the flow of venture capital into clean technology ventures

The Flow of Venture Capital Into Clean Technology Ventures Research Results

Jeff Steen amp Paul Frankel Associates

The Center for the Study of Fiduciary Capitalism St Maryrsquos College

1928 Saint Marys Road Moraga CA 94575

wwwfidcaporg

copy Copyright March 2003

The Flow of Venture Capital Into Clean Technology Ventures

Introduction This paper outlines the barriers investors as cited by the investors themselves preventing risk capital (more specifically venture capital) from flowing at higher rates into industries which offer investment opportunities in technologies that simultaneously provide both environmental and economic benefits The authors conducted first person qualitative interviews with leading venture investors in order to determine the reasons these investors either would or would not invest in so-called ldquoclean-techrdquo opportunities Venture capital in the information technology industry has funded advances ranging from the oscilloscope to the mainframe from integrated communications processors to unstructured data mining software These innovations allowed society to use information through the advanced application of improved technological innovations These technological advances were often funded by and provided outstanding returns to venture capitalists Many industries meet the criteria known as ldquoclean-techrdquo yet for some reason these opportunities lack the vast inflow of venture capital that typically characterizes the information technology sector Utility industries such as energy generation water distribution and waste treatment have vast opportunities for improvement in efficiency flow and utilization that are in many ways similar to those characterizing the value propositions of information technology applications For example utility industries rival the information industries in terms of annual revenues Many experienced professionals are available to lead new ventures and numerous innovations may be utilized to improve the performance of such industries Yet the stream of venture capital currently flowing into the utility industry is significantly less than that generally received by the information technology industry The purpose of this study was to inquire of investors what barriers they perceived to be restraining the flow of capital into so-called clean-tech ventures The authors chose to compare investments in the software and semiconductor industries with investments in the alternative energy technology and materials science industries in order to bracket the study These industries were chosen as a cross-section designed to represent different investment profiles industry characteristics and investment dynamics Background Traditional venture capital and other high-risk investors typically search for a number of telling factors a large market opportunity with customers who are ready and willing to make purchases superb management talent with a track record of success and a unique if not disruptive technology advantage that is relatively facile to protect (See Appendix One) These characteristics represent the general high level tests that a company must pass before a venture investor will consider an investment Once these thresholds are surpassed a far more detailed analysis is undertaken When investors were asked why they are unwilling to invest in so-called clean-tech or ldquogreenrdquo industriesa number of reasons were cited too risky incapable of producing the returns on

102003 The Flow of Venture Capital Into Clean Technology Venturesdoc 2 Copyright 2003 ndash Jeff Steen Paul Frankel


investment desired and lacking strong entrepreneurs or facing too many market hurdles among others However when probed these same investors often admit to basing their own views on feeling and bias not on any significant analysis These myths as we call them are each partially true yet insufficient to completely explain the slow rate of risk capital flow into clean-tech companies These myths the realities and some potential remedial prescriptions will be explored below Our research found that barriers to investment fall into five main areas These myths strongly held by venture investors are as follows 1 Money flows where money knows 2 There are no ROIrsquos for investors in these industries

bull Capital requirements are too large bull Time horizons are too long bull Successful exits are rare

3 Regulatory structures make these industries unattractive 4 Clean technology is still underdeveloped 5 Entrepreneurs in these areas are weak in business expertise The researchersrsquo working hypothesis is that the efficient exchange of information between entrepreneurs and venture capitalists will reduce barriers to capital flow into clean-tech companies An influx of capital will catalyze business and technological innovations that offer both positive economic returns as well as strong environmental benefits The researchers believe that within the capitalist system of the United States upon where this study concentrates the only true value proposition for positive sustainable ecological improvement is profit Therefore the researchers want to encourage capital markets as a complementary tool for enabling environmental benefit and as a means of ensuring a sustainable future Methodology The authors conducted a series of over 60 one-on-one interviews (See Appendix Two) with well-known venture capital investors They also interviewed entrepreneurs university professors corporate executives and others with experience in the field (See Appendix Three) In order to ensure open dialog in such a closed community the authors agreed not to personally identify the individual investors nor to personally attribute quotes Because some of the investors were highly critical of their profession and colleagues at other firms the quality and honesty of feedback would have been severely compromised without this agreement For purposes of our research we define the term clean technology as those technologies developed in the physical chemical biological and computational sciences that enable more efficient productive and valuable use of natural and other scarce resources The use of clean technology greatly reduces the ecological impact on these resources when compared to what is commercially available today



On the most basic level the alternative energy category involves one or more technologies that are not commonly used today to produce or deliver energy These technologies can be classified in a number of ways1 bull Energy and efficiency - high efficiency lighting climate control and appliances aimed to

reduce the consumption of energy bull Energy generation and conversion - solar wind bio-fuels hydrogen and other so-called

ldquorenewablerdquo energy technologies fuel cells microturbines etc bull Energy infrastructure transmission and distribution - decentralized generation technologies bull Energy storage and power quality bull Key enabling technologies bull Energy information asset and customer management systems and services For purposes of our research we define the term ldquoadvanced materialsrdquo as relating to2 bull Metals advanced ceramics polymers biopolymers metals metal- ceramic- and polymer-

based composites electronic optical or magnetic materials catalysts semiconductors or other chemicals and materials classes

bull Technologies and processes offering more rapid discovery of new materials better characterization more direct molecular-level control more confident simulation and faster access to prior materials knowledge

bull Novel engineering solutions to discovery processing and fabrication and the various computation simulation and informatics domains that support materials development and commercialization

bull Improvements in materials with regard to their intrinsic properties their costs their creation processing and fabrication and their recyclability and

bull More efficient productive and valuable use of and greatly reduced ecological impact on natural and other scarce resources applications as compared to what is commercially available today

