Apparently, June is Innovation Month in New England.  So I thought I would write a bit about one of the perplexing things about cleantech investing in New England.

Now, every region ends up being a bit self-centered at times, and New England is certainly no exception.  But it's a commonly-held and oft-stated position among those involved in energytech innovation in this region that "Massachusetts is THE world-class center of research in energy and clean technologies".

If you are one of those who takes this kind of statement literally, then it probably comes as some surprise to then see that California typically attracts significantly more cleantech venture dollars than Massachusetts, and even New England overall.  I've been part of meetings with investors and other industry participants here in the Boston area where the goal is put out there that Massachusetts should -- especially given its primacy in energy R&D! -- be able to top or at least equal California in terms of cleantech entrepreneurial activity.  And for lack of other trackable statistics, the disparity in cleantech venture capital spending is then lamented as a sign that Massachusetts is "falling behind."

I've been one to say such things myself at times.  Being here, surrounded by so many great researchers in so many varied energy and clean technology fields, really does give one the sense of being in a world-class research cluster that is second-to-none.  And then, as an investor, when I find myself inevitably investing on the west coast, I start wondering "Why?"  

Why do I seem to generally find California a better place to invest in (when I'm wearing my VC hat, versus my other private equity roles), when there's so much innovation around here?  Is it that that's where the dominant amount of cleantech venture dollars are sitting, and therefore more entrepreneurs go there?  Is it something about a disparity in entrepreneurial culture in general between the regions?  Is it just that MIT researchers hate venture capital while many California researchers seek it?  In other words, is there something "wrong" with Massachusetts (from a self-centered VC point of view)?  Or is it simply that California is so much bigger than Massachusetts, in terms of people and economy, so research cluster or not is a moot question?

I decided to take a really quick look into the question.  Starting with cleantech patents.  I wanted to test the theory that innovation is just as prevalent here as it is in California, and started naturally with patents as a proxy.  I couldn't find anyone who had already done this analysis the way I wanted it done (there are some cleantech patent tracking efforts out there, but I can't really get a tangible understanding of their methodologies, and they don't have the state-level breakdowns the way I wanted it), so I went to an online patent search engine and started searching for all published patents from 2007 to the present, with at least one inventor in the searched-for state (CA, MA, and NY).  I didn't scrub the results at all, because I wasn't looking for 100% absolutely accurate totals, I was simply looking for comparisons across regions.  Here's what I found:

As you can see, not only does it appear that California dramatically outpaced Massachusetts in terms of published cleantech patents over the past few years, but MA is even mostly behind New York state as well.  This is pretty damaging to all those Mass-philes out there who claim that this is the dominant place for cleantech innovation.  To put it another way, if you're a cleantech VC, looking at the above tallies, would you rather be in Massachusetts or California? Or even New York state?

Now two big caveats:  First of all not all patents are created equal.  This is just an unscrubbed tally of patents based on very simple search terms, and it might be that the 3 most important photovoltaic patents during this period, from an investor standpoint, were all in Massachusetts.  Or perhaps in NY, for example, a higher proportion of these patents were claimed by large corporate research arms (ie: GE) and therefore aren't accessible to venture investors.  So the above tallies might not tell the full story.  But even still -- there's a wide gulf between the number of cleantech patents published in California and Massachusetts.

Secondly, patents aren't a full proxy for innovation.  They're just a proxy of applied innovation.  For the most part, basic science research results in papers, not patents.  

In fact, I would argue that there's an important distinction between Research and Innovation.  Let me propose a taxonomy of sorts:  "Research" helps uncover basic principles, or invent entire new technology innovation areas.  "Innovation" is the application of those principles to the development of new, commercializable, patentable technology.  And then "Commercialization", the productization of that innovation and the introduction of those products to the market, is where venture and corporate capital is supposed to plug in.

So the answer might be that Massachusetts is indeed a dominant center of excellence for energy research -- but fundamental Research, not patentable technology Innovation.

This is, in fact, what I believe to be happening.  For instance, in the 2007 US Department of Energy budget, California universities and colleges received $100M in DOE support (mostly grants from the Office of Science, very basic research), whereas Massachusetts universities and colleges received $78M, a much closer amount (NY state, btw, received $84M).  And if you could map that out, I bet a 100 mile radius centered around Boston would end up being the top academic research dollar garnering area of comparable size, compared to California and New York state where the research institutions are much more spread out.  It's just one small slice of the cleantech research picture, but it does start to lend some credence to what I and others are sensing anecdotally -- that Massachusetts really is a world-class center of basic academic cleantech Research.

But basic Research.  Not Innovations ready to be Commercialized within a venture capital type time period.  

So let's go back to the original question about cleantech venture capital... In light of the above analysis, New Englanders should celebrate the fact that the region is receiving almost as much attention as the west coast in terms of early stage cleantech venture capital.  I looked it up, and thanks to the Cleantech Group's new data format for members (really a terrific job of data presentation, I absolutely love this new sortable format, kudos to them), I was able to look only at "early stage" (ie: 1st round) financings within each region:

In terms of dollars tracked by the Cleantech Group, the Northeast is only about half of the West Coast, but in terms of number of deals they're actually pretty comparable.  And as long-time readers know, because of the really broad range of capital-intensity across sectors and business models within cleantech, I always say that the number of deals, and not the dollars, is a much more accurate indicator of venture investment activity.  So the Northeast overall is right up there with the West Coast in terms of venture investments in cleantech innovation.

