CleanTech should get fire insurance
Let’s talk about cleantech investing
The history of cleantech investing sucks. In less than a decade, the cleantech sector saw a massive boom and bust that resulted in the evaporation of billions of dollars of venture capital (VC) and federal investments.
- 2006: VCs invest $1.75B into cleantech startups.
- 2008: Renewable Energy Standards are introduced in 30 states, and ARPA-E is founded within the Department of Energy to support energy innovation. VCs put in $3.8B.
- 2011: The peak of the cleantech boom. VCs put in $4.69B.
- 2012: The Solyndra bankruptcy (falling silicon prices make Solyndra’s chemistry uncompetitive, the development of hydraulic fracturing floods the market with cheap natural gas, the credit crunch from the financial crisis makes it tougher to raise capital, and the influx of Chinese competitors make cheap solar available and squeezes industry profits)
- 2013: VC investments plummet to $2.27B.
If we look at the cleantech companies that raised money between 2007 and 2011, over 90% failed to return capital to investors. The ten biggest cleantech exits returned 8.6x in A-round investments, while software exits returned 11.6x.
Breaking down cleantech A-round investment returns:
- Materials: $764M invested, $123 returned (16% return of invested capital)
- Hardware integration: $586M invested, $30M returned (5% return)
- Software: $157M invested, $542M returned (350% return, thanks to Nest, which returned 20x after being acquired by Google)
- Deployment finance: $202M invested, $52M returned (25% return)
- Efficiency and waste: $328 invested, $69M returned (20% return)
As a result, most investors today only associate with cleantech software startups (known as “the cleanweb”).
So… why is cleantech so hard to get right?
There are 3 main challenges that differentiate cleantech startups:
1. Long development cycles
It takes a long time to get from research to commercialization, with safety standards (which differ from state to state), product demonstrations, manufacturing agreements, etc.
These long development cycles make hardware harder to scale than software — and without scale, it’s difficult to compete against the giants of the energy, electronics, and chemicals sector.
Startups can’t hit competitive price points without scale, but they can’t get scale without a competitive price point. The best solution is to come up with a product that performs significantly better or serves a niche sector.
Unfortunately, it’s difficult to develop these solutions because…
2. Significant capital requirements
Most physical science startups have a high-CapEx, low-margin business model and need a lot of capital to get started — for equipment, raw materials, patents, etc.
However, cleantech startups have a difficult time raising money because of the volatility that exists from politics and from inherent fluctuations in international oil and gas prices. Because of their capital requirements, cleantech startups are often drawn to VC firms, even if VC funding isn’t their best method for raising money.
Cleantech startups and VCs operate under fundamentally misaligned business models. A respectable return for VC firms to pay back their limited partners (LPs) is around 20%/year for their 10 year fund— but because most startups fail, VCs end up looking to a fraction of their investments to make ~30x returns. Let that sink in. If a startup raises money at a $50M valuation, the VC will expect the startup to be sold for at least $1.5B, and within a few years. This kind of growth is insane for a cleantech startup (unless the business model looks similar to that of a traditional software startup). So these startups are forced to accelerate growth by making business decisions that aren’t optimal for long-term viability, like increasing their debt-to-equity ratio, which raises volatility and makes it more difficult to raise money in the future.
This also closes the door to small, niche, markets and instead forces startups to all enter the same high-growth (and hyper-competitive) markets. And while more than half of all VC funds liquidate in less than 15 years, material/hardware technologies historically take 17 years to develop. Pairing VCs with cleantech startups creates a difficult relationship from the start.
Knowing this, startups should instead try to run lean by taking advantage of cleantech incubators and accelerators (such as Cyclotron Road in Berkeley, Clean Energy Trust in Chicago, Greentown Labs in Cambridge), doing R&D work through public grant funding, and relying more on debt financing instead of equity financing. Caveat: startups still want to be careful about taking on too many public grants and losing focus on developing their core technology. Startups should also look to build strategic corporate partnerships to provide industry experience, wring out supply chain problems, and open up acquisition opportunities.
However…
3. Immature acquisition space
There aren’t many companies that will acquire cleantech startups.
In biotech, J&J and Pfizer acquires many early-stage startups, but there currently just aren’t comparable companies that will do that for cleantech. After all, energy companies like Exxon only recently began to acknowledge climate change. As a result, the biggest acquirers end up being smaller companies with less capital, like waste management providers, utilities, or renewable energy companies.