We use the categorical definitions of software semiconductors and industrial energy as defined by the 2003 PWCThomson Venture EconomicsNVCA MoneyTree Survey3 Findings According to Thomson Venture Economics the overhang (uninvested capital - the amount of committed capital remaining in the hands of limited partners) in 2001 stood at $97 billion4 The total fell to $84 billion at the end of 2002 after accounting for givebacks liquidated funds new committed capital and new takedowns5 Since venture funds typically earmark anywhere from 25 to 35 of a fund for follow-on rounds there is actually $50 billion to $60 billion available for new investments6 1 Arete Corporation NextWave Energy 2 NGen Partners 3 httpwwwpwcmoneytreecommoneytreenavjsppage=definitions 4 Thomson Venture Economics The Overhang Shrinks But Does It Matter July 1 2003 5 Ibid 6 Ibid



The researchers found that the amount of venture capital flowing into an industry is not correlated with the industryrsquos size as measured by revenue For example the energy industryrsquos electric and gas sectors totaled over $400 billionyear of revenue in 2001 according to the latest economic census data available from the US Department of Commerce7 These sectors had venture capital inflows of approximately $600 million 2002 8 On the other hand semiconductor manufacturing revenues were approximately $140 billion in 20019 while receiving venture capital inflows of $13 billion in 200210 This capital inflow rate is six times greater than the annualized rate of investment in the energy industry By contrast the software industry revenues totaled approximately $62 billion11 yet received venture capital inflows of $46 billion in 200212 Therefore the capital inflow rate in software is 50 times greater than the flow into electric and gas

Figure 1 ndash Cleantech versus overall venture capital investment for 2002 ($ Millions) Source Cleantech Venture Network If industry size is not the key determinant in the amount of venture capital then what are the key determinants The answers fall into five areas Each of these five areas were cited in the interviews conducted by the authors The information given by the respondents can be divided into myth and reality Myth 1 ndash Money Flows Where Money Knows Myth ndash Venture investors only invest in industries and entrepreneurs with which they are intimately familiar They use this familiarity and expertise as a means of mitigating risk Without deep knowledge of a particular domain the risk level of investment would be completely unacceptable Limited partners (ie ldquoLPrsquosrdquo the VC fund investors) are putting their money at risk and want to see deep industry experience and expertise before entrusting a VC with their investment dollars

7 US Department of Commerce GDP by Industry Report 2002 8 National Venture Capital Association wwwnvcaorg 9 US Department of Commerce GDP by Industry Report 2002 10 VentureOneErnstampYoung Q42002 Venture Investment Report wwwventureonecom 11 US Department of Commerce GDP by Industry Report 2002 12 VentureOneErnstampYoung Q42002 Venture Investment Report wwwventureonecom



A high proportion of general partners and other investment professionals that staff the venture capital funds spend significant portions of their careers in the information technology industry These professionals often had one of four roles prior to joining the venture capital world bull Entrepreneurs who built and successfully exited via IPO or acquisition one or more IT

companies bull Senior management of major IT firms like Cisco Sun Intel et al bull Senior engineering talent from major IT firms or bull Investment professionals who brokered deals in the IT industry Because the primary source of highly regarded investment opportunities or deal flow is a partnerrsquos network of contacts it stands to reason that most of the investment opportunities each partner sees coming from his or her network relates to an IT investment If an investment comes across a VCrsquos desk without being referred to him or her it will typically receive lower priority The investor also relies heavily on this network during the process of due diligence regarding prospective investments

Reality ndash It is true that information technology firms receive the lionrsquos share of venture capital investments In fact approximately 65 of all venture capital dollars are placed into information technology investments If one adds medical and biotechnology to that amount that figure approaches 90 (see Figure 2)

Figure 2 ndash Venture Capital Dollars Invested by Industry Segment ($ Millions) Source VentureOne 2001



It is also true that investments in areas other than technology will receive ample funding opportunities once venture investors understand the value of a given market opportunity This conclusion is especially true at present because as one investor put it ldquogood investments in software and semiconductors are almost non-existent right nowrdquo Two facts support the conclusion that venture dollars will flow into an industry outside of the VC fundrsquos traditional areas of interest in IT First witness the growth in investment in the medical and biotechnology investment areas over the past three years (see Figure 3) Once considered outside the purview of most established IT venture investors many VCs have built new practice areas and many entirely new funds have been raised around nano-tech bio-tech healthcare and related medical investment opportunities In 2002 625 venture firms invested $306 billion in the biotech and healthcare industries13

