Electronic copy available at: http://ssrn.com/abstract=2788919 Venture Capital and Cleantech: The Wrong Model for Energy Innovation Benjamin E. Gaddy Clean Energy Trust, Chicago, IL 60606, USA Varun Sivaram Douglas Dillon Fellow, Council on Foreign Relations, Washington, D.C. 20006, USA Timothy B. Jones TBJ Investments, LLC, Washington, D.C. 20003, USA Libby Wayman General Electric, Boston, MA 02111, USA (Dated: June 2, 2016) 1
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Venture Capital and Cleantech: The Wrong Model for Energy Innovation
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Electronic copy available at: http://ssrn.com/abstract=2788919
Venture Capital and Cleantech: The Wrong Model for Energy
Innovation
Benjamin E. Gaddy
Clean Energy Trust, Chicago, IL 60606, USA
Varun Sivaram
Douglas Dillon Fellow, Council on Foreign Relations, Washington, D.C. 20006, USA
Timothy B. Jones
TBJ Investments, LLC, Washington, D.C. 20003, USA
Libby Wayman
General Electric, Boston, MA 02111, USA
(Dated: June 2, 2016)
1
Electronic copy available at: http://ssrn.com/abstract=2788919
Abstract
Venture capital (VC) firms spent over $25 billion funding clean energy technology (cleantech)
start-ups from 2006 to 2011. Less than half of that capital was returned; as a result, funding has
dried up in the cleantech sector. But as the International Energy Agency warns, without new
energy technologies, the world cannot cost-effectively confront climate change. In this article, we
present the most comprehensive account to date of the cleantech VC boom and bust, aggregat-
ing hundreds of investments to calculate the risk and return profile of cleantech, compared with
those of medical and software technology investments. Cleantech posed high risks and yielded low
returns to VCs. We conclude that “deep technology” investments—in companies developing new
hardware, materials, chemistries, or processes that never achieved manufacturing scale—drove the
poor performance of the cleantech sector. We propose that broader support from policymakers,
corporations, and investors is needed to underpin new innovation pathways for cleantech. Public
policy can directly support emerging technologies by providing easier access to testing and demon-
stration facilities and expanding access to non-dilutive research, development, demonstration, and
deployment (RDD&D) funding. The public sector can also encourage new investors and corpora-
tions to invest in cleantech innovation. Corporate strategic investment in emerging technologies
coupled with deep sector-specific expertise can accelerate scale-up and provide access to markets.
And non-VC investors willing to supply substantial capital for a decade or more are more likely
to reap satisfying returns in the long run, if they work with those partners to help develop and
de-risk technology.
2
I. INTRODUCTION
New energy technology will be needed to increase the likelihood of limiting global temper-
ature increases to the 2C target set by the Paris Agreement of the United Nations Frame-
work Convention on Climate Change (COP21).1,2 New innovations to reduce emissions of
CO2 and capture CO2 will be required to avoid the most significant impacts of climate
change.3 But these new technologies face a so-called “valley of death” between government-
supported research and commercialization.4,5 To bridge this gap, innovators frequently turn
to venture capital (VC) investors to finance the early, high-risk stages of commercialization.6
Over the last decade, VC investment in clean energy technology (cleantech) experienced a
boom and bust. From 2004 to 2008, VC investment in cleantech increased from approxi-
mately $1 billion to $5 billion, an average annual growth rate of 47%. (See Figure 1) But
after 2008, funding dropped sharply, and the number of early-stage investments and the
funding into those companies has remained low and approximately constant since.
We use publicly available financing data of cleantech companies to evaluate how these
VC investments performed in comparison with investments in software technology and med-
ical technology. Our results show that early-stage investments in cleantech companies were
more likely to fail and returned less capital than comparable investments in software and
medical technology. Within the broad sector of cleantech, we demonstrate that investments
in cleantech software returned capital to early investors, whereas investments in more funda-
mental hardware, materials, chemicals, and processes tended to lose money. Venture capital
investors responded to the performance of their cleantech investments by reducing the total
capital allocated to the sector, and by shifting investments from hardware and materials to
cleantech software.
Although VCs have largely abandoned fundamental cleantech research, recent announce-
ments made at the 2015 Paris Climate Change Conference could enable a recovery in fund-
ing for cleantech research and development. Led by Bill Gates, a group of wealthy investors
known as the Breakthrough Energy Coalition have pledged to increase funding for early-
stage research and development (R&D). Their investments will complement a concurrent
effort by twenty countries around the world who have signed on to the Mission Innovation
pledge to double public R&D funding by 2020. For these efforts to succeed in commercial-
izing breakthrough clean energy technologies, however, it is vital not to repeat the mistakes
3
from which the cleantech sector is still recovering. Paramount is bridging the valley of death
without relying solely on VC investment, instead securing capital from a more diverse set
of investors, increased involvement from corporations, and elevated, targeted support from
policymakers.
