may not show up depending upon which analyst report you're looking at. And for many readers, they may not even consider agriculture and food to be "cleantech" in the first place, except for where it overlaps with biofuels. But regardless of how it's categorized and regardless of what label it receives, this seems like an area where there will be a visible uptick in venture activity -- and probably including a few deals that will make you stop and go "huh?" -- the sure sign of a hot sector.
3. There will be a wave of consolidation and shake-out in solar financing.
The consolidation wave and shake-out in upstream solar (panels, wafers, etc) is now obvious to all, and will continue. But downstream, installations are booming and solar financing is taking off, perhaps best illustrated by SolarCity's IPO this past month.
Heady times in downstream solar, to be sure, and that's probably not going away.
That said, there are reasons to expect solar financing in particular will eventually be dominated by a few big players rather than the current somewhat fragmented group. Scale-driven efficiencies can be seen in branding, installer relationships, customer acquisition, and especially in cost of capital.
This latter area is where I'm already seeing a fair amount of separation starting to develop between "winners" and "losers". We've just been through a period where a small handful of investment banks (most prominently, perhaps, US Bancorp) spread around their commitments to rooftop solar financing across a number of solar financing players. But now I'm seeing indications that these banks are starting to gravitate toward a shorter list of rooftop solar financing players, even actively shifting away from others, because of factors like dealflow, quality of contracts, low cost of customer acquisition, etc. The rooftop solar financing players who can't obtain the lowest-cost capital from banks will be at a decided pricing disadvantage, and will be forced to join forces with other financing players, or to be acquired by upstream solar panel manufacturers looking for access to certain markets, or simply will go away. I think we'll start to see this happen in 2013.
Just remember, when you see solar rooftop financing players start to fall out like this, it's not necessarily a sign of bad health for the entire sector. It's just a sorting out of winners and losers, and the winners will be likely doing quite nicely indeed.
4. Large corporates will continue to play a vital role in keeping cleantech entrepreneurship vibrant -- but there will be a shift from oil / chemicals to consumer products, IT and industrial equipment/controls strategics, in terms of level of activity.
Even as LPs and VCs have (temporarily) fallen out of love with cleantech, large corporates have continued to find these subsectors (again, under a variety of labels) strategically interesting. And over the past few years I feel like I've seen a significant upswing in the seriousness with which large corporates are looking to new energy and resource technologies for topline growth.
This seems poised to continue. Fortune 500ish companies have never been sitting on more cash, and the strategic interest in the cleantech sector broadly-defined hasn't waned much as far as I can tell. But with the emergence of low-cost natural gas in the US and the likelihood of low-cost gas (and to a lesser extent, oil) being readily available going forward, the major corporates that had been the strategic partners of choice seem to have less motivation to search for low-cost inputs. Namely, oil and gas giants, and large chemicals manufacturers.
These are the large partners who had helped some of the capital-intensive plays in cleantech to address the first-project "valley of death" by doing things like JVs where they would provide the capital to put steel in the ground. And while this role likely won't be fully abandoned by them, a) many of them already have a pretty full dance card of startup partnerships by now; and b) low-cost traditional inputs reduces the need to find alternative inputs.
Meanwhile, the data side of cleantech has risen in prominence, and many customers still care about "green". This is attracting renewed interest amongst large players like Google and Facebook and IBM who view data as their bread and butter, and amongst consumer products companies eager to offer their customers green alternatives. In terms of focus and rhetoric it's almost a return to the days of emphasizing "sustainability" such as I used when working with such companies nearly two decades ago (and, btw, which will further drive interest in things like the Cleanweb and sustainable food/agriculture amongst investors), rather than just low-cost commodities production (such as dominated cleantech over the past decade).
Furthermore, while energy prices are currently low and on the decline, volatility of demand (especially in electricity) isn't going away. In my interactions with corporates in the industrial controls and equipment markets, there's a recognition that automation and optimization around energy will be a crucial complement to controls they already offer for production, quality, and so forth. So companies like Johnson Controls, Honeywell, Siemens are all poised to be important players in 2013, and I already see them getting serious about partnerships with smaller companies. Again, they may not consider it "cleantech" per se, but under whatever label you prefer they're getting serious about it.
5. There will be no significant progress on US federal energy policy.
I plan to write up some observations soon from a couple of trips I made to DC in December to talk with policymakers, pundits, etc. about energy policy. But the short answer is that the White House and Capitol Hill don't have enough bandwidth to take on any major energy legislation effort this year -- pending some kind of unexpected disruptive disaster.
The Fiscal Cliff is taking all the air out of the room currently. And that won't be a quick resolution, even if there's some kind of 11th hour compromise that happens over the next couple of weeks -- there will be a lot of follow-on fights on the budget throughout this coming Congress. To the extent anything else can get done, the White House has already signaled that they care more about Immigration Reform and Gun Control as legislative priorities over Energy and Climate. It's not as if the White House doesn't care about energy policy. But they don't care about energy enough to elevate it over these topics and whatever other crisis-du-jour pops up along the way. Only if there is some kind of major unexpected disruption to energy supply, or some kind of horrific and obvious climate-driven disaster (because apparently even Sandy wasn't enough) will this topic pass the threshold from "yes, we should do something about it when we can" to the "we must do something immediately" category, at least in 2013. And clearly I'm not rooting for something like that to take place, so my hopes for any important happening legislatively are low. At least in terms of forward progress; there's always the chance of some rollback as the White House and Congress horse-trade in favor of higher priorities.
That said, there might be some small rationalization of energy policies that can be helpful on the margin. MLP treatment of renewables, for example, and more information-driven (as opposed to dollar-driven) efforts by the DOE to promote clean energy and energy efficiency. These would be good to see.
6. 2013 will be the year journalists (and thus everyone else) figures out that US cleantech entrepreneurship has become driven as much by family offices and other non-VCs as by VCs themselves.
Look, this is already the case. I came to the realization the other day that if I were to name the top 5 most active west coast investors I keep personally seeing engaged on potential cleantech venture deals I look at, at least two would be family offices. And on the east coast, our own group, a few angels, and quasi-governmental groups like the MassCEC and NYSERDA are as active as any remaining venture investors still investing in the sector. I don't mention this as a point of self-promotion, however, because I think it mostly points out just how far down the LP withdrawal from cleantech has taken institutional venture capital activity levels; it's not that suddenly Black Coral Capital and our breathren are taking on massively higher levels of deal activity. So it's more of a depressing thought than a point of pride, to have come to this realization.
But while family offices and other non-VC offices are now, in my opinion, as important as VCs for funding cleantech entrepreneurship, you wouldn't be able to tell that from journalist coverage of the sector. And the simple reason is that VCs have the brand names and the PR efforts to get attention, and non-VC investors don't tend to report out their funding activities like VCs do (so a lot of their investments don't show up in the deal tallies, for example). That's all fine and good, that's the way most non-VC investors would like to keep things, they typically don't want attention. But sooner or later, we'll start to see journalists pick up on this shift and start to talk about it a lot more. If only because the VCs won't be feeding them enough cleantech-related stories to keep them busy...
7. Large-format (e.g., stationary) energy storage will be the next sector to see multiple high-profile flameouts.
I am personally a fan of grid-scale and distributed energy storage... over the long run. I see several promising technical efforts out there than might eventually result in very low-cost electricity storage suited for particular needs that would complement load control to help address variability for the electrical grid.
