Plenty has already been written by many people smarter than me about why Solyndra failed, and what lessons are to be drawn from it, so I haven't wanted to write about it. I see Solyndra as having been a big but not necessarily dumb bet, one that attempted to bring expensive panels into the market but with the intent of saving costs further downstream in the solar value chain, to provide net savings for flat-roofed customers. That bet obviously didn't work out, for a number of reasons: 1) yes, panel ASPs fell faster than predicted, although everyone should have been expecting them to fall significantly; 2) the downstream channel resisted significant change; 3) some bad luck and bad timing, no doubt; and last and most importantly, 4) execution and high cash burn.  

So that's that.  Should there be an analysis of how the company so spectacularly failed, and a re-evaluation of how the DOE's Loan Guarantee Program has been designed and administered? Absolutely. This was a big loss to investors and taxpayers. I've already discussed my views on the Loan Guarantee Program before in a number of forums: I believe that it addresses a key capital gap in the "valley of death" for cleantech innovations, but wasn't designed well; that it creates negative selection biases; that it is far too bureaucratic in ways that undermines its usefulness; and that it leans too much on a small team to make very big decisions with somewhat limited knowledge and resources. So there's a sober conversation to be had about whether government should be seeking to address that capital gap, and if so, how it should do so.

But apparently, today's hearing on Capitol Hill was a useless political circus and not an honest investigation or analysis — by either party's representatives. It has become political football. And this may have a significant negative impact on cleantech startups that have nothing to do with the DOE programs or the like.

First of all, Congress is likely to throw the baby out with the bath water. While this particular high-profile program has had mixed success and will likely see some additional "wins" and "losses" going forward, there are lots of other DOE and other governmental efforts that are doing an effective job of providing economic return for investment of taxpayer dollars. But this episode is just going to further politicize cleantech and alternative energy, which is stupid. We need all of the above, in terms of energy choices. There's no compelling reason for anyone to have a philosophical problem with economically viable, domestically produced clean energy. But in an era when some people view energy-efficient light bulbs much in the same way that their political precursors viewed fluoride in drinking water, we can expect that this episode will result in even more political pressure for even the more effective governmental programs to be undermined and assaulted. If nothing else, politicization of the clean energy sector just adds further regulatory uncertainty to the environment we all operate in. And it could filter down to the state level, where to date, cleantech cluster creation has been a non-partisan issue.

Secondly, among LPs who were already increasingly skeptical of cleantech venture capital, this is just going to further dissuade them. I've spoken with a few cleantech VCs lately who are out there raising funds and have spoken with LPs who are uncomfortable with the asset category in general and the sector in particular. When Solyndra is the visible poster child for what "cleantech venture capital" is perceived to be, and then it blows up and becomes a political football — that's not exactly a recipe for pension fund LP comfort. Of course, Gentle Reader, you and I both know that some of the more compelling investment opportunities in cleantech venture capital look nothing like Solyndra. In fact, the strong shift to energy efficiency among investors in the sector is evidence of this, and information-based cleantech is starting to show some interesting early momentum. Even in sectors like solar that saw the most capital-intensive investing a few years ago, much of the action is shifting to less capital-intensive plays and into other parts of the value chain.  Nevertheless, this episode will make it that much harder for large institutional LPs to allocate resources to the sector, until the shift away from Solyndra-type plays becomes more obvious.

This is all going to make it more difficult for cleantech VCs to raise funding from LPs, and thus it's going to make it harder for cleantech startups to raise funding from either VCs or non-dilutive sources.

The shame of it is that cleantech markets have never had stronger fundamentals. Energy prices remain high. Entrepreneurial interest remains strong. Corporations are doubling down, getting more and more involved in cleantech markets and making investments and acquisitions in the sector. The solar market in the U.S. is a net positive to our trade balance, and the solar market is one of the fastest growing markets in the country, even in the midst of the capital pullback and the nattering nabobs of negativity. The solar industry is not a dog. There are dogs in the solar sector and an overdue shakeout taking place — but the solar industry is going to be a winner for the U.S. There are already next-generation solar producers who are quietly selling their products and beating today's low panel prices. They're just not making the headlines…yet. But there will be visible U.S. venture-backed solar winners who emerge from this consolidation phase with a lot of room for profitable growth.

Cleantech is at a low point right now. It will come back. The core needs are too severe. The corporate momentum is too significant. The entrepreneurial energy is too inspired. But thanks to this episode with Solyndra and with other shoes yet to drop, the sector may have to develop some successes over the next couple of years in spite of the politicians — and in spite of the LPs. Eventually, they will come running back to jump in front of the parade once again. But for now, entrepreneurs need to hunker down and run lean and run hard.

Plenty has already been written by many people smarter than me about why Solyndra failed, and what lessons are to be drawn from it, so I haven't wanted to write about it. I see Solyndra as having been a big but not necessarily dumb bet, one that attempted to bring expensive panels into the market but with the intent of saving costs further downstream in the solar value chain, to provide net savings for flat-roofed customers. That bet obviously didn't work out, for a number of reasons: 1) yes, panel ASPs fell faster than predicted, although everyone should have been expecting them to fall significantly; 2) the downstream channel resisted significant change; 3) some bad luck and bad timing, no doubt; and last and most importantly, 4) execution and high cash burn.  