0
25
50
75
100
125
150
0
1
2
3
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2004 2006 2008 2010 2012 2014
Com
pani
es R
ecei
ving
Inve
stm
ent
Inve
stm
ent A
mou
nt ($
, bill
ion)
Investment Year
A-Round Financing
Total Financing
A-Round Deals
FIG. 1. Venture capital activity in clean energy companies from 2004 to 2014, comparing trends
in the total amount invested overall, the amount invested in early-stage (A-round) deals, and the
total number of early-stage deals.
II. BACKGROUND AND CONTEXT
A. Overview of the cleantech sector from 2006 to 2011
The cleantech sector gained considerable investor attention in the years before the invest-
ment peak of 2008. For the purposes of this study, we define cleantech companies as those
which are commercializing clean energy technologies or business models, including those de-
veloping, integrating, deploying, or financing new materials, hardware, or software focused
on energy generation, storage, distribution, and efficiency. Our analysis does not include
other categories of non-energy “green” companies, including those focused on environmental
waste management or non-energy-related water treatment.
A number of factors contributed to increased investor appetite for the sector, which rose
sharply starting in 2006. First, Al Gore’s movie An Inconvenient Truth was released in
4
2006 which won an Academy Award and secured for Mr. Gore the Nobel Peace Prize.
Second, electricity prices in the United States rose 38% between 2002 and 2008, gasoline
prices had approximately quadrupled from 1998 to 2008, and financial analysts predicted
the price of a barrel of oil would continue rising—for example, Goldman Sachs forecasted
a $200 equilibrium price.7–9 Elon Musk invested in the Series A round of Tesla Motors, an
electric car maker, and joined its board in 2004 amid great fanfare.
Public policy began to reflect this growing interest in climate change and alternative
energy. The Energy Policy Act, passed by the U.S. Congress in 2005, created the Investment
Tax Credit and the Production Tax Credit—incentives for the deployment of solar, wind,
and other renewables.10 Later that year, the National Academy of Sciences released the
first version of its report Rising Above the Gathering Storm in which it urged Congress to
increase funding for energy RDD&D (R&D plus demonstration and deployment). It also
proposed the Advanced Research Projects-Energy (ARPA-E), intended as an analogue to
the Defense Advanced Research Projects Agency (DARPA), which was largely responsible
for funding early work on the Internet and autonomous vehicles.11 Congress responded by
establishing ARPA-E in 2007 and it was funded two years later.
In the late 2005, three solar companies went public at valuations above $100 million
(Q-Cells, SunPower, and Suntech) followed by a billion-dollar initial public offering by U.S.
company First Solar in late 2006. Venture capital investors responded by hiring cleantech ex-
perts, forming sector-specific funds, and deploying considerable capital to the sector (Figure
1).
After the peak of investment in 2008, VC funding for cleantech fell sharply for early-stage
companies, while investors continued to deploy capital into their existing portfolios through
2012. In 2012 alone, forty-five solar companies closed, filed for bankruptcy, or were sold
under unfavorable terms, compared to eleven the year before. Failures like these led to the
poor performance of VC portfolios discussed in this paper, resulting in decreased investment
in the sector.
It is important to note the importance of macroeconomic and policy factors which may af-
fect investment returns independently from of the capability of individual firms.12,13 Among
the macroeconomic trends that were of particular importance for cleantech firms were the
financial crisis and credit crunch of 2008, the decline in oil and natural gas prices (attributed
to slowing demand as well as increased supply enabled by hydraulic fracturing), and a glut
5
in solar panel manufacturing capacity followed by a subsequent decline in the prices of solar
modules. Policy played an equally important role in cleantech.14 During this period, the
failed attempts by the U.S. Congress to pass legislation limiting carbon emissions very likely
had an effect on investor sentiment. Despite these exogenous factors, our case studies of un-
successful companies indicate that most cleantech companies failed for reasons independent
of macroeconomic trends.
B. Overview of Venture Capital Investor Role and Strategy
Venture capital investors support risky new technologies by making investments in early-
stage companies in exchange for an ownership stake in the company.6 These investors can
play a critical role in bridging the “valley of death” that new companies face when their
emerging technology is too advanced to receive public basic research support but not yet
mature technically or commercially.4 VCs are particularly well suited to support the early
stages of this maturation, during the technology and product development phases.