Figure 3 ndash Source NVCA

The second piece of supporting evidence is the actual growth of investment in clean-tech According to CleanTech Monitorrsquos Q1 2003 publication14 investment in clean technologies doubled in Q1 2003 from the same period in 2002 The investment total of $325 million was a 50 quarter-on-quarter increase Recently many new funds have been formed to invest only in energy or materials companies while traditional IT firms such as Kleiner Perkins Caufield and Byers Benchmark Capital Draper Fisher Jurvetson and others are starting to consider and even to make investments in clean-tech (See Appendix Four) These investments are outside the typical scope of these traditional IT venture investors and clean-tech investments represent a very small fraction of their investment portfolios They are ldquodipping their toes inrdquo as one investor put it In order to get around the fact that they do not have an extensive network in the clean-tech area the VC investors are doing three things First venture partners and associates are educating themselves in the market and industries as much as possible Although this does not replace actual operating experience it can help to mitigate some of the risk of moving into a new area Second firms are looking to outsiders such as 13 The Deal LLC Venture Capital database httpvcdealcomvcindexcfm 14 httpcleantechventurecomdocumentspr_20030715pdf



consultants and industry experts to help them examine markets and technologies Lastly they are looking for technologies that have potential suppliers and customers in industries that are familiar to them And so while money does flow to what it knows investors are willing to learn if they can be shown a good opportunity and compelling value proposition on which they can conduct proper due diligence According to information from the researchersrsquo interviews such potential opportunities should present the venture investor with a minimum of five to ten times cash-on-cash return Myth 2 ndash The Returns for Investors in These Industries Are Not Significant Myth - Venture investors to a person cited the lack of ROI potential in the energy and materials science industries There were three specific reasons cited bull Initial capital requirements are too large bull Time horizons before exiting the investment are too long bull No history of successful exits Reality ndash Investors state that there are significantly higher costs involved with bringing an energy or materials product to market than those generally allocated to a semiconductor or software product Investors cite these high initial costs as one of the major barriers to achieving a strong ROI in energy or materials Yet this assumption is false Energy and materials firms tend to receive capital in the same or lower amounts than IT investments As show in Table 1 investments in energy are typically smaller than either software or semiconductors Semiconductor firms are especially expensive to launch For example Atheros Communications one of the most highly touted semiconductor start-up in recent years has raised over $100 million in three funding rounds15 and investors still have not seen an exit Martix Semiconductor another recent start-up has raised $147 million in its first four rounds of funding and still has not shipped its first product16 These numbers are larger than the amount raised by two materials companies Catalytic Solutions Inc a successful manufacturer of advanced catalytic systems for the automotive and other engine industries has raised $72 million to date through four rounds of funding Optiva a firm developing self-assembling nano-materials for use in optical applications such as flat panel displays has raised $41 million to date through two rounds of funding Venture investors who are accustomed to making investments in software or semiconductor companies may be frightened off by their own perception that higher amounts of capital are needed to get an energy or materials technology company launched (seed startup stage) bring a product to market (early stage) ramp production (expansion stage) or to reach profitability (later stage) In the first quarter of 2003 at least those fears were irrational In fact industrial and 15 Atheros Communications website httpwwwatheroscom 16 Matrix Semiconductor website httpwwwmatrixsemicom



energy companies17 were funded by fewer dollars at every stage of company development as compared with software and semiconductor companies during the first quarter of 200318 (see Table 1)

Investment Stage SOFTWARE SEMICONDUCTORSINDUSTRIAL

ENERGY TOTALS $ 796881 $ 278102 $ 117600

Number of Deals 166 34 31 Median $ 3000 $ 4000 $ 1000

Mean $ 4800 $ 8427 $ 3794

SS + EARLY $ 211106 $ 60060 $ 179244 Number of Deals 55 15 10

Median $ 3000 $ 2000 $ 1500 Mean $ 1351 $ 4004 $ 5585

EXPANSION $ 411636 $ 195042 $ 61660

Number of Deals 88 15 19Median $ 2500 $ 8000 $ 2000

Mean $ 4678 $ 13003 $ 3245

LATE $ 174139 $ 23000 $ 0090 Number of Deals 23 3 2

Median $ 4000 $ 8000 $ 0045 Mean $ 7571 $ 7667 $ 0045

Table 1 ndash Total dollar investments ($ Millions) by industry and by stage of company development for the first quarter of 2003 Source PWCThomson Venture EconomicsNVCA MoneyTree Survey The longer an investor must hold an investment without a liquidity event the lower the return on that investment Most investors we interviewed cited time expectations of seven to ten years to see a target exit in energy or materials investments This fact is especially important to VCs because most investment funds have a ten-year life span Considering that most investments are made in years two through five and that fund managers typically want to start raising another fund three to five years into this process a few early successful exits are important IT investors cite three to five years with a seven year maximum for desired optimum exit time frames The seven to ten years cited by investors as timing for energy and materials investments simply does not match the mechanics of a typical venture fund For example Captsone Turbines a leading micro-turbine manufacturer received its first VC investment in 1993 and went public in 2000 a seven-year period Catalytic Solutions mentioned above was founded in 1996 and is still privately held by the investors Evergreen

