There’s a place for VC, but adjust your expectations

After seeing two of the world’s largest technology companies – Apple and Google – close landmark clean energy deals, it is only fitting to reminisce about the intersection of clean energy and technology.

Cleantech, as is well known, has become a dirty word in the investment lexicon. Joseph Dear, the late former chief investment officer for the California Public Employees’ Retirement System (CalPERS), memorably called it “a noble way to lose money”. His view wasn’t unique. The number of venture capital-type investments in the sector has substantially diminished, to $4.8 billion last year from a high of $12.3 billion in 2008, according to Bloomberg New Energy Finance.

The reason why so many investors are still licking their cleantech wounds is well known by now. They went in expecting the kind of successful VC investments that were powering the internet revolution. What they got instead were longer than expected investment periods, higher than expected capex, and lower than expected returns – if not outright losses.

Unfortunately, a repeat of the internet success story was never going to happen. In fact, GPs that structured their funds and promised returns according to that model – and the LPs that committed to them – fundamentally misunderstood the nature of the clean energy market.

The problem is not that it is impossible for a cleantech company to come up with the revolutionary equivalent of Google’s search engine magic. The problem is that even the most ground-breaking cleantech product faces a fundamentally different route to market, one that is fraught with regulatory perils, politicised stances on climate change and entrenched, powerful market players that will not give up without a fight.

That is not to say cleantech has not a chance to bring about change in the energy market. In fact, it is already doing that, and new research into battery storage and Big Data will almost certainly bring further changes. But it was a mistake for the GP/LP community to have the same set of expectations for the sector that they did for VC-backed internet plays.

Damage done, the trick now is to convince LPs that they haven’t backed the wrong market – they just backed the wrong investment model.

So what does a better investment model look like? As many are already discovering, it relies less on backing “paradigm changes”, to quote Amadeus Capital’s Jason Pinto, and more on supporting companies in which the product economics and the route to market are clearer and closer to fruition. There are plenty of companies that require risky growth capital capable of generating substantial returns. But they will be ignored if investors don’t adjust their expectations.

And who, then, will back the kind of early stage research and development that might generate the next clean energy revolution? There’s a case for private capital to still be in there, but perhaps with a little help from government, as US President Barack Obama has recognised. Private investors that want to commit to paradigm-changing research, though, should make sure they fully understand what they are getting themselves into this time around.