Can long learning curves and ever growing skepticism would cast black clouds

on the success of clean tech. Can clean tech resurrect itself after witnessing
collapse as same as Internet did after the dot com crash. These among other
questions have been confronted by VCs.

During mid 2000s, oil prices were record high and many analysts suspected it to
climb steep, this among other factors embarked the dawn of new era of green
fuel investing. Many investors such as Khosla Ventures were chomping at the bit
to be first movers while other such as HCP have been keen observers. Many
believed that Clean tech was bigger than internet, and many vocal investors
such as Khosla Ventures invested 40% of its fund in alternative energy
technologies. However, during the case review, it was realized that there are
several structural challenges related to VC investment model in clean tech
sector. VCs ineptitude to exit at appropriate time was one of the first
impediment in clean tech innovation ecosystem. As clean tech primarily based
on producing commodity product and traditional players in energy sector face
little challenge from clean tech start-ups, the end-user adoption and regulatory
policies seem apathetic.

There are some obvious similarities between KVs and HCFs philosophy towards
investing.
Both firms believed to become first institutional investors and to play active
roles to nurture the strategy, engineering behind the product and the team for
the start-up. Through in-depth due diligence, both firms seek to specialize in the
field in which they invest, which leads to identifying new opportunities and
scrapping out any inefficiency in a budding idea. Further, both firms believed
that clean tech commanded more deployment and expansion capital than other
industry. Also they shared same mindset about the role of political activism,
potential unsubsidized market competitiveness and evolving talent network will
reshape clean tech sector.

The below mentioned paragraphs will not just highlight differences among two
firms but also try to unravel reasons for their successes. Vinod started his
company with a vision to create positive social impact. Khoslas investment
philosophy was to take risk even when it would forgo fiduciary responsibility. Its
rare focus on IRR and closure of first fund to outside investors, provided Khosla
a much needed flexibility. Focus on small innovation cycle, early failures and
deep dive primary research about the potential investment opportunity,
supported KV to identify key opportunities with defined approach. KVs
investment strategy of approaching challenges involved multiple perspectives
i.e. developing diversified clean tech portfolio with multiple and complementary
products or services. KV also believed to deliver drop-in alternatives that lower
the risk of adoption by leveraging the traditional energy sector based
infrastructure. KV devised new financial model such as focusing either on
developing commercial plant or demonstration plant for its ventures. It made
sure to get guaranteed purchase from established energy sectors and also
looked towards government funding. Lastly, KV formed a portfolio-synergism by
creating collaboration among different companies.

Since its inception, HCP has raised $3 B capital and invested in 4 sectors Info
& Comm Tech (ICT); Healthcare; Internet & Digital Media (IDM) and Consumer
(HCF). HCP was considered as top quartile performer (with higher industry
average IRR) and included 13 GPs and 20 associates. Sector specific expertise
and experience were the key elements that differentiated HCP from other VC
firms. It focused on the capital efficiency i.e. focus short-term return. HCP was
also flexible in reshaping its focus in regards to changing trends in the market.
HCP culture encouraged to invest in sectors that are not core part of HCP.
Through publishing white papers and connecting with entrepreneurs to unravel
new trends or technologies, HCP built two-way relationship with VC community.
HCP believed in high on-base percentage type of investment, with inclusion of
industry specialization and also being stage and geographic agnostic. It
enhanced its out-reach to global platform and started accepting other financing
approaches such as mezzanine or roll outs. These among other factors led HCP
to become a successful VC firm.

Going Forward
HCP has very different mind-set for clean tech. The current HCPs investment
model clearly prohibits HCP to invest in the sector. Lack of short term exit
strategy, long term returns and late stage capital intensity makes clean tech
least interested sector. But Alexs due diligence has identified some key factors
that tries to re-define clean tech. Re focus on clean tech efficiency or demand
side of management pictures an exciting image for clean tech. Keeping
EnerNOC as a center piece, HCP should invest in companies that showcase
recurring revenue model (for bolstering short term returns), guarantee
product/service buyer (de-levering risks or capturing value) and compete with
existing technologies (creating end user adoption pressure). HCP has to make
sure that EnerNOC is more of a factual-future rather than an exception,
nonetheless, macro factors (such as electric vehicles, volatile energy prices and
need of infrastructure modernization) has created an ecosystem for new growth
in clean tech.