17 See PWCThomson Venture EconomicsNVCA MoneyTree Surveyrsquos definitions httpwwwpwcmoneytreecommoneytreenavjsppage=definitions 18 PWCThomson Venture EconomicsNVCA MoneyTree Survey



Solar was founded in 1994 and IPOrsquod in 2000 In software Actuate a leading enterprise reporting firm is a typical example It was founded in 1993 and IPOrsquod in 1998 Investors in energy and materials cited the need to hold energy and materials investments longer than software or semiconductors due to bull Higher marginal costs than marginal utility bull Presence of economic and regulatory ldquoperverse incentivesrdquo19 dis-incentives bull High power of incumbent companies bull Slower purchasing cycles of target customers bull Difficulty in developing engineering and commercializing breakthrough disruptive

technologies Lastly both IT and non-IT investors cited a dearth of exit opportunities for energy and materials firms Most exits and purchase prices in the energy and materials areas have typically been lower than similarly sized firms in the software or semiconductor areas Below is a chart showing exits by energy firms between 1998-2003 (Figure 4) As can be seen strategic sales hovered around $100 million during the five-year period Considering the capital requirements and the hold periods these returns are below VCrsquos expectations

Figure 4 - Courtesty of ChevronTexaco Ventures

As seen in Figure 4 there were a total of twenty-two successful exits for start-up energy firms from 1998 ndash 2003 On the other hand in the third quarter of 2002 alone there were twenty-seven MampA deals in the software sector20 And in 2001 the mean sales price of fabless semiconductor firms was approximately $170 million21 Most IT investors stated that software 19 Factor Four Doubling Wealth Halving Resource Use Ernst von Weizsaumlcker Amory Lovins and Hunter Lovins Rocky Mountain Institute 1998 Kogan Page 20 Thomson Venture Economics 21 Fabless Semiconductor Association httpwwwfsaorg



and semiconductor firms should be able to obtain returns of 5x to 10x (some even 20x) According to venture investors this lack of numerous lucrative exit opportunities is another factor that makes energy and materials companies comparatively unattractive investments While there are indeed positive returns available to investors in the energy and materials areas as cited above they tend to be fewer and smaller than in software and semiconductors In addition the exit path through strategic acquisition is more difficult for companies in these areas This finding is supported by two facts First the network of former executives-turned-investors is less developed in energy and materials than in software or semiconductors Therefore it is more difficult to identify potential strategic options Second in addition to research and development established IT companies are accustomed to achieving technological advances by acquiring smaller companies Cisco Systems is known in the IT industry as the archetypal example of such behavior In general according to our investor interviews potential suitors in the energy and materials industries are far less likely to make acquisitions Even so there have been and there will continue to be some excellent investment opportunities in the energy and materials industries22 While they might not come along at the rate of IT investment opportunities some valuable ideas are available to those investors who actively seek them out Those few funds that are making the investment of time and energy needed to build their networks in the manner mentioned in Myth 1 are positioning themselves to well to identify these opportunities and to become innovators in the venture investing field Myth 3 - The Regulatory Structure Makes These Industries Unattractive Myth ndash Almost every respondent within the IT venture investing community cited the fact that energy is a highly regulated industry and therefore undesirable as an investment area On the other hand these same respondents consider software semiconductors and other IT industries to be virtually unregulated When asked about materials most investors cited the use of materials in energy technology as one of the main sources of investment opportunities (eg materials for photovoltaics) and retreated back to the regulatory argument Reality ndash The IT investors are indeed correct the IT industry itself is mostly self-regulated through standards Standards are achieved via monopoly (eg ndash Microsoftrsquos PC Operating System) by a standards body such as the IEEE (eg - 8023 Ethernet) or through adoption by a majority of industry players (eg Bluetooth) Few investors cited the importance of the regulatory regime governing the industry to which the technology is sold ie ndash the target customer market One of the biggest customers for software is the financial services industry a very heavily regulated industry The supplier of wireless spectrum to the telecommunications industry the Federal Communications Commission (FCC) is itself a regulatory agency Major IT customers are telecommunications firms themselves whom are also quite regulated

22 See some historical examples NREL Technology Transfer Success Stories 1999-2001 httpwwwnrelgovtechnologytransfersuccess_storyhtml