So Beat L.A.! and all that...  Massachusetts can declare (near) victory and walk away happy from this analysis, right?

Sort of.  I actually think what I may have identified is an unsustainable trend in the region.  If the patent-level innovation shows such a wide disparity, but the venture investments and research dollars look much more similar in number, one of three things is happening.

1. New England innovations, on a per-patent basis, are much more valuable than West Coast innovations.

2. New England cleantech investors have been harvesting available patentable innovations at a comparable rate to West Coast investors, but with a shallower pool to work from, so are going to hit diminishing returns much sooner.

3. New England cleantech investors have been more eager than West Coast investors (on average) to put venture dollars into more basic research efforts that are further away from commercialization.

The first one is probably nonsense.  And the second two possible scenarios (which aren't mutually exclusive, btw) are unsustainable.  When coupled with the fact that, anecdotally at least, the Boston cleantech venture capital community is rapidly shrinking and spending a lot of time on airplanes right now, it paints a picture that's less happy looking forward.

In other words, those who want to see a continued vibrant cleantech innovation-based economy in Massachusetts should be pretty pleased with how the region has performed to date, in comparison with California and other regions.  No doubt greatly helped by strongly supportive government policy at the state level. And they should be proud of the world-class energy technology research being undertaken here.  But they should also be concerned about the fact that there appears to be a possible disconnect between the large amount of brilliant basic energy Research being done here, and a relatively low amount of commercializable Innovation development being undertaken.  

To put it another way, there's an important R&D step between fundamental Research and venture-backed or corporate-driven Commercialization of new clean technologies, and in Massachusetts there's some evidence that this Innovation step is a relative weakness, at least when compared to some other top regions (it's not like Massachusetts is an absolute laggard or anything, but you get my point).

Massachusetts needs to be thinking about how to better hand-off all this fundamental science Research to the engineering-based Innovator community (which could be either internal or external to the research's academic setting) that can drive it closer to actual Commercialization.  

Or else the research will go elsewhere for commercialization -- or worse, go nowhere.

One thing that non-VCs typically don't have a good understanding of is how different venture investors view the risk versus reward tradeoff when it comes to managing portfolio companies.

How do VCs get compensated, besides salary?  "Carry", a/k/a profit-sharing.  And except in very few cases, carry on an entire fund, not on a per-deal basis.  Everyone in the industry is familiar with the studies that have shown that fund performance is typically determined, at least on the upside, by a handful of deals across an entire portfolio.  In other words, 1 or more really big wins drive all the performance.  And, by the way, 1 or more really big wins really drive a VC's career as well, because of the visibility they bring.  

It all sets up a dynamic where individual VCs, and overall partnerships, are motivated not to try to produce steady returns across an entire portfolio, but instead to try to maximize the slim chance that each deal becomes a blockbuster.

Let's put some really oversimplified math to it:  

$100M fund, 10 portfolio companies, each with $10M committed.  If each one creates a 2x outcome, that's $100M in return.  But if just one company creates a 10x outcome, then you could only break even with all the others and still come close to creating the same return ($90M).  If you get two 10x outcomes, or one ten-bagger and one 5-bagger, then the VC fund is sitting pretty almost regardless of what anything else in the portfolio does.  

This has a lot of implications for how VCs typically manage their portfolios.  To overgeneralize a bit:

First of all, it explains why VCs would so often pass on investment opportunities with good chances to double or triple their money.  Not that any one as an individual would pass up on the opportunity to double or triple their own money all things being equal, but if you're more motivated to find the 5-10x opportunities you'll pass up on attractive but smaller ones.  I interact with entrepreneurs all the time who have good solid businesses with good growth prospects, and yet they're frustrated at their inability to get VC interest.  Basically, this is one major reason why that happens.

Secondly, it means VCs will spend more time on their portfolio companies that are doing well, versus the companies that aren't doing well.  If they can help turn a 3x outcome into a 10x outcome, that's worth a lot more to them than working hard to turn a 0.3x outcome into a 1x outcome.  Many VCs I know have a hard time sticking to this rule, because at the end of the day as individuals with personal relationships and a sense of obligation they want to help out all their companies as much as possible, but the more hardnosed VCs will admit that this is how they try to spend their limited available time in portfolio management.  I've even heard of some big-name VCs who simply stop showing up for board meetings once the company gets off-track.  

Thirdly, it means that around the boardroom, many VCs will tend to push their companies into riskier situations when it means a better likelihood of an upside outcome.  Let me illustrate:

If the VC starts out with each company having a 30% chance of a 0x, a 30% chance of a 1x, a 30% chance of a 2x, and a 10% chance of a 10x, then if they can shift that to be 50% chance of a 0x, 15% chance of a 1x, 15% chance of a 2x, and 20% chance of a 10x, that can end up being a better odds-weighted return.

But note that, to the entrepreneur, that just became a much riskier scenario.  

How does this play out in reality?  Well, the other day someone was telling me about one cleantech company with two big-name generalist VC firms as investors.  And they were describing how, around the boardroom, there had been major disagreement between the two VC firms -- one wanted the company to be burning several hundred thousand in cash per month, the other wanted the company to be burning more than a million in cash per month.  With the real disagreement being around how quickly to push the company to bring a commercial product to market.  This is a natural outcome of all of the motivations described above, along with an expectation that one way or another these brand-name VCs could attract additional follow-on capital into the company if and when it ran out of cash.