So that's that.  Should there be an analysis of how the company so spectacularly failed, and a re-evaluation of how the DOE's Loan Guarantee Program has been designed and administered? Absolutely. This was a big loss to investors and taxpayers. I've already discussed my views on the Loan Guarantee Program before in a number of forums: I believe that it addresses a key capital gap in the "valley of death" for cleantech innovations, but wasn't designed well; that it creates negative selection biases; that it is far too bureaucratic in ways that undermines its usefulness; and that it leans too much on a small team to make very big decisions with somewhat limited knowledge and resources. So there's a sober conversation to be had about whether government should be seeking to address that capital gap, and if so, how it should do so.

But apparently, today's hearing on Capitol Hill was a useless political circus and not an honest investigation or analysis — by either party's representatives. It has become political football. And this may have a significant negative impact on cleantech startups that have nothing to do with the DOE programs or the like.

First of all, Congress is likely to throw the baby out with the bath water. While this particular high-profile program has had mixed success and will likely see some additional "wins" and "losses" going forward, there are lots of other DOE and other governmental efforts that are doing an effective job of providing economic return for investment of taxpayer dollars. But this episode is just going to further politicize cleantech and alternative energy, which is stupid. We need all of the above, in terms of energy choices. There's no compelling reason for anyone to have a philosophical problem with economically viable, domestically produced clean energy. But in an era when some people view energy-efficient light bulbs much in the same way that their political precursors viewed fluoride in drinking water, we can expect that this episode will result in even more political pressure for even the more effective governmental programs to be undermined and assaulted. If nothing else, politicization of the clean energy sector just adds further regulatory uncertainty to the environment we all operate in. And it could filter down to the state level, where to date, cleantech cluster creation has been a non-partisan issue.

Secondly, among LPs who were already increasingly skeptical of cleantech venture capital, this is just going to further dissuade them. I've spoken with a few cleantech VCs lately who are out there raising funds and have spoken with LPs who are uncomfortable with the asset category in general and the sector in particular. When Solyndra is the visible poster child for what "cleantech venture capital" is perceived to be, and then it blows up and becomes a political football — that's not exactly a recipe for pension fund LP comfort. Of course, Gentle Reader, you and I both know that some of the more compelling investment opportunities in cleantech venture capital look nothing like Solyndra. In fact, the strong shift to energy efficiency among investors in the sector is evidence of this, and information-based cleantech is starting to show some interesting early momentum. Even in sectors like solar that saw the most capital-intensive investing a few years ago, much of the action is shifting to less capital-intensive plays and into other parts of the value chain.  Nevertheless, this episode will make it that much harder for large institutional LPs to allocate resources to the sector, until the shift away from Solyndra-type plays becomes more obvious.

This is all going to make it more difficult for cleantech VCs to raise funding from LPs, and thus it's going to make it harder for cleantech startups to raise funding from either VCs or non-dilutive sources.

The shame of it is that cleantech markets have never had stronger fundamentals. Energy prices remain high. Entrepreneurial interest remains strong. Corporations are doubling down, getting more and more involved in cleantech markets and making investments and acquisitions in the sector. The solar market in the U.S. is a net positive to our trade balance, and the solar market is one of the fastest growing markets in the country, even in the midst of the capital pullback and the nattering nabobs of negativity. The solar industry is not a dog. There are dogs in the solar sector and an overdue shakeout taking place — but the solar industry is going to be a winner for the U.S. There are already next-generation solar producers who are quietly selling their products and beating today's low panel prices. They're just not making the headlines…yet. But there will be visible U.S. venture-backed solar winners who emerge from this consolidation phase with a lot of room for profitable growth.

Cleantech is at a low point right now. It will come back. The core needs are too severe. The corporate momentum is too significant. The entrepreneurial energy is too inspired. But thanks to this episode with Solyndra and with other shoes yet to drop, the sector may have to develop some successes over the next couple of years in spite of the politicians — and in spite of the LPs. Eventually, they will come running back to jump in front of the parade once again. But for now, entrepreneurs need to hunker down and run lean and run hard.

Take the time to read this Politico article.  It's an important glimpse inside the world of the environmental funding community, and the role it plays in energy policy.

Just a few quick thoughts/ questions:

1. Flooding D.C. with funding on a very periodic basis to support one or two specific legislative efforts is not, um, a terribly effective policy strategy.  

2. "who spent about 30 minutes with the group before racing out to watch a Chicago Bulls playoff game"… No comment.

3. By reactively pulling back so hard on funding, environmental foundations are basically pulling out the rug under many organizations that are only now hitting their stride.  Foundations need to take a venture capital mindset. No early stage VC thinks it'll take only 2 years to get their latest bet up and running and proven out.  Especially membership-driven organizations, which take a few years to start getting momentum.

4. The environmental foundation community needs to decide if they support market-based (ie: entrepreneurial) solutions or not.  Otherwise they end up finding allies in strange places: Carbon cap and trade is being rolled back in New Jersey and New Hampshire by anti-environmental groups… and also under attack in California, by environmental groups who decry specific attributes of AB32.  Letting the perfect be the enemy of the good is not, um, a terribly effective policy strategy…

5. No U.S. energy and climate policy reform effort will be successful unless it is truly bipartisan.  That doesn't mean having one or two votes from the "other" side.  It means a truly bipartisan approach.  Which will require compromise and incremental changes.  And a supportive business voice.