Additionally, unlike software startups, it may take decades for clean energy companies to finally be acquired. SunPower was 26 years old when it was finally acquired by Total, a French oil giant. And even when companies are acquired, it’s not always on favorable terms. Solar cell manufacturer MiaSole, once valued at $1.1B, was acquired by Hanergy Holding Group for $30M in 2012. Energy management company OPower was acquired by Oracle earlier this year for less than its market cap (it was acquired for $532M, when it was a public company worth $556M).
Understandably, few people are willing to invest in cleantech.
“VCs won’t touch the sector with a 10-foot pole”
“Many [cleantech-specific venture firms] no longer have the funds to be active lead investors. They’re near the end of their fund life…and they’re mostly just biding their time. And for other firms, the lure of being able to invest in later-stage companies in an increasingly capital-scarce environment pulls them away from early-stage investment…
Few cleantech venture firms of any stage preference can raise new funds from LPs… And generalist VCs won’t touch the sector with a 10-foot pole.”
— Rob Day, Partner at Black Coral Capital (June 2014)
A recent survey by the advisory firm, Probitas, asked LPs where they planned to focus their investments in 2017. Of 672 respondents, only 5% said cleantech-focused funds, putting it in 22nd place of 28 categories.
The biggest challenge is that the lack of LPs investing in cleantech funds has inhibited, and will continue to inhibit, investors from ever gaining sector expertise. This has created a generational loss of cleantech specialists.
Calling all non-conformists and contrarians
Still, I would not hesitate to say that cleantech is the greatest possible investment opportunity.
You want to be a contrarian? Learn everything about cleantech.
The fact that the market doesn’t currently value cleantech sector experience doesn’t mean that cleantech is dead — it just means that it’s undervalued.
Cleantech is necessary
The Earth has a growing population that the UN estimates will reach over 9.5B people by 2050. We have increasing industrialization around the world, primarily in Asia, where millions of people are gaining access to electricity and are beginning to demand higher standards of living.
The IEA predicts that by 2040, the global demand for electricity will grow by 70%, compared to today — this energy has to come from somewhere, and conventional sources are becoming uneconomical. The Department of Energy also says that a grid reinforced with more renewable energy is stabler against climate change, due to the decreased usage of water compared to conventional energy sources.
Cleantech is inevitable
COP21 discussed the steps that will be needed to mitigate the impacts of climate change, and proposed the Mission Innovation Pledge to double public R&D funding by 2020. The PRIME Coalition was formed in 2015 to help philanthropic foundations make direct cleantech investments. Breakthrough Energy Ventures was formed in 2016 to fund early-stage cleantech companies.
The importance of these events cannot be emphasized enough. As investments from private investors and local/federal governments increase, startups can worry less about capital requirements. As governments around the world focus on mitigating environmental damage, the strategic advantage of owning cleantech assets will increase and the acquisition space will develop. And as the cleantech sector matures, supply chains will become more reliable and will shorten development cycles. Thus, a virtuous cycle begins. And though VC funding and institutional investing has decreased, cleantech investments are, as a whole, increasing.
In 2015, clean energy investments set a new record with $329B flowing to the sector, even as fossil fuel prices plummeted. 2015 was also the first year in which the majority of global power-generation addition was in renewables (with 53.6%).
Investments in emerging markets are also picking up. South Africa’s investment climbed to $4.5B in 2015 — a growth of 300% from 2014. And Morocco pumped more than $2B in 2015, up from virtually nothing in 2014.
The breakthrough changes in policy and the rapidly evolving clean energy sector have been too recent to create a track record of investment success and properly register in the minds of investors. But the cleantech wave is coming, whether investors are ready or not. How many other sectors can you name that are necessary and inevitable?
Cleantech investments aren’t like trying to predict which trinket might be the “next big thing.” Cleantech investments are more like buying fire insurance for your house, if you had evidence that your house was already starting to burn down.
If your house were burning down and I were to offer you fire insurance, you would have to be silly not to take it. Wouldn’t you?
I’ve written over 35,000 words about 20 topics in energy and environment — check them out if you’re looking to learn about the sector. See my Table of Contents for an index of everything I’ve written about so far.