But this is a sector that has seen a fair amount of venture dollars go into a number of capital-intensive startup efforts over the past few years, with very little revenue to show for it. In the current funding climate, that's not a recipe for raising follow-on financings. And indeed, in the third quarter PwC said that energy storage investments were down 99% year on year -- although that's probably an artifact of one particularly low quarter, it's indicative of a broader trend by investors away from long-development, capital-intensive plays like many grid-scale energy storage efforts.
Thus, while some such startups will be able to carry on by combination of reduced cash burn, by reinventing their business models to accomodate existing storage/DG technology, and via the occasional follow-on financing, you have to guess that a number of them won't be able to carry forward and will be forced to shut down or sell for pennies on the investment dollar.
I'm loosely including SOFCs in this category, btw.
8. At least two well-known cleantech-focused venture capital firms will publicly shut their doors or at least acknowledge they won't be raising any future funds.
I've alluded to it several times above and written about it here, but the limited partner community has at this point really pulled back from the cleantech sector. And many of the cleantech specialist firms out there are at or nearing the end of their current fund cycles. I know several that delayed attempting their next funds in 2010, 2011, and now 2012 in hopes of finding a more receptive group of LPs later on. They limped through by supporting their existing portfolios, shedding some junior staff, and doing 1 or 2 new smallish deals a year to stay "in the game". But that game can only be drawn out so far. And several cleantech specialist VCs have some big smoking craters in their portfolios, which will make raising that next fund even harder. Believe me, I've been there.
So I certainly don't predict this with any happiness, but I do expect this will be the year when we see the cleantech venture capital shakeout extend from lesser-known firms and a pullback by the generalists, into the better-recognized cleantech specialist firms out there.
Fortunately, there are others that still have dry powder, or that have been able to raise smaller new funds, and so while this is indeed an "extinction event" period right now for the sector, new and renewed champions will emerge.
This will eventually be looked back upon as a period of significant and healthy reinvention for the sector.
9. Natural gas prices in the US will spike at least 50% at some point during the year.
Most forecasts I've seen project only a slight rise in natgas prices going forward over the next few years, and I agree. Over the medium to long term we're clearly now in an era of cheap natural gas and it's having a major impact on the US energy market.
Henry Hub prices are currently around three and a half dollars per MMBtu, and consumers (especially power generators and chemicals manufacturers) are planning around that kind of price, perhaps drifting up to a bit over $4.00 per current 2013 forward contract prices.
But natural gas has a history of sudden price spikes. Why? Because of limited storage and a lagtime to increase production.
Gas drilling rig counts are well off of their 2011 highs. Horizontal drilling activity has stopped increasing and in fact has been flat or in decline throughout 2012. Therefore production was pretty flat throughout the year, and there's no sign of it increasing suddenly. Meanwhile, whereas throughout most of 2012 storage levels were significantly higher than during previous recent years, now they're back to more normal levels.
As powergen continues to shift from coal to gas and chemicals manufacturing recovers with the economy (and shifts to low-cost US gas supplies as well), short term natgas demand in the US feels once again pretty inelastic and primed for some kind of disruptive event (such as a major summer heat wave) that would rapidly deplete available storage and result in a price spike above $5 before drilling can kick back into gear. Potentially much higher than $5.
You don't have to disbelieve the fracking revolution to believe that a significant natgas price spike is inevitable. You just need to look back at historical price charts.
This is very important for the cleantech sector. Because while I don't myself believe low natgas prices are deadly to most clean technologies and applications, certainly I've heard sentiments to this effect amongst LPs and generalist VCs over the past few months. I definitely heard it from certain partisans in DC. There's currently this perception that low-cost natgas is here to stay and therefore that clean energy technologies are endangered and/or less important. That cleantech is "just a climate issue", no longer an economic issue.
But it's not just the long-term price of energy that's economically important -- it's also the volatility. And natgas is historically one of the most volatile energy inputs. A big, disruptive price spike would serve to remind a lot of important constituencies that natgas should be an important part of the go-forward US energy mix... but that we can't let ourselves get so dependent upon it that a price spike hurts the economy as badly as an "oil shock" has done in the past. A price spike, when it happens, will hopefully remind everyone that we need an "all of the above" energy mix, and that emerging energy technologies -- and especially DG and load-control technologies -- are strategically crucial going forward.
10. The Redskins will make it at least to the NFC semifinals round of the 2013-2014 season.
Yep, I'm all in for RG3. He'll probably have some kind of a sophomore slump and/or get hurt again, but with one more draft to bolster the O-line and secondary, and hopefully a healthier receiver corps than this year's snake-bitten bunch, I think the Redskins will rejoin the NFC's elite teams.
I've even still got my fingers crossed for this year -- big game Sunday night.
So Hail! to a great 2013, everyone. Here's hoping I'm right about the positive predictions above, and wrong about the pessimistic ones. Have a terrific new year.
Looking Back On 2012 Cleantech Investing Predictions
It's been a crazy year in cleantech, and a lot of things didn't go as expected.
Even if I'm not particularly good at it, I find the annual prediction exercise to be useful for developing a coherent picture of the coming year, as at least a starting point for planning. And it's also just a bit of fun to take some guesses and see how they turn out.
2012 flummoxed me because I was too optimistic this time last year. I thought we were about to turn the corner on cleantech venture firm fundraising, and thus that we would start to see a rebound in dealmaking. I failed to see just how toxic the politicization of cleantech would become. And I generally was too aggressive on trends that I do believe are underway, but that are moving a lot more slowly than I'd projected.
"1. Both dollar totals and deal totals for U.S. cleantech venture capital will be up more than 20% over 2011."
We haven't gotten the 4th quarter tallies yet, but it would have to be a huge turnaround for the deal and dollar totals -- which have been declining throughout the first three quarters -- to end up even catching up to 2011 levels, much less expand upon them. I'd thought that economic stabilization was coming (somewhat true) and that therefore LPs would start making commitments to VCs this past year (not true at all).
2012 was clearly a down year for cleantech venture capital dealmaking. Will we see a rebound in 2013?
"2. At least one 'brand-name IT entrepreneur' will launch or join a cleantech effort."
VERDICT: DIRECTIONALLY CORRECT, BUT WRONG ON SPECIFICS
The merger of cleantech markets and IT/web business models is actively underway now, and it's become a strong driver of the current activity in the cleantech venture market. And I've seen strong entrepreneurs with an IT background get into the market this past year. I wouldn't say we've seen a "brand-name IT entrepreneur" jump very visibly into the sector this year, however (not counting those who'd done it earlier, of course). No offense intended to any who jumped in and feel I should consider them a brand-name, of course!
"3. There will be at least one additional major syndicate of family offices launched to target cleantech (or a synonymous label for the sector)"
VERDICT: DIRECTIONALLY CORRECT, BUT WRONG ON SPECIFICS
I've continued to see more and more family offices get into the sector and start to look to be active. But we just haven't seen any such additional syndicate officially launched. ...Yet.
"4. There will be no progress made on U.S. federal energy policy, and there will be a rollback of state-level policy."
Predicting very little progress on energy policy at the federal level seemed too obvious, so I just had to try to up the level of difficulty by projecting a rollback at the state level. D'oh. I still think attacking state-level policies is the next step for anti-cleantech forces out there in the political world, but really 2012 was more of a stalemate at that level than a rollback year.
"5. Significant and visible consolidation within the solar industry will occur."
And it will continue.
"6. 2012 will see the emergence of multiple 'roll-up' efforts."
