As I was preparing recently for a roundtable discussion on renewable energy with The Guardian and one of our portfolio companies, Gencell, I realized I do not know as much about the topic as I should. So I asked a couple of VC colleagues for their perspective on the resurgence of interest — and investment — in the sector. Dubbed Cleantech 2.0, the emphasis on taking a cleaner, more sustainable approach to powering the planet is gaining momentum as wildfires burn out of control and temperatures soar in places they normally don’t continue to dominate the news.
Despite the urgency, many believe that Silicon Valley’s relatively new bet on startups fighting climate change (2.0 began in 2018) could be undermined by its predecessor, Cleantech 1.0, which ended a decade ago. In fact, several firms that experienced the downsides of that era remain cautious about a renaissance.
The sequence of events, and the opinions that have coalesced around them, left me with lots of questions. What happened during Cleantech 1.0, and what brought it to a close? What have we learned from it? What are some of the challenges facing startups in the renewable energy space today, a decade later? What do the investment opportunities look like? To learn more, I sat down with Paul Holland and Peter Moran.
Peter is currently an early stage investor focused on digital health and wellness. As managing partner of DCM Ventures, which he helped nurture from infancy to one of the largest trans-Pacific venture firms, Peter has overseen more than 75 IPO’s and successful M&A outcomes, including more than 25 companies valued at north of $1 billion.
Paul, who has extensive experience working with top-tier Silicon Valley VC Foundation Capital, leads the Corporate Venture Investing practice at Mach49, a Silicon Valley powerhouse specializing in accelerating development of new venture workforces inside large corporations. He is also General Partner in Residence with TDK Ventures, the CVC I designed, launched, and currently lead. In this role he introduces the TDK Ventures team to critical concepts and best practices. He also coaches us on how to strategically partner and engage across the startup ecosystem.
I am sharing the conversation here because it seems wasteful, if not irresponsible, to let the expertise shared by two of the most insightful and accomplished individuals in our industry languish in my notes. My hope is that our conversation will help us, as individuals and as investors, develop an informed, and deeply considered perspective regarding Cleantech. That’s a necessary first step as we prepare to address one of the most urgent issues of our time.
Nicolas Sauvage: I want to know more about what’s being called Cleantech 2.0. But first, let’s talk about what happened during Cleantech 1.0 and its aftermath.
Peter Moran: I’d like to start by stating unequivocally that all the former Cleantech VCs were absolutely correct when they identified the opportunity in renewable energy a decade ago. The trends that inspired those investments have and are continuing to prove that they were good investments to begin with. There are clear winners from that period. Let’s take a look at Tesla, which is one of the 10 largest market cap companies in the world. It has upended the entire automotive sector. And solar panel producers like First Solar and SunPower, with the help of inverter companies like SolarEdge and Enphase, have driven down the cost of solar power to the point where it’s less than fossil fuel power plants — resulting in the creation of several multi-billion market cap companies. Also, powered by the special purpose acquisition company (SPAC) market, we’re seeing multiple EV and battery companies go public as unicorns in real time right now. I also think it’s important to recognize that those who invested during Cleantech 1.0 were not merely after short-term, fast-track, quick returns, which many still believe, incorrectly, was one of the factors that brought Cleantech 1.0 to its end. In Cleantech, there’s a much larger time between investment and result. In fact, the average IPO is 12 years. That tells us that those who invest in Cleantech, then and now, are actually thinking about the long term.
Nicolas Sauvage: How did Cleantech 1.0 come about?
Paul Holland: There was a convergence of factors. It began to gather real momentum in the early 2000’s, when former Vice President Al Gore popularized the issue of climate change with his series of speeches and his groundbreaking book, An Inconvenient Truth. At the same time, many top-tier firms recognized that there was going to be a massive need to upgrade technology and systems for nearly every major industrial category, first and foremost the utility and energy grid. The election of Barack Obama in 2008 was another factor that led to Cleantech 1.0. With the onset of the Great Recession, his administration used the U.S. Energy Department to inject billions of dollars into the economy under the American Recovery and Reinvestment Act, or ARRA. Another very important factor is that some of the effects of climate change, such as melting polar ice and rising temperatures around the globe, became more immediately apparent than they had been previously. The immediacy of those phenomena served as a powerful impetus for Cleantech 1.0.