On the other hand, I know that many of the "original cleantech crew" of sectoral specialist VCs, and some other specialist and generalist VCs with lower-risk approaches, tend to want the companies to get to cashflow breakeven as quickly as possible.  And thus they want to keep the company expenses lean.

I typically favor that last approach (albeit on a case by case basis).  I just think in slow-moving cleantech markets, rushing a product to market doesn't have the same likelihood of creating customer uptake and first-mover advantage as is often seen in other technology sectors.  So you can easily put a company in a high cash burn situation to successfully bring a product to market, and still fail.  Venture capital is risky enough, without adding further risk into a company... 

But no one knows which approach is truly best for producing investment returns.  In the boardroom anecdote above, those investors were deeply experienced and VC-savvy (certainly more so than me), and not dumb about cleantech either.  And until we see a wave of exits, no one in this industry will have proven that they know how to consistently make money.  So the right risk/reward tradeoff approach to cleantech venture investing remains a very open question.

However, to those out there urging that major amounts of government dollars be simply handed over to VCs to invest as they see fit... Make sure you really understand and are comfortable with all of the above dynamic, and what its implications would be for the successful commercialization of a broad range of clean energy and other technologies.  I am absolutely a strong proponent of government support for commercialization of clean technologies.  But not as a carte blanche to VCs... 

I've been most recently reading When China Rules the World.  A fascinating treatise on what happens to the world economy when, over the coming decades, China's economy becomes paramount in the world economic system.  China and cleantech is something I've been thinking about and investigating for some time now.

Timely then to see the report from New Energy Finance (note: opens pdf) that in Q1, China was the biggest recipient of clean energy project finance, nearly double that of the amount invested in clean energy project finance in the U.S., nearly two-thirds again more than that invested in Europe.

I think it's safe to say that China will be a major driver of clean energy and water technology adoption over the coming decades.  Not only because their economy is growing so quickly.  Not only because China has only 1/5th the water per capital, as well as much less domestic energy supply and arable land, than the U.S., thus necessitating wiser use of natural resources earlier in their economic development cycle.  But also because now they've visibly committed themselves to becoming leaders in the sector and, as one regional GP told me today, "they don't want to lose face by not meeting that target."

So China will be a major mover in cleantech markets.  But what does that mean?

I believe that the developments will impact cleantech investors in three phases:

1. The rapid-growth market phase

At first, the major impact on the cleantech economy will be China as outsourced manufacturer, and China as fast-adopter market.  We are already seeing this happening.  With such strong economic growth comes strong resource needs, and many cleantech startups I speak with are already in discussions in China about potential early rollouts of technology.  Using local distribution or other types of partners, they are looking to build early projects and find early customers there.  

This requires establishing such local partnerships, however, as it's a lot easier said than done to sell cleantech goods and services into this market.  So I know many entrepreneurs and investors who are racking up lots of frequent flier miles getting back and forth.  And spending a lot of time establishing strong partnerships there as a stepping stone to actual sales.

Furthermore, as cleantech hardware markets shift toward a fabless model using contract manufacturers for their device businesses, China will naturally increasingly become the actual manufacturer of cleantech hardware systems and components, just like has happened in the IT and telecom industries.

2. The homegrown innovation phase

China is awash in liquidity.  There is a lot of external capital chasing the opportunities presented by the market, but there is a lot of internal capital as well, looking for good domestic investment opportunities in China.  Plus, there is the national commitment to establish more homegrown technology leadership in this sector.

In the next few years we will see the emergence of more homegrown Chinese clean technology startups that are developing proprietary IP.  It is already beginning in sectors (such as large-scale wind turbines) where the technology is readily adaptable from technology developed elsewhere.  But with a steady source of strong technical expertise and domestic markets available, Chinese cleantech entrepreneurs will increasingly be among those developing first-to-commercialize solutions across a number of cleantech sectors and subsectors.

For cleantech investors, finding out how to access these entrepreneurs, and develop winning deals from such relationships, is the still-unanswered question.

3.  The China-sets-the-standards phase

As the Chinese market becomes the most important global market, and especially as homegrown producers become more independent producers of technology themselves, China will hold increasing sway over the development of entire industries like smart grid communications, smart buildings, distributed generation power management, M2M communications, and other subsectors of cleantech where standards-setting will be important.  

In smart buildings, languages like Bacnet are important standards that have been brought to market by European and U.S. technology developers to date.  But in the future, what the Chinese market settles on a standard will often be what the world settles on.  

And thus China will shift from being an attractive market for western cleantech entrepreneurs to think about servicing, to a critical must-address market that will be addressed by both domestic and foreign innovators alike.

All of the above will happen a lot more rapidly than many might expect.

Why on earth would anyone care about new homes right now? Isn't that a dead market?

Yes, in the U.S. the new home construction market is down 75% from its 2005 bubble levels.  The industry is badly hurting and won't go back to bubble levels.  But that still represents around 400,000 new home starts per year.  This is still a huge market.

During the last decade the way to make money in U.S. home construction was obvious:  Just throw up some homes and let people buy them.  It was a seller's market.  But now in the "new normal" where existing home sales are down and new home sales are way down, this puts pressure on builders and developers to think more creatively as market power shifts more to the buyers who are going to discriminate not only on price, but on value.

