Hoku Scientific filing to go public

Hawaii-based proton-exchange membrane (PEM) fuel cell vendor Hoku Scientific has filed to raise $57.5M in a Nasdaq IPO, the company reported yesterday. The company lost $728k on $2.9M in sales over the last twelve months.

Major venture-stage backers include Advantage Capital Partners, local angels and the Hawaiian Electric Industries.

Cleantech as the "white space" in VC -- people are catching on

Thanks to Sanjay Wagle at Vantage Point for giving me the heads-up on this article:

Here's an article from Investor's Business Daily that talks about recent trends in venture investing.

Notably, there's this quote from Matt Garlick, research director at VentureOne:

"The two most popular areas we are hearing about are in energy and advanced specialty materials and chemicals."

Not exactly a direct hit on cleantech (clean energy, clean manufacturing, advanced materials, etc.), but a pretty good proxy... And the article goes on to note that analysts are projecting that demand for energy-producing and energy-saving technologies will only grow from here.

Poll: Americans are increasingly worried about pollutants

As this article describes, a recent poll of Americans found that 58 percent believe chemicals and pollutants are more of a threat now than they were 10 years ago.

For venture investors, this points to some of the emerging opportunities for new technologies in pollutant monitoring and abatement. As concerns rise, so does pressure on drinking water utilities, local environmental regulators, etc. to

• a) know what contaminant levels look like in drinking water, air or emissions as the case may be; and
• b) have some kind of plan for bringing those levels down to reduce exposure.

The development of new technologies can then also create even more pressure for their use, in a bit of a virtuous cycle driving rapid technology adoption.

Case in point -- For years the allowable level of arsenic in drinking water was 50 parts per billion (ppb), but after the Safe Drinking Water Act was passed by Congress requiring the EPA to re-evaluate that standard, as of January 2006 many utilities around the country will have to meet much more stringent allowable levels of 10 ppb. Why 10 ppb? In part because that was close to the lowest level that could be detected and achieved via treatment (3 ppb was actually the "Practical Quantitation Level", to be precise) at the time the new standards were being written, and in part to balance costs with benefits. But scientists have identified no "safe level" of arsenic in drinking water, having seen evidence of effects on cancer rates even at levels below 1 ppb.

Many utilities across the country are going to be in violation of this revised 10 ppb standard, some based on human-caused contamination, some based on region-specific naturally occurring levels of arsenic in groundwater (see the map here to see if your area is affected, if you're curious). No matter what the cause, however, all utilities are going to have to have a better sense of their contamination levels, and a plan for abatement when levels are too high. This is going to drive significant spending on testing, monitoring and abatement technologies, and smart cleantech venture investors are looking to get out ahead of that uptake.

And what happens if someone develops new technologies that can detect and achieve even lower levels of arsenic than are currently feasible? There's a good chance that could eventually drive down allowable levels yet again, creating a new cycle of technology adoption. Given the rising concerns Americans have about chemicals and pollutants as described above, the public won't likely tolerate having their water utilities fail to meet drinking water standards, no matter how stringent.

Now let's further extend this example: Looking outside of the U.S., proven arsenic detection and abatement technologies have even more opportunities to be used in international markets. In Bangladesh, for example, arsenic poisoning from contaminated wells is threatening tens of millions of people, which has attracted the attention of organizations (such as the World Health Organization) who have expressed a desire to fund the purchasing of technologies and systems to help ameliorate the problem. So technologies developed to address domestic pollution worries and increasingly stringent standards can find large markets overseas as well.

Arsenic in drinking water is just one example of how rising concerns about pollutants and chemicals could drive increased adoption of emerging water, wastewater, soil and air treatment and monitoring technologies. As the poll cited above shows, this driver is growing even stronger over time.

June 29-30 in San Francisco: 2nd Annual Energy Tech Investor Conference

Just passing along this announcement of an event of potential interest to cleantech investors.

Why cleantech is a compelling investment area

Shameless self-promotion alert... but I did think this article might be of interest to Cleantech Investing readers.

In the latest LOHAS Journal (not yet available online), a couple of the partners here at Expansion Capital Partners have written a very nice and succinct description of clean technology and why it makes a compelling venture investment area right now.

You can find a link to a pdf of the article here, in the latest TBLI Group Brooklyn Bridge Newsletter, check it out. The article was written for a "socially responsible investor" ("SRI") audience, but also speaks to why cleantech should be a strong opportunity even for investors who aren't using any kind of environmental or social screening methodology.

