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In 2006, Silicon Valley began to bet big on clean-energy technology. Seduced by visions of making a fortune while saving the planet, venture capitalists invested a then-record $123m in the first round of fundraising for 16 such companies that year. In 2008, they would sink nearly $1bn in over 100 new clean-energy companies.
But when these investments began to flop, the cleantech bubble abruptly popped. Since 2009, VCs have barely funded 25 new cleantech companies a year, slowing investment to a trickle.
What went wrong? And where should cleantech go from here? To answer these questions, we compared the performance of every medical technology, software technology, and cleantech company that received its first round of VC funding between 2006 and 2011. We found that betting on cleantech start-ups just did not make sense for VCs, because cleantech could not deliver the outsized returns found in other sectors. This conclusion is alarming because new technologies are desperately needed to confront climate change. Still, guided by the lessons learnt from the cleantech VC boom and bust, new private and public funding sources may be able to better support revolutionary technologies.
VCs make investments in risky start-ups assuming that nine out of 10 will fail, but are betting one will succeed wildly enough to make up for the rest. And because most VCs have a fixed timescale for investment, they often need to reap these returns within five years to pay back investors. This model works well for software companies like Instagram, which in two years returned backers 29 times their invested capital when Facebook bought it. Facebook itself achieved a market value of $104bn when it listed on the stock market — another way that companies can “exit,” or return capital to their investors.
Sadly, in our study, we found that cleantech companies lagged behind counterparts in software or medical technology. In particular, companies developing new solar panels, batteries, biofuels, other energy materials and manufacturing processes collectively destroyed over 80 per cent of the initial capital investment by VCs. Many required large amounts of funding to build factories and their technologies took longer than five years to develop. The few that succeeded still did not deliver enough capital return for VCs to justify staying in the sector.
Difficulties in moving from lab to full-scale production help explain why cleantech companies lagged behind software start-ups. But many of the successes in the medical technology sector must also make the expensive leap from success in the lab to production at scale. So some other factor is needed to explain the gap in financial success between medical technology and cleantech start-ups.
Looking at the nature of exits from the two sectors offers a clue. Medical technology start-ups were 50 per cent more likely than cleantech start-ups to return profits to investors through an early lucrative acquisition. But there is a dearth of large investors willing to buy cleantech start-ups, which therefore often end up as stranded companies — ones that have run up against the capital and time constraints of VCs in spite of their promising technologies.
Without a likely pathway to a profitable takeover and facing a long grind to win support for an IPO, the cleantech sector has outlived the patience of VCs unwilling to lock up capital for a decade or tolerate massive expenditures to scale up production.
So it is unrealistic to expect VCs to return to cleantech in a big way — over the last decade, they have invested nearly $40bn in the sector and may lose up to half of it. Commercialising cleantech will require a more diverse set of actors and funding models.
Many leading oil companies have sold their clean energy portfolios over the past decade and slashed their research budgets, adding to the sector’s problems. Fortunately, some progress on funding is under way. On the sidelines of last year’s Paris climate change summit, Bill Gates, along with 27 other billionaires, committed to providing more “patient capital” for risky cleantech ventures pursuing fundamental science breakthroughs — that is, they will invest early, provide substantial capital, and tolerate long delays before potential returns. The US, China, and India are among 20 countries to have signed the Mission Innovation pledge to double public research and development funding in cleantech to a collective $20bn by 2020.
Still, demonstrating first-of-a-kind products and building factories to churn out units at scale will require further infusions of capital.
Supportive public policies could attract such capital from institutional investors such as pension funds and family offices, which are set up to wait for decades to reap returns but can be inexperienced technology investors.
Government procurement could also be used to create market beachheads for advanced technologies. But a new wave of public and private support will be required to reboot investment in cleantech after the VC boom and bust.
Benjamin Gaddy is a director at Clean Energy Trust, a cleantech accelerator. Varun Sivaram is a fellow at the Council on Foreign Relations. Formerly, both were scientists researching clean technology