6. When will the cleantech business community step up to speak up as one voice on these issues, instead of relying upon the environmental community and sector-specific trade associations?  Anti-cleantech efforts don't differentiate between cleantech sectors… 

The economy may be gearing up to double-dip, Congress and state-level governments may be soured on doing anything serious about energy technology and climate change, and LPs may be down on the venture capital category altogether. But I still continue to be approached by smart, motivated investors looking to launch a first-time cleantech venture fund. It's a testament to their enthusiasm and entrepreneurialism — and to the continued evidence of the long-term business opportunity in these sectors.

But how can these entrepreneurial investors successfully launch a new cleantech venture firm?

My first piece of advice is: don't do it. Seriously, this is a very hard thing to do even in the best of times. Venture capital is overcrowded, LPs are down on the asset category and even the sector, and it's always near-impossible for first-time funds to get traction in any case. So unless you're really a masochist, think about other roles in the cleantech sector that might also be fun and more accessible. This will be hard. It will take years of your life and probably will not work out.

If the last paragraph didn't dissuade you, then … OK, here are some other thoughts:

I've seen three different pathways for new cleantech venture firms to get up and off the ground.  

One pathway is what LPs would classically call "emerging managers." These efforts are led by well-established and recognized venture investors with a significant track record at existing firms who break away from those firms and build an independent team, most often full of other well-recognized luminaries. This is what firms like C Change Investments, Silver Lake Kraftwerk, and a few others have done.

The second pathway is the "affiliation" course. These efforts are connected and often co-branded with more established firms.  The more established firms bring some name-recognition, LP connections, deal networks and some expertise, and often some capital and operational support to help get the new firm off the ground. Blackstone's cleantech venture team is an example here, and of course Kraftwerk is, as well (these first two paths aren't mutually exclusive, after all).

The third pathway is the "pledge fund" option. And this is what's really available to those who are launching into this area but don't have the advantages of having been at an established firm with a long track record. To many of those hoping to launch a brand new cleantech venture fund, this is really the only viable option, unless they happen to have a very, very wealthy connection willing to bankroll them. And even then, it can still be the best available path to take.

In this pathway, a small (2-3 partners) group develop their pitch to appeal primarily to a small, specialized subset of LPs. It may be a regional play, or a particularly unique investment strategy, etc. The idea is to have enough of a pitch that is clearly differentiated from the cleantech VC herd that some LPs can fall in love with the concept instead of having to rely upon existing track records. Next, the firm goes out and aggregates a small pool of interested, likely pretty small LPs (perhaps in the range of $100k to $2M), typically high-net-worth individuals, corporations, and family offices rather than large pension funds and other institutional LPs.

But rather than ask these backers to put money into an unproven committed capital fund, the firm brings them fully baked deals and each of the funders decides for themselves whether they will put money into the deal or not.  These backers have "pledged" to invest in the firm's deals, and the shared expectation is that they will, but they don't have to blindly do so.  

In this way, over a few years, the firm establishes a track record. And then, if things go well they can raise a committed capital fund, from existing backers and new LPs, graduating over time to more institutional LP types. This is the pathway one of my old firms took, and over four or five years they were able to raise a fund over $100M.  It was not easy and it wasn't a straight path from start to finish; there were certainly hiccups along the way.  But they were able to do it.

Some other tips:

- I see too many such first-time investors try to go to large institutional LPs for their backing. It can be a helpful conversation if it's for general feedback and advice, but I've almost never seen such LPs back truly first-time investors (even those with "emerging manager" mandates often want to see a track record from another firm).

- Truly challenge yourself on your investment strategy. Now, in my LP role, I get to see tons of different pitches all the time. And they really do blur together. I've been guilty of this myself in the past, and so I know it's true — what you think makes you differentiated really doesn't. I can almost guarantee that your message is too nuanced, too dependent upon proof of competence (necessary, but not sufficient for raising LP funds), and too jargon-y. Take what you think makes you differentiated and double down on it. Don't go off the deep end. But don't be afraid of turning off some LPs with your differentiated strategy; your goal is to get a small number of LPs to be inspired to actually write checks, not to have a majority of LPs think you're smart.

- Know your customer. All LPs are not alike, first of all, despite my sweeping generalizations throughout this rambling column. You need to make sure your pitch is one they'll be receptive to. Also, make sure you're asking for the right size of a commitment. Many smaller funds will approach larger LPs, thinking that it's easier to ask for a smaller amount of commitment rather than a larger amount. Actually, that's not true — very often the LP will have a minimum commitment size they can do, and also restrictions about not being more than 20% of a fund (for example).  So if you're talking to a large pension fund about your $50M target fund, and they only write $20M minimum size commitments, there's likely a mismatch. So pre-qualify, do your research, and also don't be afraid to ask lots of questions.

- You will hear "no" a lot. Don't give up; don't lose heart. And if there are LPs you truly believe should be backers of your effort, make sure to keep them somewhat in the loop on all your progress. As long as you don't push too hard, a "no" can sometimes turn into a "yes" down the road. Not often, but sometimes.

This is a down point for the cleantech venture community, but the space will come back. Firms that are able to get such multi-year efforts launched successfully in this environment may well be positioned to take advantage of the upswing to come. LPs are finally starting to loosen their purse strings. So if I didn't scare you off with all the purposeful pessimism up top, good luck!

