The next generation

In recent years, venture capital firms have been investing in alternative energy companies in a big way, in part because long-established technologies are finally yielding profits. David Rapp spoke with three US venture capitalists, all experts in the energy technology investment field, to find out where they are allocating capital in this fast-evolving sector.

The public is increasingly aware of alternative energy – witness Al Gore's 2006 global-warming documentary, An Inconvenient Truth, a smash hit that is now the thirdhighest-grossing documentary of all time.

Venture capital activity in this field has risen in tandem with public interest. VCs have poured money into technologies involving solar cells, biofuels such as ethanol, and cleaner, more efficient methods of oil exploration. According to a report released by Ernst & Young and Dow Jones VentureOne, the US market saw 41 alternative-energy VC deals in 2006 alone; the capital investment increased 190 percent to $537.6 million (€409 million). Globally, so-called “cleantech” investment has also been steadily on the rise in recent years.

But interest has not always run this high, remembers Ira Ehrenpreis, general partner at Palo Alto, California-based venture firm Technology Partners. “When we started investing in this sector, it wasn't because it was fashionable,” he says. “It's since become one of the hottest sectors in the venture asset class. Frankly, we invest in long-term, enduring themes, and we got into this sector well before the recent euphoria around the space.”

Technology Partners has been investing in technologies targeting alternative energy industries for a decade. Indeed, Ehrenpreis is regarded as one of the pioneering venture capitalists in cleantech – a term used to describe products and services that aim to improve operational performance, productivity, or efficiency while reducing costs, energy consumption, waste or pollution.

CHEAPER, BETTER
Part of the reason for the recent excitement has to do with the simple fact that energy is not a single, monolithic sector, but rather a breadth of subsectors, says Ehrenpreis. It shows in the range of Technology Partners' own investments. One portfolio company, Seattle – based Imperium Renewables, is a bio-diesel company; another, San Diego-based PowerGenix, is working on a new type of battery chemistry, involving nickel zinc, to create a lighter, smaller, cheaper and non-toxic battery. “We have a coal technology investment, a biofuels investment,” says Ehrenpreis. “This is not a sector which can be generalised by a single [industry]. I would say that the breadth of the sector is both its challenge and its opportunity.”

Jeff Andrews, a partner at Waltham, Massachusetts-based VC firm Atlas Venture, points out the need for disruptive technologies in an industry growing rather long in the tooth. “A lot of these industries haven't seen enormous amounts of innovation in a long time,” he says. “I mean, when you went to college, how many people did you know who were in oil and gas research? Probably you wouldn't know any. If you walk around the R&D labs at [Houston, Texas-based energy giant] ConocoPhillips, what is the average age of the people that you bump into? They're not in their twenties, let me tell you.”

The energy market remains, quite simply, the largest market in the world, but has been “under-innovated,” as Ehrenpreis puts it. “They've been in areas where technology and innovation and entrepreneurship haven't been applied in the same way as the classic areas of venture activity, historically. You essentially have the perfect storm of huge markets that have been underinnovated, and with a whole host of attention being paid to it.”

Indeed, entrepreneurs and innovators have been targeting the energy sector for years. One of the major factors driving venture capital interest now is that technologies have become less expensive, and therefore ripe for commercial application. “The same reason you can buy a DVD player for $30 is also at the core of why solar has got a lot more economical,” says Atlas' Andrews.

Indeed, solar-power technologies have been advancing by leaps and bounds while becoming more affordable. “We are beginning to see the introduction of generation two solar technologies that are cheaper and more efficient,” says Chuck McDermott, general partner at Boston-based RockPort Capital Partners. “The physics of these systems are sometimes different: they're using different materials – they're using thin-film instead of silicon wafers.”

McDermott mentions two thinfilm companies that are robustly selling product. United Solar Ovonic, a subsidiary of Rochester Hills, Michigan-based Energy Conversion Devices, manufactures and sells an amorphous silicon thinfilm solar product, while First Solar in Phoenix, Arizona, manufactures and sells thin-film solar panels based on technology called cadmium telluride. Each does hundreds of millions of dollars of business each year.