And of course, the actress Daryl Hannah is also featured on the cover of the that issue of the LOHAS Journal, as you'll see...

Fuel cells: Soon?

Good article in Red Herring last week on the debate over when fuel cells are going to be commercialized. As the article notes, micro fuel cells for battery replacement are likely to be the first to be commercialized, but challenges remain.

Also note the entertaining quote from an ABI Research analyst:

"People have been saying for years, ‘Next year is going to be the year.’ But maybe this year we really can say that next year will be the year that we’ll be seeing some of these."

"Energy Bull Has Room to Run"

Here's a good, detailed description of the recent Forbes article which spoke to the strong investment opportunities in energy technology and the entry of hedge funds and other well-capitalized players into the space (as previously discussed here).

Beacon Power buys NxtPhase

The announcement was made yesterday that Beacon Power will be acquiring NxtPhase for something around $15M. It's unclear exactly how the companies' technologies and products will fit together (NxtPhase focuses on high-voltage monitoring applications, while Beacon Power has flywheels and inverters), but both sides say this prepares them to better serve the needs of the electrical grid.

While this particular transaction hasn't necessarily been the most lucrative for NxtPhase's prior investors (judging from the press releases listed on their website, the company raised more than $40M since 1999), it's worth noting that according to the recent "exit returns" study released by the Cleantech Venture Network (as previously described here -- scroll down a bit to find it) the average return to cleantech venture investors found via M&A exits was about 4.1x over the past ten years.

This is an important and encouraging finding, because in clean technology markets it's probably relatively more likely for venture investments to exit via trade sale than other paths (e.g., IPO). The reasons are largely positive:

• Large acquisitive players with stated strategic goals to pursue some of these markets (for example, GE with clean water and clean energy technologies),
  
• The value of a bundled technologies sale to large, key customers such as utilities,
  
• The fact that many of these technologies are taking over for older incumbent technologies rather than building entirely new markets,
  
• ...to name a few

The study tracked about 400 such transactions over the most recent five-year period, 1999-2003, so the volume is there....

Good profile on Konarka

Here's a good profile of Konarka, one of the more highly-visible and well-backed solar startups. It's always interesting to read about the company, which has some pretty lofty goals.

ZigBee finally certifying products

A few days ago I wrote of the importance of machine-to-machine communications in cleantech, and specifically in regards to sensors networks.

Good timing, because it appears that earlier this month the ZigBee Alliance announced they have formalized their certification process and have approved a first few certified products. What, you may ask, is ZigBee?

ZigBee (named after the method by which honeybees communicate) is the nickname for a low-power, low-data, cost-effective wireless communications standard based on the IEEE 802.15.4 standard. In past years many now-familiar wireless standards ("WiFi", "WiMax", "Bluetooth", etc.) have been similarly defined, but for sensors and other such applications you don't need as much data, and you can't afford to use as much power, as those established standards use. See this article for some more information on why ZigBee could be a big deal -- and some of the challenges facing its widespread adoption.

Lacking a certification process and approved products, it has been tough for early adopters to use ZigBee to build homogenous sensor/ remote monitoring/ control networks. Thus, the ZigBee Alliance has been developing the definitions and certification process for the ZigBee standard. It remains to be seen if vendor interoperability and other challenges will be addressed by the formalization of this process, but either way this is a good step forward for ZigBee-based technology providers -- and their investors.

Cypress planning to IPO SunPower

It's not exactly venture investing news, but it's still interesting for cleantech investors. Given how fast the solar market has been growing and (as referenced here) how well things have apparently been going at SunPower, the company's parent Cypress Semiconductor is now looking to spin it out via an IPO.

This is going to bring even more attention to the solar investing market. It's also interesting to see the solar unit's financials, reported at $5M loss on $11M of revenues.

Water: "The next major growth commodity"

According to the Wall Street Journal (as cited in this Water Technology Online blurb), water industry stocks rose 24% in value in 2004, with companies like GE, ITT Industries and Pentair among those getting the most attention. Wall street investors, the article says, are looking at these and other water technology vendors.

Importantly, these are very acquisitive companies. As these larger firms grow and seek to acquire new technologies, it opens up exit opportunities for venture-stage funders who invest in the smaller firms they will target for acquisition.

It may be true, as many have said, that "water is the next oil."

