The Angels and Demons of Cleantech Investment

Cost-effective clean energy will require utilization of a broad range of financing tools, intervening at different points in the technology lifecycle.

Allocation of capital is one way society expresses its values. That’s why Chris Thile receiving a MacArthur "genius" grant is one of humankind’s greatest redeeming acts, and why Kim Kardashian’s net worth is so damn frustrating. It goes without saying, then, that finding ways to finance clean energy and address climate change should be a high priority for civilization, if self-interest ranks among our top values.

Decarbonizing electricity markets is a core task in the effort to tackle climate change. However, clean energy faces strong headwinds from cheap fossil fuels in the marketplace. Fossil fuels have benefited from a long history of subsidizationgovernment investment, continued externalization of their environmental impacts, and the ability to plug into a grid that’s literally built to accommodate them. Given these conditions, a strategy for increasing clean energy’s market share requires developing policies to bring down the costs of clean energy, in addition to accurately pricing carbon and correcting market failures like pollution.

One way to drive costs down is through increasing access to capital for early-stage clean technologies. There are certainly challenges in early-stage clean energy financing (pre-venture capital/seed stage), but there are also several innovative solutions.

The Demons: Challenges for Early-Stage Clean Energy Financing

Clean energy is a tough gig to be in. It is, after all, up against the most powerful industry in the history of the world. But lots of early-stage technologies have to compete against massive, entrenched incumbents. Why should early-stage clean energy have a harder time than, for example, new computer software or an “even smarter” smartphone? I sat down with David Miller, an angel investor with the Clean Energy Venture Group, to try and get some insight about the “demons” faced by early-stage clean energy startups.

Demon 1: Extended time cycles for development, sales, and deployment. Miller explained that time cycles at every stage of clean energy are simply longer or more complex than those in industries like pharmaceuticals or software. Initial development cycles for energy technologies tend to be as capital- and time-intensive as those in the pharmaceutical industry, and certainly more than software. But the sales cycles are also extended because communication with the relevant actors in the market (often, utilities) is notoriously difficult. The process for getting those technologies adopted by big companies can be years rather than months.

The deployment time cycle is where the differences get even starker. Energy systems are frankly less welcoming of new products than telecommunications or internet systems (despite some similarities), and while the creation of a more transactive market will certainly alter this dynamic, we are not there yet. Turnover in the energy system occurs across large-scale infrastructure and over long periods of time, overlaid by many levels of regulation. Innovation in this context is a tough beat since achieving scale requires integration into a complex network, and not just a good or better product.

Demon 2: Lack of policy support. The policy landscape for clean energy is a mess. The lack of stable policy signals for clean energy, combined with the policy support for fossil fuels at every stage of development, creates a very intimidating atmosphere for investors looking to place their bets on clean technologies. To illustrate, note the historical drop-off in wind investments with the stop-and-go PTC extension fight. Letting fossil fuels pollute for free creates a huge market distortion, and absent any carbon policy, this is likely to continue.

The Angels: Entrepreneurial Approaches to Early-Stage Investing

David Miller belongs to a group that’s quickly adapting to overcome these challenges: angel investors.

Angel investors put small amounts of money into companies that sometimes have already received seed funding, but are not yet at the stage of development necessary to attract venture capital. It’s a risky business, and as a result, angels have classically looked for very large returns on their investment within a short period of time (five to seven years) or good internal rates of return over longer periods. However, because of the challenges explained above, there is rarely enough time for even the best clean technology to achieve market penetration and start generating those kinds of returns. There are exceptions, of course, but this is the rule.

Angel investors play an important role in early-stage investment because they, along with government, operate within the “technological valley of death” that exists between R&D and proof of concept. Angels generally like to see a proof of concept before they invest, and their financing is what takes that concept to the next level where it can attract venture capital. In other words, angel investors bet on technologies that have modeled well in the laboratory, but haven’t yet received enough money to get a solid initial demonstration of that technology to a customer base in the real world.

So what are some solutions angels are employing to overcome these early-stage financing challenges?

Angel Solution 1: Networks. Angel networks allow individual investors to pool capital and share information, enabling higher quality investments. In some cases, sharing risk enables networks to tolerate a longer timeline on returns (say, seven to ten years instead of five to seven years) that could make all the difference with clean technologies. The Cleantech Angel Network and Clean Energy Venture Group are two such programs specifically focused on clean energy, but plenty of other angel networks have a cleantech component. Some venture groups are already using this model to invest in clean energy.