KV has to think beyond traditional definition of clean tech that mostly included
renewable energy or bio fuels. It has to focus more on climate-innovation, which
is a combination of material, energy and resource efficiency/adaptation tech. It
has to devise sustainable financial model with short term returns and more
robust exit strategy such as possible M&A. In order to re-gain momentum, KV
also needs to tap into the growth opportunities i.e. value capture especially in
the context of developing nations such as India and China. Further, KV
strategies should be in-sync with new government regulations in terms both
emissions and efficiency. KV should act as catalyst to create more transparent
and consistent policies towards clean tech. As clean tech requires huge capital
investment in the late stage for scaling up, KV should look beyond US borders
for capital such as China. Being experienced in clean tech investment, KV
should create network effect through its innovative products i.e. controlling from
energy generation to distribution to storage options. By diversifying value chain
through different ventures, KV would anchor itself for success. Global horizons
and network of products/partners would lead KV as a both differentiated VC firm
and a global leader.

Taking inspiration from Alexs research

Limited number of clean tech opportunities make sense
Demand side of energy
EnerNOC as an exception 1) Enterprise software company with recurring
revenue model
2) It had customer to buy the product
3) It competed with most expensive power plant

HCP overlap with the IT companies was germane

As case also states that IT used IP to develop high margin based specialty
products while Clean Tech used IP to develop commodity products.
It believed that late stage financing for clean tech would be lower risk as
compared to other industry

During second generation fuel innovation KV realized that ethanol was much
worse than the other fuels and had institutional voids such as lack of
transportation infra and current engines lack of efficiency to ethanol.

, which was more based on 1 on 1 meetings with entrepreneurs - Identify large

markets and hunt for technologies with differentiated approach; never paid
attention to IRR; Higher beta and higher return
Amyris and Kior provided new financial models right from demo plant to
commercial plant; state government funding and partnerships from energy
sectors with guarantee purchase.
IPO has never been the liquidity events for KV.
Relatioships with portfolio of the companies philosophy of business building
rather venture capital and guided chaos for building management team. Small
innovation cycles.
Annual CEO summit to generate collaborative environment between the
companies.
KVs affiliations help company earn contracts.

KV also believed to include drop-in alternatives lower the risk of adoption to

leverage the traditional energy sector based infrastructure. KV pioneered do
develop product that can fit in current refining, transport and combustion infra.
Retain option value and not license.

Many Western nations are currently facing massive budget cuts due to shrinking
economies and massive public debts. Further, today only exit strategy is to get
bought by some big company

HCP drew inspiration to work towards clean tech after a long history of
successfully investing in other sectors.
Although HCP has invested multi-year research to identify the opportunity but
has been unsuccessful

HCP draw
Paul Maeder suggested to invest in Clean tech. HCP interest in clean tech
investing was diverged as compared to other VC firms.
HCP has passed more than 400 deals. In contrast where KV has invested in so
many firms HCP has not able to find a perfect fit of entrepreneur, product and
market opportunity.
Higgins bring public policy and non-profit experience with a degree from MBA
Paul brings engineering background
According both Higgins and Paul it is imperative to bring specialized industry
knowledge for any venture deal. Another thing was opportunity between CRV
funds and crashed stock market.
Bill Boyce was another person who was responsible for the building team of HCP
and brought experience from the communication sector.

Investment Model
Sector expertise and experience were the key elements that differentiated HCP
from other VC firms. Key considerations for investing first institutional
investors, which gave HCP to play an active role in shaping the ventures
development. They also believed in the capital efficiency of the deal they
indulged in. This involved a short term return on the investment and the
amount of invested capital in the firm would be in the order of $20-40 M. And
the focusing on the sub sector with in broader investment sector. These sectors
would be based on the prio industry knowledge of the sector. HCP was also
flexible in reshape its sector in regards to changing trends in the market. HCP
culture also encouraged to invest in sectors that are not core part of HCP. They
also build 2 way relationships with writing or sharing white papers and
connecting with entrepreneurs to unravel new trends or technologies. HCP
believed in high on-base percentage type of investment, with inclusion of
industry specialization and also being stage and geographic agnostic. HCP also
witnessed the re-organization in years. They went enhanced its out reach to
global platform and accepting other financing approaches such as Mezzanine.
The team at HCP was also very big 13 GPs and 20 associates. The IRR was
also high as compared to industry average.
Diversification as an advantage preferred multi sector model this would help
GPs to focus on return that less volatile and would attract long term LPs
Risk profile of clean tech is very unique as compared to high tech where latter
produced product may be consumer ready to be adopted while the former had
commodity based product with low risk profile.

