The green investment revolution has been, to put it mildly, underwhelming. As a recent WSJ headline put it , ‘so much promise, so little return’. Joseph Dear, CIO at CalPERS, called green a “noble way to lose money” and joked that these eco-friendly investments often carry an “L” curve (for loss-making) instead of a J curve. As a result, Dear has promised to scale back his fund’s green investments and will even pull back from VC generally (due to the abysmal returns over the past decade). It would seem the venture capital industry got the green-theme wrong; that this wave of innovation and opportunity was over-hyped and that investors under-appreciated the difficulty of bringing these new technologies to market.
That’s frustrating. As I saw it (and continue to see it), the green revolution was never going to be easy. And, perhaps more importantly, it was never something that the venture capital industry was going to be able to do on its own. The scale of capital required for green energy companies, for example, make them utterly incompatible with the traditional VC model. Think of it this way, the go to market strategy for some of the biggest and most transformative green energy companies would need to combine a technology company with a power generation company and a series of large-scale infrastructure projects. There’s really no way a VC alone – or even a syndicate of VCs – could pull this off. If you’re launching a green energy company, then you’re basically deciding to launch a new industry.
So venture capital lacks the necessary resources to fund such capital-intensive industries to commercialization. So where should these green companies get their growth capital? I think the sovereign funds and pension funds that believed in the green revolution should have been ready, willing and able to do something beyond writing a check to Sand Hill Road and crossing their fingers. But for these pensions and sovereigns, making these investments would have meant stepping well outside the comfort zone. Why? Because the nature of the risks embedded in these green companies placed them beyond the reach of traditional investors.
In other words, there are far, far more risks to “de-risk” (to use the VC parlance) in a green energy play (for the reasons cited above and more), which means that a green-growth stage company will not resemble a traditional growth-stage company. And, in all likelihood, the cash flows will not yet exist for the excel-based investment deciders to do their discounting or be able to get comfortable with the high valuations ascribed to green growth. I guess what I’m saying is that the nature of a “growth stage” company in the green space and a traditional growth stage company will probably be different. An investor might want or even need to apply a standard financial model to a clean energy company, but I’m not sure that’s the right way to go about this.
Joe Dear jokes about the L curve. And, by the numbers, he’s right. But isn’t it possible that the J curve is in fact just far deeper? Tesla was founded in 2003 and was written off many times. If the founder of this company hadn’t risked $70 million of his own money in the long years of getting the company some traction, would Tesla even exist today? Musk was building an entirely new industry, and that was never going to be easy. And, in 2013, the Model S was awarded the Motor Trend “Car of the Year”. So things seem to be working out ok now.
I think the problem for most investors with these opportunities is that commercial viability is really built and demonstrated during the scaling of the business (because it’s there that the economies of scale begin to make the products viable). In other words, even after these companies have raised considerable amounts of capital, there is often dramatic innovation and efficiencies gained in what would normally be perceived as the “growth phase” of the business. And, so, in clean energy plays, the venture mindset will have to continue much later into the maturation of business (something that leaves growth stage investors very uncomfortable).
In my view then, if you want to make money in the green space, you can’t outsource all of the investment and asset management to people with short time horizons and small pools of capital (i.e., the VCs). This space is all about long-term and scale. Institutional investors can no longer sit back and hope that venture capitalists can take these technologies through to commercialization. I’d even suggest that “green” is perhaps one of the better asset classes where sovereign and pension funds should team up and go direct.
But! It all comes back to the in-house capabilities of our largest asset owners (the pensions, sovereigns and endowments). For this approach to work, these funds have to be able to properly assess which clean energy investments have the most promise and make bets only on the most promising management teams and technologies. And, more importantly, these institutional investors have to be ready to take on some technology risk where they might be used to seeing only market, scale and execution risks. This is very hard.
And because it is so hard to build this type of capability in house, collaborative vehicles that bring direct investors together are required. (It’s no accident the paper I wrote on co-investment vehicles was based on a case study of the Cleantech Syndicate.) I think these vehicles will help long-term investors mobilize the resources and capabilities necessary to pick among the green opportunities ones that are, in fact, commercially viable over the long term. And because some of these investments will inevitably fail, pensions and sovereigns could be well served by pooling capital with other, like-minded investors to capture some diversification.
In the end, this is all about identifying those game-changing companies that, with the capital and time required, will generate enormous financial returns. Because if you’re a pension fund or sovereign fund, that’s the primary and often singular objective – this can’t be about “doing good”. It has to be about returns.
But in order to get those returns, the long-term investors of the world will have to do more than passively watch... they’ll have to start helping green entrepreneurs build their businesses. If they do, they might be surprised with the outcomes... the companies that break our dependence on hydrocarbons will do very, very well.
(Note that I purposely left “government” completely out of this post, as I’m not interested in arguing for or against subsidies or grants or the role of government in building out infrastructure or any of the things that governments can do to help these companies. In large part I did this because most investors discount this support anyway, as it is usually at the whim of politicians. So let’s just focus on the private sector for now.)
