Part of the value SVB brings to its clients is access to experts, potential partners, customers and investors, increasing its clients’ probability of long-term success. On April 8-9, 2010, SVB hosted its first Cleantech Leadership Summit ¬ “Crossing the Cleantech Divide” ¬ at Stanford University, hosting more than 100 cleantech insiders. The Summit was designed to bring together a select group of leaders from the venture capital, entrepreneurial, public policy, energy, academic and NGO communities with the goal of focusing attention, insight, and energy on the question of how best to promote the development of high-growth, innovative technology companies in the energy generation, energy storage and energy efficiency sectors, over the course of the coming decade.
The program featured conversations with successful cleantech entrepreneurs, customers, and energy industry executives, and facilitated small group break-out sessions in which participants interacted directly with each other to explore and develop new ideas. One of the resulting conversations are captured here:
The magnitude of opportunities in global energy markets is enormous, but scaling up a new technology to “utility” scale also presents unique challenges for the venture model. The leap from initial product demonstration and small scale manufacturing into production or assets in the hundreds of megawatts (and hundreds of millions of dollars) largely exceeds the capacity of venture equity financing. Given the current state of capital markets, start-ups are wondering what sources of lending are available for initial large scale manufacturing or projects and what role can and should government play (for example, through loan guarantees and grants) in “picking winners” and lowering the hurdle for new clean energy technologies to attract commercial capital and gain traction in the market.
As we emerge from the credit crisis and recession, the environment for funding cleantech businesses is also changing. In addressing the question of optimism around funding, the group was essentially in the middle. That is, it is clearly much more difficult to get funded that it was three years ago, but compared to 12 months ago, things have thawed somewhat. That being said, there are likely to be challenges well into the future for a variety of reasons, both financial and strategic.
1. The venture industry did not anticipate the level of interaction required outside of the “cozy” venture ecosystem. There exist a number of complexities to be successful that are unfamiliar to most investors.
2. The necessary skill sets are different, and while this is not a surprise at some level, the interaction with the VC community has come slowly.
3. Raising money at all links in the chain is difficult: LPs are far more selective; VCs take longer to raise funds making them more circumspect about investment decisions; capital markets have receded; and government programs also require a long process.
4. Much greater emphasis is placed on capital-efficient business plans. In addition, companies are getting better at forecasting costs of “bill of materials.” Even so, most investors apply a substantial discount (sometimes a 2-3X cost factor) to forecasts and focus primarily on downside scenarios.
5. In relation to the above, VC’s also coming to grips with the “return dilemma” and preserving their positions in companies. When so much money has to be raised after Series B, for instance, it is extremely difficult for all but a few firms to protect their positions. As a result, even a successful outcome might not be so successful for the early investor. And obviously this extends to fund returns and LP behavior.
6. Finally, adding to the current funding uncertainty, there is clearly an overabundance of solar companies. There will be consolidation and pain and until that plays out, there will be great skepticism for new projects. Only a few firms can take a portfolio view because of the amount of capital required.
First commercial scale financing and early project finance is a gap that has always existed. During the elevated environment prior to the credit crisis, there were a few late-stage, high valuation investors willing to bridge that gap. But that was and is an unsustainable solution. What are the shortcomings of traditional capital markets for embracing innovation? The fact is that mainstream debt providers will not take technology risk. The challenge, then, is to define what that risk is, and how to build or shorten the bridge.
As noted earlier, the VC community underestimated the complexities needed for success, and in particular, how to raise money to get to commercial scale. The private market conundrum is described above. What is constraining the government — primarily its designee the Department of Energy (DOE) — from filling the role?
At play right now in the innovation space is the misalignment between New York and Washington, or perhaps more accurately, financial versus political objectives. “Wall Street” will not take technology risk in the structuring of project finance and calculates the inherent financial risk and reward at various stages. Conversely, but just as intently, the DOE calculates political risk on a daily basis. This was summarized by one contributor as “fear of the adverse article” and the image of three guns pointed at the DOE’s head:
1. Don’t screw up and pick the wrong project
2. Get the money out the door
3. Show me the interim results (jobs)
In addition, geographic density of innovation for dispersal of funds is irrelevant in the Senate, so therefore is irrelevant to the DOE. Even though the vast majority of innovation and its financing occurs on the two coasts, senators are politically driven to encourage job creation in their home states. In this light, projects in swing states are likely to have some advantage. Entrepreneurs would do well to consider these locations.
Another evident aspect is that the government taking positions, intended or not, with respect to certain technologies ranging from electric vehicles to LED lighting. The implications are interesting: on the one hand, it may be detrimental to the development of alternative technologies, but on the other, by boosting the category may provide a broad catalyst for innovation in the technology implicitly endorsed by the government.
Acknowledging the industry is still at the beginning of defining paths to success, there are outlying solutions with corporate and strategic players.
Foreign sources of capital can be tapped in different ways. For one thing, it is believed that U.S. investors and entrepreneurs are generally ignorant (exceptions obviously exist) as to fundraising and building offshore. For instance, Europe is probably stronger from a cultural and investor standpoint. Alignment with the innovation space may not be exact, but clearly Europe has been more aggressive in support of deployment. Industrial companies such as Japanese trading companies have reportedly been looking for asset-based projects with attractive IRRs. This may be a better fit for power generation for more certain, long-term returns. Collaborations along the lines of the life sciences industry are similarly showing potential. Corporates that are cash rich are seen to be more interested in playing. The key requirement, however, is that strategic investors must be able to identify an advantage to justify investment.
While much of the first commercial challenge is focused on energy generation and related sectors, the implications also hold true for the “smart grid” and its build-out. Utilities are bound by rate bases and allowances of their public utility commissions. Conceptually, the smart grid makes sense with the result being greater efficiency and reduced costs. The problem is getting there. A proposal was offered by one attendee that would have the PUC establish guidelines for smart grid development along with a “promise” to include those costs in the rate base upon installation or other milestones. Could a bank or other financial institution finance that gap? At a surface level it comes down to the risk that the utility can execute, while also assessing the PUC risk and its promise. Perhaps an insurance product can be added to the equation.
There are clearly no sure answers for sources of credit, but just as clearly there is widespread interest in finding solutions. As things stand now, the short list of options to “cross the divide” are:
1. Shorten the divide
2. Seek DOE or other governmental support
3. Expand international scope for both investors and construction
4. Encourage asset finance from industrials
5. Look to corporate/strategic investors