Venture Capital and Green Investment

By Lauren Shwisberg

The verdict is in: as a sector, cleantech did not prove to be a profitable investment for many of the venture capitalists (VCs) who were zealous about the idea of a triple bottom line underlying their investments. Investment in cleantech, especially after 2005 when the price of gas hit $50 per barrel, seemed logical. Limited resources were showing signs of strain, and the demand for alternative sources of energy would inevitably rise. However, there are many nuances of the industry that have made it particularly difficult for VCs to realize favorable results. Though VC investments in cleantech have significantly declined in the past two years, the idea of a ‘cleantech crash’ such as that recently espoused by CBS’s 60 Minutes is a mischaracterization.

As early as 2010, investors and analysts started publicizing the notion that cleantech investments were most likely not going to be the money-maker they were anticipated to be. After the market crash of 2008, it was difficult for cleantech specialty VC firms to raise funds and generalist VC support of cleantech projects also began to wane. Looking at the numbers, VCs acted rationally when choosing to focus their attention elsewhere. Analysis by Cambridge Associates shows the energy and environment industries, on average, have been responsible for some of the lowest Internal Rates of Return (IRR) for companies receiving initial investments from 1997-2011.

There are several traditional explanations for why cleantech investments were not as profitable as VCs hoped. One of the most cited justifications is the capital-intensive nature of companies in the sector. Early on, many VCs poured large quantities of money into companies developing promising technologies, which required massive research and development capital and expensive industrial facilities. Many of these companies never reached the profit-making deployment stage, and ran out of funding during continued research and development. These capital-intensive companies also tend to be very illiquid, with their assets tied up in factories and prototypes and additional investors not willing to shoulder the risk of a company that has yet to profit.

Another interesting explanation of why VCs are abandoning the cleantech space is that the existing utility structure is a major limitation to profits. For energy generation projects, no matter the promise of the technology, returns are bounded by existing utility structures and state policy. Power Purchase Agreements (PPAs) with utilities are often the way small power generation projects create reliable revenue, but these cleantech ventures remain at the mercy of large utilities.

Still, even though VC funding has waned, there is still significant positive activity in cleantech. While VC firms have not yet demonstrated a strong resurgence in interest, corporate investors are bridging the funding gap. With the price of technologies steadily dropping and many emergent companies entering later stages of development, corporations are seeing opportunities to use their robust VC divisions to turn great research into marketable products for their established consumer networks. Eventually, some of these early funding rounds lead to successful acquisitions for corporations to expand their product portfolios, and they provide large payoffs to other initial VC investors. As more success stories emerge through mergers and IPOs, this model of ‘downstream’ investment in companies with innovative deployment strategies will gain traction. Already, the companies categorized by Cambridge Associates as ‘Renewable Power Development’ have the highest gross pooled IRR.

Additionally, the over-focus on the failure of VCs in the sector has overshadowed some of the major market growth and successful deployment of clean technologies during the past few years. For example, two-thirds of solar PV capacity in the world has been installed since January 2011 and that capacity is still expected to double in the next two and a half years. Many existing cleantech companies are growing rapidly and successfully, as showcased by the Clean Tech Group’s Global Cleantech 100.

Thus, the struggle of VCs isn’t necessarily a bad omen for future cleantech investment and has obscured the achievements and growth of the sector. The impetuses for the initial investment boom—decreasing natural resources, climbing oil prices, and the deleterious effects of global climate change—are all still very real concerns that will require creative solutions. There is no doubt that many will make money off attempts to mitigate these issues, and so, investors will return to the space well-equipped with the lessons learned from the first bust.