A lot has been made recently of low capital efficiency in cleantech investing. Truthfully, the nature of cleantech can be inherently challenging to the capital-efficient returns on which the venture industry depends. Cleantech is often heavy on hardware, requires validation at scale, targets conservative customers, and frequently pushes the boundaries of science and engineering.
But if you can crack the code, the potential returns are huge, given the massive scale of the market opportunities. At approximately $6 trillion dollars in annual value, the global energy industry makes social media look like the market for ice cream. After 10 years of early-stage cleantech investing, you learn the rules the hard way and break them at your peril. Here are four of the key metrics we consider when looking at how capital-efficient an opportunity is.
Time to Validate
You must have a clear understanding of the advantage you are seeking to develop that will make customers and partners stand up and take notice, and the realistic ability to demonstrate them in 12 to 18 months. Capital evaporates quickly in dragged-out development efforts toward poorly defined or unrealistic proof points.
Ability to Scale
Are you investing in a technology or a business? There must be a clear business model that allows the company to scale quickly. It must logically fit into the industry’s value chain and be attractive to partners. Bonus points if you can leverage existing infrastructure and overcapacity. However, be prepared for difficult questions if you’re faced with building expensive manufacturing capacity in order to get to market.
Speed of Adoption
If you build it, will they come? Cleantech companies often die in the painful commercial adoption phase, strangled by high burn rates and low or negative margins, while they are trialed to death by their conservative customers. We don’t invest in incrementalism. A new technology must be disruptive, with a huge economic value to the customer, in order to get the high adoption rate and resulting growth that’s necessary to earn a venture return.
Size of the Prize
Some deals will require more capital than others, but it’s the relative capital efficiency versus the size of the prize that matters. Developing a commercial fusion reactor is not cheap, but if you can achieve for tens of millions of dollars what others are attempting for billions, the relative capital efficiency is exceptional. Too often, the intense capital required to build cleantech companies is not justified by the opportunity.
So what kind of company can meet these hurdles? Here’s one example. Recently, we led an investment in a power conversion semiconductor company that promises to tick these four boxes. GaN Systems has developed a unique gallium nitride design topology that results in power devices that are more energy efficient and lower cost than traditional silicon solutions. If the industry were to adopt the technology widely, the emissions saved in the U.S. would be the equivalent to taking over 300 coal-fired power plants offline.
The size of the prize is the $14 billion market for power devices including transistors, diodes, etc., which continues to be dominated by silicon. There is strong and increasing demand for higher efficiency solutions. Silicon carbide devices have seen strong adoption in energy sensitive segments despite being around four times the cost of silicon. We see GaN Systems’ devices in two to three years having the same performance of silicon carbide, but at one-third the cost. There is no doubt such devices would see adoption; they offer a step change in performance and cost that customers would value.
Scaling is always a challenge, but since GaN Systems is a device design company, they can capitalize on overcapacity at their downstream manufacturing partners. There is no need for them ever to have to build a factory.
In terms of validation, GaN Systems anticipates having products in the hands of customers by the end of next year. Is there risk? Of course! If there wasn’t, this wouldn’t be venture capital, but we’re comfortable with these types of inherent execution risks. Success requires no government loans, miracles of science, or changes to customer infrastructure, philosophy, or business model. If the company’s management team can successfully execute the development plan, there is the right recipe in place for the business to scale in a truly capital-efficient manner.
And that is about all that a cleantech venture capitalist can ask for.
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Mike Sherman is Managing Director at Chrysalix Energy Venture Capital.