Cleantech Finance Insider

The Pitch

Yesterday I was with a local group of angel investors who hear seed investment opportunities in the clean energy space. I think that the biggest idea had the worst pitch.

In the venture investing arena, we hear tons of ideas, not many of them can meet the criteria necessary to get an investment, perhaps only a few percent. With in boxes always full of new business plans to review, there is always a temptation to look for the reason to decide to move on.

The entrepreneur was a young African-American man who carried himself with confidence and presented himself in a way that revealed his considerable intelligence.

He opened his pitch with "XYZ company is a minority/woman-owned business. I am personally committed to sustainable, green ....." I found myself struggling to stay open minded. Why did he open with the ethnic/gender background of his ownership and personal philosophy? If we (a mostly white group of angels) were to invest, we'd likely have to structure some kind of clever financial instruments to let him keep that designation and by the very nature of the setting only clean energy opportunities were to be heard. Even after refocusing, I found myself looking for and dwelling on the the "flaws" as I saw them in the presentation. It was 90% into the presentation before he got into the more compelling parts of the story.

After the presentation was concluded, we conferred privately about the opportunity. Most of us were put off by the presentation. One prominent angel, himself a successful, serial entrepreneur, told us that he had invited the presenter. He said that while the entrepreneur is admittedly unseasoned, he felt that there was a real idea worth investigating at least and proceeded to give us the "why should you care" pitch that we didn't hear in the formal presentation.

Entrepreneurs need to structure their presentation to tell their story while piquing the curiosity of the listeners. After learning more of the backstory, I think that I know how that same opening line might have been followed in a way that would have had us all leaning forward in our chairs.

"XYZ company is a minority/woman-owned business. Our target customers are Fortune 500 members who are regularly fined for missing regulatory mandated MBE/WBE purchasing quotas. The US addressable market for our product is measured in the billions of dollars annually."

Now, I still might have been incredulous, but I would not have had any trouble listening as carefully as possible through the entirety of the presentation.

The old saying "you only get one chance to make a good first impression" is never more true than in the entrepreneur's pitch to a VC.

Cleantech Luxury

Whenever I look at a prospective cleantech project or start-up company, I look at what part of the market they are trying to capture.

If you’ve read my other posts, you’ve seen my bias for cleantech with a strong economic case. The fact of the matter is, not all successful cleantech projects or companies actually have an attraction based on economics. There are some companies doing very well selling cleantech luxury.

Late last year my wife and I decided to start shopping for a new car of which she would be the primary driver. Her stated objective for this car? Get the most economical vehicle out there. What was her first choice to look at? The Toyota Prius. Now don’t get me wrong, Toyota has done a wonderful job of executing on this well designed automobile. When looking at the capabilities of the vehicle – 5 seats, modest cargo, there are several cars to compare it to. Most of those cars (non-hybrids) are at least $5000 cheaper. I wondered how long it would take to make that extra money back based on the great fuel economy the Prius gets?

I won’t bore you with the spreadsheet (yea, I did one), but at even today’s record gas prices and my wife’s average annual driving of 18,000 miles, it’s going to take a very long time to recoup that money. I'm not alone in this view. The most famous cleantech VC, Vinod Khosla has weighed in on my side of this topic link.

Any automobile purchase includes a certain degree of emotional attachment but few ask for (and get) as much of an emotional premium as Toyota has for their Prius. When someone intentionally pays more for an item to feel better, it is, by my definition, a luxury product.

There are many other such green luxury products. Most home photovoltaic installations fit that description as would carbon offset services and even bottled water.

The difficulty that I have with investing in luxury cleantech boils down to fact that you are placing your bets on the Marketing Department, not cost-saving feature, patents, trade secrets or manufacturing cost advantages. Creating and sustaining a company based on better marketing sounds just too risky for my money. More and more often, such marketing-driven cleantech products are being labeled as "greenwashing."

Some have succeeded (Howard Schultz did OK in the coffee shop business) but the entrepreneurs out there need to realize that without an economic case for their product, or at least a minimal economic premium for it, he is going to have an uphill battle to get funding.

Keys to Success, Part 3

The third key success factor in renewables is the ability to make the product “bio-compatible.”

