The Balancing Act

Now that the venture community has had several years of experience working with cleantech mandates, it has become clear to many that clean energy venture investing is not for the faint at heart.

It’s also not for those who expect dot-com-like experiences and returns.

Anecdotes abound regarding VCs who think transitioning to cleantech from other areas of interest is fairly simple, that the same principles apply, only to have their heads handed to them on a platter.

Given typical challenges, such as strong hardware orientation with capital-intensive development programs, the difficult and lengthy sales process to conservative customers, the impact governments have on a cleantech company’s success or failure, and revenue horizons beyond desired liquidation timeframes, nothing is more important for a VC than achieving the right balance within their clean energy portfolio.

At Chrysalix Energy Venture Capital, we invest in only early stage, cleantech companies and have been uniquely doing so for the past 10 years. Last year, we were ranked the most active global cleantech investor in the world by the Cleantech Group and we led more than 70% of the deals we entered.

I personally was involved in one of the very first successful cleantech deals in the 1980s before “cleantech” was even a defined term. That means we’ve seen it all and have learned the importance of having the right mix of companies and opportunities in our portfolio.

Now here’s the shocker—not every one of your cleantech investments should have a nearer-term market opportunity with the chance for an exit within a few years. In fact, a proportion of your cleantech investments should instead be long-term, way-out-there, truly game-changing opportunities to balance the shorter-term, smaller-reward opportunities.

At Chrysalix, we do portfolio mixture calculations which relate return against expected capital and projected time to liquidity. We know what type of returns these difficult but lucrative hardware companies must give us, and we tie this into modified “First Chicago” models which include both weighted average funds (and the dilution which follows), and the size and timing to liquidity.

It’s the First Chicago assignment of likely outcomes (i.e. risk) which drives the whole portfolio. We face up to the diversification problem from the beginning—the fewer the number of portfolio companies, the greater the fund win from anything, and the larger the number of investments, the less a bad outcome depresses results.

We think the key is to focus, have a small number of holdings, and spend a lot of partner time building the companies. As of today, we think of portfolios having between 12 and 15 items, and maybe three to five of them are in this game-changing or breakthrough category.

Sounds ideal but how should you assess these long-term potential winners and what strategies are used to make them valuable?

The routes to value will have parallel paths that culminate in strong corporate relationships long before the devices generate revenue. Given the dynamics of breakthroughs, small entrants always have huge credibility hurdles that we like to address through reviews by experts who are beyond reproach.

The capital needs will be very large, so we have focused on meaningful milestones accompanied by several sources of non-dilutive financing. Success requires pushing technology limits, and retaining top-level, next-tier managers, and a diverse venture capital syndicate.

Early stage cleantech investing may have its challenges and often gets a bad rap, but with the right technologies and the right mix selected, you can win when leading the breakthroughs that many observers believe are the only way to assure the energy supply for a sustainable planet.

As VCs, we should look upon these breakthroughs without trepidation.

In fact, we should seek them, and benefit from the competitive edge we gain in the process.

Mike Brown is Chairman of Chrysalix Energy Venture Capital, a 40-year venture veteran, and winner of the Cleantech Group’s “Pioneer Award.” He can be reached at michaeljbrown2@shaw.ca.