What future for VC in Cleantech ?

The 2008 financial crisis and the subsequent economic downturn definitely had a strong impact on the VC Cleantech sector. Data recently published show that in 2009 total VC investments in Cleantech were $5,6 billion vs. $8,5 billion in 2008, a 33% decrease. That said, there are several indicators that let me strongly believe that VCs will continue to play a crucial role in the Cleantech sector and a bright future is ahead of us:

1. Given last year’s general economic climate, the above mentioned 33% contraction in capital invested actually shows that the Clantech sector was much more resilient than all other sectors (including software, biotech and pharma). In fact, while VC investments in Cleantech declined to 2007 levels, overall venture capital retracted back to 2003 levels. In 2009 VCs were therefore focused on Cleantech more than ever and this trend has continued into 2010.
2. In 2009 the market for clean technologies continued to strengthen. Investors, governments and corporations  showed record level of activity regardless of any non-binding global climate change agreement that came out from Copenhagen. Governments in particular looked at Cleantech as one of the main drivers to stimulate economic growth and fight unemployment.
3. Even if the outcome of Copenhagen was disappointing, it is absolutely clear that global warming will be on the agenda of all political leaders and decision makers for the next few decades. In addition it is also clear that there is no concrete hope of making any substantial impact on global warming without major scientific breakthroughs that will require a considerable amount of risk capital and, therefore, VC investments.
4. Moreover, given that we do not see any major breakthrough at the horizon and one single silver bullet will not be able to solve global warming, I think there is still plenty of time for new ideas and business initiatives to start, grow and be successful within the typical 5-7 years timeframe of a VC investment.

If you agree with me that the VC Cleantech sector is here to stay and flourish, your next question should be: What are the one or two most promising subsectors within the broad realm of Cleantech? In my view the answer to this question is straightforward and comes from the two following remarks:

·         Of all possible mitigation measures targeted to reduce global warming, energy conservation measures are, broadly speaking, the ones that come at a negative cost for the society (i.e. the cost of implementing those is less than the economic benefit that comes from them) and therefore their implementation should be a no-brainer.

·         Given that mitigation policy initiatives stall due to a lack of regulatory agreement on collective action against climate change (e.g. Copenhagen), the interest and importance on adaptation measures (primarily related to water management, agriculture and related infrastructures) will have to grow. Initial estimates from UN and several non-profit foundations suggest that this market would be very significant: up to $170 billion p.a. in revenues by 2030 with up to two thirds generating economic benefits that outweigh their costs.

I therefore believe that energy efficiency and bluetech (water and agriculture related products/processes) are the two Cleantech subsectors that have the strongest fundamentals and should have the brightest 5-10 years outlook. In selecting specific business ideas within energy efficiency and bluetech VCs should focus on the ones that, in addition to all the traditional  must haves of an investment (e.g. driven founders, innovative technology content, right time-to-market, etc.) have a sound business model with the following three characteristics:

1. It alleviates the agency dilemma which characterizes almost all conservation measures (i.e. there is no incentive for the landlord in investing in conservation measures that reduce the consumption of the tenant).
2. It allows for aggregation of demand, which is by its nature very disperse, into bigger and more easily targetable clusters (e.g. changing light traditional light bulbs to more efficient ones requires millions of individual decisions, while going from a traditional meter to a smart meter requires the decision of few hundreds utilities).
3. It can provide a product or service at a price that people living in developing countries can afford (given that most of the emerging economies, like China, are vastly energy inefficient and most of the mitigation measures will have to be implemented in poor regions like Africa and South East Asia).