Between 2006 and 2008, more than $1bn in venture capital was channelled into start-ups – seed and series A rounds – focused on solar, wind and biofuel technologies.
In the past three years, however, early-stage investments in clean energy production technologies have fallen substantially to between $100m and $250m per year. Many venture capitalists (VCs) are limiting their investments to the demand side – aimed at reducing energy use – rather than investing in start-ups trying to change the way we produce energy.
It is easy to see why VCs have soured on the sector – the traditional VC model is based on high-risk, capitalefficient business models with the potential for huge exit valuations. Even if most of their investments fail, a few spectacular successes can make the fund for a VC. A star example is Google, which raised a mere $40m in private funding before its initial public offering (IPO) at a $23bn valuation.
Most clean energy start-ups, on the other hand, need huge amounts of capital to get off the ground, and so far big payoffs have been scarce. Many VCs tell us the lack of big exits makes it harder to sell capital-intensive clean energy investments to their partners, particularly at a time when the lean start-up model is in vogue. Solyndra’s example has been particularly stark – it raised over $1bn in equity finance in addition to receiving a $535m loan guarantee from the US Department of Energy, all prior to a cancelled IPO and the recent Federal Bureau of Investigation investigation into its bankruptcy.
The net result is that many VCs now turn down promising companies that might contribute to transforming the way we produce energy. Despite these gloomy headlines, three developments in the sector give us hope that the revolution in clean energy production is far from dead:
1 Although generalist VCs have shied away from the sector, a number of specialist clean-technology investors have emerged in the past decade. These investors have been willing to dedicate the time and effort required to build an energy company, and are actively experimenting with new models for investing in this capital intensive sector.
Between 2008 and 2010, more than 25 US-based, cleantech-focused venture capital and private equity funds each raised over $300m in committed capital, amounting to over $35bn of capital committed for clean energy startups, with Khosla Ventures raising more than $1bn for its latest fund.
It is also significant that energy production technologies are still attracting investment from VCs. Of the more than 200 early-stage investments made in clean-tech companies in the US between January and July this year, 40% were in start-ups related to solar, wind and biofuels.
2 While there has not been a defining exit in clean energy akin to the Netscape moment for the internet – referring to the internet portal’s IPO in 1995 – there have been numerous recent IPOs in the biofuels sector. Examples such as Amyris, Solazyme, Gevo and Kior have opened the door for other companies to file.
We are also beginning to see an IPO window open for solar start-ups, led by solar thermal company BrightSource Energy and microinverter company Enphase, which filed for their IPOs earlier this year. If the IPO window remains open in spite of Solyndra’s public failings, we anticipate a broader set of clean energy start-ups will achieve successful exits.
3 Our biggest optimism, however, comes from the evolutions we are seeing in the sector as a whole, which includes both start-ups and incumbents.
Large corporate players are beginning to show interest in early-stage clean energy companies, both through corporate investment arms and through full acquisitions.
Their behaviour displays promising parallels to the early days of the biotechnology industry. When biotech startups such as Genentech began to acquire other start-ups to retain its edge, pharmaceutical incumbents were forced to enter the acquisition mêlée to remain competitive.
This same trend is now playing out in the solar energy sector – yesterday’s start-ups FirstSolar and SunTech are becoming today’s acquirers, and General Electric’s (GE’s) acquisition of thin-film solar company PrimeStar Solar earlier this summer is intended to allow the giant to go headto- head with FirstSolar in this market.
Corporate venturing is also increasingly common, as shown by the $300m corporate venturing fund established by GE, ConocoPhillips and NRG Energy, as well as notable activity from Total, Dow, 3M and Procter & Gamble.
Since energy start-ups operate in an ecosystem dominated by incumbents, they can benefit dramatically from the use of incumbent resources. Working with larger companies gives start-ups access to manufacturing capabilities, distribution channels and credible brand names, which are even more important in capital-intensive, incumbent- dominated and relatively risk-averse industries.
While customers may be hesitant to purchase equipment from a nascent start-up, GE chief executive (CEO) Jeff Immelt has quipped: "No utility CEO will ever get fired for working with GE."
In turn, established manufacturing players such as GE, Schneider Electric and Applied Materials can benefit from integrating new technologies into their production lines and distribution channels, allowing them to develop new product offerings and expand to international markets where government incentives and market dynamics make clean energy technologies more economic.
Perhaps most importantly, the large balance sheets of established manufacturing companies are well positioned to carry start-ups across the financing gap between demonstration and large-scale commercialisation, which is often referred to as the valley of death. Start-ups such as Amyris have relied on partnerships with incumbents to help them pursue less capital-intensive paths.
This is becoming an increasingly popular trend, and allows VCs to focus on their traditional sweet spot of riskier, less capital-intensive phases of these start-ups’ lifecycles.
Moreover, if incumbents choose to acquire a start-up outright, they provide a sustainable exit mechanism for investors that can outlast any possible closing of the IPO window.
In comparison with the biotech industry, where each pharmaceutical company has relatively similar capabilities, each energy technology is more specialised and hence has a smaller set of incumbents that could realise strong synergies from an acquisition. This means start-ups risk being held hostage to the greater negotiating power of incumbents, which can force down prices when the start-up has fewer outside options relative to the sale.
Moving forward, the larger funds run by dedicated investors and the increased possibility of an IPO – our points 1 and 2 above – will give start-ups greater staying power in their negotiations with incumbents. Despite these developments, start-ups should be conscious of the path to an acquisition when they first take VC money and think about approaches to raise less dilutive equity capital.
The use of computational modelling to demonstrate viability, developing modular technology, and focusing on manufacturing components rather than systems are all approaches that start-ups in this space have successfully taken to become more capital efficient in the early stages of their development.
By using these strategies, clean energy start-ups can better position themselves for acquisitions and promising exits. In turn, we believe that a vibrant acquisition market will provide a strong incentive for entrepreneurs to build clean energy companies and for VCs to invest in them, creating an innovation pipeline that can help us meet our global energy and climate challenge.
First published on the Harvard Business Review website