Solar momentum, and natural gas extraction

A couple of deals over the last couple of days are interesting to note:

• SunPower (owned by Cypress Semiconductor Corp.) announced a deal to sell $300M worth of their newest A-300 silicon-based photovoltaic cells to German PV module manufacturer SOLON AG over 5 years. Another sign of how hot the solar industry is right now, esp. in Germany. This means adding another 25MW of capacity at SunPower -- as point of reference, last year total PV installations worldwide were 927MW. That's 62% growth off of 2003 -- and Germany's installations grew 152%. Solar is getting to be a big market with a lot of room for upstarts. But it's also still very much driven by particular regional subsidies.
• WellDog announced a new round of funding led by EnerTech Capital. The company has "downhole" sensing technologies that help natural gas extractors find reserves more efficiently. Some clean energy investors cannot participate in any fossil fuel-based technologies, while others point out that technologies like WellDog's can help minimize the environmental impact of drilling and extraction that's going on anyway, and that (all things being equal) that's a relative environmental gain. An ongoing discussion with many sides. But for investors in the latter camp, technologies like WellDog's can be compelling investments, best of luck to Tucker Twitmeyer and the team at EnerTech.
  

Cleantech and M2M

There is a very good column in the latest M2M Magazine about RFID and wireless sensor networking.

Machine-to-machine (M2M) technologies (of which wireless sensor networking is one flavor) is a relatively unheralded area of innovation, one that has caught a lot of attention in the cleantech investing world because of its potential for tangible efficiency gains and near-term implementation. Essentially, the argument goes, if you can move intelligence further out into the edges -- and increase the flow of information -- for a large complex operation (be it a manufacturing facility, an electricity distribution network, or what have you), you can introduce more flexibility and finer levels of control. This in turn helps reduce waste, because you can have systems that are more responsive and accurate.

One example of this would be the "smart building". By deploying numerous remote sensors throughout a building you can monitor temperature, lighting, security, etc., and thus set up an automated system that deploys electricity when and where it's needed -- instead of setting an entire building's thermostat at one temperature for the entire workday, to use one very narrow example. This saves electricity, and thus can save significant cost for the building owner. Other applications can be found in efficient manufacturing, smart metering, environmental monitoring, etc., and etc. (the list goes on), many of which have direct cleantech benefits in addition to hard cash savings.

But to get this system of smart, decentralized decision-making to work, you need to have an M2M communications network that can handle all of the quite significant data flow. Harbor Research calls this the "Pervasive Internet," and it is old hat to a lot of mainstream telecom/ tech investors, but cleantech investors are seeing a wide range of applications in our areas of interest as well.

When you see mention of excitement about the "automated home" or the "smart grid," know that somehow all of these devices need to talk with each other, and cleantech investors should be looking for the additional angles of value which these technologies can unlock. It won't be a "winner take all" market, and there are a lot of competing standards and technologies being developed, but there can be some interesting plays, and also M2M technology can play an important role in enabling other clean technologies as well.

A few smaller news items

It's been quiet on the cleantech deal front so far this week (at least as far as any official announcements go), but here are some news tidbits you may have missed:

• PolyFuel, a manufacturer of membranes for fuel cells, has been named one of the two hundred Finalists for the Red Herring 100 Private Companies of North America award program. Not a huge announcement, but it does serve as a useful opportunity to point out that some of the better investment opportunities may be in components for various distributed generation (DG) technologies, rather than in the DG OEMs themselves.

• When the March Venture Capital Journal mentioned that Kleiner has added Bill Joy as a full-time partner, they noted that he will be "focusing his attention partly on energy efficiency -- a major interest of Doerr, too..." Look for even more cleantech activity by KP in the near future, then. One of the more interesting bay area fuel cell startups remains the stealth SOFC company Doerr and others have backed...

• VC fundraising in the first quarter of the year was about double of what it was in 2004, according to Venture Economics, although the number of funds which closed was about the same (so: the funds that closed were much larger). But on the flip side, the number of US VC firms fell 21% in 2004. Fewer, bigger investors? The larger generalist funds will increasingly need to partner with smaller, sector-focused players with better knowledge of particular markets.
  

If you're in the bay area on June 14th...

