Low-carbon investment cuts across most industrial sectors and technologies. It involves investment in more efficient and sustainable ways for addressing the challenge of a rapidly growing population’s demands for energy, food and water. These resources are all interconnected and any solution would almost always involve the use of less energy and hence can be viewed as ‘low carbon’.

Some examples illustrate this. One is Exosect, a UK company which has developed a way for controlling insect pests with natural alternatives to pesticides. Trucost has calculated that 40,000 tonnes of carbon dioxide will be saved for every two million hectares of rice treated with Exosect product rather than conventional chemical pesticides.

Another example involves reducing the energy used to pump water. Some 70% of all water is used in irrigation of agricultural crops, which uses energy to pump the water. US-based AquaSpy has shown over many years that through a combination of sensors, telemetry systems and software, irrigation can be done more ‘intelligently’ leading to vast savings in water and energy use, as well as increased yields.

Hence low-carbon investment is not just about renewable energy production and energy efficiency.

Investment trends

Investment in low-carbon technology grew tenfold between 2003 and 2008 to about $840bn, based on data from New Energy Finance, Cleantech Venture Network and WHEB’s own database.

While the sector experienced a sharp downturn in 2009, as did all areas, the consensus is that this is one area capable of sustainable growth and presents huge opportunities for innovation. It is rare for presidents and prime ministers to lobby on behalf of a sector, and perhaps even rarer to promise putting money into it, but that is what is happening with the low-carbon field.

Investment levels during 2010, on the face of it, appear to have returned to those of 2008. However, there are some stark changes. First, European’s share of the global venture capital (VC) investment market is reducing. North America now accounts for 75% and California about 50%.
Second, these investments have been dominated by large follow-on rounds of existing, and largely solar technology, deals. Investment in early-stage deals has remained the same as during the height of the financial crisis in 2009.

Third, while North America and Europe remain dominant in VC funding, the initial public share offering (IPO) market – which is still well below 2007 levels – has seen a huge increase in activity in China. Before the financial crisis, Europe was the major market for IPOs. During the last quarter they only represented about 2% of the total by value with China representing over 70%.

Opportunities about or not?

Given the scale and breadth of opportunities and the level of government support, surely it must be a nirvana for innovators, investors and corporates?

Unfortunately not. Like other sectors, the low-carbon economy is just as susceptible to the economic crunch, and in some cases more so. A few pertinent facts:

Changes in investment appetite: The low-carbon field is still a fairly new area for investment. There is not a sufficient track record of cash-for-cash returns to help low-carbon venture capitalists raise new funds. This has not been helped by IPO markets being nervous of new offerings – except for companies showing sustainable profit growth – and the mergers and acquisitions (M&A) market being cautious over the past 18 months.

The credit crunch has also meant traditional investors in VC funds, such as pension funds, are either not investing or only doing so in those with whom they already have long-standing relationships – not good news for the newer specialist low-carbon funds.

On the other hand there are now many low-cost opportunities for less risky late-stage or growth deals due to a combination of market reality and the dearth of bank finance.

This combination of factors has led to a focus by most venture capitalists on supporting their existing portfolios and on late-stage investments. There is therefore a danger that promising early-stage low-carbon companies will fail to raise finance and fall by the wayside.

It should be recognised, though, that even during the good times, most venture capitalists tend to invest in only 0.5% to 1% of proposals they see – there is a high attrition rate. 

Changes in corporate attitudes: Corporates have increasingly made public their interest in the low-carbon field. Many have developed VC activities of their own, co-investing alongside traditional venture capitalists. But the reality is that, as in other areas such as biotechnology, they prefer to have a fully proven product to exploit and to avoid technical risk, even if it is ‘low C’.

An additional characteristic of corporates in this area is that they are often utilities and traditionally risk averse.

Changes in exit possibilities: For realising, or ‘exiting’, an investment, the IPO markets are shut to anything but companies with profitable track records or good growth prospects. Floating a company to finance negative cash flow has proven risky and many companies are pulling their flotation plans. There are some high-profile exceptions such as electric carmaker Tesla, but these are rare.

The credit crunch has forced companies to be more conservative about how to finance and value acquisitions. This might change but the M&A exit route in 2009 for innovative small companies was dire and perhaps will only marginally improve in 2010.

How to succeed

Innovative companies need money and this is now harder to get. The quick answer is that innovators and investors must be more creative and take a reality check on the market. But there are still huge opportunities to be had.  
Some thoughts which might help:

Be realistic about cash requirements: These are almost always two or three times more than expected, requiring multiple inv­est­ment rounds. 

Given the current problems in raising VC funds and not being able to rely on IPOs for later rounds, VCs are very wary of being without money to invest just when the business is taking off. This is when the new investors can take advantage of those that cannot ‘pay and play’. As a general rule, VC funds cannot put more than 10% of their total fund into any one investment.

Find ways to generate profitable revenue early: New technologies often have other applications that, while they might not be the largest market opportunity, could provide some early cash flow.

