New Finance Models For NW Cleantech, Sustainability As VC Wanes

1/8/13Follow @bromano

Venture capital investment in cleantech was down locally and nationally for most of last year, as several firms retreated from a broad, ill-defined sector that may never have been well-suited to the typical VC model in the first place.

The trend is expected to continue this year, which means young companies looking for funding from the usual suspects will probably have a tougher time in 2013. But as with any transition, there are also reasons to be optimistic.

Seattle cleantech entrepreneurs have in their backyard one of the nation’s foremost angel investing groups, the Northwest Energy Angels. Vancouver, BC,-based venture firms like Yaletown Venture Partners and Chrysalix are among those that remain committed to the sector, and they keep a close eye on the Northwest. And large corporations are expected to continue their strategic interest in cleantech and adjacent industries, providing capital, sales channels, and the prospect of acquisitions.

More promising, say several Northwest cleantech financiers, is a broader change occurring in the vocabulary and assumptions about the enormous swath of the economy that touches energy, climate, and resource management. New ideas about innovation and capital formation in the sector are creating space for new companies and business models. To many in the Northwest, the new models are more important now than new technologies.

“If you just look at cleantech in the Northwest, it’s a pretty negative situation,” says Michael Butler, chief executive of Cascadia Capital, a Seattle investment bank active in the sector. “Not only is there not much capital, there’s not many companies.”

Michael Butler

The region is not unique in this regard.

Venture capital investment in cleantech—which includes alternative energy, storage, recycling, smart grid, transportation, and wastewater treatment, according to PricewaterhouseCoopers—was down 18 percent year-over-year through the first three quarters of 2012. Total VC investment dropped 10 percent in the same period. The Northwest, which includes Washington, Oregon, Idaho, Montana, and Wyoming, saw cleantech investing drop 71 percent, following a record 2011.

The region has seen a little over $904 million of aggregate cleantech venture capital investment since 2002, according to Thomson Reuters data compiled in the latest PwC/National Venture Capital Association MoneyTree report. That’s about 4 percent of the nearly $25 billion invested nationally during the same period, a share comparable to that of Colorado (5 percent), San Diego (4 percent), and Texas (2 percent). Silicon Valley by itself claimed 39 percent of the total in the last decade.

Kirk Washington, Seattle-based partner with Vancouver, BC, firm Yaletown Venture Partners, says he expects venture investment in cleantech to remain “subdued” in 2013. It’s normal for a new sector to go through “a period of over-investment before things find the right equilibrium, and we’ve certainly been through that,” he says.

With its hefty capital requirements, low margins (in energy particularly), well-funded incumbents, and conservative utility customers, cleantech is not a great fit for the early 21st century venture capital model. The poor track record of many cleantech investments over the last half-decade, and the well-documented challenges facing the sector now, have prompted many large venture firms to back away from cleantech. For those that remain engaged in the sector, “it’s more difficult to syndicate [cleantech] investments currently,” Washington says.

Kirk Washington

Brian Carey, PwC’s US cleantech advisory leader, says those firms continuing to invest in cleantech have become more selective.

“I don’t think you’re going to see as many venture capital investments in early-stage, capital-intensive companies, just because it takes too long for VCs to get a return on their investment and an exit from some of those types of companies,” he says.

Some entrepreneurs have followed the money out of cleantech.

Like many others, Nikesh (Niki) Parekh wanted to do well by doing good. He traded in a career in tech in 2007, becoming chief executive of venture-backed Bio Architecture Lab, focused on making biofuels from seaweed. After a good run, he left in 2010, and is now an executive vice president at Market Leader, a real estate software and services company.

“There were all these entrepreneurs who basically transitioned from tech to clean tech because they heard a rallying cry of clean energy from both the venture capital community and from Washington, D.C.,” Parekh says.

Parekh’s story is common. At a holiday party he attended on Sand Hill Road late last year, the room was filled with “cleantech refugees,” he says.

Cascadia’s Butler and others argue that the action now is in industries adjacent to cleantech that might be thought of as cleaner tech—meaning natural gas, the newly abundant fossil fuel that has upended the energy market in the last three years—and a broad, somewhat amorphous category called sustainability, which can include anything that moves business processes and supply chains toward improved efficiency and lighter environmental impacts, as well as economic sustainability.

