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 funds 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.
Thats 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. Theres really no way a VC alone or even a syndicate of VCs could pull this off. If youre launching a green energy company, then youre 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 Im 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 Im not sure thats the right way to go about this.
Joe Dear jokes about the L curve. And, by the numbers, hes right. But isnt 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 hadnt 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 its 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 cant 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. Id even suggest that green is perhaps one of the better asset classes where sovereign and pension funds should team up and go direct.