Miller of Clean Energy Venture Group insists that angel investors in cleantech can both “do good” and “do well.” It just requires an understanding of the challenges outlined above, and a particular approach to the companies they are investing in. “Doing good for the climate,” he noted, does require picking companies whose technologies have the potential to scale rapidly and be high impact. “Doing well” requires a longer-term approach to the investments. But this is justifiable, he believes, because clean energy, as one of the largest industries in the world, has a certain inevitability to it as the climate challenge becomes a more determining factor and fossil fuel extraction becomes more difficult. This does mean that some of the technologies that angel networks, like the Clean Energy Venture Group, are getting in on at the ground floor have the potential for explosive growth.

Angel Solution 2: Crowdfunding. Another model that can be utilized by angels is crowdfunding, which has gotten much attention at the deployment level, but far less attention for its potential importance to early-stage cleantech financing. In essence, crowdfunding allows a wide range of investors (who aren’t necessarily formally connected) to take part in a project through smaller individual investments.

This kind of thing used to be basically impossible. While crowdfunding existed, funding portals were restricted to exchanging products for funding instead of offering an equity stake in the company. However, Title III of President Obama’s JOBS Act (signed into law last year) opened up these “funding portals” to small-scale investors seeking an equity stake in companies, as long as intermediaries register with the SEC and the total investments are under $1 million.

I couldn’t find any cleantech-specific networks launched in the U.S., likely because the SEC regulations governing these entities are still under review (but see Symbid in the Netherlands for an idea of what is to come). However, it’s likely that existing crowdfunding portals like KickstarterAngelList, and Gust will get involved. These platforms have the potential to make a huge impact on early-stage clean energy tech. As Walter Frick notes over at BostInno, while $1 million isn’t much for the later capital-intensive phases of cleantech development, it’s a huge deal for early-stage companies.

Angel Solution 3: Matchmaking. A good example of a group that’s tackling the matchmaking idea is Ultra Light Startups, which put on the Future Energy Pitching Session at the ARPA-E Energy Innovation Summit.

At the Future Energy Pitching Session, a select group of startups had three minutes to pitch their ideas, followed by an interactive question-and-answer session and feedback from the investor panel. While the companies were peppered with questions from the investors, a definite trend emerged. On the one hand, how are these companies planning to break into markets dominated by big, incumbent players? On the other, what is their core innovation, and how do they prevent fast followers who mimic their products?

The feedback given by the panel centered on a few themes. First, almost every company was told to “partner up” with big companies in the field. This increases the chances that breakthrough technologies would be able to get to the market quickly, and would ensure startups have access to lower-cost capital. As many of the investors noted, particularly in the case of “build, own, and operate” schemes, startups should not rely on their high-cost capital. Second, investors encouraged startups to get very comfortable with parametric comparisons against other products and alternative pathways. For example, startups inventing better components for natural gas vehicles should not only learn to defend their core innovation against competing natural gas vehicle technologies, but also to defend trends toward natural gas vehicles over electric vehicles or hybrids. This also hedges against the “fast-followers” trend by creating a well-thought-out and unique contribution to the energy space, instead of just another app.

Adding to this advice, David Miller told me that startups have the most success when they have a well-rounded team (with members who focus on technology, sales and marketing), a customer base that they have already approached, and some kind of proof of concept (presumably seen by those customers) that can be taken to the next level with funding. Later, Daniel Goldfarb (a partner with Greenstart) echoed this advice -- but also noted that many startups fail because they don’t have anyone on the team working to incorporate design thinking into their product. Having a more nuanced understanding of their customer base, including the difference between market segmentation and market classification, is crucial to designing a product that will overcome the apathy that consumers often feel about their energy use. Greenstart has a unique approach to addressing this problem by “joining the team” along with the companies they invest in and offering design services. But for startups not receiving this kind of treatment, adding a product expert who understands both the engineering of the technology and the customer is essential.

Conclusion

Cost-effective clean energy will require utilization of a broad range of financing tools, intervening at different points in the technology lifecycle. Soliciting early-stage financing is particularly troubling for clean energy companies, due to the challenges inherent in energy markets. However, solutions such as networks, crowdfunding, and matchmaking could be poised to direct some of the 300,000 plus angel investors, representing investments totaling $22.5 billion in 2012, into clean energy.

It’s important to remember that angel investments are only one aspect of early-stage funding, and that real success requires approaching the whole value chain with smart solutions. There are many great ideas on how to move the ball forward on attracting seed funding, and on the next steps for venture capital in the cleantech space. Even with angel funding, there’s still a very high threshold to get venture capital with up to 98 percent of applicants rejected. However, with SEC rules pending and millions of dollars in capital in the wings, early-stage investment is certainly a prime candidate for moving capital off the sidelines and into the game.

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Adam James is the Special Assistant for Energy Policy at the Center for American Progress. Editor's note: This article is reposted in its original form from Climate Progress.