An important source of entrepreneurial opportunity is the application of technology within regulation The best example of this concept is the software firm Documentum Documentumrsquos first application helped pharmaceutical firms automate the US FDA submission process The American drug trial process is one of the most heavily regulated processes in the world Documentum used this regulation to gain a foothold in the market by saving drug companies significant time in their document submissions to the FDA The Documentum solution saved drug firms $1 million for each day the average submission time was reduced Within the regulated energy industry two factors have slowed down technology acceptance First as regulated monopolies utilities have government-imposed limits on the prices they can charge as well as the profits they can earn thereby limiting their incentive to enhance efficiency via the application of new technology Second the useful life of the existing capital equipment is measured in decades Also because capital costs to utilities that are associated with the rollout of new technologies are often quite significant the replacement decision is a slow process This slow process often creates a multi-year sales cycle for technology vendors In the materials area like in the Documentum example firms are beginning to use regulatory regimes or the threat of them as a source of entrepreneurial activities One firm MBA Polymers has developed a technology process to recycle advanced polymers used in the manufacturing of electronic equipment from laptops to cameras to televisions Considering the European Unionrsquos and Japanrsquos strict product life-cycle recycling laws MBA Polymers is well positioned to provide the closed-loop waste stream envisioned by regulators Catalytic Solutions is using both the competitive advantage of superior emissions cleansing capabilities coupled with their lower cost product to gain significant market share in the automotive catalytic converter market Thus while regulation can create difficult barriers to entry it can also create opportunities for entrepreneurs to successfully commercialize and apply new technologies Myth 4 - Clean Technology Is Still Underdeveloped Myth ndash With the exception of those investors specializing in energy andor materials and a few very well respected top-tier IT venture funds investors surveyed all cited the early stage nature of clean technologies as a reason not to invest Their opinion was that the technologies were too far away from a commercialization stage to be a viable investment They stated that these technologies were better suited to government or Fortune 500 RampD departments rather than VC investors Of all the myths regarding clean-tech investing this myth is the one least supported by reality Reality ndash There are products in both energy and materials that are already commercially viable and many others that are quite close to viability In fact according to the National Renewable Energy Laboratory the cost of renewable energy technologies per kilowatt-hour especially wind and geothermal are already directly competitive with coal and gas-fired fossil fuels The same study further predicts price per kilowatt-hour equalization because the cost of new cleaner-burning fossil fuel power sources will be higher than previous more polluting techniques This



fact coupled with the downward trend in cost per kilowatt-hour for renewables firmly places these technologies in the realm of commercialization either now or in the near future23 In the area of materials science especially nano-technology perception on the part of investors is that the lack of commercially viable products is more acute than in energy technologies However as cited above there are materials technologies for specific applications that show strong promise as investment opportunities It is indeed true that venture investors generally do not and should not fund primary research However there are a number of technologies that are either ready or nearly ready for commercialization One area that some investors cited as ready for commercialization was PEM or silicon fuel cells as a replacement for the battery powered systems now used in applications ranging from back-up power for cell phone towers to installation into military radios Leading VCrsquos are beginning to make investments in these areas leaving their less forward-looking brethren behind (see examples in Table Two) Because there are fewer deal opportunities in the energy and materials areas the early movers see themselves as able to cream the best deals off the top

KONARKA

TECHNOLOGIES CLEAN AIR PARTNERS NANOMIX

Total VC Funding

$16 million $35 million $15 million

Lead Investors

Draper Fisher Jurvetson Zero Stage Capital

CIBC Capital Partners EnerTech Capital Nth Power

RBC Capital Partners

Alta Partners Apax Partners

EnerTech Capital Sevin Rosen Funds

Technology Replaces silicon with

titanium dioxide -- commonly used as a

pigment in paint -- to create flexible solar electric panels

Lets vehicles and generators run more

cleanly and efficiently by using

natural gas and a small amount of

diesel

Adapts carbon nanotubes tiny

extrusions of pure carbon to store hydrogen safely and efficiently

Table 2 ndash Examples of recent VC investments in cleantech companies Source Business 20 May 2003 Myth 5 - Entrepreneurs In These Areas Are Weak In Business Expertise Myth ndash Almost all of the IT venture investors that the authors interviewed stated that generally they have found a lack of entrepreneurial talent within the energy and materials sectors Business plans are often eliminated due to a lack of entrepreneurial experience even before the investor examines technology markets or customers Reality ndash It is true that a significant number of the entrepreneurs that the authors interviewed focused their business descriptions on how significantly their innovation would benefit the environment While environmental benefits are noble almost no venture investor would make an investment for reasons other than economic gain By using the environmental benefits as part

23 httpwwwnrelgovanalysisemaapubsceedceedhtmltrue



of the argument in support of funding their enterprise entrepreneurs take attention away from the only item most investors care about ndash return In addition firms like PGampE DuPont FPL 3M General Electric and many others have long dominated the fields of energy and materials Dominance by these major corporations when coupled with the economic barriers and regulatory disincentives has resulted in slower and less influential entrepreneurial activity for these industries Firms with great innovations in these industries have a relatively small talent pool of experienced start-up executives Because managing a start-up takes a significantly different skill set than managing in a global company the lack of an entrepreneurial talent pool based on experience is indeed a limiting factor Strong entrepreneurial talent exists in energy and materials but it is less common and concentrated than in the high tech industries The energy and materials entrepreneurial industries are in a situation similar to that of high tech start-ups ten to fifteen years ago when engineers without much business experience or formal business education were founding new ventures Conclusions In summary the myths used by traditional venture investors for declining to invest in clean-tech areas like energy and materials are based on reality yet at the same time they are not completely real These reality gaps need to be addressed from both the investor and entrepreneurial perspectives Due to structural and economic considerations regarding the industries examined here it is the authorsrsquo conclusion that there probably will not be a massive influx of venture capital into the alternative energy technology or materials science technology industries anytime soon The current slow pace of venture investment will increase over time as market forces begin to exert pressure in favor of clean technologies There are three levers that can be used to speed up the pace of change and to achieve the positive ecological and economic benefits that these technologies have to offer First there are public policy issues regarding perverse incentives in favor of existing industry structures These incentives could be changed by the reduction of externalized costs The petroleum industries are one example of an industry that would be forced to change rapidly if all the costs they force society to bear for the benefit of their shareholders were borne instead by the firm Market-friendly approaches such as the carbon taxes touted by The Economist24 would ensure a freer market with more accurate representation of costs than currently exists Secondly the next generation of technology entrepreneurs and investors needs to be educated in our leading business schools Business schools like most academic institutions are not well adapted to developing the sort of cross-campus curriculum needed to educate clean-tech entrepreneurs A successful curriculum would entail faculty from disciplines as diverse as finance and forestry economics and ecology By bridging the pure sciences engineering law business and the social sciences such a curriculum would properly convey the complexity of these solutions 24 The Economist April 18 1998



