Red light for green-tech start-ups?

A funding gap, made worse by a softening economy, could create a wall for clean-tech start-ups despite a favorable long-term environment.

For green-tech start-ups, 2008 could be the year of either break-neck speed or just hitting the brakes.

A tidal wave of venture capital has poured into clean tech over the past four years, reflecting the confidence investors and entrepreneurs have that high energy prices and climate change make the sector ripe for technical innovation.

But the economics of the energy business pose funding challenges to start-ups in the field, a situation that could be exacerbated by a softening economy, say investors.

Namely, many energy technology companies need lots of capital--far more than a Web 2.0 or biotech start-up--which in many cases is beyond the resources of start-ups' initial investors.

"Some companies that were relying on going the route of an IPO will be in trouble."
--Rob Day, clean tech investor, @Ventures

Going from technology in the labs to a demonstration facility for, say, biofuels or solar power, can cost tens of millions or hundreds of millions of dollars, creating what many call a "funding gap."

"You can't just do a typical venture capital A, B, then C round and have a company that is self-sustaining and cash-flow positive," said Daniel Goldman, chief financial officer of GreatPoint Energy, which has a technology for converting coal to natural gas. "There is an order of magnitude more capital required--it's much, much larger than other sectors that VCs are used to investing in."

Slumping stock markets, driven by signs of a U.S. recession, make the option of getting expansion money through an initial public offering a lot less likely, said , a clean tech investor at @Ventures.

"Some companies that were relying on going the route of an IPO will be in trouble," he said, adding that venture firms that are relatively new to the green-tech arena may pull out.

Sectors within clean tech considered solar, are perhaps most vulnerable.

Even before fears of a recession set in, start-ups and their backers needed to find creative ways to get their products to market.

A few models have emerged, the success of which could make or break individual companies while providing guidance to the entire sector.

Dialing for dollars
Some new companies are trying to attract the interest--and money--of their potential customers as they battle-test their products.

GreatPoint Energy initially took $37 million from venture capitalists to develop its catalyst-based gasification process. To bring its technology into the field, the company has signed on several "strategic partners," attracting in excess of $100 million.

On Friday, it announced a partnership with Peabody Energy, which will provide coal to GreatPoint for a commercial-scale natural gas facility near Peabody's mines. As part of the deal, Peabody will invest in GreatPoint Energy.

These strategic partnerships not only serve as a way of getting equity, they also give GreatPoint access to experts in related technology and project management, Goldman said. Raising more money at a later point will be easier because large industrial concerns have already backed the company, Goldman said.

"I think (the partnership model) is going to be more of a trend because you need these large corporations to add credibility to a company and because they bring a tremendous amount of value," he said.

Similarly, year-and-a-half-old ethanol start-up Coskata signed a partnership with General Motors. GM invested an undisclosed amount in Coskata, which will build an ethanol biorefinery at a GM facility to test its fuel on GM's flex-fuel cars.

According to CEO Bill Roe, Coskata in the coming months will announce partnerships similar to its GM deal to fund construction of commercial-scale plants, which cost between $300 million and $400 million.

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