Venturing Forth

If We're Not Careful...

China's going to eat our lunch in cleantech.

This was the overwhelming feeling I was left mulling over during my return flight from China last week. I had a great trip, visiting Beijing, Tianjin, Suzhou, and Shanghai over five days as I looked at some new investment opportunities. It was a lot of fun – and I was really impressed by the alignment of government policy and startup-driven innovation that have China poised to lead the world in a number of important cleantech markets.

At this point a Friedman-esque rant on US ineptitude comes naturally – but in this blog post I will instead focus on what China is doing really well right now:

Investment in infrastructure. Many of the big cleantech markets of the future – smart grid, vehicle electrification, distributed renewable generation – require big-time infrastructure investment, and the pace of investment in China right now is astounding. Whether it’s the “mag-lev” train to Pudong airport, the state-of-the-art regional technology centers, the Olympic Stadiums (Bird’s Nest, Water Cube), or just simply the hundreds of cranes and bulldozers you see during the course of a morning commute, the government’s capacity to invest in critical infrastructure is mind-boggling.  In a world where the developed western world is debt-laden, this is a major advantage, and China’s government has proven its ability to swiftly make bold investment decisions.

Government’s strategic focus and resolve. China is determined to become the world’s leader in energy and clean technology. And unlike a western democracy, when China President Hu Jintao makes up his mind, action follows quickly. I was struck by examples of this routinely on my trip, but 2 examples really hit home for me:

• Vehicle electrification. China has announced its 20-city electric bus program, whereby 20 leading cities will have 1,000 EV buses on the road by 2012.  It turns out this is a very shrewd initiative. The key to the EV market is gaining real-world experience – ie miles logged – with vehicles on the road. Buses average 16 hrs/day and maybe 100 miles/day, versus 20-40 miles/day for a car – and with a bus it is easy to collect the actual drive-cycle data from a single owner/transit authority. Therefore, going “buses first” makes a lot of sense. And it’s not like the China bus market is small: by 2012, buses sold in China could exceed 200-300 MWH of aggregate battery capacity, which is roughly the equivalent of the aggregate battery capacity of Toyota Priuses sold in the US in 2009.
• Carbon trading. Though cap-and-trade legislation passed the US House of Representatives in June 2009, and the Obama administration supports the initiative, just this week the US Senate gave up climate legislation in favor of a narrower energy bill. Meanwhile, China moved swiftly into action following the talks at Copenhagen, and on Friday morning I read the announcement of China's rollout of a cap-and-trade system. What is amazing is that China took this step even though, as a developing country, China will not be subject to the same stringent carbon emissions caps as developed countries, even if/when an agreement is finally reached at a successor event to the failed Copenhagen summit last December. China’s utilities and heavy industry will be poised to succeed in what will inevitably become a carbon-constrained world in the future.

Culture of entrepreneurship. I had expected to find a layer of bureacracy and red tape in the way of entrepreneurs in China, whereby startups wait for earmarks and other subsidies to determine a market's winners and losers. I found just the opposite. I found myself feeling very comfortable in meetings with Chinese entrepreneurs and industry executives, as the ways in which they communicated (even if at times in Mandarin!) were very familiar to me. People were direct and transparent, and there was an informality that any entrepreneur in the US would instantly recognize as an important part of successful startup culture. One of my mentors in the venture business once told me, "I can't list out all the necessary and sufficient attributes of a great entrepreneurs, but I know it when I see it." I agree that great entrepreneurs share a certain je ne sais quoi - and I saw more of it in China this week than in any of my trips to Japan or Western Europe.

All in all, it was a fun week in China and I was deeply impressed by the pace and breadth ofinnovation. There is no doubt that the US remains in a class by itself in terms of fundamental research and "ideation", but the winners in cleantech will ultimately be those that ride aggressively down the experience curve and deliver the best value over the long-term. The experience curve in cleantech is influenced by government policy in ways to which US entrepreneurs are not accustomed, and this is where China is determined to lead.

Capital-Efficiency in Cleantech

In an interview  with WSJ/Venturewire yesterday, Vinod Khosla made the distinction between capital-light and capital-heavy cleantech businesses. The capital intensity of cleantech investment opportunities is the subject of much debate in entrepreneurial circles, and it's a subject I've touched on in this blog as well (link). Vinod cites the example of Stion, a thin-film solar company that recently closed a $70m Series D financing, as a capital-light solar play compared to the $100-500m raised by competitors such as Miasole, Nanosolar, Solyndra, and others. On one level, it is an important point: if Stion is able to reach cash-flow breakeven on 50% less capital than its competitors, it is an important distinction and it will drive superior returns for shareholders. But on another level altogether, I just don't get it: I don't see how early-stage venture returns can ever be reliably achieved in segments where $100m equity raises are termed "capital-light" businesses.

For early-stage venture capital investing to make sense, the early equity needs to be applied to mitigating the biggest risks facing the company. Usually, these are risks around feasibility of the technology or validation of market size. This is the logic behind Series A financings: go build the team and build the product and see if any customers care about it. The problem with the solar, biofuel, battery opportunities that require hundreds of millions of dollars for manufacturing operations, is that the single-biggest risk facing these companies at the time of inception is their ability to raise Series D/E/F capital on attractive returns, if at all. How does the Series A investor assess and discount the risk associated with a $100-200m equity raise five years out? Solyndra's recent decision to pull their IPO in mid-June illustrates that even the world's most competent investment bankers struggle to predict the market's interest a few months out...

Here's how I characterize a capital-efficient cleantech business:

• The biggest risks can be addressed and mitigated within 2 years and with the support of its initial investorsThe biggest risks can be addressed and mitigated within 2 years and with the support of its initial investors
• Product can be brought to market within 2 years and with the support of its initial investorsProduct can be brought to market within 2 years and with the support of its initial investors
• Profitability can be reached on <$25 million equity capitalProfitability can be reached on <$25 million equity capital

As an early-stage investor making investments up to $10-15 million in a business, I like this model because I can see how my capital can "de-risk" the key questions facing the company at inception.

I also believe that many of the "hot" areas for investment in cleantech do present capital-efficient (my definition) opportunities. They're not as obvious, but they exist. As an example (disclaimer: portfolio company promotion coming) I point to Digital Lumens, an LED systems company I invested in 2 years ago that recently came out of stealth and launched product to market. In a market with plenty of capital-intensive businesses innovating at the advanced materials/chip level, Digital Lumens has launched the first cost-effective general illumination LED system for the commercial and industrial market. On far less than the $25 million threshold listed above, DL has a dozen or more early customer deployments generating 90% energy savings and <18-month paybacks for their system. The company benefits from the industry's experience curve which generates cost/lumen/watt improvements of 25+% a year and instead focuses R&D to innovate in mechanical/thermal engineering, power management, and systems controls to deliver a complete solution to the market. Digital Lumens is delivering important value to the market by bringing a cost-effective LED system for general illumination to the market - but the company has not borne big financing risk.

It's true that many of the businesses Vinod mentions simply require hundreds of millions of capital to reach the market. My point is not that these can't be successful businesses - only that it's not an attractive risk/reward bet for early stage venture capital.It's true that many of the businesses Vinod mentions simply require hundreds of millions of capital to reach the market. My point is not that these can't be successful businesses - only that it's not an attractive risk/reward bet for early stage venture capital.