The easy-to-spot examples locally include “green IT” companies, such as Verdiem; industrial energy management technology providers like Powerit Solutions; and an array of building energy efficiency contractors and service providers led by McKinstry.

Butler also points to World CNG, the Kent, WA, company doing natural gas vehicle conversions, and Seattle’s Zonar Systems, which does electronic fleet tracking and management. “You wouldn’t necessarily think about it as cleantech, but it certainly is sustainability—making operations more efficient,” Butler argues.

He says there’s “plenty of growth equity” available for more mature companies such as these.

But where can early-stage companies in cleantech and sustainability look for capital?

Once they would have tried to get in front of Rick LeFaivre, now emeritus partner at OVP Venture Partners, a Seattle-area VC firm that was active in cleantech. But OVP is closing, and while its departure is a blow, it’s not as big a hit to the Northwest as it may first appear. LeFaivre points out that only one of the firm’s cleantech investments was in a local company—EnerG2, an energy storage business that raised $9.4 million late last year—even though “we certainly took a look at virtually every potential project in the Pacific Northwest.”

“One of the things we discovered is that it is difficult to be both ‘regional’ and focused on an area such as cleantech,” LeFaivre says in an email from Idaho, where he is enjoying the “Sun Valley Lifestyle,” while also sitting on the boards of Carbon Design Group and the Pacific Northwest National Laboratory Energy & Environment Directorate.

By the same token, other cleantech-focused venture firms look beyond their home regions to invest in Northwest companies.

“Up in Canada, we have been investing in cleantech many, many years before others, before it was called cleantech, frankly,” says Yaletown’s Washington. “As a result, I suspect we’ll continue to invest for a long time, regardless of the direction the winds may be blowing in the current environment.”

He sees a potential “buying opportunity” in the wake of a broader VC retreat from the sector, particularly for “mid-stage, later-stage cleantech investments, where they’ve made a lot of progress, but maybe their existing [investor] syndicates are stretched,” he says.

Chrysalix Energy Venture Capital, also in Vancouver, BC, bills itself as “the world’s most active cleantech venture capital firm,” and touted its continued focus on the sector. Its 2012 investments also demonstrate a widening definition of cleantech. The company made a seed-stage investment in Axine Water Technologies, a Vancouver, BC, company using electrolytic oxidation technology to treat wastewater from oil and gas production and other polluting industries, and a follow-on investment in Fremont, CA-based GlassPoint, which makes solar steam generators for oil fields.

“The challenge is that the startups need to get far enough along to attract such investors, so the problem really becomes one of access to very early-state investment for cleantech companies,” LeFaivre says. He points to the importance of the NWEA, which is closing the books on a record 2012, and the new $20 million W Fund, to invest in spinouts from Washington universities, where research into clean and sustainable technologies is the raw material for new company formation.

Rick LeFaivre

LeFaivre, Butler and others say one cleantech financing model is starting to look more like biotech’s relationship to Big Pharma, with large companies making strategic investments as a way to extend their research and development efforts.

“The corporate investor wants access to the technology, and more importantly can provide a go-to-market strategy for these startups,” Butler says.

Further over the horizon, investors and entrepreneurs committed to cleantech and sustainability are working on innovative business models and financing strategies that could fill the VC void.

David Chen, a former OVP general partner who left the world of VC and startups to launch Equilibrium Capital in 2008, says we easily forget that venture capital itself was once an innovation. Equilibrium manages a family of sustainability-driven real asset funds tailored for institutional investors —think of public pension funds investing in Australian ranchlands and herds of grass-fed cattle, carefully tracked with RFID sensors, to feed a growing middle class in Asia.

“We’re inventing new strategies where the benefits and impact of sustainability can be made available to investors,” Chen says.

Most of the firm’s attention is on these strategies, with plans to double assets under management in 2013. But Equilibrium, with offices in Portland and San Francisco, also engages in research and development of new instruments to finance energy efficiency and water quality improvements, for example.

Having witnessed the shortcomings of the VC model for cleantech, Chen and his partners are pursuing a different path, investing against the same backdrop of constrained resources, climate change, and increasing demand from a growing global middle class.

“We’ve chosen to be a financial model innovator,” he says.

Photo by Images_of_Money via Flickr.

Benjamin Romano is editor of Xconomy Seattle. Email him at bromano [at] xconomy.com. Follow @bromano

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