First, a quick note: I've differed with Vinod Khosla a couple of times on this site in the past. But let's give him his due as well.  Read the story I've linked to here, and be inspired. Such drive and audaciousness is what venture capital is really all about — and what makes great entrepreneurs. Especially in cleantech, where so many customers are change-resistant, all entrepreneurs and VCs should read this story and take it to heart.

***

What exactly is a 'venture capital investment'?  

A definition seems obvious ('startup capital') but of course becomes devilishly difficult to place within specific boundaries. Generally speaking, VC as a subset of private equity is provided to early-stage companies that are still privately held and are too immature to be able to get debt financing. But even at this level, there are lots of areas of debate. Can't many startups get 'venture debt'? And is funding a raw startup at its inception phase really to be considered in the same category as putting money into a 'final round' before an IPO, for a fast-growth business?

It really doesn't matter (except under Dodd-Frank, I guess) what you label an investment. I hear phrases like "growth equity," "pre-IPO funding," and "seed capital" being bandied about as subcategories, for example, and the differences between them are broad but fuzzy. I think what's more important is that so-called venture capital investments are those that are carried out using venture capital terms, as opposed to majority-ownership type transactions or simple common-share purchases. VC terms are arcane and convoluted to outsiders, but basically boil down to two things: a) making sure that the minority-ownership 'risk capital' gets strong returns at some liquidity event, with some downside protection; and b) making sure that the minority-ownership 'risk capital' gets lots of protections against dramatic shifts to the business by the management team or other insiders. In other words, it's very mechanical, what makes a 'venture capital' round, as typically reported as a "Series [_]" investment, versus what would have been considered another form of capital investment into the same company.  By default, if we're talking Series A or Series B, etc., it's probably not confusing — only angels and VCs and government would put money into the company at a pre-revenue stage.  But it gets tricky when you see companies with not-insignificant revenue taking in a pre-IPO "Series F" or such. Is that "venture capital"?

Who cares?

It doesn't really matter.  At that point, the terms are being designed according to the VC template versus other templates simply because mostly VCs remain around the table.  So sure, call it VC — or whatever.  

Except that reporters and numbers-trackers glom onto such deals as "venture capital rounds," because they're labeled as such, and because VCs participate in the funding.  

And then these fundings, which are typically very much larger than the usual earlier-stage venture rounds and have much lower returns expectations, are all piled into the same "VC funding" category when it comes time at the end of the quarter for pundits to declare whether or not things are healthy in the entrepreneurial world.  

You just can't treat these deals that way. If there are 200 $4M Series A investments into a sector, that demonstrates much more investor excitement and optimism about a sector than four $200M Series F investments.  And it feeds into bubble talk, as well — pundits look at a really large headline number about the total "venture capital" dollars going into a sector and declare it to be over-invested, because there's no way all that capital can achieve "venture capital returns."  But first of all, what are "venture capital returns" anyway? Obviously, it varies greatly by stage, according to risk versus reward (and besides, the VC category has really underperformed against the Efficient Frontier over the last decade, anyway). So if you see a $200M Series F, are investors really expecting to get the 10x return that early-stage VCs typically hope to achieve?  Does that really mean it's a "bubble"?

So because the definition of venture capital is so fuzzy, you just can't look at the top-line totals and expect to glean any knowledge about investor expectations for sectoral growth and returns. Journalists need to remember this.

LPs need to bear this in mind, as well.  They get pitched by "venture capital" funds that declare themselves as such, but are increasingly looking to invest in companies with well-established revenue and clear paths to exit. Not that there's anything wrong with that at all!  We've done some of that investing at my private equity (note: NOT "venture fund") investment group ourselves. But it's easy for LPs to look at such pitches as being "venture capital returns, with lower risk."  No — it's lower risk, perhaps, but also comes with lower expected returns. That can be a totally justifiable tradeoff. But it's important to realize that it is indeed a trade-off.  And so if the LP is truly looking for the upside of "venture capital returns," they need to make sure they have exposure to the early-stage firms in a sector, not just the growth stage and multi-stage (i.e., 80% growth stage) firms.

As the cleantech venture capital category continues to swerve toward later-stage investing, such distinctions matter more and more to LPs, journalists, and others in the space. Entrepreneurs don't really care — a Series F by any other name would smell as sweet — but you, gentle reader, should remember that not every "venture capital" financing you are told about should really be considered as such. Thus, not every "big quarter for cleantech venture capital" is actually a sign of health for startups in the sector. I always say that if you're going to track just one number, track the number of transactions, not the dollar total of the transactions. It's still not a perfect metric, but it's less susceptible to definitional drift.

I've had a lot of good conversations recently with managers from large companies that are now eagerly looking into cleantech as a potentially strategic area. Many Fortune 100 companies, of course, have been all over cleantech for a few years now.  But it's still significant to note that a new wave of additional corporate strategy managers are looking anew into the sector and trying to determine if there are opportunities within it for growth for their company.  It's a really encouraging signal. And of course, I happen to agree with them that there are opportunities here.

Way way way back in the last century, I actually started my "cleantech" (of course, it wasn't called that back then) career advising large companies on how to think about capturing opportunities in the sector. So for what its worth, here are a few pieces of advice for any corporate managers out there who are tasked with figuring out their company's cleantech startup engagement strategy.