...You might check out a panel session I'm helping to organize for the VC Task Force, [note: rescheduled from original date, to better fit schedules] on the topic of early lessons in clean energy investing. Diana Propper of Expansion Capital Partners will be moderating, and Raj Atluru (Managing Director, DFJ), Scott Benner (Shareholder, Heller Ehrman), Ira Ehrenpreis (General Partner, Technology Partners) and Dave Pearce (CEO, Miasole) will also be speaking on the panel.

The idea is to bring together these clean energy industry participants who also have extensive experience in more "traditional" technology areas, to share their thoughts on what's similar and what's not, what works and what doesn't. Not so much a primer on cleantech; instead, a sharing of best practices.

It's a terrific group with a lot to say, so I'm looking forward to it...

Water and wastewater treatment technologies in food processing: $370M by 2010

Yesterday, Frost and Sullivan released a new market forecast for water and wastewater treatment technologies used in food and beverage manufacturing. The answer? It's already a $250M market, and will grow 50% by 2010.

That's only a 7% compound annual growth rate for the industry as a whole, but the study also showed a strong willingness in the industry to look at innovative new solutions and providers:

When respondents were asked whether they would consider a new entrant to the market, around 75.5 percent replied that they would consider such as situation.

That's great news for investors, because it means water technology startups who aim for this market segment may see much better traction and rapid penetration than you could expect to see with water utility customers, a market that takes a longer-term approach and some patience.

One VC-backed company that serves as an example for this space is Novazone, which offers ozone treatment for both water and agricultural/food applications, and is backed by Foundation Capital. In fact, there was a good article earlier in the month about that deal... Another example is one of Expansion Capital Partners' portfolio companies, Biorem, which offers biofiltration for wastewater treatment plants and (I can tell you) has been doing very well. Especially as energy technologies get all the publicity and buzz, there are great investment opportunities to find in water technologies.

Great column on Jadoo and fuel cells

If you're interested in fuel cells, here is a great column describing Jadoo and a few other competitors.

Do note, however, that the column doesn't express how crowded the fuel cell market is getting, and that the writer doesn't reflect the ongoing debate among VCs and others I've spoken with in the cleantech investment community -- as previously described in this blog, and as reflected in the comment from the column:

Andrew Burke, a researcher and fuel cell expert at the Institute of Transportation Studies at the University of California, Davis, points out that hydrogen is more expensive than electricity for recharging a device - about 15 cents per fill-up, compared with 2 cents for recharging a battery. [Jadoo co-founder Larry] Bawden of Jadoo called the difference "background noise" compared with the benefits of fuel-cell technology.

But the column is still a very good description of Jadoo and their niche market goals.

On the topic of solid-state lighting technologies...

...Word from CleanEdge about a potential breakthrough. Still in the lab, of course, but good to see.

Today's other cleantech deal

Jadoo Power announced an $11B Series B round today, giving a nice boost to the fuel cell startup with a very fun name. Mohr Davidow is one of the major investors, apparently, in yet another example of mainstream VCs paying more and more attention to cleantech.

Interestingly, this post argues that Jadoo is unique as a fuel cell startup by targeting early developing niche markets (particularly military/defense) instead of trying for big technological breakthroughs. Probably smart... But sooner or later, MDV has to be gambling that Jadoo will be able to get into some much bigger markets...

Ice Energy Series A

Today's cleantech deal: Ice Energy, an advanced air conditioning systems manufacturer, raised $5m in Series A, led by Odyssey.

Advanced air conditioning is an intriguing market. Certainly an area of energy use that is ripe for economizing/ conservation, given massive consumption, particularly in light of the fact that most energy used for air conditioning is used during peak hours (in fact, air conditioning pretty much drives peak hours). Ice Energy is one of a few players that have made some noise recently with better designs for air conditioners, across residential, commercial and industrial applications.

One caution is that an exit (probably a trade sale to a Carrier or York or other traditional HVAC systems manufacturer) requires very large sales traction before any of the most likely acquirers would become interested. HVAC is a very slow-changing industry. But new regulations (esp. around energy efficiency and fresh air requirements) could drive more rapid change, and it's certainly a massive market. Best of luck to Ice Energy and Odyssey, it would be great to see something happen in this sector.

