Clean-tech bubble talk is a red herring

CAMBRIDGE, Mass.--It's fashionable these days to ponder whether there's an investment bubble in clean tech. But I believe this discussion obscures a bigger problem for the clean-tech crowd: not enough money.

A panel of venture capitalists at the Technology Review EmTech 2008 conference on Thursday took the bubble question head on. The response from investors tends to be nuanced: no, there isn't a bubble, but there are some silly company ideas getting funded.

Before I delve into the details of the bubble debate, let me say that focusing on venture capital deals is a myopic view of the market that could ultimately give the "clean-tech revolution" a bigger black eye than just a few failed start-ups.

Clean-, or green-tech, venture capitalists will tell you times have never been better if you judge by the number of business plan proposals crossing their desks and their ability to raise funds. Many an entrepreneur and investor sees energy and environment as a ripe area for technology innovation.

What worries me is whether the hundreds of newly formed energy tech companies will have enough capital to actually succeed--and change the world as they all set out to do.

Insiders have been fretting about the dreaded funding gap, or "Valley of Death," for years. It's the stage a company must cross to take its technology to commercial scale, such as building a manufacturing plant. In energy-related businesses, it usually take lots of money.

Now the financial crisis could actually make that gap tougher to bridge, given the difficulty in the public markets and the projected cost of an anticipated Wall Street bail-out plan.

Spending hundreds of millions of dollars for say, a solar manufacturing facility, is outside the range of most VC funds. To some extent, project finance can fill in the gap, said CMEA Ventures investor James Kim.

"But if that doesn't happen, you will have all these great energy technologies which are ready to be deployed at a large scale and they have nowhere to go," he said during the panel.

Hedge funds have invested in some of these late-stage funding deals, but turmoil on Wall Street could tie their hands. Loan guarantees from the federal government are possible. But the prospect of a $700 billion Wall Street bail-out puts the availability of those funds--or some massive government-led energy initiative--into question.

A business model around private equity companies, such as the Carlyle Group and Hudson Clean Energy Partners, to invest in energy is clearly taking hold. But Kim notes there are limitations: private equity firms don't jump in unless they are sure a clean-tech company's product will work.

"They don't like small deals under $200 million and they don't like any technology risk," Kim said to me. "So if you're a company that's about to build a commercial plant right now, you're probably worried."

Because of the few late-stage financing options, CMEA expects to decide later this year whether it will raise a fund for that purpose as Kleiner Perkins Caufield & Byers has already done.

On the brighter side
The good news is that energy is an issue that transcends today's crisis. That means that the ultimate customers of green-tech products--be it a utility, corporation making a green building, or consumer--are not going away.

Corporate partners are particularly important to clean-tech start-ups, said David Berry, an investors at Flagship Ventures. These so-called strategic partners can invest in a company to get access to a technology. GE, for example, invested in battery maker A123 Systems, and Dow Chemical has backed GreatPoint Energy, which is turning coal to natural gas.

"We've seen for most of our companies (that) the strategics that were interested before the financial crisis started are still there, are still interested. They still believe there are going to be markets after this crisis is sorted out and we're still going to have an energy problem," Berry said.

The credit crisis is forcing companies to take a more realistic view of their growth financing options, he said. Using huge amounts of debt to get a biofuels plant off the ground, for example, is unlikely to happen.

But getting $50 million from a strategic partner is still a viable option, Berry said. In addition, these partnerships have a valuable purpose of vetting the technology while giving a new company access to an existing distribution chain.

Day of reckoning
Venture capitalists will generally tell you that the energy business is so big and the problems--whether it's energy security, cost, or climate change--are so acute, it's hard to see the few billion dollars a year going to clean tech as overly exuberant, particularly when viewed over the long term.

That said, the growing interest in clean tech as a category has brought in many newbie investors, pushing up the valuations of the companies getting funded.

"As new investors jump in and don't understand the space...what do they do? They follow the money," said Rob Day of @Ventures. "It's sort of like they're trying to bet on a horse race when they hit the final turn."

As a result, Day sees several bubbles within the overall clean-tech area. Biofuels and solar, which have seen the bulk of the investor interest, are the most over-heated.

Berry, too, sees a "day of reckoning" coming to clean-tech as companies fail to achieve their technology goals and investors move on.

But he predicted that the fallout will be muted. A start-up developing a plant-derived gasoline replacement, for example, will have to demonstrate its technology to fuels companies long before that customer actually buys the product, he said.

Also, because the clean-tech rubric is so diverse, it's unlikely that one sector's decline will bring down others. The corn ethanol investment boom, which fizzled out last year, didn't slow development of cellulosic ethanol, Berry noted.

Ultimately, investors and entrepreneurs need to not only do the hard work of coming up with impactful technology but also understanding the business dynamics of the markets they want to sell into.

"A lot of people are jumping in without having a firm footing," said CMEA Ventures' Kim. "What we don't want is a lot of them blowing up and everyone souring on the sector."