Reports that venture capital investment in alternative fuels is slowing, edged out by trendy fields like social networking, appear to be premature. Considerable enthusiasm for clean fuels and related products still exists, according to speakers at the Wharton Global Alumni Forum in San Francisco. The speakers were part of a panel addressing the question, “Can Venture Capital Really Influence Environmental Sustainability?” Their positive outlook is borne out by statistics.
The first quarter of 2011 was a record-breaker for so-called cleantech generally, with global investments (in North America, Europe, China and India) totaling $2.75 billion in 161 deals, up by more than 50% from the previous quarter. Solar was the leading sector ($640 million), followed by transportation ($311 million) and materials ($296 million). But the momentum slowed. According to preliminary results from Cleantech.com, investment fell 33% in the second quarter of 2011 (to $1.83 billion), with energy efficiency ($428 million in 38 deals) taking the lead role.
There is a reason alternative fuel and plug-in car companies, which access the “alternative fuel” known as electricity, remain an attractive investment. Although the risk is great, so is the potential reward. An analysis by Google.org in June 2011 created a model showing that by 2030, “aggressive energy innovation” could reduce American oil consumption by more than 1.1 billion barrels a year, add more than $155 billion a year to the Gross Domestic Product (GDP) and create 1.1 million net new jobs. Even a five-year delay in putting an accelerated schedule in place could cost the U.S. economy as much as $3.2 trillion in unrealized GDP gains by 2050, the report said.
“The fuels market is hundreds of billions of gallons, and a giant opportunity,” said Andrew Chung, a Forum panelist and director at Lightspeed Venture Partners in Menlo Park, Ca. Lightspeed has invested in algae producer Solazyme, which makes renewable fuels and chemicals through a fermentation process.
According to panelist Ashmeet Sidana, a partner at Foundation Capital in Menlo Park, “Fuels are an incredibly large market with high variety-of-use cases. People use them for all kinds of things, and that makes it extremely attractive for innovation. If you can secure even a small niche of that market, you can build a successful business.”
Panelists focused on three specific niches within the fuels market:
Algae: Serial entrepreneur Bernard David has invested in algae-based fuels, an experience that has led him to conclude that much of the technology is “still an R&D exercise,” although one with potential, said David. Algae is grown, harvested and converted into a base crude oil that can be refined into biodiesel, gasoline or jet fuel. A major advantage is that, unlike corrosive ethanol, algae-based fuel can leverage the existing network of 160,000 gas stations. By contrast, the need for a separate infrastructure has stalled the growth of both hydrogen and ethanol fuels. “Algae could be the Holy Grail, and I want to be bullish on this sector,” said David, a fellow at Wharton’s Initiative for Global Environmental Leadership (IGEL). “It’s important to have other applications for the algae.”
Those “other applications” are what led Chung’s company, Lightspeed, to invest in South San Francisco-based Solazyme — described by The Economist magazine as “a promising anomaly” because it grows algae in industrial vats instead of using sunshine to make it in outside pools. In addition to producing renewable crude oil for transportation fuels, with the U.S. Navy as a customer, Solazyme’s algae is used to make cosmetics and both human and animal food. It can replace problematic palm oil in some applications and be used to make soap, lotions, mayonnaise and even the brownies that Chung has sampled. This versatility could be a key to the early success of an algae biofuel investment. Other funding for Solazyme comes from Unilever, Chevron and agribusiness firm Bunge.
Ethanol: Robert W. MacDonald, managing partner of Craton Equity Partners in Los Angeles, sees “an active market” for biofuels, including E85 ethanol and biodiesel, especially in California, where the network of biofuel pumping stations is expanding. E85 fuel is 85% ethanol. But panelist Sidana is also concerned about biofuel “food vs. fuel” issues. The aggressive U.S. expansion of acreage for corn grown for ethanol has led to sharply higher prices and increased competition for crops. In July, the Chinese purchase of 540,000 metric tons of U.S. corn for delivery in the fall sent future prices up again, to approximately $6.75 per bushel. That was almost double the $3.60 per bushel corn future price of the previous summer.
Cellulosic ethanol, made from the non-edible parts of plants, avoids this issue. But cellulosic ethanol has struggled to move from the R&D stage to commercial-level production. POET LLC, the world’s largest producer of ethanol, has blamed the slow pace of investment in cellulosic ethanol on an uncertain political climate that includes controversy over the introduction of 15% ethanol fuel (E15) at gas pumps, and the future of the 45-cent-per-gallon tax credit for each gallon of ethanol that fuel blenders mix into gasoline. The Senate voted in June to repeal the credit, but it is still likely to survive.
Ethanol remains popular with the U.S. Department of Energy. The DOE in early July offered Sioux Falls, South Dakota-based POET a $105-million loan guarantee to help build the country’s first commercial-scale cellulosic plant. The Emmetsburg, Iowa, facility would produce 25 million gallons of cellulosic ethanol fuel annually.
Sidana was skeptical of the outlook for cellulosic ethanol. Investors like to “discover” a new technology and get in early for larger down-the-road returns, he said, but this can be difficult with early-stage alternative fuels like cellulosic ethanol. “Will you be able to finance it all the way to success?” he asked. “You need a cheap source of financing, and the Department of Energy has provided it in this space, including loan guarantees. But funding of that kind is temporary and subject to the vagaries of politics. And we’re not in the business of predicting political outcomes.”