A few items on the periphery

A few items that have caught my eye recently, which have some implications for cleantech investing:

• As this article points out, hedge funds are moving heavily into energy and emissions trading. That's interesting to see, and in part reflects the fact that such trading requires large, heavily capitalized players such as hedge funds (in such nascent markets, you need a lot of capital for counterparty risk purposes, to create liquidity, and to serve as a bit of your own market maker). What's interesting to note in parallel, however, is that hedge funds are also increasingly moving into private equity as well -- both indirectly (fund of funds) and directly. The implication for cleantech investing is the possibility of very vertically-integrated investing -- investing in the technologies used to generate power and earn emissions reduction credits, and then trading those credits. Several years in the coming, probably, but an interesting trend. Will it mean even more valuation pressure in energy venture capital, as the big sacks of hedge fund capital are put up on the table?
  

• In this posting on SiliconBeat, Mark Heesen of the NVCA is cited as arguing that the venture capital community will bifurcate into two groups -- large, heavily capitalized ($400m+ under management) players with generalist strategies, and smaller, niche-focused players. If true (and it makes a lot of sense), it's another reason why it's good to have a cleantech-focused strategy right now (as opposed to simply dabbling in the industry, with a couple of one-off deals...) -- getting out ahead of the learning curve in our niche, and staying focused.

• Updated 4Q venture returns info from the NVCA shows that 10-year average fund performance now is at 26%, 20-year at 15.7%. As previously discussed, a recent study (out of the Cleantech Venture Network, and co-edited by one of the partners at Expansion Capital Partners, Diana Propper) of venture investments in the cleantech space found suggestive evidence of ~30% IRRs. Not bad, outperforming the overall market...
  

Do you believe in angels?

They apparently believe in themselves, at least.

I'm of course referring to angel investors, who play an increasingly important role in venture investing. As this article describes, angel funding actually exceeded venture capital funding in 2004, $22.5B to $18B. The article also provides a breakdown of that spending, but it's unclear how cleantech fits into the breakdown, and anyway the breakdown doesn't add up to 100%. But it's still illuminating.

As the article notes, angel investing is stepping in where the opportunities are too niche, or too early, for VCs to back. That's a vital role, and as angels get more sophisticated it's good to see more such involvement. One challenge for such individual investors, however, is that smart venture investing requires significant effort and resources to adequately research, diligence, and negotiate with the target companies.

Since many cleantech opportunities are slow to develop, the role of angels will be increasingly important in this space, providing early stage capital. Over time, however, more of these angels will also partner with (and back) like-minded venture capital firms who will have the dedicated resources and portfolio diversification necessary for consistently stronger returns. These VCs are also better positioned to help cleantech startups to mature from the angel-backed stage through to exit -- expansion-stage investing. Smart angels will partner with smart expansion-stage VCs, and vice versa, to better identify, research, and manage cleantech investment opportunities across the full growth lifecycle...

Nifty new technology: Traffic congestion prediction

Tired of sitting in traffic?

Seattle-area startup Inrix apparently has a very interesting new technology (licensed from Microsoft) which will help drivers avoid sitting in traffic. Cleantech angle: Less wasted fuel. Even more important angle: Less wasted time, and less frustration. Inrix is currently backed by Venrock Associates and August Capital.

Let's hope the technology works, that would be a great innovation...

Cleantech and Nanotech

Nanotech has been getting a lot of attention, not only in the mainstream venture community where it has been a hot investment area for some time now, but also in the cleantech venture community where such materials sciences plays have the potential for significant breakthroughs in a number of clean technology areas. However, these materials are also criticized by many in the environmental community.

To begin with, many investors may be confused about what "nanotech" is and how it's special. It has been commonly defined as any technological developments on the nanometer scale. That is a very broad description. But what it really gets at is that new developments in manufacturing and manipulating such tiny-scaled materials have allowed them to be used in more and more applications, and in many cases the smaller scale yields very different physical, electrical, or optical effects than are seen with more traditional, larger-scale materials (see the above link for a better explanation of why that is so).

The potential advancements are being seen in a wide range of clean technologies.

• Nanotech-based solar companies such as Miasole, Nanosolar, Konarka and others are making strong progress toward effective thin-film photovoltaics that could achieve significantly lower costs than existing silicon wafer-based approaches.
  
• Advanced solid-state lighting, as previously discussed, holds promise for dramatic energy savings, and companies like Luminus Devices and Nomadics are among those pursuing breakthroughs in this area.
• Companies such as Argonide are developing water purification technologies based upon nanoscale materials.
• Other companies such as NanoHorizons are developing antimicrobial coatings, advanced sensors, pollution absorption methods, and other potentially clean technologies using nanoscale materials.

