VCs abandoned cleantech—here’s why we shouldn’t worry
This article was originally published on June 22, 2017 on the Clean Energy Trust blog.
Last month, the Brookings Institution released a new report on the state of venture capital funding for cleantech companies in the U.S. The piece was a follow-up to an article in April that examined declining patent activity in the sector. Devashree Saha and Mark Muro of Brookings’ Metropolitan Policy Center look at how cities and states are taking advantage of cleantech innovation to power their local economies, especially in light of waning support for R&D and commercialization from Washington.
Their conclusions — that cleantech VC funding contracted after 2008 and has hit early-stage companies especially hard — are in line with the papers my colleagues and I published last summer through the MIT Energy Initiative and in the journal Energy Policy. I suggest you read both of their pieces if you haven’t already. Here, my intention is to dig a little deeper on some of their results and focus on what it means for cleantech entrepreneurs.
The Bad News
First, let’s take a look at the downturn in funding. The chart below, which is an extension of the paper we wrote last year with data updated through 2016 compares what happened in cleantech VC to similar investments in software and biotech startups. There’s no question the financial crisis in 2008 hit cleantech startups hard, but it’s interesting to compare that to the other sectors, where the crisis was just a blip on an upward trajectory.
After the collapse, there was still some ongoing investment in later stage cleantech, but early-stage investment fell to a trickle. In the Brookings Report, when Saha and Muro compared early stage funding (Seed rounds and Series A rounds) to later rounds (B, C, etc.) they found that investment has been biased towards late-stage deals. That’s true, and it’s interesting to compare to what we would expect to see in a healthy funding environment.
The VC model as traditionally practiced means letting many flowers bloom, knowing some will fail fast, and doubling down on winners. In a well-functioning system, we’d hope to see early rounds to comprise 75% of the number of total deals and 25% of the total dollars invested. The figure below shows that, indeed, early stage cleantech investing falls well below this benchmark.
Of course, it is possible that cleantech startups need comparatively more capital at later stages and we therefore might expect early funding to stay a bit below 25%, but the decline and relatively low levels of the absolute and relative number of early deals is frightening.
Location, Location, Location
Given the regional focus of the Metropolitan Policy Center, Saha and Muro looked at how VC dollars are allocated around the country. They found substantial geographical concentration of the location of companies that received investment:
U.S. cleantech VC investment is heavily clustered in just four metro areas — San Francisco, San Jose, Boston, and Los Angeles, which account for a massive 54 percent of all VC flows in cleantech.
They see this as bad news, but there’s another way to look at it: San Francisco, San Jose, Boston, and LA account for 64% of total VC investment. Cleantech VC is actually less concentrated than VC at large. A note on methodology here: drawing regional boundaries is tricky, and the borders have to go somewhere. The Brookings study uses Metropolitan Statistical Areas, which has the strange side effect of separating Menlo Park and neighboring Palo Alto into two different MSAs (San Francisco and San Jose). If we look at the broader San Francisco Bay Area as a whole, the concentration of cleantech VC has been slowly decreasing since the peak in 2008. Last year, the Bay Area did around 25% of cleantech deals in the US, compared to 30% of software deals.
It’s interesting to note the geographies that are relatively underrepresented in cleantech investing compared to other VC activity. San Francisco and New York, the two biggest regions for software VC over the past decade, both underinvest in Cleantech by about 10%.
What’s a founder to do?
This may seem like more bleak news for cleantech founders, but there are good reasons to be optimistic. Cleantech companies tend to raise A rounds 3–5 years after their initial founding. The crop of companies that are raising now were founded in 2012–2014 and have the advantage of a growing ecosystem that didn’t exist just a few years ago. The IncubatEnergy network of clean energy accelerators and incubators lists 35 programs founders can take advantage of (including the CET Challenge). The Department of Energy’s Cyclotron Road, Chain Reaction Innovations, and Innovation Crossroads offer funding support, lab space, and access to experts inside our amazing National Lab system.
All startups demand incredibly hard work, and cleantech is no exception. Here are a few things founders should think about as they start building their companies:
1. Don’t pack up and move just yet.
Cleantech companies aren’t as easy to uproot as other businesses. Founders often have strong scientific advisors in university research labs and sometimes already have dedicated lab space they can use. And since cleantech investing isn’t as concentrated as it once was, there’s no reason to move just yet. If anything, this trend looks like it’s accelerating. In 2016, only 20% of A-rounds went to companies in the “top 4” metros above.
2. Take advantage of local resources
Over the last 2 years, nearly 40% of companies that raised an A round came through an incubator or accelerator program, most of which were programs with a local or regional focus. These organizations exist to help companies at the earliest stages develop their pitches, business plans, and strategy. As the companies grow, the incubators plug them into the network , connecting them with customers, investors, pilot and demonstration opportunities.
The first wave of cleantech investing may have been driven by a bit of exuberance, and it is clearer than ever that traditional VC has all but fled the sector. Instead of saying “cleantech can’t be done,” founders today are finding ways to stay capital-efficient and build amazing business. The time is right for Cleantech 2.0 companies to shine.
How much early-stage activity to we need to prime the pump for ongoing investment? Over time, successful companies move on to raise more and more money with each successive round of funding but there are fewer companies that make it to each level. For example, Anand Sanwal at CB Insights has shown that only about half of funded companies make it to the next round, but that funding for each company more than doubles in the first few rounds. In short, if we looked at each round independently, we would expect total funding to start small, grow into B and C rounds, and then gradually taper off. When we combine two early rounds (seed and A) and compare to all of the subsequent late rounds (B, C, D, and so on) we would expect 75% of all deals and 25% of all dollars to go to the early stages.