Lastly unless there are significant changes in the way both investors and entrepreneurs approach each other clean-tech ventures will continue to receive investments at rates significantly slower than their IT counterparts However enough potential opportunities exist that VCrsquos would be remiss if they did not take the time to learn about current clean-tech initiatives and the potential customer benefits they may offer Although traditional venture investors would be able to find strong entrepreneurs and technologies in these non-IT fields their networks of contacts experience and pre-conceived notions often prevent them from seeing these opportunities By adding energy and materials investments to their portfolios venture investors will achieve a number of benefits First they will begin to reduce the risk associated with their existing portfolios Currently with investments in semiconductor hardware software systems and services IT sectors venture firmsrsquo funds are made up of a large number of positively correlated investments By broadening the profile of their portfolio investors will offer some degree of risk mitigation during a depressed market or recession Second by entering these non-IT industries at this point in the market cycle investors have the chance to obtain favorable valuations Lastly early investors will benefit by having access to the best investments with less competition than in their traditional investment sectors Entrepreneurs also need to expand their views and skill sets Most investors we interviewed thought that there was enough deal flow in IT technology to support the existing funds and achieve acceptable if not stellar returns There is little or no incentive according to the majority of these investors to invest in areas that are outside the realm of current investment The path of least resistance especially when based on past success is difficult to overcome In order to affect this bias entrepreneurs must approach VCs in a manner that educates them on the market opportunities as well as the reasons why a particular venture will win in its chosen addressable market Entrepreneurs must use the same approach that existing IT entrepreneurs use to secure funding yet they must work hard to educate potential investors by selling them on the business concept demonstrating its value proposition and lining up customers who are ready willing and able to make purchases The final conclusion supports a market opportunity for professionals from the energy and materials industries to found their own venture funds Firms like NGen Partners with its deep materials expertise and Nth Power with its energy focus can serve as models These companies have taken the venture capital model used by IT investors and applied it to their respective industries staffing their firms with industry as well as financial experts While opportunities in the energy and materials markets are not as viable because of the structural and economic issues present at this time there is certainly room for firms and funds focusing on opportunities revolving around these often overlooked technologies



APPENDIX ONE Investor Decision Metrics There are six major criteria venture investors use when deciding to invest capital Different investors place different weights on these areas when making investment decisions No two investment decisions are alike however these factors are overwhelmingly the ones cited in the research to date

1 Economics bull Market size

o Is the market opportunity for the innovation large enough to bring the type of returns VCs expect on their investments

o Can the product be developed produced and sold in a manner that will make the firm profitable

bull Potential Returns bull Appropriate financial instruments and vehicles

2 Management team bull Is an experienced team in place or are there personnel readily available who are

well suited to making this venture a success bull Does this team have the right set of skills and experiences to guide the firm

through the growth phase 3 Quality of the innovationUniqueness

bull How unique is the innovation bull How efficacious is it bull How defensible is it (patents trade secrets copyrights control of resources etc)

4 Exit bull What is the exit strategy for this investment (IPO merger etc) bull How likely is this firm to achieve that exit strategy bull Time horizon to exit investment

5 Risk bull How will financial business operational technological political and other risk

types impact this business bull Is the business in a position to overcome these risks

6 Location bull Are there sufficient sources of needed inputs such as talent services innovations

etc are within close proximity of each other bull Is there sufficient information availability and flow to help with investment

decisions bull Is there enough deal flow to ensure the availability of suitable investments bull Are the investment opportunities in close enough proximity to allow the investor

proper oversight



APPENDIX TWO Interview Questionnaire Sample Set Each interview utilized a set of typical questions A sampling of such questions follows

1 What specific industry characteristics make the software and semiconductor industries attractive as an investment area

2 What specific industry characteristics make the alternative energy andor advanced materials industries attractive as an investment area

3 What is the role of regulation in your investment decisions 4 At what stage does a technology need to be before you will consider an investment (ie -

alpha beta clinical trial stages roll-out customers using it etc) 5 What types of problems do the technologies you invest in solve (efficiency revenue

enhancement cost cutting improve use of existing resources etc) 6 What factors do you examine when trying to understand the barriers to a technologyrsquos

acceptance 7 What proofs do you require to determine if a technology can overcome barriers to

acceptance 8 What is the business background and experience profile of the typical entrepreneur in

whom you invest (ie ndash do you look for engineering and development talent above business skills)