UK-based Bowman Power has developed turbo-generation technology for large diesel engines. It uses the 35% of energy lost through exhausts to generate electrical power that can be fed back to the engine or used to drive auxiliary systems.

Mobile applications offer the biggest opportunity for the product but require incorporation in the engine design and long-term testing by the large truck-makers. A quicker market entry lies in retrofitting static diesel gensets, which Bowman has shown can offer 10% fuel savings.

It has won large orders for this product in Europe and Australia, which has allowed it  to become profitable, refine its technology and iron out teething problems in large-scale manufacturing.

Look carefully at sales lead times: These are often underestimated because corporate partners and municipalities seem to live in another time zone when it comes to making decisions.

In the current economic climate, expect even further delays in investment decisions. Time costs money – which goes back to the point about cash requirements.  

Avoid capital-intensive projects unless it is clear how they can be financed either through corporate or government guaranteed support. However, be careful about relying on government subsidies for economic viability. Assume governments will change their minds in the current environment – they will.

Fantastic progress has been made in many renewable energy technologies. In certain areas, such as on-shore wind, it is reaching the goal of grid parity in pricing. Solar is becoming competitive with low-cost Chinese suppliers that pose a growing threat to western suppliers.

But there is evidence that government subsidies in many countries are being reduced, leading to investment uncertainty. The capital-intensive nature of the renewables industry did not deter enthusiasts when banks actually lent money and credit was cheap. However, it is now a huge problem for new developments and will hinder the further development of the less-proven technologies such as wave and tidal.  

Find an investor syndicate that will add value and has business experience: They all say they do but unfortunately this is not always the case – inexperienced investors can wreck a business. Whenever WHEB undertakes an investment outside the UK and Germany, where we have offices, we insist on having a local active investor who we know and can add complementary expertise.

Sensortran, based in Texas, services the oil, gas and the power transmission industries with technology that can monitor the condition of pipelines and power lines to identify leaks and hot spots, and thereby take preventative action virtually in real time.

WHEB’s co-investors include a Texan oil and gas specialist as well as other US-based funds. Our role in the syndicate is to help with European expansion. Netherlands-based FluXXion, a spin out of Philips, uses microelectronics technology for process intensification within the chemical and food industries. The investor syndicate comprises Dutch speakers (very important for legal documents) and people having appropriate technical expertise and contacts within the relevant target sectors.

Be realistic about your skills: Hire people who are more experienced and cleverer than you – easy to find but difficult to do. This is called strengthening the team and succession planning.

Investors can take two approaches to this. Some raise succession planning at the last minute as a fait accompli, which is not conducive to an ongoing working relationship. Others raise it early during due diligence and often incorporate an independent review of the management team as part of the due diligence process.

If we cannot come to an agreement on succession planning with management during due diligence, we do not invest – this is typical of most investors. Such planning is a crucial part of any investment because the skills required by top management change as a business develops. 
   

On a similar vein, hire a useful board of independent non-executive officers who can genuinely open doors, are willing to do so and are strong enough to make investor directors listen.

Again this can change as the business develops but these individuals are chosen for their senior-level contacts in target markets and their expertise in exits.

Dealing with large customers and distribution partners often entails a ‘pincer’ movement with the company working at the operational level and the non-executive officers promoting the company at senior level thereby, hopefully, shortening the decision-making process.

Be careful of markets requiring government certification or approval, which can be expensive in terms of delayed sales. This is a problem that EU governments in particular seem to be reluctant to address.

An example is products designed for energy-efficiency buildings. These often involve new materials that are not covered by the standard certification procedures required by the construction sector.  

When it comes to distribution partners, big is not always beautiful and avoid leaping into exclusive arrangements. Large corporates tend not to be good at creating new markets but are good at exploiting them when they show potential. Hence small, hungry partners can often produce better results at an early stage.

Exclusive arrangements can hinder an exit. It is much better to slice and dice the market with a range of partners, many of whom could be exit options, and hence create a “competitive tension” among them. There is nothing like creating the framework for an exit auction at an early stage.

Be realistic about valuation: Having 10% of something that is worth something is better than having 100% of something that is worth nothing.

VC investors evaluate an investment on the basis of being able to show how a 5-10-fold return can be made within 3-5 years. They will have views based on market research showing possible exit values within this time frame and will use this to determine their entry valuation – this is part art, part science. At the moment, the reduction in M&A and IPO activity, coupled with scarcity of funds, has lowered entry valuations. With this being likely to continue, 2009–2010 could be vintage years for VC funds with money to invest.

The low-carbon investment area is starting to mature with definite and continuing market drivers and an increasing number of experienced investors and entrepreneurs.  It is one of the most exciting and sustainable areas of investment, but like all others, it is not without its difficulties. However, none of which are insurmountable.

Biography: Dr Rob Wylie has focused on the clean technology investment for over 20 years and is a founder partner of WHEB Ventures, which raised the UK’s first broad-based clean tech venture capital (VC) fund in 2005. WHEB now manages two specialist clean tech VC funds, with total assets under management of £130m.