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
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.