The VC models are to blame, not the green technologies

It’s worth reviewing this great presentation from the folks at @Ventures:

[vodpod id=Video.16097730&w=425&h=350&fv=]

If they’re right — as I believe they are — we are soon going to see lots of greentech venture capital funds lose money. Given the potential for that loss to be skewed as “green technologies aren’t profitable” rather than “greentech VCs don’t have their models right,” and for politics and business to respond to the conventional wisdom rather than the facts on the ground … you see where I’m going.

What I particularly like about the presentation is that it articulates concerns those of us in the space have had for a while, but does so from the view of the investor rather than the investee. Click the link to see their vantage point. In the meantime, my theories are below the fold.

The late ’90s saw an explosion in venture capital firms that specialized in tech investments, primarily IT and biotech. (Indeed, if you’ve read The New New Thing, you’ll recall that IT investors very quickly transitioned into healthcare investors, with very little rigor connecting those two industries. Many of those same firms are now in the energy space.)

Broadly speaking, those investors made a lot of money — which means that they had to find a new place to invest. Along came greentech, which was never clearly defined, but seemed awfully sexy, needed cash, and had the potential to be massively socially transformative. (In the VC world, green tech is a big bucket, ranging from hydrogen to ethanol to fuel cells to demand-side management.)

Superficially, greentech looked a lot like things the VC world had proven itself good at. But — to misquote Rick James — hubris is a hell of a drug. And the skills it takes to find value in IT and biotech are different than those necessary in the greentech space. Specifically:

1. IT and biotech are largely technology plays. Find the company with the strongest patent position and then worry about business model.
2. IT and biotech are, to a significant degree, about market saturation. Build the company so that they have 70 percent of the market space (be it the market for e-books or the market for type-1 diabetes drugs), and then worry about the business model.
3. IT — and to a much lesser degree, biotech — is only minimally dependent upon regulation. (Indeed, for every IT firm nervous their model won’t succeed unless the anti-trust regulators damp down Microsoft’s ambitions, there are probably 10 counting on Microsoft to leverage their dominance to buy them out once they succeed.)
4. Finally, neither IT nor biotech depend to any significant degree on unrelated infrastructure investments.

Now compare these to greentech:

1. Green technologies compete in one way or another against a massively regulated and subsidized energy sector. On the one hand, this means that if your management team doesn’t have the savvy to negotiate those regulations, you won’t make any money. On the other hand, it means that there are a ton of profitable technologies out there that haven’t been deployed because of the subsidies to status quo industries. This is a sector who’s success is based not on the development of new technologies, but on the reform of old laws.
2. Green technologies are all, ultimately, about selling commodities (electricity, fuel, etc.). The guy who sells 1 percent of the electricity in a given market has no particular pricing advantage against the guy who sells 10 percent. And the market is so enormous that it’s not possible to get the 50+ percent market shares targeted in the IT space. This means you need a totally different ramp strategy.
3. Many green technologies are highly dependent on massive infrastructure changes. Want to make money in wind? Better hope someone drops a couple billion dollars on transmission lines. Want to get into the hydrogen business? Better hope we build a network of hydrogen fueling stations and hydrogen cars. The cost and time required to make these changes are massive, and these infrastructure investments have no direct parallels in the IT and biotech spaces.

My predictions

So where does this leave us? As the @Ventures presentation makes clear, an awful lot of VC firms look like they’re getting squeezed as they’re forced to take bigger and bigger bets on earlier and earlier stage technologies. (The slide of theirs I find particularly compelling is the one that shows VC money overwhelming concentrated amongst the highest-cost approaches to GHG reduction.) It’s hard to see this having a happy ending for the VC firms in the space.

Many are going to lose money. Some will conclude that greentech simply doesn’t pencil. Others will conclude they need to apply a different investing model if they want to succeed in this space.

Once that happens, we will see a reallocation of capital into technologies and business models that are no less green, but much more profitable. In the meantime, expect much sound and fury signifying nothing more than a bad investment model. But I guarantee it won’t be reported that way.