Whats Wrong with Cleantech Venture Capital

DRAFT

What's wrong with
cleantech venture capital?
December, 2008

2

We are all convinced cleantech = $$, right???

This information is not investment advice and should not be used to inform any investment decisions by anyone at any time

3

Some very smart VCs are 110% on board

“John Doerr said to me: ‘Are we going to have any more Googles?’ And I said:
‘You're damn right we are, because we are at the point of new wealth
creation when it comes to green technology.’”
Bill Joy

“The underlying markets of cleantech are among the largest markets in the
world. India and China represent 40 percent of the world's population, and
they're undergoing the type of industrialization that we experienced in the
twentieth century. The energy demands that will cause is a tremendous
opportunity.”
Ira Ehrenpreis

“There are many such things going on that are radical, implausible – each
individually (is) somewhat implausible, on the aggregate (it is) highly
plausible that one plan will work. That's the key to the solution.”
Vinod Khosla

“I think the oil industry is actually getting fat and lazy, and I think there
are some great opportunities there in clean tech.”
Tim Draper


4

Just one little problem...

Almost no exits yet

And few failures either

VCs don’t yet know what
works and what DOESN’T
work in this sector


5

So what should cleantech VC look like?

What structural and strategic
considerations would
maximize IRRs?


6

’95-’96: What VC used to look like

• 1996 average fund size = $138M
• 2,000 total VC investments per year
-Avg. around $4.5M per investment across all stages
-50% in seed and early stage investments
-37% of venture dollars into CA, 9% into MA
-Top 5 MoneyTree sectors (out of 17) garnered 57%
of venture dollars
 1995: Software, telecom, media, biotech,
medical devices
• 20-35% of investments resulting in IPO
-Accounting for the bulk of the profits
-Average holding time to exit = 4 years
-IRRs >20%

MoneyTree; Gompers and Lerner, 1999


7

VCs shifted in the late '90s, and learned hard lessons

160

140 Average Annual Rate
120
of Return to
100
Investors in U.S VC
Funds
80

60

40

20

0
1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
-20

Source: Venture Economics


8

But are cleantech VCs now making the same mistakes?
Circa 2000


9

We can make some assumptions (1 of 2)

1) VC economics haven’t changed
• Buy low, sell high
• Still looking for 5-10x return potential
• Still operating under 2.5 and 20 comp structure
• Still looking for 3-7 year holding periods

2) VC operations haven’t changed
• Pick one out of a hundred opportunities, lots of time
spent in search and evaluation
• Serve on Boards, lots of time spent on portfolio
• Raise new funds every two years

3) Valuations are often affected by round size*
• Entrepreneurs focused on dilution more than a dollar
valuation
*Even if they shouldn’t be!


10

We can make some assumptions (2 of 2)
4) The money needs to go to where the ideas
and entrepreneurs are

5) Over time, cleantech exits will look like other
VC-backed exits
• The usual mix of M&A and IPO, at similar values

6) Exits require profits, not to mention strong
revenues
• See point #7 below if you disagree

7) THE LATE 1990s WERE AN ABERRATION AND
THOSE KINDS OF RESULTS WON’T EVER
HAPPEN AGAIN IN VENTURE CAPITAL


11

So what are cleantech exits likely to look like?
Most VC exits are via M&A
# of US VC-backed exits, all sectors

340 313 439 408 426 445 205
100% IPO

80

60

M&A
40

20

0
2002 2003 2004 2005 2006 2007 1-3Q08

And the median M&A exit is <$100M
$200M

$153M
150

100 $98M

$74M $77M
$98M

$54M $57M
50 $63M
$38M
$29M $47M $52M
$27M $39M
$18M
$24M Median
Mean
0
2001 2002 2003 2004 2005 2006 2007 1Q08

Finding IPO-worthy companies is still important, but you
can’t price deals with that expectation
Thomson Reuters/ NVCA,
Dow Jones Venture Source

12

Even IPOs aren’t a guaranteed big return
Largest US-domiciled VC-backed cleantech
IPOs, 2001-1H08

Company Year Raised Pre Exchange
Comverge 2007 $95M $286M Nasdaq

EnerNOC 2007 $92M $486M Nasdaq

Clean Air Power 2006 $18M $29M AIM

Protonex 2006 $16M $52M AIM

Hoku Scientific 2005 $21M $80M Nasdaq

Ocean Power 2003 $42M $73M AIM

Metabolix 2006 $95M $233M Nasdaq

PolyFuel 2005 $14M $26M AIM
E&Y


13

So how do you get a 5x out of a decent trade sale?

ILLUSTRATIVE

It helps to be an early Oversimplified example
investor
FirmA $$ Rnd $$ Pre- FirmA own%

Series A $3M $6M $6M 25%

Early rounds need to be at Series B $2M $8M $18M 25%

reasonable valuations
Series C $1M $10M $50M 23%

FirmA
$6M 23%
Total
And you can’t end up $130M exit * 23%
5x return
putting gobs of money $6M in
=

into the company


14

Yet VCs are putting more $$ into each deal

Avg. US cleantech round size Avg. total capital per VC-backed company
(all stages) (so far!)