Higgins have different mind-set for clean tech venture and he tried to compare
it with Biotech.
Scaling is the key element in the VC investing
The going forward approach is also different HCP believes in focusing clean
tech efficiency and demand side of management.
Initial review didnt fit the investment model of HCP (the analysis compared the
clean tech to the space program)

Taking inspiration from Alexs research

Limited number of clean tech opportunities make sense
Demand side of energy
EnerNOC as an exception 1) Enterprise software company with recurring
revenue model
2) It had customer to buy the product
3) It competed with most expensive power plant

HCP overlap with the IT companies was germane

As case also states that IT used IP to develop high margin based specialty
products while Clean Tech used IP to develop commodity products.

rising energy costs, increasing environmental regulation and growing political concern regarding
climate change

Khosla had three prong approach team building, strategy and leveraging
technologies
In contrast Khosla made more absolute dollars than large investment and at late
stage of the start-up. Reasoning for leaving KPCB was to make positive social
impact.
Khosla has a technical background and enjoys working with entrepreneurs and
building companies from out of concepts. And help companies hire
management team.
Investing approach

Khosla ventures has able to raise $2.1 B third round funding

Khosla had vision to change that how fuel is consumed and manufactured not
only in the west but also in the developing world.
Cost effectiveness and affordability - He also created ChiIndia test where the
product for clean tech would cheap enough to be purchased, without subsidies
Khosla is usually first round investor investing $2-4 M in seed or Series A
funding
He started the fund by putting his own money
Since its inception KV has invested in 75 clean tech ventures
Successful stories 4 firms have gone public and 1 has been acquired

HCP

In 2008 VC funded more than $8.4 billion into 567 clean tech companies.
US $1.24 billion in 149 clean tech companies (solar, transportation and energy
efficiency)
HCP passed more than 400 deals in the past year
Compelling entrepreneur, solid product development and market opportunity

2010
$3 Billion committed funding raise 4 sectors IT, healthcare, digital and
consumer
Consistent top quartile firm

The founders went to Ivy and got MBA from HBS -

1) Higgins worked very early in his life
Non profit CEO stints after then he went to CRV
2) Paul Did his technical degree
He was recruited by Higgins to join CRV

Inspiration of HCP
No specialist at the CRV everyone was generalist
Opportunity CRV was between fund and the stock crash
They recruited Bill Boyce who had experience in the telecommunication
company

Maeder leading software

Higgins leading healthcare
Bill leading communication

HCP provided support to entrperenurs in the form of advisors and capital

Exposed to business partners, employees and co-investors
SECTOR EXPERTISE AND EXPERIENCE
FIRST INSTITUTIONAL INVESTORS
HAVING ACTIVE ROLE IN SHAPING THE START UP

DIFFERENCE
CAPITAL EFFICIENCNY
Have significant returns over short period and amount invested to bring the
company at the exit would be $20-40 M
SUB SECTOR FOCUS
DIVERSIFIED PORTFOLIO

APPROACH on raising money

1) High on-base percentage
2) Stage and geographic agnostic
3)

Organization was evolved

The new associates were hired to explore sub sectors
Geographical extension went global
Achieved net rate of return of 20% as compared to industry standard of 9%
Healthcare sector relatively unchanged

After internet bubble

1) Early stage start up investment
2) Own 20% of the company
3) And work closely with entrepreneurs

HIGH LAND consumer fund

In 2009 clean tech was the key sector where most of the funding was going
around 25%
2 side effects more spending (leaving less to spend on the other sectors) and
more return for investment
same explanation for the commodity nature of the clean tech
Government changes, grassroots activism and human capital were the key
drivers for the sector
Biotech firms made the equity intensive companies according to Higgins