VERDICT: ANECDOTALLY CORRECT
I've talked with a lot of entrepreneurs and investors who are starting to see the opportunity to take advantage of today's low valuations to roll up separate vendors into a fuller offering for customers. I've seen it happen a few times as well. But I wouldn't say it's been a very significant and meaningful trend yet. Stay tuned.
"7. New hybrid investment models will emerge."
VERDICT: STILL HASN'T HAPPENED
On the basis of talking with a lot of investors who are talking about and planning unique strategies (such as combined debt / equity offerings, venture capital + project finance, or investments into service models), I have now predicted the visible emergence of such hybrid approaches in 2010, 2011, and 2012. It's time to stop making this prediction. This appears to be one of those concepts that everyone agrees should happen, but for some structural reasons few investors have the flexibility to actually do it at scale.
"8. 2012 will see a big wave of corporate M&A in the cleantech sector."
We still don't have the Q4 numbers on this, of course, but the Cleantech Group data for the first three quarters indicate that global cleantech M&A activity was actually down slightly. I end up talking with more and more corporate managers about cleantech, and I see a lot more anecdotal evidence that large corporates are getting serious about investing in and making acquisitions in the sector. But thus far that hasn't presented itself in the data of completed deals.
"9. A major geopolitical event will spike oil prices above $120/barrel."
Here's what I wrote a year ago: "I predicted this last year as well, and sure enough, we had spikes because of geopolitical events, but in the end, the macroeconomic blues held down prices below $120/barrel for the entire year. As noted, I'm hopeful of at least some economic stabilization in 2012. On the basis of that hope, I'm willing to continue to bet on major price volatility for oil, one of the world's tightest and most easily manipulated markets. Until we finally figure out how damaging it is to our economy that we allow ourselves to be dependent upon such a headline-risk input, and start to wean ourselves off of Middle Eastern oil through smart policy and long-term capex decisions, markets will continue to be near-term price-inelastic and thus we will continue to see spikes whenever some crackpot somewhere around the world decides to make a stink.
"If China's economic expansion loses significant steam, or Europe fumbles and causes a global recession, this prediction will be wrong. But given even a halfway-decent economy in 2012, such volatility seems pretty inevitable. To borrow from Rick James, 'Oil is a hell of a drug.'"
Wrong two years in a row. And now there are more supply-driven downward pressures on oil than we've seen in several years.
"10. Several 'environmental markets' will collapse and shut down."
In fact, the launch of the California carbon trading market was good to see. Carbon credits and other environmental markets continue to have their difficulties, but I was wrong to suggest they were going away in 2012.
"11. There will be an overall pullback in non-U.S. cleantech venture capital deal counts, but an increase in project finance."
VERDICT: TOO EARLY TO TELL, BUT SEEMINGLY CORRECT
We need to wait to see the Q4 numbers, but early indications are that this guess ended up being right.
"12. The Redskins will have a losing record next season."
VERDICT: DELIGHTFULLY INCORRECT
RG3 is even better than I'd hoped.
So all in all, I was probably only around 25% right for 2012. Meh. In a few days I'll once again attempt to forecast the year ahead. Will I manage to do better for 2013? I hope that we all do, 2012 was a pretty lousy year for our sector.
An Open Letter to Limited Partners from a Cleantech Investor
Dear venture capital limited partners:
I get it.
You were promised that cleantech was going to be the Next Big Thing and it didn't happen. Instead, you've seen the GPs you've backed in the sector have to face a legislative/political headwind, a dearth of big exciting exits, and a number of high-profile flameouts. At this point you're doubtful that there are big returns to be made in the sector and your colleagues are telling you cleantech is a bad place to put capital and so you're pulling out altogether, at least for the time being.
Sure, some cleantech-focused GPs tell you that cleantech hasn't actually performed worse than other sectors for the venture capital category, and they're right, technically speaking. But that misses the point, doesn't it.
As one major LP told me a few years back, the major reason for LPs to put any money into venture capital at all, with its sub-par risk-reward performance over the past decade, is in the hopes of getting in ahead of the next great bubble... and he hoped that cleantech might become that. But that was a few years back -- at this point, cleantech looks very unlikely to become a bubble sector with lots of high-flying IPOs anytime soon. So what's the point of doing marginally better than the barely-returning-capital performance of the overall VC asset category when there's no upside to a particular subsector. Especially when some of the smartest investors in venture capital have seen some major smoking craters in their portfolios in the cleantech sector.
And yes, cleantech venture capital was supposed to save the world. This was supposed to be a feel-good story. Do well by doing good, and all that. But in the meantime bigger resource shifts (namely, natural gas abundance in the US) have led to reduced carbon emissions while also lowering the competitive price targets emerging energy technologies have to beat in order to look attractive. So again, what's the point?
By now, you view cleantech as a low-upside, very difficult, politicized, capital-intensive sector with bad to mediocre returns expectations. And so naturally, you're staying away. Like I said, I get it.
I'm not going to try to dissuade you from any of the above. I think we cleantech VCs took some very questionable approaches to investing in the sector over the past decade, and now deserve your skepticism. But of course I'm not actually a cleantech VC right now, I'm investing out of a family office and don't need to ask LPs for capital and don't have a vested interest in trying to promote one particular investment strategy or another. But I do want the sector to succeed. So for what it's worth, let me just make a few points, in hopes of getting you to take a more nuanced view on the sector...
1. What hasn't changed: In the long run we need some new, efficient solutions
Yes, carbon emissions have gone down in the US thanks to some natgas cannibalization of coal-powered generation capacity. But remember even just a year ago, when natural gas was supposed to be free? It can't possibly go back up, right? So we can't possibly need additional energy resources to support continued economic growth, right?
And even without getting into supply-demand energy arguments, climate change shifts are clearly going to need to be either addressed or accomodated. Because they're real. Just ask your real-asset colleagues what assumptions they're having to make regarding climate shifts when evaluating timber and agriculture resources, or any analyst covering the insurance industry.
And speaking of which, if we look beyond energy of course there are a host of other resource-related pressures caused by climate change or the commodities boom that will lead to a need for more efficient ways to provide shelter, food and water to humans in the future.
I'm telling you what you already know, sorry. But it's worth noting that there are still some very basic, Maslovian underpinnings to the macrotrends underlying this umbrella investment thesis we've called "cleantech" for the past few years. They haven't gone away.
2. Not every "world-saving" innovation will be a fit for venture capital
I think there was an implicit assumption a few years back that if the solution was audacious and broad enough, it was going to lead directly to an opportunity for VCs to make returns going straight at it. So we need more and cleaner liquid fuels? The direct path to riches is to make them in as proprietary a way as possible. We need cheap solar power? A proprietary formula for making cheap solar panels will result in a big IPO or three.
Indeed, while there have been some isolated wins in both of these examples, we should just simply acknowledge that a big business opportunity doesn't necessarily equate to a great venture capital opportunity. Capital intensity, risk and timeframes can make it difficult to tackle some major opportunities head-on with a venture capital model and make superior returns. Difficult but not impossible, absolutely. But difficult.
It's entirely possible, in fact probable, that those who create the really big solutions to climate change, etc., won't be able to capture much of the economic rent that they create. That fast-followers, large corporates, governments and others will grab enough value from first-movers that those who expensively created proprietary solutions won't get the returns they deserved for it.
It is what it is. But let's acknowledge it as such.