And yet, nanotechnology is under attack from some in the environmental community. As this Forbes column relates, some leading scientists and environmentalists worry that the very same nanoscale effects that drive desired properties as described in the above list could also have unforeseen effects on health and the environment. They point to some early studies which show the potential for brain damage from some of these materials, and for some greens -- such as the ETC Group -- there are enough unknowns and potential dangers to warrant a moratorium on manufacturing of nanotech materials until after much more study and debate.

In many ways, these developments are similar to those that were seen in the early days of the genetically-modified organisms (GMO) debate, which continues to rage on. GMOs have in some cases enabled more food production with less erosion and use of pesticides, but many activists and customers also worry about health effects and impacts on biodiversity. The issue has become very divisive, as anyone who has tracked the international debate can attest, and this has had important impacts on the development of that industry.

Similarly, the early concerns over nanotech are not to be taken lightly, and the resolution remains unclear. For cleantech investors, nanotech holds a lot of promise for breakthroughs that address known environmental and health risks, and that are advantaged in the face of looming natural resource constraints -- what the cleantech venture investment thesis is all about.

But it is still very early days for nanotech, and investors should also be aware of the risks that some of these technologies may in turn be creating new problems as well -- problems that could be obstacles to the much-ballyhooed massive market development that some pundits are predicting for nanotechnologies...

Business 2.0 article on clean energy investing

There's a brief article on clean energy venture capital in the Business 2.0 online magazine.

Most of what the article covers has already been discussed here before. But I did enjoy the following statement:

Your chances of picking up some of the VC funding are increased if your company falls into one of two broad categories: companies that are bringing technology to the energy industry to improve business processes, and companies with technology to extract more oil or build a better battery.

Essentially, they're taking Nth Power's data, which is intended to show interest in clean energy (and indeed the B2.0 article cites the fast growth in solar and fuel cell investing...), and saying "the lesson is that you should be providing enterprise software for utilities and extracting more oil."

I think they kind of missed Nth's point...

Two cleantech deals: Oryxe and Protonex

• Oryxe, a promising fuel-additive company, announced a $2.5m Series C add-on raise, apparently led by Ridgewood Capital. I haven't seen much information about the raise other than a brief mention, but here is Oryxe's website. They're strongly positioned in regulation-driven markets, specifically "non-attainment" air quality regions, where local regulations are mandating significant changes to fuel mixes. Instead of extremely costly changes at the refinery -- which supplies much wider regions than the regulatory-affected regions -- Oryxe's fuel additive enables similarly improved emissions performance, and can be added closer to the point of use. One interesting thing about this deal: Ridgewood Capital hasn't been a big cleantech investor to date, but in the last few months they've invested in Oryxe and Comverge. Another new entrant to the cleantech space...

• Protonex announced a $9m second round. The fuel cell company's round was led by existing investors Conduit Ventures Ltd., SAS Investors, Solstice Capital and Commons Capital. New investors are Parker Hannifin Corporation, Contango Capital Management and the Massachusetts Green Energy Fund. The company is as much a "homeland defense" play as a cleantech play, as the fuel cells are used mainly in military applications to date (although they claim to be targeting commercial applications as well).
  

Some of the best clean technologies...

... aren't high profile technologies like solar power, fuel cells, desalination of water, etc. They're basic innovations that help make our use of basic materials more efficient.

One good example might be Hycrete Technologies, which announced a $2m Series A on Monday. The company manufactures an additive to concrete that helps prevent corrosion, which (they report) therefore prolongs the life of the concrete. Since concrete is a highly energy-intensive industry, this seemingly minor improvement could have some significant benefits for both users and the environment. It will be interesting to see how the company develops; and it provides a good example of some of the lower-profile cleantech opportunities out there.

California Clean Energy Fund gets started

One good outcome of the PG&E bankruptcy here in California -- as part of the bankruptcy settlement, $30m has been set aside for clean energy venture investments.

The advisors tasked with setting up the California Clean Energy Fund (CalCEF) originally looked at setting up the fund as an independent direct-investment entity, but eventually decided to allocate most of their fund to three existing firms for co-investment and fund management -- Nth Power, DFJ, and Vantage Point got the call.

One implication of this decision is that the CalCEF capital will now be tied to the same types of investments (with the same return expectations, timeframes, etc.) as the co-investment firms' funds target. As a "public benefit" fund, any profits will be recycled back into the CalCEF for future investment.

