Can Cleantech Entrepreneurs Rely on Venture Capital?

Despite the recent declines in investment, the macro-trends for cleantech venture capital are very positive — funds are getting bigger, the market for clean energy has grown to a respectable size and long-term signals from government are coming together.

“This is a renaissance time for the cleantech sector,” said Ira Ehrenpreis, a general partner with the firm Technology Partners, during a panel discussion at the Renewable Energy Finance Forum in New York City. “This is not an obscure area of investment anymore.”

Last week, the Cleantech Group released a report on the state of venture capital, which showed that venture investments in the cleantech space were up 12 percent from the first quarter of this year. Total investments reached US $1.2 billion globally. That is still down over 40 percent from this time last year, but a rebound certainly seems to be underway.

The characteristics of this growth are different than in the past. Many venture capital firms are opting to re-invest with their portfolio companies rather than dig for new opportunities. As a result, series A rounds dropped by half in 2008, according to figures from New Energy Finance.

While the average size of those rounds has grown from approximately $6 million to $8 million, smaller companies are not getting as much attention, making it more difficult for undiscovered, game-changing technologies and business models to get funding.

“I'm actually highly concerned about the risk aversion and incrementalism that I'm seeing in the venture asset class,” said Ehrenpreis. “We're seeing people not swinging for the fences the way that venture capitalists ought to be swinging.”

This trend is a reflection of the broader economy, not necessarily a change in venture capital culture, said Ehrenpreis.

But some believe that venture capital culture is taking on a new form as the cleantech sector sees explosive growth. One would think that interest in this sector would make it easier for entrepreneurs to get a business off the ground. But the opposite is often the case, said author and entrepreneurial consultant Sramana Mitra.

“Increasingly, the VC model is more of a banking model,” said Mitra in an interview. “If they're only going to do late-stage financing, it's no longer a venture capital model. That is surely something that cleantech entrepreneurs need to address.”

The massive funds and large rounds of financing are creating unprecedented opportunities for clean energy companies. Funds of $250 million and above for renewable energy-related investments are not uncommon. However, as the figures from New Energy Finance show, most of those companies are in later stages of development.

Venture capital used to be about taking big risks by investing in early-stage companies; increasingly the venture capital community is going the other way, said Mitra.

Mitra does not believe that entrepreneurs should be frustrated by these trends. Instead, they should see them as an opportunity. Quite often, people get sidetracked trying to raise venture capital rather than focusing on “mentor capital” from smaller angel investors like colleagues, friends and family.

Given how capital intensive the clean energy industry is, relying on this type of funding can be more difficult. But it can also make an entrepreneur more successful by forcing them to be frugal and focused as they bootstrap their way through early-stage growth.

Venture capitalists are typically looking for returns within a seven-year time frame. In many cases, getting an idea off the ground can take longer, especially in the energy sector. Without having to rely on this more "impatient" model, said Mitra, entrepreneurs can take the time needed to develop their idea — assuming they can keep smaller investors on board that long.

In addition, more project finance opportunities will become available when the new clean renewable energy bond program, loan guarantee program and grant program are rolled out through the stimulus package over the next year. It will be crucial for entrepreneurs to understand these options, said Mitra.

“There are all sorts of other non-venture capital types of financing models out there, which entrepreneurs have to get incredibly savvy about in order to get their cleantech ventures off the ground,” she said.

The venture capital community may be focusing on later-stage companies, but that doesn't mean that things are easier for those players either.

According to a recent study from the Clean Energy Group and New Energy Finance, the so-called “valley of death” has widened for new clean energy technologies. The valley of death refers to the difficult period between proof-of-concept for a technology and large-scale deployment.

At a certain point, technologies become too capital-intensive for a venture capital firm to develop; however, the technological risk is sometimes too high for private equity investors and project financiers. This makes it difficult to deploy new energy technologies.

This recent report shows that average commercialization rounds of funding have risen by about $15 million, but the number of such rounds has dropped. That has stretched out this difficult period for many companies ready to bring their product to market.

“The valley of death looms large no matter how you measure it,” said Dan Reicher, Director of Climate Change and Energy Initiatives at Google.org in an interview. “With the economic crisis...so many technologies brought to commercial scale by the venture capital community are dying on the vine. This is quite a critical issue.”

The renewable energy industry faces a particularly expansive valley of death. Google has recognized that problem and made some high profile investments in order to stimulate the market for capital intensive technologies.

Over the last year, the company invested about $10 million dollars in advanced geothermal companies, $130 million in a concentrating solar power company and millions more in electric-vehicle and smart-grid technologies. Industries like advanced geothermal, in which companies drill miles beneath the earth to access temperatures over 1,000 degrees Fahrenheit, are currently very high risk. But Google sees the potential and continues to heavily promote the industry.

“We're very bullish about these various technologies,” said Reicher. “We have to build a few big plants to prove to the finance community that this is a viable technology.”

With high-profile firms like Google backing clean energy in a big way, early-stage companies in the space have a lot to be excited about.

The issue now, said Technology Partners' Ehrenpreis, is whether the venture capital community will continue to take the risks needed to harness innovation from entrepreneurs and new start-ups.

“We're trying to find things that have such game-changing characteristics,” he said “It's a challenge for the venture community to have the conviction to truly invest in the kind of venture-backed profile deals that we need and not invest in another 'me-too' deal that is defining today.”