Meanwhile, we are seeing the early signs of backlash against commuting in this country.  The decades-long trend of suburbanization and exurbinization appears to be somewhat reversing itself.  It took the downturn to reveal this, but available market data indicates that the biggest price and default hits have taken place in the exurbs, and urban and near suburbs have been the most insulated from such effects.  Basically, as the real estate market has gotten softer, overall people have preferred to take advantage of availability closer to the downtown areas to migrate inward (or at least abandon the further out properties).

As people expect energy prices to continue to rise, this trend will continue.  So-called "smart growth" and "urban infill" are going to become more widely-heard buzzwords.

But energy prices don't only hit on the commute, they hit on the home itself.  Homeowners are going to increasingly care about the energy usage of their home... and they're going to be caring about other attributes (eg: indoor air quality, overall use of "sustainable" materials, etc.) as well.

All of this is on the margin.  I mentioned that the new home construction market in 2009 was around 400k units -- compare that with around 5M overall existing home sales per year.  And 72M in total owner-occupied homes in the U.S.  Any analysis of green homes in the U.S. needs to account for the fact that change is hampered by the deep installed base of existing inefficient homes.

Nevertheless, I think we can expect to see some significant changes over the next ten years.  

On the existing homes side, as energy prices do indeed rise (or at least become more volatile), we will see new residential construction further emphasizing efficiency and dense growth.  Oil price future are indicating long-term price expectations above $80/barrel.  Natural gas price futures indicate expectations of price rises of at least 50% over the next couple of years (and this will also drive marginal electricity prices).  Potential homeowners -- and even renters -- will start caring more about the energy efficiency of their homes.  And not just because of the energy costs themselves, but because of that as an indicator of construction quality overall.

There's a limit to how much premium potential homeowners and renters will be willing to pay for energy efficiency, but bear in mind two other factors: 1) as "smart growth" drives shorter commutes, that will free up more wallet-space for home "green-ness"; and more importantly 2) green attributes will be increasingly important to the developers themselves as it will help accelerate necessary approvals.

It's this latter point that's often forgotten, but all real estate markets are incredibly local, and any developer will tell you that construction is actually relatively easy to manage -- it's siting and getting necessary approvals that are the huge determinant of their profits.  The time it takes to get a development started and the costs along the way.  And the fact that evidence suggests "green buildings" have lower vacancy rates than other buildings. So even in the absence of a "green premium," developers have strong incentives to adopt green building attributes.

Not to mention new laws in many places like California that are often requiring zero energy homes and other similar mandates by 2020.  I expect that such deadlines will get pushed back.  But they still are important market signals.

Meanwhile, in the existing homes market, energy efficiency can be retrofitted, with compelling paybacks.  In a low energy cost market this type of activity has lapsed, but it is clearly coming back strong.  Again, it's on the margins, but even if only 1% of homes got energy efficiency audits and basic retrofits (air sealing, insulation, etc.) it would make a huge difference overall -- and certainly would be rewarding for that 1%.  And new government incentive programs designed to encourage such efforts are only now starting to have an impact and will not go away quickly even if the programs are not re-upped.  

So what does this all mean?

Well first of all, we can expect significant activity in the green homes market.  But it won't be geared around "sustainability", it will be focused on location and energy efficiency.  "Sustainability" implies environmentally-sensitive materials (ie: bamboo, or certified wood) and above-standard environmental performance (ie: water re-use, etc.) that appeals to a certain small high-end niche of the market, but most homeowners won't be willing to pay for (because of long payback periods, if any paybacks are even applicable at all).  But many more homeowners will care about the energy efficiency of a home because of aforementioned cost and quality indications.  And, barring a long-term drift downward in gasoline prices, on the margins new homeowners will increasingly care about shorter commutes as well, driving increased interest in denser, closer-in neighborhoods.  Mid-range "green homes" are a relatively untapped niche, but with strong latent demand.

Therefore, developers who can address energy efficient new home construction in a cost-advantaged way will be rewarded.  And developers who can do this in a dense-housing format will be doubly rewarded.  This is a tiny part of the market now, but I wouldn't be surprised to see a quarter of new residential construction in the U.S. (mostly on the coasts, but also in places like Chicago and Dallas) qualify under such concepts by 2020.  This will create an entirely new industry in new home construction done to tighter tolerances, using new processes and designs to improve energy efficiency, and with intelligence and automation built into the home from Day 1.

But this will add up to only a small dent in the installed base of homes.  But we can also expect a significant chunk of existing homes to start to adopt such technologies as well.  It will be hard to retrofit core designs to be more energy efficient.  But air sealing and insulation is easy.  And HVAC will be increasingly intelligent, able to incorporate retrofitted, very small (and cheap) sensors to more efficiently meet required comfort levels.  Home automation will be flirted with, but really boils down to HVAC controls from an energy perspective, and it would make sense that it would eventually be integrated into central HVAC rather than be a standalone add-on application.

All of this will be only a "niche" even by 2020.  But with such a huge overall market, even as a niche it will be measured in the billions of dollars by then.  And it will be growing quickly.

Back in my consulting days, at one point I was part of a major project with a regional investor-owned utility, helping them do an overall strategic and operational review of the entire business.  It was a great learning experience to see what such utilities think about and have to deal with from the inside perspective.  One thing that always stuck with me was when we looked at revenue-growth opportunities for them.  The answer was that there was really little that the IOU could do to significantly grow revenues within their regulated gas and electric utility business, other than to generally work to promote economic growth in their region -- not a lot of top-line high-CAGR possibility there...

