Considering Venture Capital’s Role in the Energy Transition - Part I
We’re sitting in the giant conference room at Kleiner Perkins Caufield & Byers, where the partners hold their weekly meetings. After loading his plate with Chinese food from a buffet, Gore is firing detailed questions at the management team of Ausra, a Kleiner-backed company in Palo Alto whose technology uses mirrors the width of a flatbed truck that focus the sun’s energy to generate electricity. - CNN MONEY February 12, 2008
What was clear to some then is clear to a growing number of people now - we need a significant mobilization of capital to build, deploy, and scale the solutions required for a full decarbonization effort in the coming decades.
Venture capital can play a role, but as the cleantech boom and bust proved, it is not built to support innovation in technologies like power generation or carbon capture without significant help from the other types of capital allocators. It’s important to address and understand those concerns if we are to deploy innovation at scale.
The required capital needs for a full transition to cleaner energy is estimated to be $1.5-3.5T annually between now and 2050. In 2018, that number was closer to $750B, or at best, half of what will be required and maybe even only one-third.
It’s important to acknowledge how small the venture capital investment pool is in relation to private equity, asset manages like pensions funds, endowments, etc…, banks, and the government. These entities combined are several trillion dollars in size whereas VC as a total asset class is around $200B USD.
While venture capital is beginning to set its sights on sustainability once again, cleantech and industrial investments have skewed towards late-stage, 87% in 2016.
That is a trend that is starting to change as firms like Lux Capital, DCVC, etc… are taking earlier stage bets while building “full-stack” investment firms that allocate capital at the earliest of stages while continuing to lead funding in later rounds.
But, raising large funds and a gaining deep understanding of scientific knowledge in the fields related to energy takes decades, so they don’t solve for the rapid change required.
In the current landscape, financing risk is too high for a seed fund that allocates 250K-1.5M per deal. Venture investors at the earliest-stages must have some insight into where the funding to scale will come from. To broaden the potential pool of capital partners, we must consider the factors that can prevent them from participating.
There remains a large group of investment professionals who are cynical about investing in sustainability due to the lack of standardized metrics, but other impediments include:
Timing of climate-related impacts: “If you’re early, you’re wrong.”
a. It’s extremely difficult to make an investment in something that APPEARS to be decades away. EV’s are a great example and only in the last 5 years have started to scale up after 15 years of being the next big thing.
b. Timing and magnitude of risk + reward are crucial for investing in any asset or project - the opacity of decarbonization and its results have yet to be solved.
a. Governments like the US and AUS are wavering in their commitments to decarbonization. The US, in particular, hasn’t proven it can pass sweeping, bipartisan legislation that will empower next-generation infrastructure.
a. Most publically traded companies are judged based on quarterly and/or annual returns making it difficult to justify investing in something that could take several years to even begin showing a return.
b. The 5-7 year hold period for investments across most asset is really short, even for technologies that are in a deployment phase.
c. Early-stage VC’s usually have 10 years (±1-3 years) to fund and exit investments for each fund. This is the same problem that has plagued healthcare investment as well. Developing, deploying, and scaling “hard” technology often requires more than 10 years - venture needs help from other allocators OR from new firm business models.
Venture capital remains a crucial asset in the fight for decarbonization and an energy transition. We must remember the limits of the venture capital model to maximize risk-adjusted returns and work in coordination with other asset allocators to scale impact its maximal potential.