3. Not every great return in the "cleantech" sector will be world-saving
Re-inventing entire multi-trillion industries is very hard, naturally. But the flipside of that is that making even small dents in those multi-trillion industries can end up revealing multi-billion dollar "niche" and optimization opportunities, and consequently some great returns.
What does this mean? It means that some viscerally underwhelming plays may end up resulting in great venture capital investments, even if they're not radically changing how energy is produced and consumed. Coming up with complicated financial structures for residential rooftop solar can actually turn into big business opportunities, for instance. Helping homeowners get the residential energy information and improvements they've always lacked access to can be a big growth service business. Simply providing previously-missing information to commercial/industrial building owners and managers can help launch a new marketplace for new solutions. These things may not lend themselves to holiday party cocktail conversation like "I invested in an electric vehicle that'll change the world" would, but that's not really the ultimate point, is it.
If you want your GPs to be investing where others aren't, in cleantech that means they'll be investing in some arcane, niche-y and unsexy stuff at times. And so just separate out in your mind the idea that something has to be a Really Big Idea to make great venture capital returns in cleantech. Instead, it comes down to deal size/structure, and real economic value creation, which can happen in some obscure and seemingly marginal areas.
4. If any GP tells you they know how the global climate challenge will be solved, or the "right way to do cleantech venture capital", they're blowing smoke
I see it on Twitter all the time, these debates among investors and pundits about whether the best path forward for society and for investors is heavy-innovation in hopes of a breakthrough that will result in wholescale cannibalization of the incumbent energy industry, or more immediately-feasible efficiency improvements within the current industry structure. Between those like Vinod Khosla and Bill Gates who advocate emphasizing hardcore technical innovation, and those who emphasize figuring out how to more rapidly scale-up the more efficient solutions we already have in the marketplace.
"Yes, please" to both.
So-called Black Swan events happen in any number of industries and are likely to happen in the energy and resource industries over the next couple of decades, sure. But the nature of such events is that no one really sees them coming, and that those who precipitate them don't necessary get any economic benefit from having launched a new trend which others rapidly jump in on. On the other hand, making the current energy/resource scheme more efficient might just be rearranging deck-chairs on the Titanic, in an era when we're already locked into major climate shifts.
I personally don't think you can make any money betting against the innovative and self-preservation capacities of the human race. So therefore, you might as well bet on an eventual reversion to a sustainable path forward one way or another, because otherwise what's the point, any other bets are moot. The problem is, you can't just assume one of these pathways (Big Innovation vs. Accelerated Deployment) is better than the other. Or decide ahead of time which pathway will lead to better returns.
What do these four points together mean for limited partners?
It means that I understand why you have been pulling back from venture capitalists in the cleantech sector. But that I think perhaps it's been overdone a bit at this point.
I've seen many very smart venture capitalists with deep experience in this sector be forced out and into either non-cleantech investment roles, or non-VC roles altogether. I've seen innovative cleantech entrepreneurs who are actively trying to avoid the mistakes of the 2000s, but who can't get the funding to get their ideas into the marketplace.
If you believe the above four points, you acknowledge that at some point -- now, or later -- there will be some solutions that come to the marketplace with some really strong potential economic gains. And like me (my firm has made several LP commitments, ourselves), you've likely been approached by a myriad of venture capitalists with new and innovative approaches to trying to make returns off of these solutions, be they revolutionary or evolutionary. You can probably see that at some point this sector will get momentum again, in a big way, although in a form that might be different from what you've been told to expect.
Unfortunately, because you and all your colleagues have decided not to put any dollars into cleantech venture capital at all, there's no push to help get this momentum going. There are almost no first-time and/or small cleantech-focused venture firms that can get off the ground and prove out their ideas or not, because they can't get LP funding. The generalist VCs are pulling back even from the 10-20% allocations they'd had into the sector, and losing the experienced investors who could help figure out new approaches at those larger platforms. Some of you are backing a very small cadre of high-profile investors in the sector, but by and large even they are not really trying new investment models, they're just shifting to later-stage investments where sectoral differences don't matter so much. And thereby creating an early stage funding gap that has now reached crisis levels.
So my plea to you is this: Fund some experimentation. Purposefully fund some smaller, emerging efforts -- at big-named firms or at fledgling firms -- to figure this sector out. Help get early promising reinvented strategies out into the marketplace. Place a few smaller, perhaps even sub-scale (from the perspective of your governance requirements) bets that will help support the experienced minds eagerly trying to figure out this cleantech venture capital problem. They may in fact not even call it a "cleantech" focus, amen to rebranding if that's what will help.
Because I totally understand -- from your perspective, underperformance by the cleantech venture sector is indeed a legitimate problem. But eventually, with a problem as big and important as this one, those who come up with the solutions will end up making phenomenal financial returns one way or another, and their early backers (not the too-late, solution's-obvious-to-everyone backers) will too.
And in the end, no one solves a problem by just sitting on the sidelines and not trying anything.
Lessons From the Past Ten Years: Localization
"Cleantech" being a catch-all term that covers a wide range of mostly disconnected industries and markets and technologies, it's always interesting to note commonalities across subsectors where you can find them.
One such macrotrend which I believe will end up driving a lot of cleantech innovation is the emergence of distributed alternatives to previously centralized processes.
There are two factors underlying this trend.
First of all, long-range transportation costs appear likely to be higher going forward, simply because they are so dependent upon oil prices. This is not a given. But there are reasons to believe oil prices are likely to rise over the medium to long run, including supply-demand dynamics ("peak oil" and all that), the possibility of climate-related externalities being priced in, or further geopolitical conflicts leading to greater volatility if not outright price increases. There are other reasons to believe oil prices might not rise or may even fall, such as new extraction techniques (fracking, EOR, more efficient tar sands production, etc), or even the emergence of alternative fuels and drivetrains (although this appears more likely to make an impact on short-haul routes in any near-term). But the current outlook appears to signal more risk of price increases than price decreases going forward.
Oil prices appear to be headed upward, and they will likely dictate long-range transportation costs for the foreseeable future. Some industries such as chemicals already see regionalized production trending upward because of transportation costs, for example.
Secondly, we're getting better at making, distributing and controlling things cheaply in smaller batches.
Economies of scale have traditionally dominated many industries such as manufacturing, chemicals, energy production and distribution. But advanced technologies are disrupting this dynamic. IT innovations make it easier to track small batches of inventory, identify and sell to buyers with smaller appetites, and to better remotely automate and monitor processes. Innovations in flexible robotics and manufacturing (3D printing, etc) make it less costly to make things in small batches. And modularization trends across industries as diverse as power generation, biofuels manufacturing, and housing construction mean that "building blocks" are more readily available to be built into whatever size production facility or end product is desired for any particular circumstance.
What these two trends mean in combination is that we're seeing a shift toward more localized production and distribution of physical products, much of which is directly related to cleantech.
This is, of course, most discussed and visible in electricity. Distributed generation, storage and customer-side load control are challenging the traditional utility model with its natural monopoly based upon the distribution and management of centralized power production, as many have noted.
But we're seeing very similar, albeit perhaps more early-stage, trends toward localized production in biofuels, in food, in wastewater treatment, and even in hardware manufacturing and metals production (via e-waste recycling). For higher-end products, not only transportation cost in dollars but also the time delays are often driving a desire for more localized production -- tomorrow's cleantech hardware may more often be assembled in the U.S. than in southeastern China, for example.