1. Collect your company's own energy- and resource-related pain points first, and address them as a priority.

Building a brand new revenue pathway is hard and takes time. Many great corporate ideas have withered on the vine because the internal champions ran out of rope before the benefits were felt.

But I guarantee that in any large company, there are plenty of opportunities where energy and other input costs are a problem. And quite often there are lots of opportunities to improve operational performance via some of the tools available from cleantech startups today. The best way to help build internal support for a cleantech startup engagement strategy is to first use such engagements to benefit the bottom line, before addressing the top line.

One large utility I've been speaking with recently does a phenomenal job of this. They have delivered to our firm and to several other groups a full list of several dozen identified "needs and wants" in terms of technology innovations that could help their operations. It's a very specific list, which really helps focus their conversations. It helps them qualify the conversations they're having — are they talking to investors and advisors that can actually help them, as opposed to those with nothing more to offer than lots of opinions? It also gave this utility's tech team an excuse to go talk with the company's operating business units and get buy-in for their strategy for engaging cleantech startups and investors.

Very often I see corporate strategy managers launching into something of a fishing expedition when tasked with developing a cleantech startup engagement plan. They start at a very, very high level and eventually work their way down to sector-level recommendations. But my suggestion would be instead to start with a bottom-up approach, working from real challenges their company already faces. The brand new top-line growth opportunities will become more obvious along the way anyway.

2. Bring some money to the table.

Startups are busy. Investors are busy. Both operate on a vastly different timescale than most corporations. Trying to mesh those different perspectives and make a productive relationship is difficult unless there are incentives involved.

Many corporate managers understand this. But I do see examples of corporate managers looking to engage with cleantech startups and investors in hopes of getting insights and relationships, yet not bringing any financial resources. But with little real value being brought to the table from the large corporation, the conversations don't really go anywhere. And to be blunt, if the corporation isn't willing to put a budget toward this kind of exercise, there isn't really a strong internal mandate for it anyway.

It's important to note that this doesn't mean I'm advocating that all large corporations get into venture capital investments. That's a fit for some companies, but not for others. Yet in most cases, what would be a relatively small amount of capital from the perspective of the large corporation could be a meaningful amount of NRE-type revenue for a startup, and having that kind of potential relationship as a possibility will help sharpen conversations on both sides of the table. That's not to say that the corporation should lead with their checkbook. But it makes the conversations more tangible and meaningful for both parties if there's a potential small (and eventually large) partnership that can be developed, and that means there needs to be a budget allocated for such things right from the beginning.  

This also fits with the first point I made above. Clearly, to justify a budget, there needs to be an IRR, which means addressing real needs.

3. Don't just follow the venture capitalists.

Many of these corporate managers make venture capital firms their first stop. Makes sense — VCs should have already filtered a lot of information and should be able to help identify trends in the market. They should know about a lot of startups already, and they often have a pre-existing portfolio and can be a good access point into that portfolio.  

But don't stop there.  As we've discussed ad nauseum in this space, the venture capital model is a fit for only a very small share of good business ideas in cleantech.  And given the differences between corporate and venture investment expectations (in terms of openness to different timeframes, different rates of return, different levels of capital intensity, etc.), there's a good chance that the more attractive areas for large corporate growth in cleantech won't overlap with what turns on cleantech VCs.  So if you're only viewing the cleantech market through a VC-colored lens, you're going to miss most of the picture.

For this same reason, don't use venture dollars as a proxy for assessing entrepreneurial activity levels in a sector. For example, just because VCs haven't (yet) gotten heavily into the water tech sector doesn't mean there aren't tons of water tech and water services entrepreneurs that might be interesting to you. Likewise, I talk to too many corporate managers who start off their conversations by discussing solar. Just because VCs have over-invested into the solar subsector doesn't mean it's the right place to start your own investigations.

So do start with VCs, and start a conversation for potential mutual benefit, but don't stop there.  Figure out how to reach beyond and see beyond the cleantech VC community.

4. Find and join cleantech networks.

So if you can't use VCs as the ultimate sherpa, where can you turn?  Fortunately, there are a number of great networking organizations that can be used to both build visibility, and to build a broad array of relationships, to find out more about what's going on across the entirety of the market. Corporations need to be joining these groups, even if they don't yet consider themselves a "cleantech company" — not only because of the networking potential such memberships would bring, but also because, per the first point above, resource and input cost issues affect all companies big and small, regardless of sector. Joining these groups can be well worth any nominal corporate membership fee, if the relationships are initiated with a strong intent to maximize their value to the corporation, across strategic, sales, communications, recruitment, and potential policy dimensions. Companies like Google and National Grid have been using this type of relationship to great effect, but many other corporations are still figuring it out.  It can be critical, however, to successfully getting a complete picture of this highly fragmented market and industry, where no one knows all the relevant players (not even the VCs).  

Several such national-level organizations I've been involved in and would recommend include the Clean Economy Network, the Cleantech Open, and the Cleantech Group.  Here in New England, there are also regional organizations like the New England Clean Energy Council that play an important role at that local level. There are other groups as well, too numerous for me to list here, that you can find without having to look really hard. Join them. Use them. And deploy those relationships to get real smart and real connected, real quick.