But things have changed.  Among other reasons, the past decade has seen the emergence of a new significant growth opportunity for such IOUs:  Plug-in vehicles.  By transitioning energy demand away from gas stations and into plugs in garages, utilities could boost their revenue growth significantly.

Right now what I'm mostly hearing about are the fears from T&D (transmission and distribution) engineers at utilities about such a prospect.  They argue that putting a car on the grid is tantamount to putting a new house on the grid.  And they worry that clusters of early adopters creating hotspots of demand that would create local distribution problems.

This is a natural part of the utility adoption cycle.  Utilities are paid to provide electricity, but since in the U.S. electricity is seen as a god-given right of every citizen, utilities are heavily incented to avoid disruption first and foremost.  And T&D engineers are the ones most tasked with keeping the lights on.  So whenever there's any new concept available for adoption by a utility, it usually gets pushed over to the T&D engineering group for evaluation.

These engineers are often very smart.  But they have no incentive to go out on a limb, their pension rests on their ability to keep the lights on, and in my work with the utility I found that financial considerations like revenue growth were something they could nod their heads at but never truly embrace.  So the first reaction from these T&D engineers is always to highlight the potential downside scenarios, no matter how minor.

This is where we're at with utilities and plug-in vehicles, here in 2010.  Really, utilities can't handle adding more pseudo-houses to the grid?  Isn't that what happens with a new subdivision development in any case?  And especially because recharging a commuter's plug-in vehicle can be managed to occur mostly during the off-peak hours in any case.  These are the concerns of someone who's paid to think up concerns.  And they will be addressed and will pass.

Because soon, CEOs of investor-owned utilities will realize that adding new pseudo-homes to the grid in the form of plug-in vehicles is a really good way to grow revenue in a regulated business where other growth opportunities are few and far between.

I think we'll start seeing this shift happen over the next couple of years as all the moderately-priced plug-in vehicles start to enter the marketplace.  Right now when the vehicles aren't available to consumers in any case, it's easy for the conversation to be dominated by downside scenarios.  But once consumers start adopting plug-in vehicles -- even in small amounts -- the upside potential will start to get the attention of utility CEOs.

As always, it takes a few years for such mindsets to change.  But by 2020 I believe we'll be seeing this in earnest. 

• Forward-thinking IOUs will be embracing plug-in vehicles and encouraging -- even providing incentives for -- their customers to purchase such vehicles.

• This shift will be most rapid in states where retail-level deregulation allows homeowners to determine their electricity provider. Incentives for plug-in vehicles will become another point of marketing differentiation for the various electricity retailers vying to grab customers.

• A couple of more advanced utilities will partner with a provider of recharging stations (maybe a startup like a Coulomb, but more likely over time it will be one of the larger, already-established T&D equipment vendors) to come up with a low-cost solution they can push on their customers that will also have very simple timing rules so as to make sure and push the recharging into off-peak hours.

• We'll see the emergence of startups vying to establish recharging stations at major corporate HQs and other major commuter destinations, where consumers can plug in their vehicle and swipe a card and the recharging station will be intelligent enough to have the charge show up on their residential electricity bill.  But most consumers will still do most of their charging at home -- so you'll be seeing these stations over at the far corner of the parking lot, not at every single space.  The alternative vision is that of battery swapping stations -- this may happen more rapidly overseas but I don't see it having much momentum in the United States quite yet.

• Utilities, who to date have largely taken a live-and-let-live approach to dealing with the oil giants when it comes to legislative efforts, will start to more heavily promote gasoline taxes and other disincentives for the consumption of imported oil.  As major IOUs like Duke Energy, et al, start to see their future growth being in part impeded by the presence of low gasoline prices, they'll start trying to adjust the playing field so that they can more effectively cannibalize that market.  This will mean further efforts to differentiate natural gas (which the utilities will be increasingly relying upon) from oil (which they'll be trying to steal market share from) in the overall regulatory scheme.

• Electric vehicles and PHEVs will see adoption happen more rapidly than pundits currently expect, toward the latter half of the decade, driven by all of the above dynamics.  More vehicle volumes will help drive down up-front costs, particularly in the battery packs.  And utilities will be helping to defray, either directly or indirectly, the upfront infrastructure costs of purchasing and installing recharging stations.

• Adoption will be slower in areas where the utility is a muni or otherwise not profit-incented, as the fears of grid disruption aren't trumped by desires for revenue growth.  And also because such utilities are often found in rural areas where commuter cars are less prevalent in any case.  But as the successful examples of IOU programs demonstrate the viability of integrating these kinds of systems into the grid, such utilities will slowly start to accommodate customers who want to go in this direction.

By 2020, I believe a significant minority of the new-sale U.S. commuter car market will be plug-in vehicle.  And investor-owned utilities will be leading the charge.

Pretty timely re: my last post on water, this afternoon they declared a major water emergency in the Boston area, thanks to a huge water main break.  One million people, including everyone in my town, are under a "boil water" order.  I got a call from my local water district, a recorded message telling everyone not to use any water at all, not even lawn sprinklers, until they have it fixed.  Since the water main break is dumping 8 million gallons of water per hour into the Charles River, doesn't sound like it'll be fixed very soon.

