In Tough Fundraising Environment, VCs Hone Skills

In the toughest fundraising environment since the financial crisis and a significant drop in new capital available for cleantech funds, investment managers are going back to basics.

Consultants and institutional investors said the “all things to all people” approach does not work anymore in the private venture capital space, and cleantech venture capital managers need to find a niche story to tell that will set them apart.

“It’s not only important to identify the right sub-sectors for investment, but also to closely evaluate the teams that are making these investments, to make sure they have the private investment experience and background to evaluate these sub-sectors effectively,” said Nathan Mazonson, an associate consultant at Cambridge Associates. “We have observed success stories in different sub-sectors, so we are really looking for investment managers who are deeply experienced.”

Mazonson said the private equity, venture capital cleantech sector is too broad for investment managers to have the knowledge to invest in everything, and in turn, investment managers are refining and focusing investment strategies.

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Shawn Wischmeier, chief investment officer at Margaret A. Cargill Philanthropies, said he sees a mix of funds that are both broad and extremely niche, and a good manager will strike the right balance. “You need the ability to be a little flexible and have the opportunity to bet on a couple spaces, yet not be all things to all people,” he said at a Greentech Media conference on Sept. 12.

“I’m excited about some of the opportunities out there,” Wischmeier said. “I’m probably more of a fan of the hardcore technology stuff than the various web-enabled or cleanweb. I think there is still an opportunity in that area. The big bonanza success stories have still been out of the tech stuff. I do think it will have safer returns with the business model type strategies but that’s not what we are into. We are impact investors. We are still willing to lose money on eight or nine deals to get another Tesla.”

Mark Hayes, managing director of portfolio strategy at Stanford Management Co., which manages Stanford University’s endowment, said renewable power development was making money and looked the most attractive. “You’re not necessarily taking a lot of technology risk and deploying existing technologies into the grid,” he said at the conference.

Indeed, renewable power development had some of the best returns, according to Cambridge, which screened over 70,500 investments held by over 5,500 funds in its private investments performance database. The cleantech sample was a result of 1,233 investments in 652 companies across 409 funds as of March 31.

Across the four major cleantech investment groups, 33.2% of capital was deployed in renewable power manufacturing investments, 30.8% in renewable power development investments, 21.9% in energy optimization investments, and 14.1% in resource solutions investments.

Renewable power development had the strongest returns with 11.1% gross internal rate of return. That sector includes processes that allow for the financing, installation, management, operation, or ownership of renewable power generation projects.

The worst performer was renewable power manufacturing, returning only 0.8%. That sector includes solar and wind power manufacturing, other power generation manufacturing like renewable inputs, fuel cells, or waste capture, and biofuels and biomaterials.

“If you look at 2005 to 2008, dedicated cleantech funds raised a significant amount of capital and quickly put it to work,” Mazonson said. “When too many dollars chase too few good investments, returns tend to not look that good, regardless of the private investment asset class. This capital was also put to work right before the market crash.”

That dynamic created poor returns for dedicated cleantech funds, and coming back has been a challenge. Still, there is more interest in the sector now than there was a year ago with limited success stories helping to spur demand.

For example, renewable power manufacturing technologies are becoming more cost competitive, and some investors are looking to integrate and scale these technologies through more capital-efficient business models, Mazonson said. “Think smart grid, energy efficiency, and clean web plays.”

“Cleantech returns have not kept pace with other private investment sectors to date, but in interactions with certain Limited Partner clients, they have expressed that returns are better than they expected.” Mazonson said. “So even though cleantech hasn’t been particularly profitable, when investors see the data, it makes some investors more open to the idea of considering this sector as a viable asset class.”

While investment returns are important, consultants say having a good story to tell could strike the right tone.

“I’ve met with many cleantech investors and it bothers me when a cleantech investor comes in and they always talk about their previous fund to pitch the next fund and they say, ‘Well, if the market hadn’t crashed we would have done really well,’ and that thesis doesn’t pass the sniff test,” Mazonson said at the conference. “Cleantech is in a bit of a transition mode. Articulate the next wave of cleantech innovation. If investors can come to us and articulate that thesis clearly, people will listen.”

Stanford’s Hayes agreed. “People say, ‘We are the top quartile of our vintage,’ and I don’t care. If that’s your story we are done now,” he said at the Greentech Media conference. “I’d rather have a thoughtful conversation about what were the challenges, what’s changing. Being the tallest midget isn’t the way to win.”

Cargill’s Wischmeier said even new managers in the space with a good story to tell can pass the test. “I tend to feel better on fund one than on six or eight. If you can get that right element and you feel good about it and think they have a lot of support in the area, then I’m a little willing to take some bets there.”

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