9 What type and what level of ROI do you expect from your investments What are the typical ROIrsquos you have actually received from your investments

10 Typically what size market must be evident to make an investment attractive Please give specific examples

11 How do you evaluate financial and non-financial risks in your investment What about in your portfolio

12 What is your time horizon for a typical investment 13 What types of competitive advantages do you look for in your investments How are they

graded or scored 14 How many exits have your portfolio firms gone through 15 What role does government have in creating and regulating new markets that favor

sustainable products and services



APPENDIX THREE Types of Research Participants The following list contains functional classifications of the types of people whom were interviewed for this study This list is not exhaustive nor is it prioritized in any particular order While this study could be successfully conducted by interviewing only the financial community by adding a breadth of viewpoints the researchers hoped to find additional insights into the issues at hand

1 Financiers bull VCs

o Information Technology o ldquoGreenrdquo or non-traditional

bull Corporations bull Investment bankers bull Angel investors bull Foundations bull Venture philanthropists

2 Complimentors

bull Government bull NGOs bull Academics bull Incubators bull Thought-leaders bull Practitioners bull Professional services firms

3 Corporations and Entrepreneurs

bull Energy bull Materials bull Information Technology



APPENDIX FOUR Partial List of Energy and Materials Venture Investors25 26

40 Energy and Environmental Ventures

LLC 1 Adams Harkness amp Hill 2 Advanced Materials Partners Inc

41 Energy Capital LLC 3 Advent International 42 Energy Ventures Group 4 Altira Group LLC 43 EnerTech Capital Partners 5 Ameren Energy Fuels and Services 44 Entegrity Partners LP 6 Angels with Attitude I LLC 45 Environment Capital Company 7 ARC Energy Venture Funds 46 Epsilon Synergy Development

Corporation 8 Ardesta 9 Arete Corporation

47 Exelon Capital Partners 10 Asia West Environment Funds 48 Expansion Capital Partners 11 Beacon Group Energy Funds 49 FA Technology Ventures 12 Bechtel Enterprises Inc 50 First Analysis Corporation 13 Black Emerald Group 51 FondElec Group Inc 14 Blue Hill Venture Partners 52 Fuel Cells America LLC 15 Brand Equity Ventures 53 Gaebler Ventures LLC 16 BridgeWorks Capital 54 Genesis Park 17 Cadre International 55 Geneva Energy Advisors 18 Calvert Funds 56 GFI Energy Ventures 19 Cartesian Capital Corporation 57 Goldman Sachs 20 CEfotech Pte Ltd 58 Green Planet Venture Capital LLC 21 CEI Community Ventures 59 Haddington Ventures LLC 22 ChevronTexaco Technology Solutions 60 Harris and Harris 23 Chrysalix Energy 61 Hydrogen Ventures LLC 24 CIBC Capital Partners 62 Hydro-Quebec CapiTech Inc 25 Cimarron Capital 63 Jane Capital Partners LLC 26 Cinergy Ventures LLC 64 JP Morgan Partners 27 Commons Capital Management LLC 65 Kinetic Ventures 28 Conduit Ventures 66 Laranda Solar Technologies 29 Connecticut InnovationsClean Energy

Fund 67 Marathon Capital LLC 68 Meridian Venture Partners 30 DR Coven amp Associates 69 Merrill Lynch 31 DQE Enterprises 70 Moore Clayton amp Co 32 DTE Energy Technologies 71 MRI Ventures 33 EA Capital LLC 72 New Energy Capital 34 Easenergy Inc 73 New Hampshire Governors Officeof

Energy and Community Services 35 EBARA Corp 36 Ecoelectron Ventures

74 NextGen Partners 37 Ecology Capital Partners LLC 75 Nth Power Technologies 38 Edison Development Corporation 76 OPG Ventures 39 El Dorado Investment Company 77 Pacific Venture Capital LLC

25 httpwwwfse-directorynet 26 httpwwwnrelgovtechnologytransferentrepreneursdirectoryhtml



98 Sun Coast II 78 Parker Venture Management 99 Sustainable Development Fund 79 Partech International 100 Sustainable Energy Fund of Central

Eastern Pennsylvania 80 Perseus LLC 81 Prometheus Equity Partners

101 Sustainable Energy Ventures 82 Prospect Street Ventures 102 Taproot Ventures 83 Prospero LLC 103 Technology Partners 84 Protech Asset Management 104 TechQuest Capital Partners 85 RAM Capital Management 105 The Lubrizol Corporation 86 Rockefeller amp Co 106 TransAlta Corporation 87 RockPort Capital Partners 107 True North Partners LLC 88 SAM Equity Partners Ltd 108 US Global LLC 89 SAS Investors 109 US Trust 90 Saw Mill Capital LLC 110 VcapitalJesup amp Lamont 91 SciVentures LLC 111 Vencon Management Inc 92 SDTC 112 Ventures West 93 Sempra Ventures 113 West Penn Power Sustainable