I make sure and keep backup water supplies at the house just for such eventualities, but I was curious, so about an hour after the emergency was declared I went over to the nearest grocery store, one of those that's so large you can get lost.  And almost their entire supply of water was already gone.  Empty shelves, almost everything grabbed, and people were milling around the aisle in front of the empty shelves looking around as if more water was going to be found.  No panic or anything, people were nice enough, but wow nonetheless...

The phone message said something about the emergency taking only a "couple of hours", and people can boil water to drink, and yet this was still the immediate reaction.  Can't imagine what would happen if something actually serious were to happen to the water supply.

Yep, water's "free".

I've been thinking a bit about water lately.  So much media attention and investor and entrepreneurial interest are expended on looming energy shortages, but water shortages are perhaps even more acute.  A recent article in Fortune gave a good brief overview of water from a global standpoint.  If you're looking for water statistics and updates, the website of XPV Capital (a water tech specialist) has some good info.

There are clear looming issues with water use in the U.S.  And there are lots of uncoordinated actions going on in various parts of the country, and some hand-waving in general, but I haven't seen anyone really start to play out what's going to happen.

But it's clear to me that water is going to get more expensive over time.  It likely won't be because of any proactive water price increases by the governing bodies.  Indeed, local governing bodies appear to be just as allergic as ever to doing any kind of forward strategic planning around water.  And historically, in the U.S. people view water (for drinking, agriculture, or industrial purposes) as some kind of god-given right that shouldn't really need to be paid for.  So I think water pricing will only be affected by local and regional shortages and crises, not by any overarching strategic approach.

But such local and regional shortages and crises are happening.  In parts of the American southeast and southwest water shortages are already acute.  Here where I am this week in Texas, The Aransas Project has sued the governing state bodies for failing to manage water properly and thus endangering the whooping crane.  Take a step back and think about this one -- this is a group of Texans from all political persuasions, filing a lawsuit under the Endangered Species Act.  Water issues break across political lines, in other words, but they're also very local.  It's a really good illustration of what's likely to start happening lots of other places around the country where water withdrawals are starting to exceed water supplies.  (And an effort I've supported, btw)

And what will happen in the Southwest when the upstream states on the Colorado River start demanding access to their existing water rights?  In fact, California, Arizona, Nevada, etc. are all only able to access the water they need, thanks to upstream states like Wyoming and Colorado not fully using their own rights.  But that can't happen for long.  And even if it could, the water usage is already at unsustainable levels as it is.  We've built out some pretty major population centers in the Southwest that are dependent upon unsustainable levels of water demand. 

So I don't expect to see any forward-looking strategic policy shift at the national level that would result in any significant shift in the pricing of water.  But I do expect local water shortages (and the resulting legal, economic, etc. challenges) to rise up over the next couple of decades, and thus de facto raise the cost of water where they occur.

What does this all mean?

1. Water will be a sub-regional issue.  Which means that future water price rises will happen in isolated fashion, on a watershed basis in many cases, but certainly by region.  It will be a lot cheaper to access water in some places (like New England, for instance) than in other places (like the Southwest, for instance).

2. As such price disparities arise, it will start to affect the location of manufacturing operations.  Water-intensive manufacturers will have to trade off locating close to cheap water and energy supplies (mostly: far away from cities) with transportation costs to deliver to demand (generally: cities).  Easily transportable end products that are water-intensive, like pharmaceuticals, will relocate where water remains cheap.  

3. As water gets to be more of a strategic issue, corporations will lead the way in terms of adoption of new water treatment technology and water "microgrids" with significant re-use of water.  It'll be easier for corporations to adopt to the "new normal" in such situations than the local politically-driven processes affecting municipal drinking water, etc.  So selling new water tech to corporations will continue to be a key entry point for innovations.

4. Water efficiency will be increasingly important for agricultural use.  Water efficiency will be increasingly important for energy generation.  Both are very large consumers of water, but startups that can address either or both issues in a scalable and low-cost way will see entry points.

5. During the NEXT economic downturn, water infrastructure may be given the same government subsidies as energy infrastructure saw during this economic downturn.  Ditch-digging and pipe repair are good jobs creators, they just didn't get the necessary attention this time, but when people in swing states start being told they can't water their lawns because of infrastructure issues...

6. Local water districts will be pressured to encourage more intelligence at the end of the pipe -- the water analogy of demand response in energy.  So far the local government response has been necessarily binary: When there's a shortage, no one gets to water their lawn, etc.  But faced with more such instances, I expect we'll see more startups start focusing on "smart use" of water, and then they'll start pressuring local cities to grant exceptions for consumers who implement such solutions.

These are just some shallow thoughts around water, but it's interesting to think about how water shortages will specifically play out.  And that will affect entrepreneurs and investors in the water space as well.

Happy tax day, everyone. 

Silicon Valley Bank put out a must-read study yesterday, examining returns from more than 850 VC funds in the U.S., looking specifically at returns by fund size.  And what they found out was that smaller funds do better than larger (>$250M) funds.

This won't be a surprise to some limited partners out there that I speak with, in my current dual role as both an LP and direct investor.  These LPs see smaller funds as being more focused and hungry.  As the SVB report states:

"Managers of [small] funds often have industry-specific expertise and focus on particular strategies or sectors compared to those of larger funds which usually target multiple stages and sectors.  Small funds tend to have a strong general partner commitment, which heightens the alignment of interests with limited partners and potentially increases investment discipline."