Venture capital funds are often structured as 10-year partnerships, where outside investors
(the limited partners, or LPs) provide capital to the VC fund (run by the general partners,
or GPs) to make high-risk, high-reward investments on their behalf.15 The typical fund will
invest in a portfolio of 10–20 startups. Investments are typically made over the first 5 years of
the life of the fund. Returns from these investments are realized during years 5–10, through
an “exit,” that is, when a portfolio company is either acquired by another firm or issues it
shares on a public market through an initial public offering (IPO). The capital invested by
the limited partners is typically illiquid until a portfolio company exits.
The 10–20 investments are made with the expectation that only one or two will succeed.
Most are expected to fail, and a few investments will break even. From the LP perspective,
these one or two successes must be sufficient to make up for the investments in all of the
failed companies, in addition to returning a premium for the length and illiquidity of the
investment. The venture capital fund (run by GPs) typically is entitled to keep 20% of the
proceeds of a sale, but only after the invested capital has been returned. The nature of the
venture capital investment strategy implies that the most successful venture-backed busi-
nesses will be easily scalable and in high-growth markets in order to provide large payoffs
within a short time frame.16 Thus, venture capital investors are incentivized to pick compa-
6
nies that have the potential to return 10 to 100 times the amount invested within three to
five years of the investment.
Venture capital funds may invest at multiple stages of a company’s development, starting
with early “seed” rounds, typically $1 million or less, continuing through subsequent rounds
(named “A”, “B”, etc.) typically on the order of $10 million, and in late-stage growth rounds
that can raise $10–$100 million or more. The amount invested varies depending on the size
of the fund and the needs of the company. Several venture capital firms often invest in a
given round as a syndicate to further diversify risk, and a given company may be financed
by different funds in each round.
III. METHODOLOGY
An assessment of the performance of cleantech companies from the perspective of VC
investors and relative to companies from other sectors can inform judgments about whether
the cleantech sector is well-suited to the VC investment model. To this end, we compiled
a database of all early-stage venture capital investments in cleantech as well as in two
other technology sectors. Previous studies have discussed the changes in the amount of
early-stage cleantech investment during the period of increased investment and just after
the retrenchment began.17,18 In order to report the performance of those investments, we
have selected A-Round investments that occurred in 2006–2011, which corresponds to the
significant rise and fall in early-stage financing (Figure 1). This data enabled us to compare
the risk and return profiles of cleantech investments against those of other sectors. Moreover,
we used the database to isolate commonalities among companies that underperformed as VC
investments and to identify factors that drove success in other sectors but not in cleantech.
We evaluate the performance of cleantech venture capital investment over the life of the
investment as of January, 2015, starting with the A-round financing event, and concluding
when the invested company either closes or returns capital to the investors. Previous analy-
ses of non-sector-specific venture investment have evaluated the performance of investment
funds using proprietary data provided by investors in the funds.15,19–21 This study addresses
the need for transparent analysis based on publicly available data. Because cleantech in-
vestments were made by both sector-targeted funds and generalist funds, we use individual
financing events and track the returns to investors.
7
A. Sector Analysis
We compare the performance of cleantech investments to that of software and medical
technology investments. Software companies include those producing enterprise and con-
sumer focused software, web applications, mobile applications, and social media. Medical
technology companies include those commercializing pharmaceuticals and medical devices.
We have also subdivided the cleantech sector to gain a deeper understanding of the reasons
for underperformance of cleantech investments. We placed each cleantech company into one
of five categories based on the core innovation it commercialized through VC funding:
• Materials, chemicals, or manufacturing processes
• Hardware integration
• Software or software appliances
• Finance and deployment
• Other products or services, including recycling, consulting, and energy efficiency audits
Examples of companies developing new materials, chemicals, or manufacturing
processes include those developing new collector materials for solar photovoltaics, such
as copper-indium-gallium-selenide, or cathode materials for lithium-ion batteries, such as
nickel-manganese-cobalt-oxide. The category also includes biofuels companies creating fossil-
fuel replacements from plant matter. New processes for creating existing compounds are also
included, such as using algae to create ethanol. Hardware integrators combine off-the-
shelf components in novel ways. One such company, Better Place, hoped to assemble electric
cars and electric vehicle charging stations. Cleantech software companies, like OPower, and
software appliances, like Nest, apply advances in computing power to energy management
or energy efficiency. We distinguish hardware from software appliances, where significant
value is added by software, even if a tangible product is sold. Companies that finance and
deploy clean energy technologies may include those that directly install or provide loans for
installations of new technology, including solar panels and energy storage systems. Other
companies, those that did not fit into the previous categories, typically offered materials
recycling services, recycling infrastructure, energy audits, or energy efficiency consulting
programs.