Just as in implanted medical devices or drugs, success requires much more than proper technical function. You have to engineer your solution to peacefully coexist with its surroundings. Ignoring the entrenched business practices, mindsets and regulations of the existing industry can and will trigger an “immune system response” that virtually guarantees failure in the market.

In the case of renewable transportation fuels, standards are set by the ASTM. If your biodiesel or ethanol does not meet those standards, you aren’t going to have much of a market. Many state governments are big buyers of biofuels. Inevitably, they too have their unique requirements for their vendors to meet. Meeting those standards undoubtedly increases production costs as does documenting your processes to prove compliance. Anything less however, will eliminate your product from consideration.

All power producers have interconnection standards that govern how non-utility generators hook up to the grid. State regulatory bodies, IEEE, Underwriters Laboratories and utilities themselves all have a hand in these complicated standards. Without complying with those standards, no utility will connect to your generator and no one is going to buy your electricity.

Even such broadly popular and well established renewable energy technologies such as wind power are running into perceived incompatibility problems. The intermittent power that wind delivers and how it interacts with the admittedly stretched transmission grid pose ever-growing problems for further production. One Canadian utility has called for a maximum 20% of total generation from wind and another has turned down offers of 3000MW of additional wind power while they spend one billon dollars on grid reinforcements.

Industry standards is the easiest to understand bio-compatibility issue but far from the only one. "But that's not the way we've always done it" could be the most discouraging words a new energy entrepreneur could ever hear. All to often, prospective buyers of new energy products or technologies have little incentive to take the risk of trying something new. When I meet with entrepreneurs and they show me their pipeline of prospective customers, I always ask "who's bonus would be affected by the successful use of your product?" All too often the answer is silence, followed by the names of entities not involved in the buying decision.

Nearly every aspect of the traditional energy business is full of established industry standards and practices. The successful entrepreneur in this space has some uniquely difficult challanges as he seeks to develop substitutes that are both disruptive enough to generate high returns for investors yet not-to-disruptive so as to trigger the immune system response from the stakeholders who also write industry standards.

Success will follow to those who can effectively answer these questions:

How are you getting and keeping an “insider’s view” of the compatibility issues in the industry you will be part of?
What resources can you tap into to avoid inadvertently stumbling over the ‘third rails’ that exist?
Will you maintain enough independence from the industry and friendly market participants to actually change it?

This won't be easy but financially, geopolitically and environmentally it will be essential. For those about to "launch", I salute you!

Keys to Success, Part 2

Last time we explored the first key success criteria for renewable energy startups. Today we move onto the second. I believe that key is the ability to identify and target real economic buyers for your product.

Newspaper reporters and eco-enthusiasts run to embrace the latest “green” idea. A long term successful company will have to meet real-world financial hurdles to adoption. Will real people and real companies on real budgets buy it and continue to buy it?

A new renewable way of generating baseload electricity that costs $.20/kWh to operate will have a difficult time gaining widespread market acceptance. A new renewable way of generating baseload electricity that costs $.20/kWh to operate in remote Alaskan villages where power currently costs $.40/kWh, will have all of the business they can handle for quite some time.

Most often the way new products bring down their costs is by identifying and capturing the segment of the market that can and will afford their product. These revenues will sustain the company until the product is refined and/or production scale increases bring down costs to make them more broadly competitive.

The current situation with investment tax credits and production tax credits point to the precarious place that many renewable energy projects find themselves in. Until there are long-term tax credits or better, widespread, formal carbon markets offering forward, commodity-type options, predictable cost/value comparisons that businesses must conduct will be problematic. Investors will continue to look at your marginally cost effective energy solution with one eye on your plan and the other eye on the calendar as they contemplate looming incentives sunsets.

This isn't to say that there won't be any winners who lack an economic value proposition. I believe there will be. There is a market for voluntary carbon credits. There is a market for carbon footprint mitigation. They are, primarily "feel good" products. People are spending their money to feel better (or less guilty) about themselves. This is also the definition of a luxury product. Start ups rarely earn venture capital type returns in luxury products do to the need for broad, high impact marketing, distribution channels and flawless execution. Luxury tends to be the domain of the larger, better established concerns.

The "greenness" of your product will still matter. It will gain consideration and early adopter purchases that will allow you to drive down the cost curve to the mass market value proposition. But getting there won't necessarily be easy. You'll have to ask yourself some tough questions.