This macrotrend toward smaller-scale, localized production might appear to fly in the face of much of what we've called "cleantech" over the past decade, such as the quest for ever larger "commercial-scale" production of biofuels, of solar panel manufacturing plants, of desalination plants. But even in these areas, modularization techniques are more common now than they used to be. In large part this has been driven out of necessity -- less-available capital for large amounts of steel in the ground leads entrepreneurs and their backers to seek approaches that require less money spent to get to "Dollar One" of revenue. But it's also been driven by new capabilities. And thus not only startups are getting into the trend; I think we'll see more big companies start to embrace the localization vision as well.
But when they do, it may require them to buy the technologies necessary for them to shift in this direction, rather than be able to build them from scratch internally. And because of this, and the deeply entrenched centralized production/distribution networks many are dependent upon, this localization trend remains a highly entrepreneurial one. And that makes it pretty interesting for investors like me.
The Role of the DOE in Obama’s Second Term
Have been on a run of policy-related columns lately, and am eager to get back to talking about cleantech entrepreneurs and investors.
But I have had a few people request some thoughts on the role of the DOE in Obama's second term, so figured I would tackle that first.
In short, my overall perspective is that the DOE under Secretary Chu has launched some important things, but now needs to transition from a focus on technological innovation (without losing the progress made there) to a focus on commercialization and consensus-building.
First, let's recap what the DOE actually does, because many people don't really know. The DOE is a massive organization, with something like 16,000 employees. It's not just an energy technology organization, not at all. The $27B annual budget is divided up into:
- $10.5B allocated for nuclear security (i.e., managing the handling and disposal of nuclear material)
- $10.6B for "Energy and Environment" (much of this is actually allocated to improvements of incumbent technologies)
- $4.9B for "Science" (early-stage research)
- And a billion dollars' worth of management and "Other"
As you can tell, the DOE is not what many cleantech entrepreneurs and analysts might expect. It's not just ARPA-E and a national lab system. It's not some kind of "Cleantech Administration." It oversees FERC, several major public electricity organizations (such as the Bonneville Power Administration), traditional energy technologies, etc.
Under Secretary Chu, however, innovation and commercialization of new (and generally, cleaner) energy technologies have been the focus of a lot of attention and effort, as guided mostly by the Energy Policy Act of 2005 and the ARRA of 2009. In my opinion, the wave of management talent that Secretary Chu was able to attract to the DOE starting in 2009 has resulted in several huge wins for the cleantech sector, including some really important work done at the ARPA-E program and the EERE. The National Lab system's operations have been improved, including broadening their scope to better incorporate "innovation hubs" outside of the national labs themselves.
These are significant improvements, and they must not be lost. There's some discussion these days that Secretary Chu may be looking to transition out of the role, and the danger of course is that when a leader comes through and makes changes like this, once that leader leaves the organization reverts back to how things used to be. That's particularly likely in this case, because the DOE is remarkably divided between career DOE workers and the politically-appointed top management that comes and goes with administrations, etc. Front-line DOE workers are quite used to Secretaries of Energy coming and going, and just doing their own thing. Just read Mike Grunwald's book The New New Deal for some great anecdotes about this.
Nevertheless, while I hope the DOE in Obama's second term (and potentially under a new Secretary) doesn't abandon the progress made on the technological innovation side, I think commercialization efforts need a major upgrade. There's been progress made on this score, but it hasn't yet gotten to where it needs to be.
As I've written about before, "demand creation" for energy efficiency and renewable energy technologies has fallen into two major unofficial buckets (very often conflated) at the DOE over the past couple of years.
Demand creation for well-established technologies and services, such as residential energy efficiency improvements and large wind farms, etc., has been done pretty well. The wave of home efficiency improvements has made a big impact, as driven by community block grants, and the much-maligned Loan Guarantee Program has actually done a good job of bringing project finance to large-scale powergen projects that otherwise may not have happened.
But commercialization (I use the term loosely, to also include demand creation and also manufacturing capacity) of emerging technologies hasn't worked out so well, despite a lot of well-meaning efforts to date. The LGP's failures in this part of its program are well recognized, to say the least. But looking across the lab system and other aspects of the "innovation system" Secretary Chu helped put in place, there are other major commercialization gaps that haven't been addressed.
The challenge, of course, is how now to tackle this without much of a budget. I've laid out several ideas before; you can read them here. It includes things like wiki-based buyers' guides, incorporating incentives for new tech adoption into community block grant programs, and setting really aggressive performance bars on green buildings standards, etc. From what I've been told by those in the know, the special challenges of encouraging widespread adoption of emerging technologies in the energy market appears to have flat-footed Secretary Chu and his top team, and that really needs to be given special focus in Obama's second term. What's the use of having a re-energized innovation pipeline if the innovations aren't actually adopted. So figuring out how to do this, in an era when the DOE can't expect big budget increases or new subsidies to be passed by Congress anytime soon, is now a key challenge for the DOE.
I would love to see a special assistant brought in to really spearhead this as a special project, drawing lessons learned from other industries and other sources of innovation (corporate R&D, academic research, etc). It's fine for investors like me to personally spitball some ideas for the DOE commercialization managers who've reached out to us, but this really needs to be done thoroughly and thoughtfully, and with an urgency as highlighted by bringing in a pretty senior person to help drive a process, akin to how Matt Rogers was brought in to coordinate the ARRA effort at the DOE.
The other major priority of the DOE in Obama's second term needs to be consensus-building. The DOE has a key role to play in helping to get rational energy policy passed in the U.S., but frankly has fallen way short of what has been needed. I'm not proposing the DOE develop and lobby for specific energy policies or whatnot. But as I've talked about a few times recently, there's a void right now of rational, inclusive discourse on energy policy. The DOE has a powerful potential role as a convener of the private sector and of other major constituencies, for a couple of purposes that would greatly help the situation.
The first task is simply to help kill the continuing canard that energy improvements are a burden to shareholders and homeowners, rather than the energy cost savings they should represent. This is particularly true for energy-efficiency technologies, of course. There's a massive body of evidence to show that with energy efficiency, there are indeed twenty-dollar bills lying on the sidewalk to be picked up. The DOE could convene a meeting of major-company CFOs, to have them hear from their more successful peers out there that they are failing their shareholders by not making efficiency-driven cost savings a priority. The DOE already puts out case studies and white papers, but someone needs to grab these CFOs by their lapels and force them to recognize that they are pissing away shareholder money on stupid wasted energy that could be addressed with some high-IRR capital allocations, if they just prioritized it. And just as importantly, someone needs to arm those CFOs with concrete examples as to how to go about doing that as effectively and efficiently as possible, and to then send them away with lots of resources (again: a buyer's guide!) to pass along to whatever lieutenant they will then task with executing on the opportunity. It needs to be a peer-driven exercise ultimately, but the DOE needs to convene it.
The next task is to drive resources to help the incumbents better prepare for the looming energy transition. Some of this is in place. But the DOE must become a powerful advocate for the energy incumbents and utilities, to help make sure they are given good support now and in the energy future. Nothing I'm writing here should be construed as me arguing that the DOE should focus solely on emerging technologies. It's obviously my own focus, but on topics such as coal-fired generation switchover to natgas, responsible fracking practices, grid stabilization, etc., the DOE should emphasize being an advocate for facts and science, and an advocate of congressional support for those industries on their paths forward. I do believe the DOE should continue to help push a transition to a low-carbon, domestically-produced energy industry, but everyone has an important role to play in that future industry, and the cleaner shouldn't be made out to be the enemy of the cleanest, and vice versa.
