Lightspeed's venture into Cleantech

Taken from http://www.lightspeedvp.com/news/stories/LSVP_20070829.pdf

Outstanding article on Challenges and Potential growth for Cleantech

When emerging sectors or geographies erupt onto the investment scene - such as China, India, or cleantech – generalist VCs like Lightspeed have to determine whither and how to extend their franchise into a new area. Some generalist firms simply grow a practice by hiring partners away from specialist firms, while others observe from the periphery, sending team members to conferences and selectively seeing deals.

At Lightspeed, we have taken a phased approach by initially making a focused effort to divert resources into cleantech, with a goal of expanding presence over time – but what were some of our considerations before taking the plunge? What might have potentially given us further pause? From an initial survey of the space, we quickly
observed a number of structural challenges for generalist VCs to ramp up quickly and get comfortable with cleantech investing.

First, cleantech comprises an umbrella of sectors that draws from a vast range of technologies and sciences. On an average day, one may evaluate solar concentrators using thin-film cells (materials science, physics, optics), enzymes that facilitate biofuel production (synthetic biology, biochemistry), alternative proton exchange membranes for fuel cells (nanotech, chemistry), and ocean-wave-powered generators (fluid dynamics). For generalist VCs who are more used to dealing with bits and bytes as opposed to bandgap absorption wavelengths and alkane-producing algae, properly evaluating such investments can be a nontrivial task.

Second, cleantech startups have to deal with a range of macroeconomic, policy, and regulatory externalities that are often absent in IT investments. The solar and biofuels sectors continue to depend on subsidies and face upstream feedstock supply issues. Smart grid or water purification companies need to sell into utilities or municipalities, whose purchase affinity can change with evolving regulations. At a roader level, any major shifts in electricity and oil price trends could represent a doomsday scenario for multiple sectors.

Third, many cleantech plays require a different style of investing vis-à-vis eneralist IT deals. Many companies that have a technology founded in advanced materials, enzymes, or catalysts can have long development timelines that match more closely with biotech or pharmaceutical investments. Others have capital requirements from capacity expansion that are more characteristic of project finance or private equity type deals. Similarly, opportunities in “hot” areas like solar concentrators, thin-film, and cellulosic ethanol that have reached lofty valuations may look less like venture-backable deals. As such, for many generalist funds with shorter time horizons or smaller fund sizes, cleantech can pose significant structural and financial challenges.

Finally, the increased number of entrepreneurs coming out of the woodwork to dust off their 20-year-old solar concentrator concept or backyard biodiesel refinery has
also served to depress the signal-to-noise ratio, making it harder to find quality deals and solid management teams. Early-stage founders often have less experience in building teams and scaling production, and successful serial cleantech entrepreneurs remain few and far between. In addition, the geographical diversity of the opportunities in this space adds further challenge to deal sourcing and management team recruiting.

While the amalgam of the above challenges can overwhelm at times, Lightspeed continues to be bullish on cleantech. What are some factors that give us
confidence that the space holds promise for outsized returns?

• Massive global energy markets served and strong macroeconomic tailwinds. Overall energy demand has marched upward relentlessly in recent decades, with electricity generation nearly doubling in the U.S. and up eightfold in China since 1980. Solar,
biofuels, wind, storage, grid management, and water purification each already represent multibillion dollar markets, yet alternative energy in sum accounts
for only approximately 5 percent of total energy output today. As such, we believe that many of these sectors have double-digit growth potential, especially with rising oil and natural gas prices and increased concerns over national security.

Further, in sectors like solar, biofuels, clean coal, and clean water, we
have observed that supply-demand imbalances have reduced market and customer risk; if you can produce it at reasonable cost, someone will buy it.

• Improved cost economics. The intersection of technology- and scale-driven cost reductions within cleantech sectors and recent price increases for traditional energy sources has made a range of business models viable. Solar, for example, has
reached grid-parity pricing (with subsidies) in select geographies for the first time in the sector’s history, and as the industry continues to scale rapidly and
go up the learning curve, we believe solar costs will drive closer to today’s power rates. A similar phenomenon can be seen in the biofuels sector, where economies of scale combined with subsidies have closed the cost gap between crop-feedstock based
biofuels and petroleum-based fuels.

Significant technology headroom for innovation. Many of today’s companies utilize decades-old design approaches and manufacturing practices. For example, in solar, crystalline PV upstream processes are based on old techniques from the semiconductor industry, and the most oft-discussed thin-film materials such as copper indium gallium selenide (CIGS) have remained relatively unchanged for decades. Thus, as a new wave of technologists experiment with processes and materials designed to optimize for solar applications, they have an opportunity to create PV cells with quantum leaps in efficiency and cost reductions. Beyond solar, recent advances in synthetic biology have created enzymes and microorganisms that enable the use of noncrop biofuel feedstock and step-function changes in production yields. We have also seen recent breakthroughs in nanotechnology and materials science that have interesting applications for slowmoving sectors like batteries, fuel cells, and water
purification. The increasing number of world-class technologists and non-cleantech serial entrepreneurs now lending their talents to the emerging space should further increase the opportunities for disruptive innovation.

• Opportunities to play to Lightspeed’s strengths.
As we venture deeper into cleantech, we have found that certain aspects of our firm’s experience,network, and investment model actually help overcome the challenges related to this space. With deep roots in early-stage semiconductor investing,we have helped entrepreneurs build successful businesses and top management teams in an industry that relies on fast-cycle-time technical R&D, strong manufacturing execution, and heavy pre-revenue investment in capital equipment
– not too different from the lifecycle of many cleantech operations. Further, we have observed many well-respected, senior-level veterans from the semiconductor, networking infrastructure, and software sectors exploring cleantech ventures of
late, and we believe that the entrepreneurial DNA of emerging companies in this space will increasingly come from industries where Lightspeed has a robust
network. Our global platform, including investment programs in China, India, and Israel, also gives our portfolio companies access to opportunities for new
deals and potential customers in key international markets for cleantech. Indeed, we feel strongly that generalist VCs do have capabilities that can lend well to cleantech investing.

• Government, corporate, and social imperatives.
There has not been a time in recent memory when public and private sentiment aligned so well in supporting clean technologies as it has today. Governments worldwide have instituted tax subsidies and incentives for consumers to use clean energy sources and manufacturers to make “greener” products. In the U.S., an emerging portfolio of compliance laws and regulatory policies has targeted traditional energy providers like coal-fired plants to seek cleaner, lower-emissions alternatives.

Meanwhile, major corporations like Google, Wal-Mart, AMD, and British Petroleum have sponsored initiatives to increase the usage of renewable energy. BP made the headlines earlier this year in partnering with the Lawrence Berkeley National Laboratory to lead a $500 million research effort to develop new sources of energy. We feel that at least in the short-term, such social sentiment will help support the economic value proposition for cleantech, move industry-wide R&D efforts along, and contribute to public and investor interest in the space.

Armed with conviction in the market fundamentals, cost economics, and technology headroom in cleantech, Lightspeed has pursued investments with a concentrated internal effort and external collaboration with many of our specialist and generalist
VC colleagues. After having seen 300-plus deals that span the breadth of sectors, we are well-calibrated and have embarked on the beginning of our focused investment program in cleantech. With a portfolio of four companies to date spanning the energy storage, biofuels, LED lighting, and clean coal sectors, we believe we are off to a strong start and will continue to make an impact in cleantech.