One alternative would have been a standalone fund that targeted lower returns, essentially as a non-profit. This would have possibly allowed CalCEF to target investments with longer exit horizons, or lower expected returns -- seed funding for 10-year-plus potential "breakthrough" technologies, funding for less-scalable service and consulting business, or funding for niche opportunities, as some examples -- something that private VC cannot realistically address. In many cases, such funding is either made through angel investors or government grants, or often isn't made at all. So it would have been interesting to see how that might have played out.

However, one cannot fault CalCEF's advisors for choosing to leverage the existence of several established funds in the clean energy space, it is certainly the safer decision...

Recurring revenue and cleantech: Pros and cons

Recurring revenue is a recurring theme in cleantech investing.

For a couple of reasons, cleantech entrepreneurs and investors often look for firms to develop business plans that bring in annual revenue from services instead of one-time sales.

• First of all, it creates more stable cashflows for the firm, which makes it easier for management and easier for investors to underwrite.
  
• Secondly, it often means that the end users of the technology/ product are signing up for easier-to-swallow annual expenses instead of large one-time capital expenditures; this is especially important when selling to certain types of customers (facilities managers, for example, often have a tough time getting approval for large capex budgets), or in selling long lifetime equipment (e.g., solar power systems with a 20-year lifetime). By amortizing costs and margins over the expected lifetime of the equipment and charging an associated annual cost (using the solar example from above, selling the power over a long-term guaranteed contract), the manufacturer doesn't scare customers away from expensive solutions (as are often found in clean technologies...).
• Finally, it also puts a lot of the risk in the hands of the manufacturer of often unproven equipment -- if the equipment fails, they are still required to provide the service one way or another, instead of a customer being stuck with a very large, useless piece of equipment.

Makes sense, right? Thus you see companies like SunEdison doing quite well in selling solar services along the lines of the example described above by using innovative financial solutions, and a number of distributed generation companies (e.g., RealEnergy) have set themselves up as "onsite utilties" offering combined heat and power (CHP). There are plenty of examples outside of energy as well -- water technologies offered as services, monitoring technologies offered as outsourced options, etc.

But there are some real drawbacks to this approach. RealEnergy, for example, has had some major difficulties as explained in this Distributed Energy article. In general, the pursuit of recurring revenue can hurt companies in the following ways:

• If, as noted above, the customers aren't incurring the technology risks... the startup is. And the startup is probably not very positioned to deal with any problems that arise, due to limited financial resources.
• Such a strategy often forces the startup to guess how the customers will end up using the technology. Guessing wrong, even a little bit, can kill a great technological solution. For example, RealEnergy guessed that large office buildings would pay for the backup power presented by their offerings. Instead, where CHP services are gaining ground, it appears to be in other settings where power usage is close to 24/7, and where hot water is used in higher volumes (e.g., hospitals, colleges) than in offices. It can be a lot easier simply to put the technology out there, and allow people to use it as they see fit.
• In order to pay for the equipment they are placing at the customer sites, the startup will need additional capital. In some cases, they seek project financing or debt -- but that can be very tough for a startup to arrange. Often, startups are asking VCs for the money -- but as mentioned in earlier posts, VCs often don't like the idea of using their expensive capital to purchase long-life, hard assets. Even if the company is able to arrange the financing somehow, they've got to pay for it over time. So this creates a huge financial risk for the company.
• Setting up a service organization is very different from setting up a manufacturing organization. So this sets up an additional set of challenges for the startup to tackle, at a time when they should be trying to stay very focused.

So what is the answer? In reality the answer is that there is no one-size-fits-all solution. Some startups will successfully build recurring revenues and be very successful. Others will be very successful simply selling product and growing from there. Entrepreneurs who are experienced in their industries will often know what works best in their market.

Successful VCs also keep this in mind, providing guidance on this issue based on their experiences, flexibility on a case-by-case basis, and strong contacts in the project financing world when needed.

So... where is the money going to go?

"[Venture] funds raised three years ago still have a significant amount set aside for new investments. According to the survey, 15% of 2001 funds remain set aside for new investments compared to 50% of 2002 funds, 60% of 2003 funds and 85% of 2004 funds." Hence the $53.6B overhang.

This from an article titled, "Venture Capital Fund Raising Doubles in 2004." And echoed in this Economist article.

Cleantech, according to many, is in the fortunate position of remaining underinvested even in the midst of such well-capitalized "optimism," as a quote in the article terms it.