Cleantech venture investing: dying – or just resting?

Two weeks ago, I sat on a panel of eminent (that is, other than myself) cleantech venture capitalists at the New England Venture Summit to discuss our sector as we approach the end of 2012.

The basic theme being explored was whether we should be optimistic or pessimistic about the current state of affairs for cleantech investing.

As I noted in my opening quip:  “I have friends on both sides of this issue, and on this issue, I’m with my friends.”

Seriously, it’s easy to understand being pessimistic.  While the data on cleantech venture capital investing activity has been mixed and erratic over the past few years, the qualitative indicators have led to a plethora of articles during 2012 suggesting a cleantech “bust”.  True, the litany of woes is substantial.

• Several high-profile venture capital firms have retreated from or at least strongly de-emphasized cleantech investing, and other cleantech venture firms are widely thought to be in challenging positions likely precluding a next fund for ongoing viability.
• Valuations on cleantech investment rounds have experienced significant downward pressure.
• While early-stage deals can get done, the trend is towards focusing on later-stage deals, and ventures with long histories but only limited customer traction and modest revenues (less than breakeven) will find it difficult to obtain the next round of capital at favorable terms.
• The Solyndra debacle has been an excruciating black eye for venture-backed cleantech deals in general.
• Very low natural gas prices from the shale bonanza make it difficult for many energy-related cleantech firms to compete economically with their products.
• The Republican party has successfully made cleantech a political litmus test, which in turn means that roughly 50% of the U.S. population views the sector with a general sense of skepticism or disdain.

When you sum this up, it’s pretty tough to be a cleantech venture investor these days.   But, there’s also a strong case to be made for cautious optimism, too.

Taking the long view – which I can to a fair degree, since I’ve been playing in this sandbox in various capacities for nearly 15 years, far longer than most observers – the situation we face today is not as discouraging as it was in the late 1990s (when only ventures called ______.com could get funded) or in the 2002-2005 era (post-9/11, post dot-com meltdown, post-Enron, still-cheap oil).

A much-needed cleansing of the sector is going on, a case of Schumpeterian “creative destruction”.  I suspected then, and am pretty convinced now, that a significant cleantech venture investment bubble occurred in the 2006-2008 timeframe.  The confluence of rapidly rising oil and natural gas prices plus greater political consensus about climate change (recall that 2008 GOP Presidential candidate John McCain supported carbon-mitigation policies) drew in not only too-much capital, but also investment professionals that – in my opinion – weren’t applying a prudent set of commercial perspectives when making bets in the uniquely challenging cleantech space.

Simply put, venture capitalists drawn into cleantech from other sectors – either software or healthcare – because it was the “new new thing” employed many of the tricks they used (often successfully) in the past, but which don’t necessarily work so well in cleantech.  Combined with ever-increasing sizes of venture funds, which need bigger investments to “move the needle” (i.e., generate returns upon exit sizable enough to be noticeable), excessive quantities of capital were thrown at a number of cleantech ventures before they were ready to make productive use of such resources.

Using a pricelessly-wise idiom that I first heard from legendary venture capitalist David Morgenthaler:  “Getting nine women pregnant won’t get you a baby in one month.”

Not surprisingly, too many capital-intensive cleantech deals got funded, focused on a too-narrow set of investment theses, including thin-film solar, lithium-ion batteries, electric vehicles, and second generation biofuels.

Clearly, there will be a shakeout in cleantech investing.  More ventures will go bust.  More cleantech venture capitalists, and venture capital firms active in cleantech, will withdraw from the space.  Only the strongest will survive.

Yet, those that survive will almost certainly be better prepared to prosper in the next uptick in cleantech venture investing.  And, the deals will be more attractive:  valuations will be lower, business plans and models will be sounder, and leadership teams will be more seasoned.

Yes, there will be a rebound in cleantech.  I’m not going to predict exactly when it will become fully evident, but it must happen.  After all, the overall fundamentals in support of the cleantech thesis still remain:  growing populations and increasing standards of living worldwide who are demanding greater environmental protection while simultaneously competing for finite (in many cases, dwindling) essential resources such as energy, water and food.

The members of the panel on which I sat generally reiterated the same basic themes:  capital-efficiency of scale-up, clear technological differentiation and economic superiority, greater involvement of corporate venture capital as funders, working early with strategic partners (future acquirers) to accelerate market penetration, improved teams with relevant entrepreneurial experience from prior cleantech ventures.

Paraphrasing Mark Twain, the death of cleantech venture investing has been greatly exaggerated.  Although it may be “stunned”,  it’s not “just resting” or “pining for the fjords”, either.

The cleantech venture capitalists who will be successful in the future are today still working hard on their portfolio companies.  Most will not be noteworthy exits.  Some will need to be terminated, others “worked out” through turnarounds and restructurings, with a few winners coming out at the end of the process.  Not all the winners need to be “the next Google” or even “home runs”, but rather solid companies producing good (if not outrageous) rates of return to investors.

This restructuring of the cleantech venture sector will take time and be painful for pretty much everyone involved.  But it’s the price to be paid to stay in the game, and will surely separate those who are truly committed and capable from the “wanna-bes”.

I intend to remain engaged for the rest of my career, and will be working diligently to continue to earn the right to do so.