Venture capital (VC) companies play a key role in the development of the new technologies and the industries that will underpin a cleaner, more sustainable economy.

For starters, VC firms are a significant source of the money required to fund the different stages in taking a product from prototype to market, then on to profitability and commercial success. Just as importantly, VC companies are a source of expertise. It is common for them to take seats on the board of investee companies to provide strategic guidance. They can also assist with business development and further capital raisings through their networks, or even second staff to provide operational assistance.

What we look for

Different VC companies specialise in different stages of a company’s development, and in different technological sectors. The typical things that a cleantech VC firm might look for include:

  • A proven and experienced management team. Quality management is key, and in our experience; it is very rare in an early stage cleantech company. Make sure you can demonstrate experience and that you are in it for the right reasons.
  • Disruptive technology or a business model with high barriers to entry.
  • A positive environmental impact when compared to business as usual.
  • A compelling business plan that sets out channels to market, risk management, exit opportunities and a fit with the general economy.
  • The ability to scale.
  • A requirement for little in the way of regulatory support.
  • Relatively low technology risk.
  • A relatively short commercialisation time requiring modest capital investment.
  • A well-researched pitch that is not too idealistic, too naïve or too greedy.

Some of these are quite high hurdles, particularly for cleantech. IT style start-ups often just need capital to develop a great software innovation. A clean energy idea needs to build a prototype followed by a demonstration project, and then prove productivity for months if not years. It can take tens of millions of dollars just to get to the demonstration stage. As a result, there is currently very little capital available in Australia, and indeed globally, for early stage investments. Very early stage companies will nearly always require at least one more and usually many more investment rounds before they achieve profitability. As a result, most VC companies currently have a preference for expansion stage investments – companies that have achieved positive cash flow and are now looking to expand.

Risk and return

Just like any investment, a key consideration is the level of risk taken to achieve a targeted return. Risks include technology risk, demand weakness, regulatory risk, and the cost and availability of capital. VC companies make an assessment of the likelihood of each risk occurring, and the capacity of the investee company to mitigate or manage those risks.

In Australia, regulatory risk is very high at the moment. Most clean technologies, particularly clean energy, have some dependence on good long term regulation. Australian clean energy policy has flip-flopped in recent years so many VC companies are shy of clean energy investments that require regulatory support.

Not surprisingly, VC usually sits at the higher end of the risk scale. About 10% of investee companies fail and go out of business. Another 60 % either under-perform or lose money, and 30% exceed expectations. For the inherent risk in early stage investing, VC firms usually target an investment return of 30% to 40% per annum.

Exit options

At some point, usually in the range of three to seven years, the VC partner will want to cash in on their investment and realise their profits (if any). This can be done through a trade sale, i.e. selling to a new private owner, or though an initial public offering (IPO) that will see the investee company listed on the stock exchange. In some cases the VC partner may retain some ownership so they can receive ongoing dividends.

VCs generally specialise in a certain stage of the commercialisation process (seed, demonstration, expansion etc.). These VCs will often exit by selling to an investor with expertise in later stage development. This ensures that the investees have partners with the right skills and support for the next phase. The VC can then recycle capital into investees requiring early stage assistance.

Tough climate

Cleantech companies seeking a VC partner need to take a realistic view. Most Australian cleantech funds are winding down. Although there is no specific data available on the performance of this sector in Australia, cleantech funds in the US appear to have done poorly in recent years. (Being privately held, there isn’t much public data on many VC funds).

This means it is difficult to commercialise new clean technologies in Australia at the moment, which leads to a vicious circle – funding becomes tighter with poor sector performance, a lack funding generates poor sector performance and so it goes…

But brighter for some

On a brighter note, more mature Australian clean tech companies are doing reasonably well, particularly in waste, water, solar and environment. In 2012 they generated over $28 billion in revenue, employed 53,407 people and completed over $1.3 billion in capital transactions. So the outlook isn’t completely bleak. Clearly, the world needs to find new, cleaner ways of doing things, and there will be many opportunities in areas including energy efficiency, waste to energy and smart grid technologies.

While most VC companies will do their own homework to identify areas of promise, and then actively look for investment opportunities, many will also consider approaches from entrepreneurs. Just plan for, and be ready to undergo a very thorough assessment process.

Jo Hume is an Investment Analyst with CVC Sustainable Investments.