Smaller funds also are less susceptible to the kind of minimum check size restriction I described in my last post, with its implications for capital efficient investments.  I caught a little bit of grief from some colleagues at smaller funds after that post, because they thought I was talking about ALL venture capital firms getting caught up in check size inflation, but really I was only talking about the larger funds and their need to shovel dollars out the door.  Indeed, this SVB report adds further support to what I was talking about -- with smaller VC funds, you can put less dollars at work in a single investment and still get the kind of outsized return that can "make the fund".

So if smaller funds are so great, why don't they get more favored by LPs?

First of all, their performance is probably more volatile.  The SVB report focuses on the portion of funds that returned high multiples.  They state that smaller funds (those under $250M) were seven times more likely to provide a 3x return or better to LPs, than larger funds.  But that's 22% vs. 3% of each population, respectively, so the comparison leaves out a lot of lesser performances.  In their study, more than a third of smaller funds returned less than 1x, meaning they lost money for LPs.  Of course, in the pool of larger funds, more than HALF lost money!  But it's unclear from their report how many of each category lost a LOT of money versus losing a little bit.  LPs may be more willing to back a larger fund that has a more limited downside, than a smaller fund that could end up with more volatile results.

And what's also true is that smaller funds tend to have less experienced managers.  Most first-time funds will be under $250M, naturally.  And LPs are often leery of first-time managers.  I've spoken with some accomplished LPs who take an opposite approach, but generally speaking LPs have a difficult time determining the caliber of a first-time fund's managers, lacking a track record to refer to.  This obviously is related to the volatility/ downside point from above as well.

And furthermore, someone did the limited partner community a great disservice at one point by doing a study showing that top quartile performers among venture managers tend to stay top quartile performers over multiple funds.  I'm sure the study was totally valid and accurate, albeit backward-looking.  But what that study did was provide all the air cover any LP manager ever needed to simply pile capital into any big-name venture firm's latest huge fund.  It'll be interesting to me when that study is eventually revisited, to see if the effect remained valid over time, because I believe it provided fundraising momentum to larger funds that encouraged them to get unsustainably big and drift in their investment strategy, in some cases.  In the fund size retrenchment SVB identifies, I believe we're seeing the results of this.  But that having been said, there are certainly some large funds that have figured out how to make money at that scale -- as the SVB report shows, less than 10% of large venture funds returned 2x or better, but in that small group I bet there's some repeat performances by the same very few fund managers.

Finally, many LPs are of such a size that they really can't engage with small fund managers.  If you are managing a multibillion dollar pension fund with hundreds of millions of dollars allocated to private equity, can you really afford the time to identify, evaluate, and manage a $5M or $10M commitment to a small, specialist venture fund?  Some can, but many don't have the bandwidth to do so.  It's the LP analogy to the venture fund size dilemma I mentioned in the last post...

So smaller funds are, according to this SVB study, a better bet for LPs.  But LPs still find it hard to effectively engage with smaller funds, as a rule.

What does all of the above mean in cleantech in particular? 

It helps explain why cleantech-interested LPs have been drawn to larger cleantech funds, and large generalist funds who are getting active in cleantech.  This has exacerbated the shift over time toward more growth stage cleantech investing, and away from early stage cleantech investing (although there are some signs this shift has mitigated recently). 

The study suggests, however, that investing in smaller cleantech specialist funds may be a winning strategy for LPs -- if they have a rigorous way to effectively identify, evaluate, select and oversee those venture managers.  We'll have to wait and see if LPs actually do this more often.  But I believe they should.

And kudos to the team at SVB that did this study.

"My job is to look for entrepreneurs who want to change the world," one young cleantech VC told me in an engaging twitter conversation last night, "and build bigger companies."

Very true words!  But how do we define "bigger companies"?

I've seen someone mention that only two percent of startups get their financing from venture capital.  I don't know the accuracy of that number, but it does ring directionally true.  That doesn't mean 98% of startups are bad businesses, however.

Let me describe two basic types of startups:

1. The big game-changing startup that is going to be manufacturing or otherwise producing something very new.  They're going to need some significant level of capital in order to accomplish this, because R&D and commercialization efforts and then production capacity don't come cheap, but they do come before revenues. 

2. The small local startup that is going to be a nice personal business, perhaps growing over time into something a bit bigger.  These tend more to be service or retail companies going after an established market, perhaps with a new twist.  These can be really compelling businesses for the entrepreneur, and if pursued in a lean way they won't require millions of dollars to get started.

The first type of company is the purview of VCs like the one I cited above.  The latter type of startup is the one that is classically self-funded by the entrepreneur (and their credit cards), as well as friends and family, and perhaps a community bank.

But what about the companies in the middle?

Let's better define the upper end of the problem...  What many entrepreneurs often don't realize is that large VC firms typically have a pretty significant minimum check size they'll write -- quite often the bar is set at $2M or $5M, depending upon the firm.  Even funds that will do smaller seed stage checks need to see enough capital intensity in the model that they'll have the opportunity to put significant money into the company over time.

Why?

Simple math.  The larger the venture firm, the more pressure to put significant dollars at work.  And the single most limited resource for that company is the time of the partners in the firm.  Each company in the portfolio requires time to manage, whether they hold a Board seat or not.  And there are often companies in the portfolio from previous funds that haven't exited as well.  They can't have a 100 company portfolio and claim to be "value add" with a straight face.  So these larger funds are pressured to invest only when they see the opportunity to put significant dollars in either up front, or over time.

