After Losses, Should Cleantech VC’s Retreat or Double Down?

In this age of full-scale Tweet wars, it was more of a Twitter kerfuffle. When three top venture capitalists appeared before a group of budding entrepreneurs at the Department of Energy’s Clean Energy Business Plan Competition last week, they encouraged the young businesspeople in attendance to focus not on the short-term profits but rather on big, risky tech breakthroughs that may revolutionize entire industries.

Sound risky? Yes. That’s the point.

“The amount of money needed is two-and-a-half times the amount needed for the average startup,” Matthew Nordan, a partner at Venrock, said of startups in the cleantech space. “And the risk curve is very different. You’ve got to spend a lot more money before you know if you’ve won.”

Rob Day’s response, delivered with respect for his friend and esteemed colleague? That’s nonsense. Day, a partner at Black Coral Capital, fired off a series of exasperated Tweets when he read quotes by Nordan and other blue-chip VC’s in a recent story by CleantechIQ.

“(H)ardware innovation is vital. But this common VC perspective that it’s what really matters is frustrating,” Day said in one of Tweets. “Wasteful, too.”

A battle royale this was not. The difference between the panelists and Day is one of emphasis and degree, not of polar opposites. But the disagreement is nevertheless important. Venture capitalists are still responding to investors’ dashed hopes, built up over a decade, that the next Google-scale mega-hit lays somewhere in cleantech, says Nicolas Eisenberger, managing partner at Pure Energy Partners.

The fact that such an opportunity has not yet materialized is causing venture capitalists to choose between two quite different paths. Some, including the venture capitalists on the DOE’s panel, have effectively doubled down. If the risks are even bigger than they previously imagined, these investors say, so too are the potential profits.

“Last year, 12 of our companies successfully raised collectively over $500M (mostly up rounds) in equity during the most difficult funding environment ever: because they each had unique, not incremental, technologies,” Andrew Chung, a partner at Khosla Ventures, said in a recent email. “The key message is that entrepreneurship in any form – especially cleantech – is damn hard, so one should make the effort count and not doing something that’s undifferentiated or incremental – rather, something ‘big.’”

Down the opposite path walk venture capitalists burned by big losses. These VC’s are more nervous than ever about promising big and delivering small.

“I do think the VC cleantech world is in a defensive crouch right now because the investing has gone down in the early stage,” Eisenberger says.

The problem, as Day sees it, is twofold. First, dreams of 10-X returns were based on commodity prices as they stood in the early 2000s. Ten years and billions of dollars’ worth of VC investment later, tech innovation has been so widespread that “everybody’s margins got crushed,” Day says.

The second, even larger problem is that technological breakthroughs were not accompanied by innovations in business models. So many companies spent so much money getting advanced products to market, Day says, they had nothing left to ride out the inevitably lengthy customer adoption period.

“That’s why so many cleantech startups have failed. I’ve lost a lot of money on this,” says Day. “You’re burning money, and then it takes two years longer than you expected for people to start buying it, and then you run out of cash.”

These perspectives are not mutually exclusive, of course. Any venture capitalist worth her salt swings at singles and potential homeruns. Regardless, some combination of personal opinion and data-driven research is driving venture capitalists apart, turning any conversation dubbed “advice for nubies” into a potential flashpoint for controversy.

Following the advice of the panelists to go big—and if that doesn’t work, go bigger—could cause entrepreneurs to miss solid opportunities such as solar and LED’s, where mature technologies need “soft” innovations in financing, customer acquisition and supply chain in order to succeed, Day says.

“This is the reason for my whole friendly rant,” says Day. “If you’re talking to the whole ARPA-E crowd and they’re doing these 20-year tech developments to do something massively breakthrough from a science perspective, awesome. What worried me in the presentations to entrepreneurs, there is absolutely zero evidence that that works in this market. We need both.”

Besides, Day says, savvy entrepreneurs understand that their interests may be quite different than their investors. Oftentimes, a VC who finds a successful company wants to flood it with additional funding rounds and earn more money from his deployed capital, even if the entrepreneurs would profit more from an early sale.

“I’ve absolutely had conversations with entrepreneurs who raised a growth round with a really high valuation, and they’re really excited,” says Day. “What they don’t realize is their opportunities to have a successful exit just got a lot smaller.”

The way to avoid such disputes is to make sure VC’s and entrepreneurs agree early about the company’s direction, Chung says.

“At Khosla, our mission is to help great entrepreneurs build companies of lasting significance – so we’re unlikely to invest in founders who are predisposed to seeking a modest or early exit,” Chung wrote.

Another difference lies in the entrepreneurs’ aversion to policy risk. The fact that Congress can change the rules of the game regarding incentives, tax credits and tax policy with the stroke of a pen makes Nordan nervous.

“Venrock has never made a solar investment, a smart grid investment, because we believed those markets were being created by regulatory fiat and we couldn’t determine whether it would still be there in two or four years,” he said.

Different investors with different degrees of policy risk aversion is natural and normal, Eisenberger says. But claiming complete isolation from policy changes is a fool’s errand, says Day—what if Congress decides to default on the nation’s debts?

Besides, even if Nordan looks for as little policy exposure as possible, other investors are more than eager to take those bets.

“I don’t think that ‘No policy risk’ should be taken too seriously,” says Day. “If Matthew was saying investors shouldn’t take policy risk, that’s silly. If he’s saying ‘We don’t take policy risk,’ that’s fine.”

 

 

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