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Planet-Profit Report, reporting on sustainable development in the Western United States.

Early stage cleantech financing: Light at the end of the tunnel?

The traditional rules don't apply

During the last two years, I have spent developing clean energy companies at Colorado State University, I have encountered the plight of nearly every cleantech startup — the steep uphill climb of prying money from the hands of early-stage investors. 

While raising money for three early-stage cleantech companies and consulting with dozens of others, I have heard countless objections and learned to take a pragmatic look at each company. Even with the tremendous scientific and technical vetting process that we have at CSU, investors don't take the technical success for granted.

We have had some success (which lead to our suggested solutions below) but all too often we see it take three months to raise just enough money to last a company another three months. Although I have learned empathy for early-stage investors, I have spent more than one night thinking about the smirk I am going to have when I tell investors who have rejected us how much money they would have made.

By early stage, I mean a company that is 12 to 60 months from selling production goods or services. Many investors who previously invested by this definition no longer do, yet they haven’t changed their mantras — they just changed how they define “early stage.” 

The investors who have professed interest in early cleantech companies include large private equity groups, venture capitalists, angel investors, strategic investors and investment banking firms. This group has shrunk to only two-thirds of the number of companies two years ago. Meanwhile, the remaining investment companies have all-too-often refocused their investment attention towards later-stage companies with revenue. 

I also have spent hundreds of hours applying for every form of Small Business Administration loan, federal loan, government grant, bank loan and convertible debt and have found no silver bullets, although I have had smatterings of success. 

People who have never done a technology startup -- especially government officials and real estate professionals -- often who ask, “How can it be so hard? If these are truly good companies, why can’t they get bank loans or other traditional debt?”  

The answer is simple: By definition, early stage companies don’t have revenue, and thus debt instruments generally don’t work when there is no revenue stream. 

I have developed a concise understanding of the issues surrounding financing a clean energy startup, as well as some poignant proposed solutions that will require engagement from the full clean energy ecosystem of entrepreneurs, scientists and government entities. In only slightly prioritized order, here are my thoughts: 

Problems and challenges:

No good ending in sight (from an investor’s perspective) --- Initial public offerings have dropped to one-fourth of what they were in 2002, and the number of cleantech IPOs in the last two years can be counted on one hand. Add to that an expected three-to-10-year time to market, and any investor is going to get cold feet. 

This lack of exit opportunity has led to a train wreck throughout the investor community, resulting in a reduction of more than 30 percent of the venture capitalists and a flight to safety of many of the remaining investors. This change has resulted in hundreds of later-stage companies that were planning on reaching IPO that are now stranded and offer the appearance of a safer investment with shorter-term returns. 

Market hurdles are too great compared with other investment opportunities — The combination of unpredictable U.S. government support -- combined with exhausting regulatory requirements even for the “lucky” winners of government support -- and a competitive market that is wild and unpredictable gives every early-stage investor a pause. Finding early adopters is often fraught with more regulatory hurdles: Try selling anything in the transportation industry, where EPA and National Highway Safety regulations require millions to satisfy. 

Technology hurdles –The landscape is littered with cleantech companies that never crossed the technology chasm. Many early stage investors had become accustomed to software and IT companies, which typically had far fewer technical hurdles and a much shorter time-to-market. Many cleantech companies have failed at the door of the demo —a spot that software companies rarely failed, largely because it is much easier to fake a software demo than a cleantech demo. 

Solutions: 

The lack of IPO market and corresponding venture capital is unlikely to change in the next three years, so we have to design companies from the ground up assuming no IPO.

This means: 

Find a way to design the company to get to revenue within two years. This will often seem untenable, but the team must go back to the drawing board until they find some way to get it done. It usually means compromises the scientists and technical team don’t want to make, and it often means getting creative and looking past the first target group of customers.  

Target strategic investors from the outset. Strategic investors often represent a realistic exit target, and many strategic investors find value in company assets that don’t require an exit to monetize. Further strategic investors tend to be more patient and generally bring a good understanding of the target market space. 

Start fund raising with a conservative and reasonable valuation. With an IPO, the public is assumed to be willing to accept valuations of 20 times price to earnings rather than a more typical private acquisition target of five times P/E. Without an IPO, early-stage valuations must be pragmatic and lower than they would have been in times of a potential IPO. The early investors must be able to make money, and every future round needs to be an up-round, so don’t start out with high expectations. 

Early-stage investors need to recalibrate to the lower upfront valuations — thus realizing that there is great money to be made by getting in early. The strategy of waiting until the risk is gone shouldn’t pay off for investors. There has to be outstanding early returns in store for the investors willing to take the early risk, and they have to know it and become interested in focusing there. I hear all the time that an investor wants to wait until milestones are met, but for a startup they have to have money to get to those milestones, so we have to ensure that there is great money to made by investing in startups — and that starts with the valuation. 

Keep your hopes up for higher energy prices. Energy prices appear to be back on the rise, and that helps all clean energy companies find a larger market space. Many clean energy companies have by-products and side benefits of their products that provide value even if traditional energy prices are low — so we all have to find and focus on early adopters who can define return on investment more broadly than simply the savings provided versus traditional fuels. We also need to look more carefully at Europe, Canada and other markets that have sustainably higher energy prices today. These represent excellent opportunities to create exports — the best kind of local jobs. 

Let’s quit wasting our time and emotional energy hoping for big federal government grants and loans. I have spoken to several companies who counted themselves lucky enough to win one of those grants or loans and are now wishing they didn’t have the money from the federal government. The never-ending delays and onerous reporting requirements often aren’t worth the money. 

The government can lend a helping hand by reducing the subsidies provided to traditional energy companies and activities (which total more than $1 billion without taking into account all the side government activities). Further, as the government creates tighter regulations for the traditional energy sources, the prices will go up, even if the base commodity does not rise. I get tired of hearing the general public state that clean energy won’t work until it doesn’t need subsidies, when they have been unknowingly subsidizing traditional energy for more than a hundred years. 

One more activity for the government (federal, state and local) — Become early adopters yourselves.  There is no reason the government cannot be the first buyers of most clean technology. In most cases, having an early adopter customer who bought the product, is providing data (and most importantly credibility), is worth far more than grants or loans. 

Keep the technical goals conservative, and accept that most first products will be flawed. The technology will always take more time and more money than expected. Perfection will remain just out of reach, so start with smaller goals that you can get to market with, and grow from there.  If Microsoft had started with Windows 7 — they would have never made it to market. But they started with a flawed but sellable DOS, and the rest is history.