After two weeks away from everything, I'd planned on writing this post Sunday night. Somehow, I got a bit distracted. The 2011 news cycle has been incredibly intense so far, and shows no signs of slowing down anytime soon.

In any case, there's been a lot of news over the past few years about the smart grid and how utilities and startups and VCs are working to make the grid more data-driven, flexible, automated, etc. Very often, the discussions about the timing and pace of smart-grid rollout are focused predominantly on utilities and major vendors of transmission and  distribution equipment, including smart meters.

But while that's a large and important aspect of the smart grid market, I think it's not going to be the pacesetter for this industry. Instead, smart grid features and applications will likely be driven from inside the meter, out into the grid.

Some years back, in my consulting days, I had the opportunity to work inside a large utility. I got to see how these kinds of decisions are made, and the limits such entities face in trying to quickly roll out anything new. In fact, I helped pull together a business case for a "smart meter" investment by the utility (really, just automated meter reading: this was a while back). The business case included a lot of "soft" cost savings — those that didn't have a specifically identified cost savings level, but were still likely to drive down costs in areas like improved customer service, more accurate billing, better blackout detection, etc. The problem is, lacking a concrete projected savings level, these savings got heavily discounted by the utility decision-makers because they knew they would have a hard time defending those projected savings to their real customers — namely, the Public Utility Commission, with which they needed to negotiate for any significant capex program. And the "hard" cost savings weren't any easier — they basically boiled down to fewer meter-reading jobs required. Plus, the local communities and PUC weren't thrilled about the idea of downsizing of any kind, so that was not an easy "win" for the utility either. In the end, the savings were sufficient that the project would potentially have been warranted, all things being equal; all things not being equal, the utility ultimately passed on the opportunity.

Things have changed in the decade since then.  Many of the "soft" cost savings have more proof behind them by now and PUCs are more open to accepting them in rate case negotiations. Additional functionality from smart meters and the smart grid also bolster the argument. And the aging workforce at utilities means that they're increasingly worried about how they're possibly going to be able to manage their assets going forward, even more than they're worried about having to explain a downsizing due to more automation. As a result, smart grid technologies are doing better now, and will continue to do better over time.

But these same obstacles remain. Talking with one utility's managers recently, they told me quietly that they'd like to do more smart grid investments, but their PUCs won't let them. They estimated it would take two rate cases (at five years for each one) for the PUC to agree to any significant investment. They also said that the PUC was actually allergic to smart grid investments as a potentially risky investment, even going so far as to reject investments in "smart grid" equipment that the utility had been purchasing for 20 years, before the term even existed! Other examples of this include all the negative press that has surrounded Xcel's "Smart Grid City" and the cost and time overruns there, and the recent pushback in California around smart meters and data communications. These don't make me pessimistic for the long-term future of smart grid technologies; progress continues to march on.  But these examples underscore how slowly it will likely happen at the meter and in the T&D grid.

Meanwhile, inside the meter, things are happening quickly. The secret weapon of the smart grid is the "demand charge" — the fee large utility customers pay the utility for their single biggest spike in demand each billing period.  It is billed separately from overall consumption for the month.  You can find a useful explanation here (PDF).  Demand charges have been in place for decades — and for large, variable electricity users like manufacturers and even office buildings, they can be upwards of one-third of the monthly electricity bill (the other two-thirds being consumption).

This isn't really something that can be addressed by simple efficiency improvements, or by putting solar on the roof.  Efficiency improvements may not avoid the monthly spike.  And with intermittent power production from solar on the roof, the monthly spike might also be just as high as before, even while net consumption goes down. So demand charges are a major pain point for large commercial and industrial electricity consumers.  And to really address them requires automation — inside the meter.  Thus, even in the absence of any utility smart grid program, or demand response or dynamic pricing program, such customers can see compelling economic reasons to invest in energy-automation systems for this purpose.  Of course, with such utility programs coming into effect in many regions, the economics get even better.  So we're seeing a rapid uptake of such inside-the-meter systems.

Furthermore, as electricity customers large and small see energy prices going up in the future, there's been a wave of interest by early-adopting building owners in better energy information and automation in general, to reduce the consumption portion of the electricity bill as well. Thus, there's been a rapid rise in the number of existing building services companies looking to get into building energy services (I talked about this in regards to EnerNOC in particular a while back), but they are very far from alone in getting into these services.  But whether it's through a service provider, or just self-managed, such energy automation and information is only enabled by a smart building energy management system, with a lot of "smart grid"-like attributes. So for instance, with our investment Powerit Solutions (as one example among others, I'm sure), we're seeing a lot of inbound interest from many of these service providers who are looking for tools that can simultaneously address demand charges, enable participation in demand response and other utility "smart grid" programs, and also enable the service provider to remotely manage efficiency programs at the customer site.

So while "Utility Time" means a pretty slow pace of roll-out of the smart grid on the utility side of the meter, inside the meter, it feels like it's "off to the races" right now. Lots of systems are being introduced to the market, early adopters are jumping on board, and major equipment vendors are getting involved. What will be critical is for a common set of standards to enable such systems and equipment to easily connect with each other, and also to the eventually automated grid.  But there too, with efforts like OpenADR underway, the groundwork is rapidly being laid.  