Nicolas Sauvage: Then what?
Peter Moran: What happened next is well documented: A number of early VC portfolio successes drew more money from LPs, which contributed to creating a mania to invest in anything related to Cleantech. ARRA funds totaling nearly $1 trillion were distributed at breakneck speed to help lift the country out of a deep recession.
Nicolas Sauvage: What went wrong?
Paul Holland: Simply put, the hype cycle effect kicked in, and Cleantech 1.0 descended deeply into what’s known as the trough of disappointment. During that time period, startup valuations associated with industrial innovations crashed back to earth from their previous lofty heights. The result was that the early and big adopters in the VC world saw their fund values diminish, and the later adopting firms that typically paid up to get into ‘hot’ deals lost substantially all their money. This experience left a bitter taste in the mouths of VC firms as well as LPs.
Nicolas Sauvage: What are the important lessons from Cleantech 1.0? Also, what would you say to investors who got burned and are understandably still wary?
Peter Moran: I think the lessons learned from Cleantech 1.0 are important for all of us, whether we were investors during that time or not. It’s important to remember that external factors really matter. A case in point is when governments sponsor your competition, which is what happened with Chinese solar companies. Another important point to remember is that being 25th in a new space probably isn’t a very promising position. You must get the technology to work, and you must understand that there is neither unlimited time nor unlimited funding to do so. And don’t forget that betting your portfolio of companies on a single sector can blow up in your face if that sector encounters headwinds.
Paul Holland: The biggest takeaway, I think, is that Cleantech 1.0 was not the disaster it’s often been made out to be. I would say that for the funds that had generally good portfolios and stuck with them, the ultimate reward was rich indeed. At the bottom of the trough of 1.0, one top-tier investor was carrying their $400 million in ESG investments at a value of $200 million. Later they were able to exit those companies at a combined value of $1.6 billion. Had they held longer, they would have exited at closer to $16 billion. Another firm had invested about $250 million in cleantech 1.0. At one point, the total exit value of those companies was less than $2 billion. Later, that same portfolio had a combined exit value of more than $25 billion. Companies like SunRun, Tesla, Silver Spring Networks, Azure Power, Enernoc, SunPower, Bloom Energy, Jinko Solar, Vestas Energy, and others all exited at valuations well north of $1 billion, or otherwise saw their market value soar past the trough of Cleantech 1.0. It will be very interesting to see how the story ends for the portfolios now being assembled during the ascendancy of Cleantech 2.0.
Nicolas Sauvage: What are the biggest differences between Cleantech 1.0 and 2.0?
Paul Holland: One major difference between the two is that there is more urgency at the core of Cleantech 2.0. For several reasons, when Cleantech 1.0 wound up in the trough of disappointment, fighting climate change became a cause that wasn’t as urgent as it had been previously. Cleantech 2.0 began to emerge in the 2018–19 period, as it became apparent that climate change was reentering the public consciousness as a first-order problem that needed to be solved. There are of course other major differences between the two. The governmental imperative to solve climate change has become more widespread and more global. Most of the world signed on to the Paris Climate Accords, while countries like China and India began real initiatives to move from hydrocarbon to renewables-based growth. Also, electrification is underway in a serious way for huge sectors of the traditional economy, such as transportation, utilities, energy, and others. These and other factors are driving massive new markets for environmental, social, and governance-based (ESG) startups.
Nicolas Sauvage: How has the investment community evolved since the Cleantech 1.0 period?
Peter Moran: There are many signs that investors have learned a lot from Cleantech 1.0 and made some significant changes in how they approach investing in the sector. Those changes leave me hopeful that Cleantech 2.0 will be better from many standpoints. One thing investors generally did not understand earlier was the technology risks that are simply part of Clean technologies. Understanding and evaluating those risks requires a level of scientific talent that investment teams don’t normally retain in-house. During Cleantech 1.0 the VC industry drew on what it knows best, which is innovations driven by software. Funds did their recruiting not from Ph.D. programs but mainly from MBA programs. The capital intensity of Cleantech is something else I don’t think investors fully appreciated during 1.0. The comparatively high costs of bringing Clean technology to market and also at different points in a company’s early life has an undeniable impact on returns. That’s why I think it’s encouraging to see large institutional investors are now playing a critical role in Cleantech. The capital stack is definitely diversifying.