Demand side of energy equation power generation and renewable fuels

CICO

Rising fossil fuel prices and recent legislation enhanced the investment case for cleantech
And growing consumer awareness about climate change
VCs could point to the success of start-ups in the semiconductor and biomedical sectors as evidence
that cleantech start-ups might also turn scientific breakthroughs into commercial profits
Falling natural gas prices from the fracking revolution and a glut of cheap Chinese solar panel
exports had undercut the competitiveness of U.S. energy start-ups
And the credit crunch from the financial crisis made it tougher to raise enough capital to achieve the
manufacturing scale necessary to compete in a commodity market

We found that betting on cleantech start-ups simply does not make sense for VCs, who require a
profile of risk and return from their investments that is better found in other sectors
In particular, cleantech companies developing new materials, hardware, chemicals, or processes
were poorly suited for VC investment because they required significant capital, had long
development timelines, were uncompetitive in commodity markets, and were unable to attract
corporate acquirers

By contrast, cleantech companies developing software solutions were a better bet, consistent with
the superior performance of the software sector. As a result, VCs have since reduced the total capital
they allocate to cleantech, and within the sector they have shifted investments from hardware and
materials to software.
That model relies on high-risk investments in early-stage companies in exchange for ownership
stakes that may deliver high returns in the future
The start-ups rely on VC funding to bridge the valley of death when their technology is too
advanced for public R&D funding but not yet commercially viable.
Venture capital investors responded by hiring cleantech experts, forming sector-specific funds, and
deploying considerable capital to the sector

. First, cleantech companies were much riskier bets than counterparts in the other two sectors
Second, cleantech investments yielded substantially lower returns compared to medical or software
technologies
After 2007, cleantech investments delivered internal rates of return (IRR) much lower than those
offered by the other sectors. Cleantech companies funded in 2010 appear to deliver handsome
returnsan IRR of 45%

The biggest money loser for VCs was the segment of cleantech companies commercializing
fundamentally new materials and processes, losing A-round investors over $600 million. For
example, in solar photovoltaics, companies like Nanosolar, Solyndra, and Miasole tried to
commercialize an alternative to silicon known as CIGS (a thin film composed of Copper Indium
Gallium Selenide that promised flexibility, light weight, and cheap processing) but struggled to
match the scale of production of conventional silicon solar panels, which leveraged tried-and-true
manufacturing techniques from the semiconductor industry.
Amyris, which designs synthetic microbes to convert Brazilian sugarcane into renewable - The
biggest money loser for VCs was the segment of cleantech companies commercializing
fundamentally new materials and processes B. Gaddy, V. Sivaram, and F.O. Sullivan, 2016 9 diesel
fuel, first offered shares at over $17 apiece that now trade at less than a tenth of that value. And Kior,
which invented a proprietary catalyst to convert waste (cellulosic) biomass into a biofuel that
could substitute for gasoline and diesel, went public in 2011 but filed for bankruptcy in 2014

First, they were illiquid, tying up capital for longer than the 3-5 year time horizon preferred by VCs,
because working out the kinks in new science is time consuming.25 Second, they were expensive to
scale, often raising hundreds of millions of dollars to build factories, even while the fundamental
technology was still being developed.26 Third, there was little room for error because these
companies competed in commodity markets with razor-thin marginsagainst cheap silicon solar
panels or abundant oil and gasmaking it difficult to invest in R&D while also operating a lean
manufacturing operation.27 Finally, the likely acquirersutilities and industrial giantswere
unlikely to acquire risky start-ups and averse to paying a premium for future growth prospects when
they did invest

The correct lesson is that cleantech clearly does not fit the risk, return, or time profiles of traditional
venture capital investors. And as a result, the sector requires a more diverse set of actors and
innovation models.

vThat money could come from institutional investors like pension funds, sovereign wealth funds,
and family offices, which are set up to wait for decades to realize returns but are often inexperienced
technology investors.

Public policymakers can support increased involvement of these actors in supporting cleantech
companies by lowering the risk of cleantech investments. First, they should increase support to start-
ups and private investors to provide an alternative to VC funding.
B Second, to encourage corporations to participate in cleantech innovation, the federal government
should incentivize regional partnerships between large corporations, startups, and incubators and
offer favorable technology transfer terms from the national laboratories