And you know what? Having "smart-grid-enabled" customers already in place makes it even easier for the utility to talk to their PUC about making investments in smart grid technology in the T&D network. This is why, when we start seeing massive smart grid rollouts for real, my guess is it will have been really driven from the inside out, regardless of where the smart grid pundits and writers may be focusing their attention today.

One of the challenges for cleantech VCs, and for VCs in general right now, is the potential negative selection bias that comes from being a large fund. This particularly applies to the large, big-name firms that adopt a "go big or go home" perspective when it comes to their investments.

Many such large funds have minimum ownership targets — they want to own at least 20% of the company they invest in, so that if it's a big success, they end up with a big return, which makes sense, right?  This is rarely a hard-and-fast rule, although it's often presented as such.  But whether it's a hard floor or not, big firms don't want to own only a small piece of the companies they invest in, unless it's a really obvious high flier like a Facebook or such.

What this means in practice, however, is that when they're coming in as an outside lead in a Series B round, they need to either have it be a pretty low valuation, or they need to put a lot of money at work, especially as insiders will also want to exercise their pro rata rights. For instance, let's run through some really basic math to illustrate this point.

If the pre-money is $25M, the math works for "Big Name Fund X" (BNFX, let's call them) if they put in $10M of a $25M round, or $8M of a $15M round.

But what if the company deserves a higher valuation than that?  The math starts to stack up pretty quick.  If the right pre-money is really $50M, that means that $16M of a $30M round will be necessary, for example.  

Here's the problem — many of these companies don't need to take in that much capital at that stage. They may need only $10M for their Series B, not $15M or $25M, and certainly not $30M.

But should they take a lower pre-money valuation just because BNFX needs to get to a certain ownership target and they don't want to raise more than $10M?  So if the insiders' pro rata is, say, 40%, that leaves only $6M for the new investor BNFX.  To get to 20% with that means a pre-money of only $20M.  This might be a flat, or even down round for the company.

This has several important implications.

First, it results in an institutional bias that applies to the BNFXs of the world, one that tends to steer them toward investing in companies that are raising big rounds — capital efficiency be damned.

Second, it means that well-performing companies are pushed to take larger rounds than they need.  This is healthy neither for the now-overcapitalized company, nor for returns.

Third, it means some of the best companies will turn down nice offers from even the biggest-name venture firms out there — simply because the math doesn't work. In our example, BNFX (assuming they now believe in the overall market opportunity) must now hunt around for a lesser company in the same sector and either take advantage of their lesser standing to drive a lower valuation or convince this second company to overcapitalize themselves when BNFX's first choice wouldn't. Maybe BNFX can successfully take this B-grade company and leapfrog them over the one they preferred — but maybe not.

This exemplifies the negative selection bias I'm talking about. It doesn't happen every time, of course — there are lots of cleantech startups backed by the biggest name venture firms that truly are best in class, and these big firms obviously have a lot of other factors working in their favor. But because it does happen sometimes, that means that when you see BNFX invest in a company, don't assume that means that company is in their eyes the best company in that market. It just means that that was the company they could work out the math with. (Note to journalists: Do your homework before you start trolling BNFX's portfolio as a shortcut for your "best of" lists. It's a good starting point, but only that.)

There's an easy solution to this, of course, which is for BNFX to invest in the best companies at the Series A stage, and get their ownership (typically at an even higher level) starting point while the valuation is low enough for the math to be easy. Many such big firms take just this tack.  But in cleantech, they've been learning that it's tough to be an early-stage investor and choose bets with confidence. This helps to explain why we've seen the significant shift away from early-stage investing.  This in turns serves only to further exacerbate this negative selection bias, at both sectoral (favoring capital intensive plays) and company-specific (per the math above) levels.

And it's all because the big-name firm needs to have a significant stake of the company to make it worth their while.  

Sometimes venture capital is a seriously screwy industry.

Hardly surprising to see that the major headlines coming out of the release today of the Cleantech Group's Q1 numbers focused on the top-line dollar count — $2.57B!

But here's what you need to read in that:

1. Yes, deal dollars were up, but deal counts were way down.

As we've talked about for a while now, cleantech VCs are continuing to shift to later-stage companies. In fact, 93% of dollars in the quarter went into follow-on rounds. That bears repeating: Only 7% of cleantech venture dollars tracked in the first quarter were for first rounds.

This is not a sign of health for the sector. It's not a sign that VCs are actively putting money into the sector. Rather, it's a sign that VCs are predominantly putting money into existing portfolio companies. Their own, and maybe each others' –  maybe. Which brings us to point number two.

2. No one — the Cleantech Group or otherwise — is tracking "new" money into cleantech companies.

Because it's pretty much impossible to do so, no one is able to tally up how many of these announced deals represent re-ups from existing investors supporting existing portfolio companies, and how much is coming from new investors making an affirmative investment into a company they hadn't invested in before.

This is an important distinction. When a VC makes a new investment, they typically reserve follow-on funds for investing in that same company later. If the company crashes and burns, they won't do so. But if the company goes sideways, they may still opt to put more money into it, in hopes that it can turn the corner. It's a lower bar. Comparatively, in the case of a new investment, the VC will put a higher bar on a decision to invest — especially now.

That's not to say that insider-only or insider-heavy deals are necessarily a sign that a company isn't going well. I have seen situations where a company is doing so well that insiders don't want to give up any ownership to outsiders, all things being equal, so this isn't necessarily a bad thing. 

