Cleantech Industry Makes Strides

If the direst forecasts from climate change alarmists come to pass, then Canada is one of the few places on Earth that may offer a pleasant living environment.

The country is flush with abundant freshwater, arable land, and a nippy climate that could, half-jokingly, benefit from a bit of warming. Plus, Canadians are among the planet’s most eco-friendly citizens. The country ranked highest in the Americas last year for sustainable practices, according to Yale University’s Environmental Performance Index.

Lately, environmental-consciousness has flowed to the entrepreneurial sector. Last year, VCs invested about $119 million in Canadian cleantech companies, according to Canada’s Venture Capital & Private Equity Association (CVCA), an industry group that uses data from Thomson Financial (publisher of VCJ). That’s nearly double the $65 million invested two years previously.

This year, venture investing in Canadian cleantech companies is on the rise again, with funding in the first half of the year reaching $76 million, according to the CVCA.

While Canadian companies currently account for less than 10% of cleantech venture investments in North America, firms focusing on the sector say that they believe there’s a much larger supply of entrepreneurial talent in the Great White North that has yet to be funded.

“We have a large resource-based economy, so it’s important for us to be aware of the environment,” says Chris Erickson, a partner at Vancouver-based Pangaea Ventures, of his fellow Canadians. “And, we’re right next door to the largest market in the world, which helps a lot.”

Cleantech Evolves

Although energy has long been the centerpiece of Canada’s export economy, the surge of venture interest in clean energy is a relatively recent phenomenon, says Rick Nathan, president of the CVCA.

“The core sectors in Canadian venture capital for many years have been software and telecom,” he says. “It’s only in the last couple of years that people are raising dedicated funds and calling themselves cleantech investors.”

To date, venture investments in cleantech still account for just a small share of overall activity. In the second quarter, cleantech companies raised $37 million, less than 10% of the $426 million in overall VC funding raised by Canadian companies, according to the CVCA.

There’s more money sitting on the sidelines. Currently, several domestic funds are actively pursuing new investments in environmentally friendly technologies. Top investors include a host of diversified funds as well as cleantech-focused firms, such as Pangaea Ventures, Chrysalix Energy, Emerald Technology Ventures and XPV Capital.

VCs at several Canadian firms cited easier access to cheaper deals as a key draw. Valuations for Canadian cleantech companies are commonly 30% to 50% lower than comparable deals in the United States, says Peter Crombie, a partner at Emerald Technology Ventures, a cleantech fund with offices in Montreal, Toronto and Zurich.

“There’s not as much competition for cleantech deals in Canada,” he says. “In the United States, the cleantech deals are bid up.”

Deal flow is holding up, too. Since last summer, Crombie says that he and his partners have met with more than 800 companies. Emerald held a final close on its $185 million second fund in February and has made about six investments from it to date. Canadian portfolio additions include Vaperma, a Quebec City-based maker of membranes for gas separation, and Angstrom Power, a Vancouver developer of hydrogen portable power systems.

Federal help

Private venture firms aren’t the only ones chasing cleantech deals. The Canadian government invests in cleantech through a $550 million fund operated by the non-profit Sustainable Development Technology Canada. Since 2002, SDTC has provided $270 million to 124 cleantech projects.

SDTC invests in biofuels, renewable energy generation, hydrogen and technologies to reduce the environmental damage of oil, gas and coal extraction and consumption. Of these, biofuels is roughly the largest component, accounting for nearly one-third of funding requests and 28% of investments.

Biofuel companies span the nation. Examples include Vancouver-based Terra Gaia, a developer of technology for eliminating hazardous wastes produced by the steel industry; Montreal-based AirScience Technologies, a maker of a process to produce hydrogen from landfill gas; and Ottawa-based Advanced BioRefinery, a developer of technology for converting logging residue to biofuel.

Environmental policy also encourages new cleantech ventures. This year, the national government passed legislation imposing stricter caps on air pollution and greenhouse gas emissions. Under Canada’s Renewable Fuels Standard, 5% of the content of gasoline transportation fuel is to be renewable by 2010, and 2% of diesel fuel is to be renewable by 2012.

Green profit potential

While green technologies are attracting plenty of investment dollars, venture-backed companies in the sector haven’t generated many exits lately. That’s understandable, several VCs noted, since much of the recent investment has been early stage, and it will take years for startups to develop into viable, standalone businesses.

Erickson of Pangaea points to wind power as one of the active areas for acquisitions. Lehman Brothers in July bought a stake in Toronto-based SkyPower, which builds and manages large-scale wind and solar projects. The investment, for an undisclosed sum, includes an up-front acquisition payment and commitments to future project financing.

Questair, a manufacturer of gas separation equipment for fuel cell systems that raised funding from Ventures West, Advent International and Working Ventures Canadian Fund, went public on the Toronto Exchange in late 2004. Shares have not performed well since, recently trading below 60 cents, having shed more than half their value since the spring.

Undeterred by the lackluster number of exits, Canadian cleantech investors plan to partner actively with their U.S. counterparts, especially in later stage rounds. That’s in line with the prevailing practice in other industries. The CVCA reported in August that market share from foreign (principally U.S.-based) investors stands at more than 40% of all 2007 venture capital investment in Canada. There’s also been a steady decline in fund-raising by Canadian venture capital firms, the CVCA found.

“We’re really trying to encourage our U.S. brethren to come and join us,” says David Berkowitz, general partner of Vancouver-based Ventures West. His pitch to his southern neighbors is that they can get in at lower valuations for companies of comparable quality, take advantage of better tax credits, and benefit from a lower cost of doing business. That message apparently resonated with Silicon Valley’s VantagePoint Venture Partners. The firm led the Series B round in Angstrom last September. Ventures West had led the A round.

However, raising a fund in Canada can be slow-going. It took Emerald more than a year-and-a-half, Crombie says, to raise its second fund, which includes such strategic investors as Dow Chemical and Suncor Energy. He says that the key to success will be to keep valuations in line and be prepared to wait.

“One of the factors in our space is that the investment hold (from early stage to exit) can be seven to eight years,” he says. “It takes longer to generate returns. So you don’t want to bid up too high because you’re going to be there for a while.”