It's been a while since I've last had the chance to do so, but I always look to try to draw out lessons learned from successes and failures that I've witnessed firsthand in this sector over now something like 12 years of being a cleantech investor. In particular, over the past year or so, I've gained a lot more of these lessons, for better or for worse. (We've already covered exits and the limitations of the venture model.)
For startups, growth -- especially revenue growth -- is a good thing. Right?
But what if I told you that cleantech startups can grow themselves into disaster?
In previous columns, I've talked about the pressure venture capital puts on cleantech startups to grow their topline. To recap: Many of the natural acquirers for cleantech innovations (chemicals producers, industrial equipment and controls OEMs, utilities, etc.) don't typically pay big strategic multiples on their acquisitions, nor do they feel urgency to move early on startups. Thus, growth in revenue is crucial, because the startups that do get acquired end up getting acquired for their revenues and customers, more than for their IP. For example, I've heard repeatedly that the exit path for any water equipment startup is "grow to $100M in revenues, and then you can sell the company," and from what I've seen firsthand, this is in fact how that industry expects things to work. But growth can be expensive.
This is why a key assumption in the venture model even beyond this sector is significantly diminishing selling costs per unit over time. In other words, the more systems or services you sell, the cheaper and easier it becomes to land the next customer. I've spent countless hours in startup boardrooms, poring over the sales metrics and pipelines, trying to discern whether the company was close to achieving such an inflection point, close to getting the "boulder rolling downhill."
But I've seen fewer such inflection points than I and my fellow investors had hoped for.
I think a basic challenge for many non-software/web cleantech startups is that they really don't operate in markets or with business models that afford them such diminishing selling costs. With some exceptions, when it comes to selling physical assets or in-person services in energy, water, etc., these things just simply don't sell themselves. You need to have a salesperson, or a distributor's salesperson, show up in person and make a sale happen. You can get incrementally better at the selling, but unless you can grow the number of salespeople representing you, you don't really see huge inflection points in sales efficiency.
Alternatively, you could try to get more revenue per customer, by fulfilling more of their needs. You don't just sell them the core service or solution, in other words, but rather focus on a bigger project with the full implementation, etc. The problem here is that many of the adjacent revenue opportunities are often lower-margin, and not in your skill set to begin with. So unless you started out from day one building a holistic solution and the skill set and integrated innovations to make the entire thing a high-margin exercise, you can end up growing your topline via expansion but losing money in doing so. And probably introducing strategic drift along the way.
Thus, if you're under a lot of pressure to grow quickly, and your only path to do so is to put a lot of feet on the street and/or to expand your offerings into low-margin adjacencies, it can actually spell disaster. You grow the topline, but you're losing more cash than ever, because of having to make the hires and other investments ahead of the required growth. And I've seen this be the downfall of several cleantech startups. This is especially compounded when they inevitably have to slow down such growth efforts -- momentum is lost, wind-down costs of discontinued side efforts can be a cost that investors don't want to foot, and even relatively innocuous factors like working capital lines of credit can suddenly become major cash draws driven by declining accounts receivable. Trying to jump off the growth train can be really painful, even deadly.
Growth is not as good as you think it is, in other words.
There are exceptions to this gloomy observation, and they're very encouraging.
- Intelligence-enabled hardware utilizing IT and automation can build a "network effect" where each system on the network makes the entire network more valuable. This makes the startup much more valuable than just its existing revenue alone. This is happening in some areas of building controls and lighting, for instance. Such "virtuous cycles" are available for the right cleantech innovations, mostly those that are controls- and/or web-based.
- "Clustering effects" can help drive buyer behavior, with the prime example being residential rooftop solar. This requires branding, visibility, etc. to be successful, but I've also seen it be effective within niches in the B2B market.
- Early movers can take the lessons they learn in selling their own solutions, and become sales enablers for the broader market, lending their systems, and their own sales solutions, to become a service provider to their peers or to other market participants. There are big opportunities for this in the distributed renewables and energy efficiency markets, for instance, often providing back-office and/or financing solutions.
- Where existing market growth is already crazy, simply riding the coattails of such growth can be relatively easy. But for most cleantech entrepreneurs who are attempting to pioneer a new market, these conditions probably don't exist.
So fast, profitable growth is entirely possible for cleantech startups. But it isn't easy.
Cleantech entrepreneurs and investors need to be very cognizant of what growth model they're pursuing. It's easy to slip into pushing for growth as a top priority, to accept unprofitable efforts to expand the topline, and to be overly optimistic that some kind of inflection point will be reached along the way where the entire effort will achieve escape velocity. Maybe! But you can't take growth by itself as an indication that things are working. And you need to be very conservative about the resources you devote to the pursuit of growth without seeing critical inflection points in clear sight.