But my sense (and again, there are no real numbers to support this, but it's just my sense) is that many of these follow-on rounds have been insider-only or deals where the insiders set the terms. And that's a sign that valuations offered by new outside investors remain low, which in turn is a sign of a continued imbalance between supply and demand of investment opportunities — investors with money for new deals have lots of these opportunities, so why pay up for anything? And then insiders, who may not be doing new deals at the tail end of their fund but do have reserves for follow-ons into portfolio companies, decide just to fund it themselves and save the headache.

This is further bolstered by the sectoral breakdown, which doesn't show much evidence of any shift in how investors are spending money sector-to-sector. That's a sign of follow-on activity, not new thinking.

This means that mark-to-market in cleantech VC portfolios is even more suspect than usual, by the way.  

It means that new cleantech entrepreneurs don't have many choices when it comes to finding investors.

And this tells me there will be a reckoning sometime soon, when insiders start running out of reserves, and before new investment activity picks up.

All of which means, despite the headline dollar total, this is a very tough time for cleantech entrepreneurs to raise money, unless they're already backed by deep-pocketed investors.

3. Corporate investors are getting more and more involved in the sector.

In the specific deals that have been announced, there's a lot of evidence (and I see it echoed anecdotally) to suggest that large corporate players are, contrary to VC pullback, getting more active in the sector.

This is a good thing. Corporate investment into follow-on rounds, even those that are insider-led, can help address the need for new capital and can also — when the relationships work out as hoped — give startups a leg up in getting into the marketplace.

There's some worry that corporations getting involved in venture capital has typically been a lagging indicator. But generally, I believe cleantech startups, since the channels in their markets aren't equipped to handle new products and services very well, might get more value out of such corporate venture activity than we might see in other venture sectors. Also, since so many of these follow-on stage cleantech startups are in capital-intensive plays, corporate balance sheets can be a critical way to get around the lack of project financing.

In the past, we've seen that this is a lot easier said than done. I know of several cleantech startups that have been disappointed by the lack of promised value from corporate investors that actually gets delivered, thanks to organizational inertia, mismatched expectations, NIH syndrome, etc.

Generally speaking, however, seeing corporations get more involved in funding cleantech startups feels like a very good thing. It's validation of the market opportunity. It's vital capital and market expertise. And it may be the first step toward a wave of acquisitions.

Among VCs (and their LP backers), cleantech is on the outs right now.  So says this pretty good article from the past week.  And it reflects what we've been saying here in this column for a while — there's a shakeout underway in the cleantech venture sector, with many generalists abandoning dealmaking in cleantech to head for "easier" returns in social media, and many sectoral specialists having a hard time raising new funds.

But there's a revolution underway in cleantech, and it's being led by the entrepreneurs.  

In my recent "Cleantech venture capital in 2015" presentation, I talked about the need for a new truly capital-light style of company-building in the sector (which I whimsically called "Cleantech.VC"), but I've seen very little evidence of VCs in the sector "getting" this yet.  One intriguingly different effort is Sunil Paul's "CleanWeb" approach, but for the most part when cleantech VCs say they're into "capital efficiency" they're still focusing on the same old approach that delivered mediocre results during the past decade — backing proprietary technology, major new product development, chasing commodity price curves, not rethinking service delivery models in the sector, etc.  A recipe for spending significant capital to develop great new products, but with slow market adoption.  As I described in the presentation, there will continue to be an important role for this approach to cleantech venture capital, but it will need to be more sectorally focused so VCs can more effectively open up channel partnerships and pathways to the market, and it simply can't be the only way we build cleantech startups…  Meanwhile, Cleantech.VC style investing doesn't require a big fund to be effective, so in a time when LPs are generally down on putting money into cleantech venture capital, it might be the way we see the next wave of cleantech venture firms arise.  Maybe.

Just spend some time with the startups in Boston's Innovation District and Greentown Labs, however, and it starts to become clearer how the next wave of cleantech startups are being launched, even ahead of any Cleantech.VC venture model catching on.  Some of this next wave of startups will be hardware, but many will be software and/or services.  Many will be bootstrapped or at least run very lean until they have actual revenue.  "Lean Startup" approaches will be adopted, formally or informally.  Business model innovation will often be stressed over technological innovation.  They will sometimes marry energy-related market opportunities with Web2.0 and social media business models and platforms.  Most strikingly, they will be led by young underpaid entrepreneurs, bringing a heck of a lot of fresh energy and a strong sense of mission to the sector.  And they'll therefore be able to make a relatively small amount of angel and grant money, and low-rent space, go a long way… I was invited to speak to a group of these entrepreneurs this past week; some free grub and beer for the entrepreneurs, and a few words by me on the current political climate.  The crowd made me feel old… which was awesome and invigorating.

I've backed my share of well-staffed cleantech startups with nice headquarters, and I will continue to do so.  I'm certainly not saying that all of cleantech will switch over to this lean cleantech startup model.  But I'm excited to see it start to emerge.  It won't get much attention from business journalists at first, because these startups won't be taking in big venture rounds, and they won't have big P.R. and press outreach budgets.  But the revolution is happening.  Go spend some time in your local cleantech incubator, and with your local university's energy club.  You'll see what I mean.