Energy Fund 94 SJF Ventures 95 Solar Development Group

114 Zero Stage Capital 96 Stephens Inc 97 Summit Energy Ventures




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End of Document

Background

Methodology

Findings

Myth 1 ndash Money Flows Where Money Knows

Myth 4 - Clean Technology Is Still Underdeveloped

Myth 5 - Entrepreneurs In These Areas Are Weak In Business Expertise

Conclusions

Investor Decision Metrics

APPENDIX TWO

Interview Questionnaire Sample Set

APPENDIX THREE

Types of Research Participants

APPENDIX FOUR

Partial List of Energy and Materials Venture Investors


Introduction This paper outlines the barriers investors as cited by the investors themselves preventing risk capital (more specifically venture capital) from flowing at higher rates into industries which offer investment opportunities in technologies that simultaneously provide both environmental and economic benefits The authors conducted first person qualitative interviews with leading venture investors in order to determine the reasons these investors either would or would not invest in so-called ldquoclean-techrdquo opportunities Venture capital in the information technology industry has funded advances ranging from the oscilloscope to the mainframe from integrated communications processors to unstructured data mining software These innovations allowed society to use information through the advanced application of improved technological innovations These technological advances were often funded by and provided outstanding returns to venture capitalists Many industries meet the criteria known as ldquoclean-techrdquo yet for some reason these opportunities lack the vast inflow of venture capital that typically characterizes the information technology sector Utility industries such as energy generation water distribution and waste treatment have vast opportunities for improvement in efficiency flow and utilization that are in many ways similar to those characterizing the value propositions of information technology applications For example utility industries rival the information industries in terms of annual revenues Many experienced professionals are available to lead new ventures and numerous innovations may be utilized to improve the performance of such industries Yet the stream of venture capital currently flowing into the utility industry is significantly less than that generally received by the information technology industry The purpose of this study was to inquire of investors what barriers they perceived to be restraining the flow of capital into so-called clean-tech ventures The authors chose to compare investments in the software and semiconductor industries with investments in the alternative energy technology and materials science industries in order to bracket the study These industries were chosen as a cross-section designed to represent different investment profiles industry characteristics and investment dynamics Background Traditional venture capital and other high-risk investors typically search for a number of telling factors a large market opportunity with customers who are ready and willing to make purchases superb management talent with a track record of success and a unique if not disruptive technology advantage that is relatively facile to protect (See Appendix One) These characteristics represent the general high level tests that a company must pass before a venture investor will consider an investment Once these thresholds are surpassed a far more detailed analysis is undertaken When investors were asked why they are unwilling to invest in so-called clean-tech or ldquogreenrdquo industriesa number of reasons were cited too risky incapable of producing the returns on








































ENERGY TOTALS $ 796881 $ 278102 $ 117600


Mean $ 4800 $ 8427 $ 3794


Median $ 3000 $ 2000 $ 1500 Mean $ 1351 $ 4004 $ 5585

EXPANSION $ 411636 $ 195042 $ 61660


Mean $ 4678 $ 13003 $ 3245


Median $ 4000 $ 8000 $ 0045 Mean $ 7571 $ 7667 $ 0045








As seen in Figure 4 there were a total of twenty-two successful exits for start-up energy firms from 1998 ndash 2003 On the other hand in the third quarter of 2002 alone there were twenty-seven MampA deals in the software sector20 And in 2001 the mean sales price of fabless semiconductor firms was approximately $170 million21 Most IT investors stated that software 19 Factor Four Doubling Wealth Halving Resource Use Ernst von Weizsaumlcker Amory Lovins and Hunter Lovins Rocky Mountain Institute 1998 Kogan 0 Thomson Venture Economics 21 Fabless Semiconductor Association httpwwwfsaorg











KONARKA


Total VC Funding


Lead Investors












diesel




























proper oversight
























2 Complimentors



























End of Document

Background

Methodology

Findings




Conclusions


APPENDIX TWO


APPENDIX THREE


APPENDIX FOUR








































ENERGY TOTALS $ 796881 $ 278102 $ 117600


Mean $ 4800 $ 8427 $ 3794


Median $ 3000 $ 2000 $ 1500 Mean $ 1351 $ 4004 $ 5585

EXPANSION $ 411636 $ 195042 $ 61660


Mean $ 4678 $ 13003 $ 3245


Median $ 4000 $ 8000 $ 0045 Mean $ 7571 $ 7667 $ 0045



















KONARKA


Total VC Funding


Lead Investors












diesel




























proper oversight
























2 Complimentors



























End of Document

Background

Methodology

Findings




Conclusions


APPENDIX TWO


APPENDIX THREE


APPENDIX FOUR

















KONARKA


Total VC Funding


Lead Investors












diesel




























proper oversight
























2 Complimentors



























End of Document

Background

Methodology

Findings




Conclusions


APPENDIX TWO


APPENDIX THREE


APPENDIX FOUR
























proper oversight
























2 Complimentors



























End of Document

Background

Methodology

Findings




Conclusions


APPENDIX TWO


APPENDIX THREE


APPENDIX FOUR
























2 Complimentors



























End of Document

Background

Methodology

Findings




Conclusions


APPENDIX TWO


APPENDIX THREE


APPENDIX FOUR
























End of Document

Background

Methodology

Findings




Conclusions


APPENDIX TWO


APPENDIX THREE


APPENDIX FOUR