After helping to address the concerns that energy innovation means higher energy costs through this and other high-level conversations, the DOE can also then help bring together major stakeholders from across the energy industry. Remember, as noted, the DOE is there to help all players in the energy value chain. It should be possible, then, to help set up the kinds of conversations involving incumbent energy producers, utilities, entrepreneurs, innovators, consumers, military leadership, etc., to start to hash out common ground and common goals.
But so what? This is where the DOE must become a loud advocate for those common goals and simply getting stuff done. The Secretary of Energy should be placing a lot of political pressure on Congress to pass comprehensive energy reform. Armed with even a very broad set of shared energy policy goals, the Secretary of Energy should be advocating progress on behalf of the private sector, the military, the consumer. This requires a very strong public advocate, an effective organizer of fragmented constituencies, and a very strong behind-the-scenes political player. We need the Secretary of Energy to step up to being the nation's most visible and effective champion for energy policy reform. That, it must be admitted, hasn't been the case in Obama's first term.
Besides all of the above, I also believe the DOE really needs to address some of its deeply rooted bureaucratic challenges. Over the decades, it has become a very entrenched and stagnant organization that is by far most powerful in its ability to resist change. That can't continue. I would love to see someone take on a major organizational efficiency project and really fight to drive a new "corporate culture" within the Department. There are probably a lot of resources that could be redeployed toward the above objectives with no additional cost to taxpayers, in fact likely with additional resultant savings. So the Secretary of Energy also must become a powerful organizational change agent, drawing lessons from knowledge of bureaucratic infighting to know how to crush it and really fix things. This will be very difficult, but it's long overdue.
So in Obama's second term, we need to see a DOE that doesn't lose ground on technological innovation, but that does focus a lot more effort on commercializing those innovations. And the DOE will need to be a stronger convener of the entire energy industry around a few commonly held goals, and then champion the resultant priorities with Congress and with the public as a whole. And the DOE will need to fix its organizational culture and tackle a much-needed bureaucratic refurbishment.
Not much, just a few small things.
Don’t Fail This Time
We all watched with horror this week as Sandy carved a path of destruction through some of the most populous areas of our country. Please, stop reading this, go find a way to help, and then when you can, come back to the rest of this. Let's focus on helping those in need as a clear first priority.
It's been fascinating to me to watch how quickly the media and some politicians have pivoted this week, post-Sandy, to talking seriously about the dangers of climate change. Whereas just last week I felt the conversation was so pushed to the sidelines that even just forcing a sober discussion would be a step forward.
Let's acknowledge one basic fact: If we ever get to the point where energy and climate security is consistently a high priority for most Americans on every single day, we're already in a terrible place. Day to day, most Americans will care about stuff that has a more immediate impact on their lives. Sadly, we're increasingly getting to that bad place -- as Gov. Cuomo said this week, "We have a 100-year flood every two years now," and the extreme weather the U.S. felt this year is probably now more the norm than the exception.
But if we're going to work to mitigate that outcome, we need to grab the infrequent opportunities to push for change when Americans, their politicians, and journalists are focused on the issue.
So what does that mean? What do we do now (other than helping those in immediate need, of course)?
I think my proposal from last week, for a bipartisan presidentially nominated commission to develop and propose a coherent energy policy, is even more important today. At times like this, it's easy to forget that within a month or less, the conversation will have moved on to something else. And no coherent energy policy will magically transport itself through Congress within a month, nor will politicians remember this so vividly next year when any such policy discussion might come up. Energy policy is increasingly (and uselessly and needlessly) a partisan issue. We must wrest that back to the realm of collaborative thinking and compromise, and codifying that spirit in such a "Simpson-Bowles" effort can help, especially if it is mandated by the President, whoever that is. We need to set the process in motion to develop a consensus energy policy, even if it won't pass in the 113th Congress, because unless we have something like that ready to go, the next big "teaching moment" will be wasted like so many in the past have been. That's, at the very least, what we need to do this time.
What we can't do is to let the opportunity fragment into the usual million pieces of individual and NGO-specific policy advocacy. I continue to talk with many people who care deeply about this issue, and yet who each have their own strongly held perspective about the policy ideas that they feel can be passed, and then who set upon each other with rhetorical knives fighting over which specific policies make the most sense. That's dumb. If we can't collaborate and compromise amongst ourselves, how can we expect collaboration and compromise across a wider political spectrum? We need to find a vehicle to come up with a plausible, coherent, and centrist set of policy proposals that we can all agree upon supporting, even if we all don't 100% agree with all of it. Stop with the constant "what if we relabeled it as the following" policy proposals. Start being a constituency, not just a smart individual or attention-seeking NGO.
What we can't do is to let this just be a cleantech industry issue. The cleantech industry is a terrible spokesperson for addressing climate change. When we as a fledgling industry narrowly focus the argument on ourselves, we look selfish and therefore are ineffective.
But climate change is not a cleantech issue. It's not a green issue. It's a security issue, an economic issue, a food issue, an energy issue, a military issue, a safety issue for all Americans. The fight to mitigate climate change needs to be led by large insurance companies, by major manufacturers, by farmers, by soldiers, by homeowners, NOT by a handful of cleantech entrepreneurs and their increasingly scarce financial backers. Not that we don't have our own role to play. But we need to stop making it all about ourselves.
For example, anytime I see a policy proposal from the cleantech community to address the externalities of climate change (via carbon tax or cap and trade, etc), it's coupled to a proposal to recycle the resultant government revenues into subsidies for cleantech deployment, or cleantech R&D. Yes, we need all of this -- to price carbon, to support early deployment, and to support R&D. But when we bundle them all together, we appear to be looking to make others pay taxes just for our own benefit. It's easily cast that way, at least. Let's be smarter about keeping those conversations and proposals separate. And let's be smarter about making sure we're clearly looking for benefits for other important constituencies (i.e., manufacturers, etc.), not just ourselves.
What we can't do is to just throw up our hands and blame a partisan Congress and be fatalistic. If you've given up on even the slightest chance of bipartisanship in the face of a crisis, you've given up on America. Certainly President Obama and Governor Christie get this. But so far this morning I've already been pinged several times by people in our industry who just seem ready to declare nothing will be done and it's all the Republicans' fault. That's just useless thinking. Stop it. First of all, there's been arguably more environmental policy progress done in this country over the past half-century under Republican presidents and congresses than under Democrats. This isn't historically a red-versus-blue issue, even if it has been recently, and many of even today's politicians remember that. Secondly, if you're just going to throw up your hands and say nothing can be done, then kindly be quiet and move out of the way; others are willing to keep fighting.
What we can't do is let the perfect be the enemy of the good. Already I'm seeing fired-up climate advocates venting in tones that suggest any kind of compromise and any kind of sequential movement toward policy progress is useless. As one person tweeted me this morning: "commissions are sideshows w no teeth NOT PATH TO LONG TERM EFFECTIVE POLICIES" [sic].
The more I hear the above kinds of things from people in our industry, and the more I then speak with people outside of our industry and hear their perspectives on this issue, the more I'm convinced that the real problem is a lack of a coherent consensus policy agenda, and a lack of determination. Americans agree that climate change is real and should be addressed. But the eventual policy proposal that breaks through won't come from just one industry, or from just one smart individual, or from just one party. We need to set the table for a grand compromise that helps us move forward. We need to acknowledge that a consensus-building exercise is a necessary first step.