McDermott mentions another “generation two” technology now being applied to solar: concentrating photovoltaics, or CPV. “They're using optics and special designs to concentrate light, focusing on a target so you get a higher output from the photovoltaic material,” and thus generate more energy. “These concepts have been around for a long time,” notes McDermott, “but now smart technologists are applying knowledge gained sometimes in other areas.”

If all these businesses are planning to enter the market in four or five years, my prediction is that they're going to have a lot of company

Jeff Andrews

Such repurposed technologies are powering new startups. For instance, RockPort has invested in a solar concentrating company, Pasadena, California-based Practical Instruments, which was founded by an engineer out of NASA's Jet Propulsion Laboratory. “He designed systems that allow telescopes to track stars light years away,” says McDermott. “Now he's got a system that can track the sun – which is a pretty big target when you're used to tracking stars – and apply optics and other things, to create a highly efficient solar model.”

Due to such technological advances, solar power is on its way to being competitive with fossil fuels, says McDermott. “Depending on where you are, it's already there – like in Hawaii, where electricity is very expensive, solar already makes sense and is economically competitive without a subsidy,” he says.

In the continental United States, it usually requires a subsidy to be competitively priced to the end consumer versus grid power – but parity is getting closer and closer every year, says McDermott. “Some of that is because we're getting better at today's technology, manufacturing it more cheaply, and at a larger scale,” he says. “The conversion efficiency of the modules themselves – the percentage of sunlight they can convert to electricity – is getting better and better every year, getting closer to the metric called grid parity.”

‘WIND IS OVER’
Another alternative energy sector, wind power, is already ahead of solar in terms of price viability. “Wind is pretty mature,” says McDermott. “We have these very large wind machines now that generate power at a price that would be eight or nine cents per kilowatt hour. That's competitive with a lot of fossil-fired power generation technologies, without a subsidy.” Subsidies do exist for wind in certain parts of the world – and certain parts of the United States – but it's an example of a sector where the technology has become sufficiently efficient that it can compete.

Atlas Venture's Andrews echoes the belief that wind energy investment by VCs has pretty much run its course. “Wind is sort of over in terms of venture capital investing, largely speaking,” he says.

Furthermore, Andrews even wonders about the prospects for solar technology due to overinvesting. “A lot of innovation is going to come pouring into the solar market in the next three to five years, maybe faster. There are so many solar companies with great technology. If all these businesses are planning to enter the market in four or five years, my prediction is that they're going to have a lot of company. The companies that are there will either be acquired by big companies or they will themselves be big companies; either way, you're a small guy trying to compete with a big guy.”

THE CLEAN DOZEN
A selection of private equity and venture capital firms specialising in investing in alternative energy companies and technologies.

NAME OFFICES SNAPSHOT
Abu Dhabi Future Energy Company Abu Dhabi Division of Mubadala Development Company; operates a centre for the development and commercialisation of alternative sources of energy.
Atlas Venture Waltham, Massachusetts; London; Paris; Munich Invests in solar and biofuel technologies.
Chrysalix Vancouver, British Columbia Backs disruptive technologies focused on large markets within the clean energy technology industries.
DFJ Element Ventures Radnor, Pennsylvania; Cleantech-targeted inaugural fund, capitalised at $284m, is a
Menlo Park, California partnership of Element Venture Partners and Draper Fisher Jurvetson.
Emerald Technology Ventures Zurich, Switzerland; Founded in 2000 as SAM Private Equity, the firm recently spun
Montréal, Québec out as an independent team.
Expansion Capital Partners San Francisco; New York; Invests $2m to $5m million in companies that are poised to
Boston reach $30m to $50m in revenues.
NGEN Partners Santa Barbara, California Venture investing in cleantech and other technologies enabled by materials science.
Paladin Private Equity Partners Los Angeles Secured a $40m commitment from CalPERS last year for its California-based cleantech fund.
RockPort Capital Partners Boston Invests between $1m and $10m in energy and power, advanced materials, and process and prevention sectors.
Sail Venture Partners Costa Mesa, California; Arlington, Virginia Invests between $500k and $5m in the energy/cleantech sector
Technology Partners Palo Alto, California Cleantech; manages a total of more than $400m of investment capital; currently investing from a $250m fund.
VantagePoint Venture Partners San Bruno, California; Cleantech; focuses on the application of technology to energy,
New York; Québec water and materials.