Why Venture Capitalists Abandoned Clean Energy
Posted by hkarner - 15. September 2016
Source: The Wall Street Journal
Two experts say high costs and low returns sent venture capitalists fleeing. A new funding model, they say, is crucial.
Venture capitalists and clean-energy companies thought they had a bright future together. It hasn’t worked out that way.
A decade ago, clean-energy companies were the hot trend that venture capitalists were chasing. Oil and natural-gas prices were on the rise and Al Gore’s “An Inconvenient Truth” had just made its premiere.
But high hopes that the clean-energy sector would replicate the big returns of biomedical and software startups quickly faded. Instead, monumental losses piled up: Venture-capital investors lost more than half of the $25 billion they pumped into clean-energy technology startups from 2006 to 2011.A study of why venture capital and clean energy haven’t been a good match was launched by Benjamin Gaddy, director of technology development at Clean Energy Trust, a startup accelerator in Chicago, and Varun Sivaram, the Douglas Dillon fellow at the Council on Foreign Relations. In a paper recently published through the MIT Energy Initiative and written with Francis O’Sullivan, the Energy Initiative’s director of research, they predict future funding for energy startups increasingly will come from more-patient providers than venture capitalists—including groups like the Breakthrough Energy Coalition, formed by Bill Gates and more than two dozen wealthy investors last year. And they argue that established energy companies and governments need to play a bigger role in nurturing clean-energy startups.
Following are edited excerpts of an interview with Dr. Gaddy and Dr. Sivaram.
WSJ: When did venture capitalists first start looking at renewable energy, and what were they expecting?
DR. GADDY: Before 2006, VCs perceived that clean tech might have a risk/return profile that was similar to software or biomedical. And in fact, there is a strong case to be made that clean tech is similar to the biomedical industry. Just like the biomedical industry, clean tech is capital intensive—you need a lot of money to stay aloft. It relies on fundamental science breakthroughs—it might take a little longer.
WSJ: How did the clean-tech startups that you looked at perform?
DR. GADDY: Ultimately, when we looked at the data, when we looked at companies that got venture-capital investment, [clean-tech firms] were slightly more risky [than software or biomedical], but the real difference was the returns. Those outsize multiples simply weren’t there.
This home-run return requirement—that the 1-out-of-10 successes need to pay back the entire fund—we found that that simply was not true for clean-tech companies. When clean-tech companies exited they didn’t return sufficient capital to investors.
WSJ: Why didn’t it work for VCs to continue betting on clean-tech startups?
DR. SIVARAM: First, we found these investments were illiquid. They would tie up capital for much longer than the three- to five-year time horizon that VCs preferred.
It also takes a lot of money to get fundamental science right and to scale it up. Building extensive factories and building demonstration projects to scale, those were not activities that VCs ended up being willing to fund at the hundreds of millions of dollars level.
Third, energy companies or clean-tech companies were going into markets that are legacy industries, for which a product already exists that does a pretty good job. So when you’re a solar-panel company competing with cheap electricity from natural gas, you don’t have the benefits of high margins. You instead have to compete at the razor-thin margins of the commodity markets.
And finally, the fourth reason we found was that the valuation premium that companies might receive upon exit, even if they were successful, simply was not high enough to justify the investment put into them.
DR. GADDY: A new cancer drug doesn’t have to compete in a commodity market the way an improved solar panel does. Certainly the incentive for medical companies to be willing to take those risks and acquire those companies is there. And unfortunately in the case of the energy companies, it’s simply not.
WSJ: So far, what has the dearth of funding in recent years meant for the pace of technological development and new startups in clean tech?
DR. GADDY: Realistically, one of the consequences has been almost a lost generation of energy innovators. So in 2006, 2007, engineers and scientists coming out of American universities who had a passion for solving the climate-change crisis founded companies, went to Sand Hill Road, raised money and they really gave it their best shot. But once that funding dried up, there really was no pathway for the energy innovator to create a company and try to bring their technology to the market.
DR. SIVARAM: Certainly it’s the case that in solar, my field, we have lost a decade of good commercial work, and the rift between academia and industry has never been larger.
WSJ: Are these challenges signs that these companies just aren’t viable, or do they point to a problem particular to this funding model?
DR. SIVARAM: Clean-tech innovation is absolutely crucial. We think it’s alarming that there’s no support from the private sector for commercialization of important technologies.
The VC model is broken for clean tech because the short time horizon leaves them capital-constrained. But what about the institutional investor? The pension fund, the family office or the sovereign-wealth fund who has more capital to play with and a longer time horizon to recognize returns? And there are some signs already that those investors are willing to invest.
The second type of actor is corporations. We really need corporations to start to invest both as strategic investors in the equity of the company as well as fully acquiring companies.
We think that trickle of activity can turn into a flood if the federal government is more expansive in its support for research and development but also demonstration of these technologies.