8
TABLE I. Financing events in the data set. The table shows the number of companies in the
data set in each technology sector, as well as the breakdown of companies with disclosed A-round
financing events. Each subsequent row reports the number of “live” companies remaining after we
filtered the data set, first to limit our scope to companies that received A-round financing events
between 2006–2011, then to companies whose exit outcome is known or reasonably guessed. The
details of this filtering process are described in Section III B.
Cleantech Software Medical
All Companies 1611 25635 4174
All A-Rounds 365 6033 982
A-Round 2006-2011 266 3064 523
Included in Set 185 2169 260
B. Venture Capital Investment Data
The deal-by-deal financing data discussed in this study was obtained from CrunchBase,
aggregate cleantech financing data from Bloomberg New Energy Finance, market capital-
ization data from NASDAQ, and S&P 500 data from the Federal Reserve Bank in St. Louis
and Yahoo! Finance. In some cases, when financing data was not available in the data set,
additional data was gathered from public sources including news articles, press releases, and
disclosures to financial regulators. In order to evaluate the cleantech financing boom that
peaked in 2008 and subsequent bust, we evaluate financing rounds that occurred from 2006
to 2011 and exits through the end of 2014. A summary of the available data and how it was
filtered for this analysis is shown in Table I.
The details of financing events and exits are sometimes unavailable in non-proprietary
data sources. Occasionally, the amounts invested in early funding rounds are not public. We
find that undisclosed fundraising events are more common in earlier financing rounds, were
more common in earlier funding years and have become less frequent, and that these trends
are consistent across sectors. As seen in Table I, across the three sectors, approximately
23% of companies had disclosed A-rounds. The distribution of B-rounds (not shown) was
slightly more variable: 11% of cleantech companies had disclosed B-rounds, compared to
9% of software companies and 15% of biotech companies. Among the companies in the
9
data set that raised A-rounds, 33% went on to raise a disclosed B-round. Approximately
half of the companies that raised B-rounds did not have disclosed A rounds. When an A-
round financing event was disclosed but the amount of money raised in the round was not
available, we approximated the funding by using the median level of all disclosed A-round
funding events in that sector, and we set uncertainty bounds at the first and third quartile.
Acquisition prices are also not always available, because there is no disclosure requirement
unless the acquisition is material to a publicly traded acquirer’s business. Undisclosed exits
are often an indication that an investment did not return capital to investors. For these
companies, we estimate on average that the exit returned the invested capital to investors,
yielding a 1× multiple, and we set our uncertainty bounds at 0× and 2×. Companies
that closed or declared bankruptcy are categorized as having failed, and are recorded as
having an exit value of $0.0. To separate companies that “succeeded” from companies that
“failed,” we use a very conservative metric, classifying “successful” companies as those who
returned more capital to A-round investors than what they originally invested. Because VC
investors have a higher threshold for success, this classification will conservatively classify
more companies as successes, making any result supporting the hypothesized higher failure
rate of cleantech companies more credible.
Our data shows that ninety percent of companies that received venture capital investment
during this period neither exited nor closed. Their status as successes or failures can be
difficult to categorize. Some of these companies may be growing steadily and may raise new
funds. Other companies may yet exit. Still others will continue to operate for many years
without exiting. Companies in this last category are considered failures from the perspective
of the investors, who expect a large exit within three to five years. Investors refer to them as
the “living dead” or “zombie” companies.22–25 Among these companies that have not exited
or closed, we separate them into “dead” companies, and “live” companies. Over 80% of the
companies that either exit or raise a new round of funding do so within three years of their
previous funding round. Therefore, companies that received venture capital investment in
the past three years are categorized as “live” companies, and are excluded from the data set,
since their fate cannot yet be determined. It is likely that on average, “live” software and
medical technology companies would fare approximately as well as companies who received
investment earlier and whose fate has been determined. It is possible that because the
cleantech sector is newer, recent investments may perform better than the initial cohort
10
TABLE II. Example investments and returns. The distribution, IRR, and cash-on-cash multiple
for an investment of $10 million and a $200 million exit are shown as a function of the ownership
stake at exit. All dollar values are reported in millions.
Investment Exit 8% Stake 12% Stake 16% Stake
Date VPIC Date Vexit Dist. IRR CoC Dist. IRR CoC Dist. IRR CoC