Nicolas Sauvage: What role is business playing in Cleantech 2.0?
Paul Holland: That’s one of the most significant differences between Cleantech 1.0 and 2.0. The Global 1000 is taking a very strong role this time. Whereas Cleantech 1.0 was met with tremendous resistance from many of the G1000 companies, the era of Cleantech 2.0 is one in which nearly every major global company is launching significant ESG-related initiatives. Between sovereign wealth funds, pension funds and Global 1000 operating companies, there are hundreds of billions if not a few trillion dollars focused on ESG initiatives. Some of the largest spenders are traditional hydrocarbon energy and energy services companies, which perceive the move to renewables as an existential threat to their businesses.
Nicolas Sauvage: What are the implications of Cleantech 2.0 for startups?
Paul Holland: I think the outlook for startups is good overall. As a result of the Global 1000 playing such a strong role, startups focused on ESG have a much stronger and ready market for their products and services. Also, the faster growth rate of this new generation of ESG startups is in turn attracting even more capital. In fact, in a recent CNBC piece that links the renewed interest in Cleantech with the pandemic, climate disasters, and racial injustice coming into sharp focus, Cowen estimated that 1 in 4 dollars of private investment is now going into ESG.
Nicolas Sauvage: What are the risks and challenges to startups in the Cleantech 2.0 space?
Paul Holland: In spite of the positives I just shared, I think there’s still a risk that the Hype Cycle will kick in for a second time. That would result in disappointment from some of the current ESG investors, especially those paying up for later stage rounds. I do want to emphasize, however, that the risk of the Hype Cycle kicking in is not unique to Cleantech. It’s a risk factor whenever there’s hype, regardless of the industry.
Peter Moran: I also am optimistic about how startups are going to fare in Cleantech 2.0. But I think it’s important to keep in mind that Cleantech represents an almost total departure from the type of innovation technology startups and the VCs that fund them are known for. Cleantech isn’t about mobile apps or cloud-based customer service platforms. It’s about the energy sector that everyone interacts with every single day. It’s highly regulated and capital intensive. There are complex supply chains. The customer base in well established. The same services are provided to everyone. The technology has to function properly from the start and you have to prove that it operates safely. There’s a focus on reliability and safety, something I think we can all appreciate. The regulations are extensive, and the politics, to put it politely, are complex. One of the most consequential differences, I think, is that Cleantech is at odds with the agility and flexibility at the core of the startup ecosystem, which supports innovative ideas rapidly reaching customers. Cleantech is often dependent on academic and scientific innovation being commercialized. It takes longer to productize an academic or scientific discovery, so the initial phases often do not attract the same level of private sector investment. The bottom line, however, is that when it comes to addressing climate change, we don’t have a choice, so Cleantech, regardless of the VC ecosystem, is imperative.
Nicolas Sauvage: What’s the investment outlook for Cleantech 1.0?
Paul Holland: As Cleantech 1.0 exited the bottom of the hype cycle, there was an incredibly high mortality rate for all but the best startups. As the hype cycle moved toward the Slope of Enlightenment, the strongest remaining companies began to develop momentum that has carried them all the way into the new booming Cleantech 2.0 market environment.
Nicolas. Sauvage: What’s your prediction for the next decade of Cleantech?
Peter Moran: I think the next decade looks incredibly bright for Cleantech. Converting the gasoline powered automotive fleet to electric over the coming decades will require massive improvements as well as spending for next-gen batteries, high speed charging networks, and battery recycling. Grid scale energy storage remains a wide open opportunity. While first generation indoor farming techniques are just now beginning to scale, certainly there will be another generation of farms that are even more efficient in terms of cost, electricity consumption and water usage. This remains a gargantuan market opportunity, and multiple startup winners will emerge across the Cleantech landscape.
Paul Holland: While I agree that the future looks bright, we have to remember that virtually every time a sector of the venture capital world overheats, a significant correction soon follows. The difference this time is the overall level of activity, investment, interest and market demand is so much greater than the last time, I believe that there will be a ‘higher floor’ whenever the correction takes place.