“Good decisions come from experience and experience comes from making bad decisions.” Mark Twain
Twenty years of investing in this space builds the experience needed to make good decisions, but only if we can learn from the “less-good” decisions of the past. When we started out, we were a first-time team, first-time fund in a sector that didn’t exist. Deal flow sourcing was manual, business plans arrived by post and the eco-system of entrepreneurs and investors was effectively non-existent.
Lessons from the Cleantech Bubble
We launched our first fund in 2000, just as the internet tech bubble was bursting, but we were investing in the “real economy,” so we felt immune. With our euphoria for investing in potentially breakthrough (read unproven) technology, came a sense that we were on to something. Five years later, the generalist VC funds and institutional investors discovered cleantech and first hype cycle was in full swing. In retrospect, as with all hype cycles, there were some telling signs that the growth was not fueled by sound investment discipline.
Firstly, everyone was suddenly a cleantech fund. VCs follow the money and there were some very large institutional investors making specific allocations to cleantech. Unfortunately, many also attached geographic restrictions which only makes the pond smaller and the fish seemingly bigger. Cleantech is mostly industrial tech and these companies are addressing global markets. Start-ups not only need cash, they also need significant support to define their go to market strategies and land their key reference customers. A fund with deep industry expertise and global connections to industrial customers is what they need, regardless of their track record in unrelated sectors or geographic proximity to the institutional investors.
Lesson #1 – VC competencies have to match the startup’s challenge.
Secondly, a lot of the cleantech deals are targeting large but conservative existing industrial sectors where technology development, proof of concept and pilots take a long time. We all admire entrepreneurs for their optimism, but we need to be realistic about the time and money involved in seeing these industrial tech innovations to market success. In addition, the ecosystem (including incubators and accelerators) to support really early-stage companies was not in place and VC money was insufficient to carry these companies from ideation to IPO. Many funds investing in the early stages ran out of reserves and ran out of time. Many potentially interesting companies simply ran out of fuel before they could gain market traction.
Lesson #2 – Match VC investments to the VC fund time frame.
Thirdly, valuations were going up and up and up. This drove paper returns higher, but as the IPO window was narrow and short-lived, we were still dependent upon corporate M&A guys offering real cash to lock in returns at similar multiples as the VC rounds. Unfortunately, they never got the memo. Industrial corporates tend to buy profitable companies as they are typically incorporating these new businesses into their existing divisions, and the bonus metrics are tied to profitability and cash flow metrics, not just top line projected growth.
Lesson #3 – A trade sale to a corporate is the most likely exit – value the investments accordingly.
Fourthly, companies were raising huge financing rounds. While in 2000 it was difficult to cobble together a USD 10 million round, by 2005 there was a race to see how big the rounds could get. With this came cash intensive business models, inflated cost structures and enormous burn rates… and thus the VCs dug their returns hole even deeper. Most industrial tech companies cannot accelerate growth just by throwing more money at the problem. We went from drought to flood and neither provide the foundation for sustainable growth.
Of course, it was simply bad luck that this hype was followed by the financial crisis and those VCs that had raised their funds at the beginning of the hype had already deployed most of their funds before the crisis hit. This meant portfolio companies in need of significant follow-on rounds were left to fend for themselves, and many newly minted “cleantech” VCs recognized that they had little means to help the companies survive beyond pumping in more cash. Exactly those investors who encouraged high spend rates quickly triaged the high-burn companies out of their portfolio, leaving the charred remains along the roadside.
Lesson #4 – Once a company is in revenue, they should aim to raise enough to get to Cash Flow Break Even and raise it from investors who have demonstrated a long-term commitment to their sector.
Quo Vadis, Climate Tech?
Compared to the early 2000’s, a lot has changed…
Corporate climate commitments are at an all-time high. Corporations are internalizing their sustainability goals, getting action plans in place to achieve the commitments, which is driving technology adoption and deployment at scale.
Many promising innovations in our sector come from an interdisciplinary approach including disciplines which have been foreign to large corporations – digitization being the most obvious example.
Many corporations accept that not all innovation will come from within their four walls, are embracing Open Innovation and have dedicated resources and defined processes to engage with startups. This opens up access to industrial markets and accelerates commercialization.
The IPO markets (mostly via SPAC mergers) is currently wide open but even in absence of the public markets, trade sales are robust. Institutional investors are shifting massive sums from the climate sinners to the climate saviors, which has the additional impact of catalyzing the shift to cleantech strategies by most incumbents.
The cleantech (or climate tech) VC community has expanded in depth and breadth. Many VCs have been around for a full cycle, to see what works and what doesn’t. Many of the dedicated VCs can navigate around the micro-bubbles and protect their returns from the effects of naive exuberance.
Time to profit from experience!
Although some signs indicate that we are in the early stages of another bubble (partially fueled by the SPAC excitement), this time we will fare better – venture and institutional investors are more experienced, industrial players are more committed, the time frame is more realistic, and ultimately the climate crisis is more urgent every single day. The UN SDGs are catalyzing major transformations and corporations are responding. To thrive in their industry transformations, corporations will need to collaborate with promising startups and for the VCs to succeed, they need to understand the industry challenges and find the solutions. Together as a venture community, we can build on our hard-earned experience and create value for our sustainable future.