• 18 Oct 2010
  • Lessons from the Classroom

Venture Capital’s Disconnect with Clean Tech

Clean-tech start-ups depend on patience and public policy to thrive—the Internet models for VC funding don't apply. That's why Harvard Business School professor Joseph Lassiter is making an unusual recommendation to his entrepreneurship students: Spend a few years serving time in a government job. Key concepts include:
  • MBA students and young venture capitalists often assume that all promising start-ups can grow and exit as fast as Internet start-ups, but they're mistaken.
  • Clean-tech start-ups are often stymied by a "valley of death"—that precarious stage between researching and developing a product and going to market.
  • The success of clean-tech companies often is dependent on public policy, so it behooves budding VCs and entrepreneurs to spend a few years learning the ropes in a government or corporate job.
by Carmen Nobel

MBA students often fall into one of two categories—those hungry to rush into careers as venture capitalists, and those eager to found a venture-funded start-up. For all of them, Harvard Business School professor Joseph Lassiter has some intriguing advice: Spend a few years working for the federal government or a large corporate player first.

Those business school students and young venture capitalists frequently share a common misconception about start-ups in the heavily publicized clean-technology field, according to Lassiter, who teaches courses in both entrepreneurial finance and building green businesses.

"They tend to think clean-tech investing is like Internet investing," he says. "They think, 'It's gonna happen fast, and it's just gonna happen.' And the answer is no, it's not gonna be fast, and it might even not happen."

“They tend to think clean-tech investing is like Internet investing. They think, 'It's gonna happen fast, and it's just gonna happen.' And the answer is no, it's not gonna be fast, and it might even not happen.”

There are a couple of key differences that make the various clean-tech sectors and the broader green business world vastly different from the historically well-funded Internet start-up industry. In the Internet start-up world, VCs can reasonably assume that a company can go from launching a product to getting acquired—or even going public—within a few years. But clean-tech doesn't work that way.

While venture-funded Web companies can crank out a marketable prototype in a matter of months, clean-tech companies can take years to develop products—solar panels, batteries, biofuels, and the like. And even when a working prototype is born, it's hard for a clean-tech company to deliver economically viable production volumes without massive follow-on funding.

This creates a catch-22 situation. A clean-tech company can't prove its ability to scale without actually scaling. And venture capitalists are wary of funding a company that can't prove its ability to scale.

Valley Of Death

It's a problem that has squelched many promising start-ups, which, without multiple funding rounds, fell into a financial "Valley of Death"—that precarious stage between researching and developing a product and actually going to market with it. "You could raise enough money to fund the bench science, but not enough to build a prototype," Lassiter says. "The scientific risk of moving from the lab to the product was too great."

Furthermore, any industry that revolves around energy is heavily dependent on public policy, at both the federal and the local level, and much more so than the general high-tech sector. This is a big problem when product development cycles and election cycles don't mesh; government funding may be available with one administration and gone with the next.

Consider California's Global Warming Solutions Act of 2006, which mandates that the state's greenhouse gas emissions be reduced to 1990 levels by 2020. This creates an obvious market for clean-tech companies, which often focus on greenhouse gas emissions. But now voters are considering Proposition 23, an upcoming ballot initiative heavily funded by out-of-state companies. If passed in November, the proposition would suspend the emissions reduction law until the state's unemployment rate falls below 5.5 percent for four consecutive quarters.

"The cost curves you see in renewable energy are falling fairly predictably," Lassiter says. "But public policy is remarkably volatile…and the entrenched political opposition to changes in energy and environmental policy is unbelievably strong. For the time being, public policy support in the form of subsidies or mandates is required if renewables are to be used."

Learning From Government

To that end, Lassiter suggests that learning how policy affects business is one way to assure future success as a venture capitalist-especially in the clean-tech field. Actually effecting policy change is another way. That's why he's pushing would-be VCs at Harvard Business School to spend some time working in public policy positions after they receive their MBAs.

"I want them to think about government service," he says. "Whether you like the government or don't like the government, somehow we need to get more smart people into the government."

“I can't tell you how difficult it's going to be to build businesses in this area.”

Lassiter likens clean-tech energy production companies to the biotech firms that were sprouting up in the early 1980s. Their success, too, relied on government policy much more than that of general high-tech firms. He recalls former students who eschewed established company jobs for gigs at flashy biotech start-ups, only to find themselves spending the bulk of their time writing government grant applications. "For most folks who graduated from HBS in the 1980s and who wanted to work in biotech, the place to work wasn't in any of these first-generation start-up companies," he says. "The place to work was the National Institutes of Health or in business development at one of the established big pharma/medical device companies."

To further emphasize the role of government in clean-tech, next month Lassiter will teach a case called U.S. Department of Energy & Recovery Act Funding: Bridging the "Valley of Death." The case discusses the Department of Energy's attempt to bolster the green economy by investing more than $32 billion in clean-energy efforts, including $16.8 million for to energy efficiency and renewable energy companies. The DoE also gave $4 billion to a new loan guarantee program, dubbed "1705," dedicated to renewable energy, smart-grid, and biofuel projects. The grants also included $400 million for the Advanced Research Projects Agency-Energy (ARPA-E), a new government agency that provides grants for advanced, albeit financially risky energy research.

There's no question the DoE investments have made an initial impact. For instance, in March 2009, the DoE granted a $535 million valley-bridging loan guarantee to thin-film solar cell maker Solyndra, to support the company's plans to construct a commercial-scale manufacturing plant. In September, in conjunction with breaking ground on the new plant, Solyndra officials announced that the company had received $198 million in private equity since receiving the DoE loan guarantee.

"They've certainly been effective in bringing private money into the game," Lassiter says of the DoE. "It's definitely speeding things up compared with where they would have been without it."

Deals Declining

The question is how effective those publicly funded investments will be in the long term, especially in terms of a venture capitalist's idea of company success—that is, going public or getting bought. A few clean-tech start-ups, including Tesla and A123 Systems, have gone public, but many others appear stalled. Solyndra announced plans to file for an IPO in December 2009, but reneged on the filing the following June. Daqo New Energy, Trony Solar, and MiaSolé are among other clean-tech companies that have withdrawn or delayed IPOs.

And despite the boost from Recovery Act funding, VC interest in the space has been waning in the past few months. Following a record first quarter of 2010, when North American companies raised $1.5 billion in clean-tech venture investment—81 percent of the worldwide total that quarter—funding has withered. In the third quarter, according to the Cleantech Group, North American clean-tech companies raised just $928 million, down a whopping 42 percent from the second quarter, and accounting for only 62 percent of third-quarter global investments in the sector.

"I can't tell you how difficult it's going to be to build businesses in this area," Lassiter says. "But, in some sectors, there are real opportunities for entrepreneurs with ideas that can move the needle and not drain the bank."

Finding those breakthrough ideas and entrepreneurs is a tough task for venture capitalists, he says. In his classes, Lassiter teaches the case of Highland Capital: the venture firm evaluated some 400 clean-tech start-ups—and invested in only three of them.

About the Author

Carmen Nobel is the senior editor of HBS Working Knowledge.