what's wrong with cleantech vc

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

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Written for an upcoming limited partner event, this presentation explores current trends in cleantech venture capital and what's working and what's not.

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Page 1: What's Wrong With Cleantech VC

What's wrong with cleantech venture capital?

December, 2008

DRAFT

Page 2: What's Wrong With Cleantech VC

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

2

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

Page 3: What's Wrong With Cleantech VC

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

Page 4: What's Wrong With Cleantech VC

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

4

Just one little problem...

Almost no exits yet

VCs don’t yet know what works and what DOESN’T

work in this sector

And few failures either

Page 5: What's Wrong With Cleantech VC

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

5

So what should cleantech VC look like?

What structural and strategic considerations would

maximize IRRs?

Page 6: What's Wrong With Cleantech VC

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

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 dollars1995: 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

Page 7: What's Wrong With Cleantech VC

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

7

-20

0

20

40

60

80

100

120

140

160

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

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

Average Annual Rate of Return to

Investors in U.S VC Funds

Source: Venture Economics

Page 8: What's Wrong With Cleantech VC

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

8

But are cleantech VCs now making the same mistakes?

Circa 2000

Page 9: What's Wrong With Cleantech VC

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

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!

Page 10: What's Wrong With Cleantech VC

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

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

Page 11: What's Wrong With Cleantech VC

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

11

$27M

$18M $24M$39M

$47M $52M

$98M

$63M

2001 2002 2003 2004 2005 2006 2007 1Q08

$54M

$29M$38M

$57M

$74M $77M

$153M

$98M

0

50

100

150

$200M

MeanMedian

So what are cleantech exits likely to look like?

IPO

M&A

2002 2003 2004 2005 2006 2007 1-3Q08

340 313 439 408 426 445 205

0

20

40

60

80

100%

# of US VC-backed exits, all sectors

Most VC exits are via M&A

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

Thomson Reuters/ NVCA, Dow Jones Venture Source

Finding IPO-worthy companies is still important, but you can’t price deals with that expectation

Page 12: What's Wrong With Cleantech VC

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

12

Even IPOs aren’t a guaranteed big return

Company Year Raised Pre Exchange

Comverge 2007 $95M $286M Nasdaq

Largest US-domiciled VC-backed cleantechIPOs, 2001-1H08

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

Page 13: What's Wrong With Cleantech VC

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

13

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

And you can’t end up putting gobs of money

into the company

It helps to be an early investor

Rnd $$ Pre-

Series A $6M $6M 25%

FirmA own%

Series B $8M $18M 25%

Series C $10M $50M 23%

Oversimplified example

FirmATotal 23%

ILLUSTRATIVE

Early rounds need to be at reasonable valuations

FirmA $$

$3M

$2M

$1M

$6M

$130M exit * 23%$6M in

= 5x return

Page 14: What's Wrong With Cleantech VC

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

14

Yet VCs are putting more $$ into each deal

1995

1995

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

(3Q)

0

5

10

15

$20M

Water

Energy Eff.

Biofuels

Solar

Transportation

$13.9M

$13.9M

$39.1M

$40.9M

$61.0M

0 20 40 60 80

Avg. US cleantech round size(all stages)

Avg. total capital per VC-backed company(so far!)

MoneyTree; E&Y

Page 15: What's Wrong With Cleantech VC

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

15

Cleantech is complex and varied…

GreenTech Media

Page 16: What's Wrong With Cleantech VC

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

16

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

Cleantech Group; GreenTech Media

• 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)

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

Page 17: What's Wrong With Cleantech VC

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

17

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

Includes many

demand-related

solutions

Includes most of the

supply-related

solutions VCs are

investing in

Page 18: What's Wrong With Cleantech VC

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

18

Cleantech VCs are shifting to late stage

• Clean technologies in the lab can

take longer to commercialize than

I.T., Web2.0, etc.

- But not longer than biotech! Shh!

• The returns this decade have been

stronger in later stage

- But that’s not true for longer term

returns, shh!!!

• The herd is moving to later stage

and “balanced” (ie: 80% late stage)

• It’s also the only way to spend all

the money in the latest mega-funds

in the sector

Seed

Firstround

Followon

2003 2004 2005 2006 2007 2008*0

50

100

150

200

North American # ofcleantech deals by stage

Source: Cleantech Group* Annualized from Q1-Q3 data

So let’s go later!

Page 19: What's Wrong With Cleantech VC

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

19

The problem is… Everyone is going later.

How will so many firms going after the same few deals find reasonable valuations?

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

It raises a few questions…

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???

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?

Page 20: What's Wrong With Cleantech VC

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

20

Cleantech isn't just in CA and MA…

"solar" "wastewater" "ethanol" "energy" +"consumption"

1,012 610 389 265

0

20

40

60

80

100%

No. of U.S. patents filed since2000, by keyword in abstract

CaliforniaNew England

Mid-Atlantic/NY

Southeast/TX

Great LakesRockiesSouthwestPNW+AK/HIPlains

Other USA

Boston

CA

Renewable Energy BusinessNetwork: LinkedIn members

6,193

0

20

40

60

80

100%

Cleantech entrepreneursCleantech innovations

Author’s patent search; REBN

Page 21: What's Wrong With Cleantech VC

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

21

But VCs aren’t happy travelers

AK/HI/PR

Rockies/Plains

SoutheastNorthwest

Southwest

Midwest

Northeast

California

1st round VC deals

330

0

20

40

60

80

100%

Cleantech deals(first round only, since 2004)

Cleantech Group

Page 22: What's Wrong With Cleantech VC

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

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

Page 23: What's Wrong With Cleantech VC

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

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 efficientbusinesses 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

Page 24: What's Wrong With Cleantech VC

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

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.

Page 25: What's Wrong With Cleantech VC

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

25

Questions?

Peter [email protected]

650-322-3245

Matt [email protected]

650-322-3246

Rob [email protected] x5

Marc [email protected]

978-658-8980 x1