We need to break this stupid cycle of getting angry and impatient every time a disaster like this happens, not putting in place the mechanisms for a long-term consensus to be reached, and then throwing up our hands and giving up, blaming others for it.
Because every time we end up missing the opportunity. No one wanted to work on the "sideshow w no teeth," and then when the teaching moment happened and there was an opportunity for real change, there was no go-to solution ready to be voted on by a temporarily cowed set of partisans in Congress.
You want to vent? Fine, we're all angry and frustrated at our impotence to provide more help for the victims of Sandy, and to prevent future Sandy-type events from happening; vent away. You want to push more aggressively than simply setting up a longer-term conversation with a presidential mandate? Fine, do that too, I'll be there alongside you. But let's at least lay the "boring" groundwork this time. The stakes are too high. The danger is too real. The waste of life and livelihood and economic damages are too much. Tell the President-elect, whichever one it is, that at VERY LEAST we need to start having a coherent conversation with the right people in the room.
Because without even that? You're just shouting into the wind.
Again: Please help those affected by Sandy. Give generously to your neighbors; next time it could well be you.
A Modest Proposal
"It is remarkable how little concern men seem to have for logic, statistics, and even, indeed, survival: we live by emotion, prejudice, and pride."
- Dwight Eisenhower, in a letter to Winston Churchill
The above quote is very true, and it would appear particularly so right now regarding rhetoric about clean energy policy. Over the past week, we've seen a bunch of op-eds, some fiery, some sober, attacking clean energy policy and its proponents. And of course, then there are lots of reactions from the clean energy community and its proponents, some rebuttals with data, but a few just some form of a primal scream. The issue has become politicized to an illogical level, pundits are making statements that have no thought-out, sensical conclusion, and the entire situation is basically just, well... stupid.
I think it's time for everyone to take a step back and re-insert sanity and fact-based decision-making into how we talk about energy policy. I would propose to both presidential candidates that they pledge to establish a bipartisan commission, with representatives from big business, entrepreneurs, military, public policy, and former legislators, to investigate and then propose a balanced, coherent and comprehensive energy policy to the President. A Simpson-Bowles for energy policy, in other words. Their stated objective wouldn't be just clean energy policy. But it would be to develop policy recommendations that would result in cheaper, more domestically sourced energy, in as environmentally sustainable a fashion as possible, and with a net reduction in the federal deficit.
A real honest-to-God energy policy for the nation, in other words.
Reading the various op-eds this week, one gets three distinct impressions:
1. A lot of complaints, no solutions.
I didn't have the harshly negative reaction to David Brooks' column this week that some others had. A lot of his logic about the flaws of the Loan Guarantee Program holds water for me. And he acknowledges that climate change is a priority problem for society, and even suggests he would support a carbon tax, even though he admits that cannot pass Congress right now.
But then he just leaves it there.
Either you think climate change is a big problem, or you think it isn't. If you're in the latter camp, I think there's a fairly large body of evidence at this point that says you're wrong, but at least then it's intellectually honest of you to simply favor doing away with green energy policy altogether (leaving aside all the other many policy benefits of supporting the technologies and industry, of course).
But if you do think climate change is a big problem, you simply cannot say that clean energy policy is flawed and then not offer any alternative proposals. That's just negligent. And intellectually dishonest.
2. Way too much focus on small pieces of the energy policy puzzle, used to paint too broad of a picture.
Our current national conversation around energy policy is, like our energy policy itself, highly disjointed. Which then allows grand sweeping attacks and proclamations based upon relatively small facets of the story.
I'm a free-market type by nature. Yes, as I've written before, I agree that the Loan Guarantee Program made a mistake extending what was intended to be project finance support into the grey area overlaps of late-stage venture capital. And yes, at a more general level, I believe that government staffers are always at a disadvantage in making investment decisions versus relying upon the larger private sector, if assigned the same objectives.
But that's a pretty limited set of situations. It's silly to evaluate government "investments" simply on financial returns, because that's never the primary objective of such programs to begin with. If you disagree with the other objectives (which can include jobs, technological leadership, environmental impact, or simply accelerating learning curve effects on the costs of emerging technologies), see point number one above, but also don't ignore them when evaluating the effectiveness of clean energy policies. And there are many other aspects of energy policy that have been very successful even from a returns perspective -- in fact, within the Loan Guarantee Program's project finance investments, for instance.
The conflation of totally different government policy efforts further exacerbates the issue. A lot of the recent failures of government-backed startups have been the result of economic development programs, not clean energy programs.
Let me tell you about a state that has backed several cleantech startups with hundreds of millions of dollars in benefits, to attract their manufacturing facilities to the state. Yes, the state's name begins with an M.
Yep, you guessed it -- it's Mississippi. The state government under notorious liberal Haley Barbour has shelled out tons of handouts to at least five cleantech startups, to get them to relocate their operations into the state.
And they're not alone, nor is this a new trend. States have for decades had their Economic Development departments provide heavy incentives to individual companies to try to outcompete other states and attract new facilities, whether those are creating green jobs or non-green jobs. I'm not trying to single out Mississippi, it happens all over. Such as in Massachusetts, with Evergreen Solar and several cleantech startups that got similar packages and subsequently got a lot more negative attention for it. I personally am not convinced of the worth of these types of economic development policies, it always seems to me like classic "corporate welfare" and the type of auction-based bidding where the winner often ends up with buyer's remorse. But it happens all the time, in most states, under Republicans and Democrats alike, and it's got NOTHING to do with clean energy policy.
And of course, the failure of many of these cleantech startups would have a lot to do with the direct and indirect (ie: price drops in incumbent energy) effects of the macroeconomic downturn. If cleantech startups fail after receiving government support during the worst economic period in living history, there are actually TWO possible conclusions: 1. the policies are flawed, or 2. there wasn't enough support.
If David Brooks or Steven Syre or others want to attack cleantech-supportive policies as having failed, they need to better articulate a) that they're really talking about a small subset of cleantech-supportive policies, and b) exactly how the policy failures are a more impactful factor than macroeconomic conditions, or broader energy policy impacts, etc. And it would help if they would stop conflating long-running economic development policies with the more recent clean energy subsidies.
3. Cherry-picking and misusing data.
I hope someone alerted the Red Cross to the clear violation of the Geneva Convention in this recent Washington Post article about Al Gore's wealth, because the data has been absolutely tortured.
Hey, maybe Gore's wealth has indeed increased 50X during the past twelve years. How is that possibly due solely to his cleantech investment activities? He gives paid speeches. He runs a media group. He gets compensated by companies like Apple, Google, and Metropolitan West Financial for serving as an advisor or as a board member.
Based upon the investment track records of the groups he's been associated with on the cleantech investment side, it wouldn't be surprising if he's made some money there, if only off of fees -- maybe some carry, maybe not.
But if, predominantly as a cleantech venture investor, he's made $98 million over the past 12 years, we should all tip our cap to the man. Because he would be the ONLY ONE of us to even come close to doing so. Just looking at Gore's various business activities, what makes most sense to you? The reporter who pulled together this horrible piece of "journalism," and its implications of underhanded business and government practices, should be ashamed of this article. It was clearly just a manufactured and strained effort.
I mean, this kind of stuff makes no sense even on its face, and yet this is just one example of a lot of really screwy data being thrown around out there. Romney suggests that half of the companies backed by the Obama administration have failed? Clearly factually wrong. $90 billion in "green pork" says Paul Ryan? Completely debunked by the fact-checkers. Claiming that the ARRA stimulus is largely responsible for driving down the cost of solar panels, as some have done? *Ahem* China *ahem.*
You can't have a rational dialogue about any policy area if everyone insists upon bringing their own cherry-picked and perhaps completely made up "data" to the effort.