Have you identified markets that would welcome your products based on price and performance alone, without consideration for its “greenness” or “sustainability?” If not, how will you find those markets? Do you have access to the expert advice to help you target your products properly?

Will you be ready for changes to your product’s competitiveness when likely carbon markets are legislated (cap and trade or carbon taxation or similar)?

The answers to these questions will separate the cottage industries from the corporations of tomorrow.

Renewable Energy Startups, the Keys to Success

Today's post is the first in a 3-part series describing what I look for in companies that are seeking risk capital investment for the renewables space.

The first key criterion is about the entrepreneur and his senior managers. There must be a balance between passion and pragmatism.

Finding entrepreneurs who are passionate about changing the energy industry is easy. Finding the ones who also can and will adapt their ideas to accommodate market and industry realities is harder.

The passion needed to succeed here is no less than in any other start up field. In fact it may be higher due to desires (or early investors’ mandates) to maximize performance across as many as three different bottom lines (financial, environmental and social).

Also entrenched incumbents, be they utilities, refineries or other well established market participants, can make market penetration all the more difficult. It will be passion and determination that sees the entrepreneur through all of the hurdles.

Yet passion without pragmatism to balance it is quixotic. I have seen many otherwise promising entrepreneurs who were so convinced of the “rightness” of their renewable energy efforts that they felt that determination alone could be enough to overcome all obstacles.

The old saw “success has 100 parents, but failure is an orphan” tends to be quoted to point out human nature’s desire for self-aggrandizement, but there is more to it. Start-ups will need to make many friends and allies along the way to success, often by compromising initial goals. Those unable or unwilling to make such compromises are unlikely to succeed. “A bird in the hand is worth two in the bush.” “Some battles are not worth winning.” All of these old sayings have special value to the passionate, yet pragmatic new energy entrepreneur.

The successful entrepreneur must ask himself these things:

• How important is this to you?
• What level of sacrifice are you prepared to make?
• Are you really ready to completely commit your professional life (and a good part of your personal life) into making your vision come true?
• Are you willing to bend with the compromises that will be required?
• Are you able to build a board of directors or advisors who can and will be your pragmatic “backstop?” Will you listen to their advice?

How he answers these questions will go a long way toward predicting the success of his venture.

Start-Up Finance: Conventional vs. Cleantech

While there are many similarities between newly created companies in the cleantech space and those of other fields, every entrepreneur needs to be aware of some important differences as it will apply to his prospects for success.

Most other venture investments aim to provide to the market a product or service that has one of three traits:

• “Cool” services that we didn’t know we needed until we saw them – such as social networking
• Dramatically improved efficiency in accomplishing well-established business tasks like sales automation
• A solution to a heretofore intractable problem such as a new cancer drug

On the private equity/project finance side, investors are backing projects that meet a different set of criteria:

• Widely recognized, generic services or products that are in limited supply such as electricity
• Products or services whose values are very well-defined for a predictable period of time, usually measured in years
• Projects whose markets and delivery technologies are so well understood that lending institutions are willing to extend non-recourse debt to the project

(Jargon watch: non-recourse debt means that should there be a failure to pay on time, the lender can only look to the assets of the project, itself a separate company, to satisfy the shortfall. The developer's home, for example, would not be at risk because of a failure in the project.)

Cleantech and renewable energy ventures tend not to easily fit into any of those categories. Cleantech ventures, as often as not, offer an alternate way to accomplish an existing task, in an environmentally friendly way, at minimal ADDITIONAL cost.

One of the difficult factors in evaluating these investment opportunities is the fact that the value of the environmentally superior solution is most often not quantified or quantification is dependent upon governmental mandates, which can and do vary from jurisdiction to jurisdiction, state to state, country to country and year to year.

Nonetheless, this segment of venture investing has captured the imagination of the popular press and to a certain extent, the institutions who put money into venture funds. In 2007, VCs invested over $2.2 billion in cleantech startups according to recent statistics released by PriceWaterhouseCoopers.

In a similar vein, renewable energy projects received over $55 billion in 2006 and are expected to grow to over $225 billion by 2016 according to a report from Clean Edge, Inc.

So as different as the renewable energy business is from more classic entrepreneurial fields, there are still many people getting their ideas funded and many more that will in the coming years.

What will define these successful cleantech entrepreneurs? I will leave that topic to be explored tomorrow.