The venture capital system is "broken" for clean energy technology, according to a new paper from the Massachusetts Institute of Technology.
The analysis concludes that alternative funding streams from government or elsewhere are needed to boost the next wave of clean energy innovations.
"The picture for clean tech venture capital looks grim — especially for companies developing breakthrough energy technologies," said Benjamin Gaddy, director of technology development at Clean Energy Trust and author of the new research released by MIT’s Energy Initiative.
There was a major boom and bust in clean tech between 2006 and 2011. The paper aims to provide a more comprehensive analysis of what happened to clean energy startups in that time by considering the fate of every clean tech, software and biomedical technology startup receiving a first round of venture capital funding.
The study "is significant in that it does provide some of the best numbers that tell the story of the ‘boom and bust’ of clean tech venture investing over the first serious decade of venture investing in the sector," said Patrick Von Bargen of 38 North Solutions.
In 2006, rising fossil fuel prices, pending energy legislation and growing public awareness about climate change helped fuel venture capital interest. Clean energy startups attracted $1.75 billion in venture capital funding that year, more than double the amount from previous years.
But the boom went bust within five years, as venture capital firms lost half their money. More than 90 percent of clean tech companies funded after 2007 failed to return just the initial invested capital, the report said. Between 2008 and 2013, clean tech funding fell from more than $5 billion to $2 billion and has remained flat since.
The report cites the cases of Solyndra and Nanosolar, which "struggled to match the scale of production of conventional silicon solar panels, which leveraged tried-and-true manufacturing techniques from the semiconductor industry."
"Cleantech offered VCs a dismal risk/return profile, dragged down by companies developing new materials, chemistries, or processes that never achieved manufacturing scale," states the paper, which was also co-authored by Francis O’Sullivan, director of research and analysis at MIT’s Energy Initiative, and Varun Sivaram, a fellow at the Council on Foreign Relations. It was a very different outcome from software and biomedical technology, which lived through the same global financial crises but fared better.
Why was clean tech so different?
For many companies, there was little room for error because they were competing "in commodity markets with razor-thin margins — against cheap silicon solar panels or abundant oil and gas — making it difficult to invest in [research and development] while also operating a lean manufacturing operation," according to the report. A glut of cheap Chinese solar panel exports, for example, hit U.S. solar panel startups.
Often, factories required prohibitive amounts of funding, as they involved expensive components. Many technologies required a longer development time than the three-to-five-year time frame expected by venture capitalists. The problems were particularly acute for companies developing solar panels, batteries, biofuels and other energy materials.
Declining research budgets at large energy companies further stalled the environment for entrepreneurs. Among those cutting back were oil companies like BP PLC, which exited the solar industry in 2011.
Startups in non-energy sectors also benefitted from more early acquisitions, which allowed them to bring lucrative profits to investors from the start. Take the case of pharmaceutical companies that acquired medical startups that could demonstrate the viability of a drug via milestones in the regulatory process.
With energy, "the likely acquirers — utilities and industrial giants — were unlikely to acquire risky start-ups," the report says.
"Utilities and corporations in the electricity generation and delivery sector have a mandate for reliability, which inevitably leads them to be risk-averse. From the perspective of the customer (and the regulators), a blackout has a huge downside, while clean energy is simply a ‘nice to have,’" said Gaddy.
There is not likely to be a repeat of 2006’s cash surge for clean tech, considering the inherent challenges in scaling up energy companies, according to the authors.
Instead, there needs to be greater government support for clean tech R&D along the lines of what the Obama administration supported as part of its Mission Innovation plan last year, according to the researchers. Congress has denied much of the funding for the plan (Greenwire, June 2). But institutional investors like pension funds and sovereign wealth funds also could help, as they "are set up to wait decades to realize returns," the report states.
It also calls for the Department of Energy to increase support for programs that help energy entrepreneurs, including the Advanced Research Projects Agency-Energy and small business voucher programs.
"Some have called for investors to allocate more money to the sector and be willing to wait longer for returns. But our analysis shows that this would not be enough. Clean tech entrepreneurs must find ways to reduce their capital requirements by accessing shared facilities at incubators, national laboratories and universities, and they must take advantage of public R&D grant funding while they develop their product," said Gaddy.
In an online commentary, Generate Capital Inc. co-founder Jigar Shah, criticized some of the research for focusing too much on "energy miracles" from billionaires.
"We all love a good story of cleantech VCs and resulting billionaires, but that is simply not the story of cleantech infrastructure. Cleantech infrastructure is a story of thousands of well run companies worth less than ten million dollars that have been started since 2003," he wrote.