Hence my proposal: It's time to wrest back the energy policy discussion -- clean energy policy and traditional energy policy, combined -- into the realm of reality. It's time to pull it back from all this useless partisan bickering. This isn't inherently a blue vs. red thing, both energy and environmental policy have traditionally been non-partisan issues. And it's time to bring together deeply experienced experts from across the various stakeholder groups to bring real data to the table, and to have an open dialogue around what should be done to pursue some shared national objectives, and get both sides to stop using our sector as a political football.
I don't kid myself about any such commission's ability to force through their recommendations. Like with Simpson-Bowles, I would expect the commission's findings to be given lip-service support and then once again attacked piecemeal in partisan-based rhetoric.
But even just establishing such a commission would send a powerful signal of how important it is that we come up with a coherent national energy policy, for security, economic, and environmental reasons. And it would create a "safe space" for a rational, fact-based dialogue.
And who knows, maybe it would actually come up with something that a group of lonely centrist politicians could support.
I think both presidential candidates should be asked to sign on to a proposal like this. And I wish journalists would take such an approach on the increasingly rare occasions when they ask the candidates about these issues.
A Few Things to Note in the SolarCity S-1
I'm a few days late to this party, but finally took a look at the SolarCity S-1 yesterday. A few things have already been written about the business, so I won't redundantly go into all the discussion of operations, risks, etc. (Even better, read it for yourself.) But here are a few items I'll add in that caught my eye.
First of all, for a business model like this, discussions about cashflow and margins aren't straightforward. Much has been written about this being a high cash burn model -- but you have to look under the hood on that, and then really pay attention to the IRRs of their projects, which is the heart of the business. That's not spelled out in the S-1, of course, but this Woodlawn Associates analysis does a very good job of teasing that out. I'll echo what they say, namely, that SolarCity appears to be getting pretty industry-standard IRRs, from what I've seen in the market. A good data point, but it also suggests there's no magic returns advantage to the company, other than benefits of scale to attract the lower-cost capital.
Secondly, the company really is growing impressively. It's basically been doubling installations every year since 2009. Again, I think that's not that unusual for this market -- solar financing is simply exploding right now. Part of that is simply the power of this type of financing model to unlock consumer buying decisions; part is the significant drop in solar panel and other costs, but a relatively unnoticed factor is the drop in the cost of customer acquisition over time.
You would expect there to be an inflection point in any small but fast-growing market where customer acquisition costs go down over time simply because customer awareness breaks through some kind of threshold and then customers need less education, etc., to want to make a purchasing decision. Interestingly, however, for SolarCity, there are indications that from 2009-2011 the cost of customer acquisition stayed flat. A simple calculation of sales and marketing spend per MW booked stays pretty constant during that period, coming in at between $250-$300 per. This is a curious lack of advantage from scale at the company, and if these figures are indicative of the industry as a whole, it is even more curious.
But I'm seeing a pretty important shift in the marketplace over the past 18 months or so, to really focus on reducing the cost of customer acquisition. Lots of innovative approaches either via technology (remote assessments) or economies of scope (turning to roofers, energy auditors, etc. as lead generators). I think we'll continue to see these costs driven down over time as better data mining and direct marketing capabilities are introduced to the market. And that's more important than you might think -- as Woodlawn Associates points out, SG&A costs per Wp for SolarCity averaged $0.48 over the past few years, with sales and marketing being something close to two-thirds of that spend. When we're all enamored of solar panel prices falling below a dollar per peak watt, reducing the implied $0.30 per Wp in sales and marketing costs would be important for continuing to accelerate the growth of this market.
It's an under-appreciated aspect of the solar market for sure -- I recently was told by an insider about how frustrated even Secretary Chu got a couple years back, when he started learning about how important installation, etc., costs were to solar power competitiveness, and that simply reducing the costs of panels wouldn't be sufficient.
But in light of all that, it's striking to see that in the first half of this year, SolarCity's sales and marketing per MW booked dropped by something like a third, to under $200 per. And it's not because the projects got bigger -- a similar drop is seen on a per-customer basis (from $5,356 per new customer in 2011 to $2,399 per new customer in 1H12). Is that a sudden materialization of the market shift I describe above? Or is it the result of SolarCity's "SolarStrong" program with the military, and similar aggregated sales that might require less effort per home booked? If the former, that's great news. If the latter, you have to wonder if it's a bit of an aberration, at least for SolarCity. The truth may lie in the middle somewhere.
Finally, the company's recent venture financing history is pretty fascinating. At least to me.
At first blush, the company's $81M Series G raise earlier this year was at a shocking valuation. The implied valuation appears to have been something in the neighborhood of $1.9B (fully diluted).
But before all you solar entrepreneurs get stars in your eyes all over again, note the fine print on the bottom of page 137:
"Each share of Series G preferred stock is initially convertible at the option of the holder into one share of our common stock. Pursuant to the terms of our amended and restated certificate of incorporation, upon the closing of this offering, each share of Series G preferred stock will automatically convert into a number of shares of common stock equal to the quotient obtained by dividing (A) the original issue price of $23.92 per share by (B) the product of (i) the public offering price in this offering (before deducting underwriting discounts and commissions), multiplied by (ii) 0.6. However, in no event will one share of Series G preferred stock convert into more than approximately 2.47 shares or less than one share of common stock as a result of this conversion adjustment mechanism. As a result, the outstanding shares of Series G preferred stock will convert into no more than 8,372,072 shares and no fewer than 3,386,986 shares of common stock."
So the valuation was high on paper, but there's a pretty significant ratchet attached to it. And by my simple calculations, this implies that down to a post-IPO price of $16 per share (note: much lower than the $23.92 per share paid by the Series G), they lock in a 67% return -- as long as the price remains that high at the point where any lockup expires. That's not a bad return, and locking it in with this ratchet makes the high Series G valuation much less relevant than it might appear. Indeed, the share price would have to fall back down below the Series F price of $9.86 per share before Series G starts losing money on an investment where they purchased shares at more than double that.
Venture capital terms like this always fascinate me, and it may be a good lesson for other late-stage investors in the sector, if they're not already deploying this kind of strategy. It's a good lesson in how to give a high valuation and still get a good chance at a decent return.
But it's not a panacea, and I'll note one important implication of this kind of arrangement: It adds pressure for this to be the last round of financing into the company before an IPO (barring possibly just re-opening the Series G if needed), and it puts the company into an "IPO or bust" situation, as far as some very important investors are concerned.
I really want SolarCity's IPO to go well -- we all have a lot riding on its visible success at this point. But I note how the incentives around the table would be for the company to IPO as soon as possible. And that the company's current cash position suggests they may need additional financing relatively soon. Knowing the caliber of the investors in this company, I trust them to not send this company out to the market before they feel it's really ready for prime time, and as discussed above, there's a lot to like about the story (while also some points of concern, as many have noted). But more generally, we've seen too many cleantech IPOs that clearly went out too early. And it's hurt us on Wall Street, and thus hurt our returns as a sector.
Fingers are crossed this time around. Not only do we as a sector need a win badly, SolarCity also looks a lot more like the kinds of companies I've been espousing (and investing in). So I'll be cheering them on. And if they keep growing like they have been, there's a lot to cheer for.