Electric Cars: Electric vehicle startups also face an uncertain political climate, including the need to renew or extend tax benefits, and also volatile gas prices that can dramatically affect demand. But with carmakers increasingly convinced that the automobile will electrify in the long run, it is also a high-risk, high-reward investment.
Panelist Cynthia Ringo, managing partner at DBL Investors in San Francisco, noted that she “fundamentally believes in electric vehicles.” DBL has invested in Palo Alto, California-based Tesla Motors, which makes the all-electric $109,000 Tesla Roadster and the forthcoming all-electric $49,900 Model S Sedan. “We don’t think that fossil-fuel dependence can be addressed solely with hybrids,” Ringo said. “Tesla has had some near-death experiences, and the investment we made was frequently ridiculed. A lot of smart people disagree vehemently in venture capital, but look at how Tesla has developed.”
Tesla Motors has yet to post a profit but raised $266 million in 2010 in a successful IPO and is widely considered to have some of the world’s best battery technology. The company is also a possible takeover target for Daimler or Toyota; both have invested in Tesla and have technology partnerships with it. Tesla’s “intellectual property, powerful brand image and industry-leading products will make it a very attractive and likely acquisition for a well-established car manufacturer,” according to BusinessInsider.com.
Ringo noted that Tesla’s management team would prefer to remain independent. But if the company is acquired, she said, “it would not affect DBL at all, because we have distributed the stock to our investors already. And it’s possible that an acquisition would mean a big bump for whoever is holding that stock.”
Panelist MacDonald noted that other electric vehicle (EV) startups “are queuing up to go public.” But he cautioned that new EV makers will have to demonstrate staying power and all the ancillary services that go along with selling an automobile. “The existing companies have an edge over the startups because they have been making cars for many years,” MacDonald said. “With Detroit back on its feet, it will be producing competitive electric vehicles. The startups will need to provide comparable sales and service, and they will have to be ready to handle warranty claims and recalls.”
Sidana pointed to Better Place, a Palo Alto-based EV-charging company, as a potential game changer. Founded in 2007 by Shai Agassi, Better Place has brought to the table two ideas that have changed the debate on building an infrastructure for EVs, according to Sidana. “It is the combination of battery swapping and battery leasing that is so intriguing,” Sidana said. Battery swapping involves installing a fresh pack through an automated process when the old one runs out of charge. “Leased batteries can be easily swapped because there are no ownership issues, and that can eliminate the need for rapid, 480-volt DC charging,” Sidana said.
Exit Strategies: “When we get involved with clients,” noted John Krahulik, the global head of clean technology banking at Bank of America, “part of our job is thinking of exit strategies for investors. And the opportunities for mergers and acquisitions in the cleantech space are massive.” Tesla is just one of many cleantech companies in play, he said.
Krahulik described companies that address energy efficiency — either on the demand or the supply side — attractive investments today. So are companies that offer innovation in clean-water technology and sustainable building. “There are companies trying to figure out the quickest way to fund their model,” Krahulik said. “They’re lining up government-backed capital or finding corporate partners in the venture life cycle. It boils down to economics. We’re looking for technologies that are cost-competitive with or without a government subsidy.”
New technology can be a tough sell, however. “It is fairly infrequent that consumers will gravitate to a product that is economically less attractive than conventional solutions,” said Krahulik. “Companies that have the right message need to be able to lay out a path forward — a short path. If they can do that, they’ll see good uptake in the markets. And if they can provide a real competitive advantage from energy generation, then exiting through M&A is very attractive. We’ve seen some great exits, and there are seven times more exits through M&A than there are IPOs.” In Tesla’s case, the company could be acquired after it has gone through an IPO.
Today’s Market: MacDonald offered an historical cautionary tale. In the 1980s, high oil prices prompted a wide variety of alternative energy projects, he said, including hydroelectric, solar, waste-to-energy and co-generation. “They had a great run of success because of the availability of capital — you could finance your project with 40% equity, and the utilities cooperated. But then oil prices came down again, and everything went away. It took concern about climate change and a new focus on a cleaner environment to renew the interest.”
Today’s up-and-down oil prices continue to affect the market for many types of alternative fuels. Yet there is a greater public consensus about the need for cleantech than there was in the 1980s, according to MacDonald, and the opportunity for investors is larger than ever before and has been building in recent years. “Cleantech investment in the U.S. in 2000 was less than $500 million,” he said. “Now it is $9 billion, and $200 billion is going into clean tech worldwide.”
MacDonald’s Craton Equity Partners created a $240 million fund dedicated to cleantech in 2004 and secured investments from large pension funds and other sources. “The pension funds are extremely happy, and plan to renew their investment,” he said.
Summing up the outlook for cleantech, MacDonald sees “an active market” for biofuels. While algae fuel is “not our market,” he says, the growing scope of investment in algae is “good for us” because it indicates a growing and much better-prepared alternative fuels market. Craton invests in second- or third-stage companies, and algae fuel is still emerging.
“The deals we’re seeing now at Craton as opposed to five years ago are more mature,” MacDonald added. “There are more investors in the market and better management. There’s a migration of top talent from Fortune 500 corporations to smaller companies because the cleantech opportunity appeals to them.”
While there will always be trendy investment sectors, MacDonald noted that cleantech provides an alternative to an oil industry that is challenged by supply questions and growing concern about the impact of fossil fuels on climate change. He acknowledged that “a lot of money has gone into social networking, but the investment market is trillions [of dollars]. We continue to see very strong cleantech activity in the market.”