Over the past two or three years, a consensus view has developed that the capital inefficiency of clean tech startups makes them incompatible with the venture capital funding model. Many investors with their feet half in are delegated to invest only in business model innovation, efficiency software, controls technology, grid optimization and so forth. It’s hard to disagree with these folks when reflecting on the colossal quantities of risk capital that has been deployed to support innovation such CIGS solar - without commensurate returns. Unfortunately, this ignores the fact that the change-the-world type innovation occurring in labs around the world is exactly the type of technology that has scared many investors away.
As a clean tech VC firm investing in game-changing materials enabled technologies, building a capital efficient portfolio might seem like a daunting task. Of course all clean tech start-ups are pitching capital efficient business plans today, but very often there is a Wolf hiding in that Sheep’s clothing. To make things a bit easier I have developed three simple checks in evaluating the potential for capital efficiency:
All physical systems, be they chemical, biological, mechanical or electrical are governed by the laws of thermodynamics. Unless you are interested in 5-10 year development program, and a risky, costly scale-up process to yield, thermodynamics need to be on onside. While by no means a unique example, to keep things simple, I’ll pick on CIGS solar again. A CIGS phase diagram reveals that the Copper, Indium, Gallium and Selenium really don’t want to be together. Thermodynamics is an uphill battle. Producing thin films of CIGS with the stoichiometry required for optimum efficiency requires the perfect Goldilocks formula of temperature, pressure etc. to get the composition “just right”. It turns out this is relatively easy to accomplish in the lab but start-up companies have spent a decade and billions bringing these processes to yield over large area. Fine if you’re Showa Shell, but if VCs are writing the checks you had better pick some thing that is bit less of an uphill grind. Check One: Is advancing the innovation like coasting downhill or grinding up?
Clean tech companies face external risk from all directions including complex supply chains, conservative customers, intellectual property theft, and volatile markets. A recipe for failure is making it harder by adding layers of risk with complex and highly customized process or product. Once again, most CIGS start-ups were guilty of developing proprietary processes requiring customized equipment for their entire manufacturing process flow, perhaps under the illusion this would create more valuable IP. In-house engineering teams of hundreds were required. The capital efficient way would have been to leverage standard processes from established industries, with the innovation around one or two key steps essentially “dropped in”. Check Two: Are you creating an industry and supply chain from scratch or fitting into what is already in place?
In almost all cases, clean technologies are providing commodity products (i.e. fuel, electricity, water, chemicals), competing against commodity products (i.e. use of LEDs vs. more electricity) or playing in the value chain of a commodity product (i.e. bio pesticide for agriculture production). Furthermore, start-up companies are usually competing against incumbent technologies that in most cases have an inherent cost reduction curve. The majority of start-up business plans are conceived in an economic bubble with irrational consideration of these realities. I’ll pick on our thin film solar friends one last time. The funding rolled in without rational consideration of the short-term nature of a silicon raw material crunch, belief that traditional silicon technology was mature and not likely to improve, and distorted product pricing and demand due to government subsidies of various sorts.
Check Three: Are credible, projected cost structures well below the cost roadmaps of the competition, and is the business plan sustainable without fickle government subsidies?
Of course there may be more warning signs for capital intensity, but in my experience these quick checks are a catch-all for most. While most clean tech start-ups fall down on at least one of the checks, the best entrepreneurs have already figured these out. At Pangaea Ventures we are working with these true innovators on building a capital efficiency portfolio that we believe has a real potential to change the world.