The failure of Cleantech VC

For those looking for VC Cleantech funding, these are rather dark days. While sad, there is a reason VCs are jumping the Cleantech ship: the returns over the past 10 years have really sucked really bad. The question is why? Why have VC IRRs dropped from 40 during the days of tech to <10 in the days of Cleantech?

Although nobody knows the right answer, two things are clear: Cleantech does not appear to be capable of producing the explosive returns that tech companies can and something is fundamentally wrong with the process that VCs are using to decide what companies to fund and what companies to reject. Lets look at both these issues.

Cleantech companies cannot deliver the explosive returns of tech/web

Yes. How could this not be the case. In Cleantech it takes orders of magnitude more time and money to reach commercialization in a market with intrenched incumbents. Clearly the return on a successful company is not going to be the same as a return on a successful tech company. So why would you fund companies with the same approach?

The slow to come, low returns of Cleantech have been discussed again and again, but nobody seems to change the game. Many Cleantech exits have reached the magic 10X return mark, but  if you want to maintain a that level across your entire fund, you cant count on a single tremendous success to cary your fund. Instead, you need to ensure that, since each success will be smaller and slower than a tech success, your success ratio is much higher. But how...

The IT methods

The VC selection process was created funding tech companies. In order to figure out why this method is not working for cleantech, it is important to understand the things VCs look for when funding tech companies: idea, team, and go-to-market. For tech companies this approach works due to the structure of the tech market.

Idea: in tech, the idea is the least important of the three things VCs look at. This actually makes a lot of sense because in tech, the ideas are usually technically simple and easy to fact-check. Take Amazon, can you create a website that allows people to sell and buy books? Yes, even in 1994 anybody with a modem knew that this was technically possible. So the idea is not that important to VCs and thus, the VCs did not need to be computer scientists that understood the details of how an IT system would be setup to handle selling books online.

Team: this is one of the important ones. I think there is debate about weather go-to-market or team is more important for tech. But either way, both is significantly more important then the idea. Infact, the founder of techstars, David Cohen, makes it a point to tell each new group to consider dropping their idea. "we funded you, we didn't fund your idea. feel free to change your idea". Its hard to find a more clear description of the preference of Team over Idea in the tech world. And really, this makes a ton of sense for tech. If Amazon had realized 1 month in that they couldn't get a website to run that would sell books how hard would it have been to do a technical pivot? Not hard. In tech, technical pivots are relatively easy, but having the vision to see where to pivot is hard. So putting team before idea makes sense and delivers results.

Go-to-market: This is going to sound offensive, but in tech companies you rarely generate tangible innovation based value outside of your core vision. Take Amazon again, in their startup phase did they create anything that was tangibly valuable if their vision of selling books online did not work? No. Sure, they have a bunch of patents and copyrights on different web-based innovations that have generated a tremendous amount of value. But do those patents and copyrights have value if selling books online does not work? Can you license them to your competitors with brick and motor bookshops? Can you perform a go-to-market pivot and use those tools to serve another vision; say, search (google was founded in 1998). No, the tangible innovations you generate in a tech company are more aligned with your vision. So having an air-tight go-to-market, wich Amazon clearly did, was critical. You absolutely must know that the way to monetize your vision is going to work, because all the tangible innovations you create along the way will not have any value if your core go-to-market vision is false.

The failure of these methods

There is no doubt that these methods work for tech companies. The question is why would they work for clean tech? Clearly they havent, but what methods would work better? The first step is to take these three concepts and re-prioritize. In the order of most to least important they should be Idea, Team, Go-to-market.

Idea: Cleantech ideas have two major differences from tech. First, they are based in complicated science. Second, they almost always replace an incumbent technology. There is a huge risk in Cleantech that a technology will simply not work or not meet performance targets that beat incumbents. Unlike tech, there are complicated scientific and engineering hurdles for even the simplest of Cleantech companies. It is important to have an idea with more then sufficient technical merit and for investors to understand the technologies pros and cons.

Team: The group of people running a startup is always important. In cleantech, the skills a good team needs are very different from tech. Tech companies face significant vision challenges and so a team with experience commercializing a vision is important to success. In cleantech, the challenges are much less about the vision, because the vision is already well defined by incumbents, and much more about the technology and adapting that technology or market approach to external forces. In the face of these challenges, past experience commercializing visionary projects is not as much of an asset. Instead, a team with an agile technical skillset that can execute grueling technical pivots as the market and technical forces become more clear is of higher value.

Observing cleantech pitches I am always shocked when VCs comment about what a good team has. For the most part, what they want to see is past startup experience. That experience being in 3D animation technology, is ok as long as it led to a good exit. What? How about experience with a technology missing performance specifications? How about experience pivoting a market approach around that failing technology? Its for this reason that one of the only correlations between team and cleantech success out there is having the inventor on the team. (The other is having a strong past relationship with your other founders, go REbound).

Go to market: In an abrupt reversal, the go-to-market is clearly the least important factor VCs should be looking at in the startups they fund. This is out of step with nearly every VC and business advisor out there, but it is a pretty defensible position, so I will try to make the point. In tech, the go-to-market is critical because of a lack of out of market value generated in the execution of the go-to-market plan. In other words, if your go-to-market is false, all the work you have put into your company has no value. This is very different from cleantech because most clean-tech companies are developing tangible technologies with high value to other applications.

Lets say a company was trying to develop an alge based biofuel technology. You develop a good looking go-to-market and you start to execute. You develop a host of technology around that go-to-market, but then, 4 years in, after many millions of dollars invested, you are faced with the fact that your original go-to-market was false. You simply cant make money on algae based biofuels. What is a company to do? If this were a tech company it would be curtains. But this is a cleantech company and you have amassed a huge amount of proprietary technology with value in different markets. So you pivot your go-to-market significantly by using your proprietary algae system to make Omega-3 instead of biofuel. After 4 years and more then 20 $M invested, this is not a huge challenge because, as a cleantech company, you have developed a competitive advantage around process equipment and technology that has applicability to processes outside your original go-to-market. This is exactly what Aurora Biofuels (now Aurora Algae) did in 2010 when they realized their original go-to-market was shot.

Another great example of this is Sundrop, a company who developed a solar based Biofuels process only to pivot away from solar and transition to natural gas. They could do this because the remainder of their system was still state-of-the-art and delivered considerable value to their new customers.

Another, SunPower Inc (the stirling company), started out in the 70s to develop solar powered engines but pivoted to power satellites with radio isotopes based on the far superior engines they developed in their solar pursuits.

In the end, this low go-to-market risk is the flip-side of the high technological risk. Tech companies don't come anywhere near the technical hurdles that cleantech companies must overcome while sprinting through their go-to-market. When each company gets to a position where they really know if their go-to-market was right, the cleantech company is far more likely to have developed a huge portfolio of valuable technologies. If their go-to-markets were false, they are far more likely to be able to pivot their go-to-market to get revenue fast enough to save their companies. Tech companies on the other hand, will likely just be stranded by a set of technical solutions that serve only their vision.

VC funding has failed cleantech. Or perhaps cleantech has failed VC funding. Either way, there is a clear lack of a cleantech-centric VC approach and the rules for tech clearly dont work. As always, everything I say could be and probably is wrong. But one thing I think we can all agree too is that cleantech funding is titanically broken and that we need to try something else. Until such time however, I will keep working on my pitch...