$20M
Transportation $61.0M

15
Solar $40.9M

10 Biofuels $39.1M

Energy Eff. $13.9M
5

Water $13.9M

0
0 20 40 60 80
19 5
19 5
19 7
19 8
20 9

20 1
20 2

20 4
05

20 7
20 0

20 3

20 6

(3 08
9

9
9

0

0

0
9

9
0

0
0

0
19

20

)
Q

MoneyTree; E&Y


15

Cleantech is complex and varied…

GreenTech Media


16

…Yet VCs are piling into just a couple of techs…

As new investors get into the market, by default they jump into the
sectors where money is already flowing

• GreenTech Media is
tracking 150 solar startups

• Solar is now >35% of
global cleantech VC dollars

• Together, solar,
biofuels and
transportation are now
~60% of global
cleantech VC
investments (1H08)

Cleantech Group; GreenTech Media

17

...And techs which don't always have good economics

Includes
most of the
supply-
related
solutions
VCs are
investing in

Includes
many
demand-
related
solutions


18

Cleantech VCs are shifting to late stage

North American # of • Clean technologies in the lab can
cleantech deals by stage
take longer to commercialize than
Follow
200 on I.T., Web2.0, etc.
- But not longer than biotech! Shh!

150 • The returns this decade have been
stronger in later stage
- But that’s not true for longer term
100 returns, shh!!!
First
round • The herd is moving to later stage
and “balanced” (ie: 80% late stage)
50
• It’s also the only way to spend all
Seed
the money in the latest mega-funds
0
2003 2004 2005 2006 2007 2008* in the sector

Source: Cleantech Group
* Annualized from Q1-Q3 data
So let’s go later!

19

The problem is… Everyone is going later.
It raises a few questions…
How will so many firms going after the same few deals find
reasonable valuations?

Later stage investors with good brand and networks in
cleantech will have successes, but how much will the
“winners curse” otherwise impact a crowded market?

How does a $10M minimum check size (as some investors
now have) work within an M&A-driven exit environment?

How will we create enough early stage companies to fulfill
the appetites of the late stage investors???

Are more big late-stage funds really the answer???


20

Cleantech isn't just in CA and MA…

Cleantech innovations Cleantech entrepreneurs
No. of U.S. patents filed since
2000, by keyword in abstract
1,012 610 389 265 6,193
100% 100%

80 80

Other USA
60 60
Plains
PNW+AK/HI
40 Southwest 40
Rockies
Great Lakes
Boston
Southeast/
20 TX
Mid-Atlantic/
20
NY CA
New England
California
0 0
"solar" "wastewater" "ethanol" "energy" + Renewable Energy Business
"consumption"
Network: LinkedIn members

Author’s patent search; REBN


21

But VCs aren’t happy travelers

Cleantech deals
(first round only, since 2004)
330 AK/HI/PR
100%
Rockies/
Southeast
Plains
Northwest
80 Southwest

Midwest

60
Northeast

40

20 California

0
1st round VC deals

Cleantech Group


22

What Cleantech VC looks like today
• >100 VC firms investing in cleantech, with most dollars and deals
going into late stage

• Mega-funds (>$300M) being raised, locking in the crowded late
stage as an entrenched feature of the market

• Most clean technology subsectors being relatively neglected as
everyone piles into the increasingly zero-sum-games of solar,
biofuels and electric vehicles

• Most investments going into California and New England, artificially
limiting the pool of possible investments

• Many VCs gambling that they can find “black swans” that will be
huge IPOs, even knowing that such outcomes will be very rare

• Lack of exits and failures means little track record to differentiate
between VCs – so P.R. is heavily deployed


23

What Cleantech VC needs to look like

• Probably fewer funds in the sector overall, but definitely fewer late
stage focused funds

• More smaller funds writing smaller checks into capital efficient
businesses with high-growth and good exit potential

• Early stage specialists and sophisticated seed stage funders acting as
“scouts” in the underdeveloped subsectors/ technologies, leading the
way where generalists can then co-invest and follow

• Investments where the innovations and entrepreneurs are,
not where the VCs are based

• Building subsector ecosystems, not betting on singular “black swans”

• A focus on building high-growth and PROFITABLE companies that
then become natural acquisition and IPO candidates


24

Conclusion

VCs need to stop trying to figure out what
new investment models work in cleantech…

…They need to start figuring out what parts
of cleantech work for the proven VC model.


25

Questions?

Peter Mills Marc Poirier
pmills@ventures.com marc@ventures.com
650-322-3245 978-658-8980 x1

Matt Horton Rob Day
matt@ventures.com rob@ventures.com
650-322-3246 978-658-8980 x5


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