In other words, IRRs are not enough.  If you have a $400M fund, and you put only $1M into a company, even if that returns 10x it's nice but not going to move the needle in terms of aggregate fund returns (not to mention the chances for glory for the GP who did the deal, btw, which is no small consideration for some).

You can't just add more partners because GP salaries and support staff have to be paid out of the management fees, typically 2%.  So this is why most large VCs I speak with -- even early stage and seed stage ones -- tell me they need to see the potential to put something like $10M into a company over time, at a minimum.  

That's a long way of explaining why VCs need to see some level of capital intensity in a startup before they can get involved.  And yet, if a company is going to need $1-3M of capital over time, that's probably too much for credit cards and friends and family to support. 

Where does this all hit in cleantech?  In Web2.0, people are already used to capital efficient businesses, so they've had to invent efforts like Y Combinator to compliment the bigger check-writers in the space who won't touch certain sized deals.  But in cleantech the gap remains.  If you are trying to develop something like a new solar cell, or a smart-grid network, or a new LED chip or fixture, that will require some significant capital before you get to cashflow breakeven.  But what if you're just developing something purely software-based?  Or a scalable service model?  If managed well, often these won't require such large amounts of capital.  And yet they can grow to be decently-sized businesses, even if they probably won't be the "Google of cleantech".

For outside observers tracking cleantech VC dollars, to a certain extent the reason they tend to declare that ALL of cleantech is capital-intensive is because they see all the VCs flocking to capital-intensive businesses because of the above dynamics.  Even in areas like energy efficiency and smart grid, where VCs now say they're interested because it's less capital-intensive, they typically are backing businesses that will "only" require tens of millions before an exit, instead of the hundreds of millions that have been required for some of the bigger named startups that were the focus a couple of years ago.

But there are indeed truly capital-efficient businesses in cleantech.  I get contacted by entrepreneurs all the time who are only looking for $1-3M or so to get started.  They're entrepreneurs, and they read about certain high-profile VCs who are interested in cleantech, so they reach out to those investors to raise their funding.  They have a business that, with a little bit of money, might turn into a $20-50M company, resulting (they believe) in very nice IRRs for the investor with such a light capitalization.  In many cases, they may already have significant revenues, and they just need a little bit of capital to hire up some more sales and implementation teams, or to shore up the balance sheet.

And then they're surprised they can't get any big name VCs interested.

In some cases, these entrepreneurs are simply underestimating the amount of capital they'll really need -- I'll write about that sometime soon as well (short version: take more money than you think you need, especially in the current fundraising environment).  But there are a lot of solid service, software, web-based, etc. cleantech businesses out there, that are having real trouble raising the capital they need.

It's a serious capital gap, if you care about more than just innovation in cleantech -- if you care about actual near-term implementation.  Because these businesses are the ones positioned to make an impact today.  To go back to the initial quote, these are companies that are poised to change the world... even if they're not poised to become a "big company" of the massive scale that young VC thinks he needs to see.

If you are one of these entrepreneurs, however, there are some underexplored options you should focus on instead.  Don't waste your time with the big-name firms who structurally won't be able to engage with you.  Instead, look to regional, smaller VCs -- such as the network of Village Ventures firms.  Reach out to local angel groups, and local smaller family offices.  And if you are indeed already at a revenue stage, local commercial bankers may be able to do a venture loan alongside any equity you might be able to bring in.  In other words, don't waste your time flogging your plan up and down Sand Hill Rd., spend your time networking locally to find the investors in the right check size range.

My point isn't to knock the perspective of the VC I quoted at the beginning of this overly-long column.  He's looking for a certain profile of investment that is right for his firm's size and strategy.  And I'm certainly not saying there aren't big-dollar VCs who won't write smaller checks.

But as this same VC wrote elsewhere in the conversation, "VCs want to be involved if the entrepreneur wants to build to a big outcome.  If you are happy selling [your business] for $20M, surely go to angels."  A snarky comment, but I would say it's completely valid at the $50M exit level and below, not $20M.

When the average venture-backed M&A event is well under $100M, a $20-50M exit can be considered a real win for the vast majority of startups.  Entrepreneurs need to acknowledge to themselves when their business is most likely going to be a <$50M exit down the road -- if it even exits at all, it may instead become a cashflow producer for the entrepreneur and angel investors.  That's NOT a bad business.  It can be a phenomenal business that makes the entrepreneur and angel quite wealthy, and makes a significant impact on their community. 

But it does mean you have to be smart about what types of funders you approach when you need startup and growth capital.

Well, it appears it's finally happened -- energy efficiency is now the hot sector in cleantech venture capital.  That's based upon the writeup of Q1 as reported by The Cleantech Group and Deloitte, who put out their numbers today.

Overall, the picture is one of continued return to healthy dealflow in the sector.  They tallied $1.9B in global cleantech venture dollars, across 180 disclosed deals.  On a dollar basis, this is their largest quarter since 2008, but in terms of deals they claim it was the largest quarter ever.  With Project Better Place providing $350M in one single tracked deal, this implies that deal sizes are relatively down.  

As I have said for a while, it's important to track the number of deals, not just the dollars.  And this Q1 tally illustrates this well. 

Thanks to PBP, the transportation sector had the highest dollar totals.  But in energy efficiency they counted 39 deals totaling $217M, versus 27 each in transportation and solar. 

What's interesting to me is to look at those three sectors in comparison to recent history.  For this, let's look at annual totals, not the ups and downs of quarters. 

• Solar:  In 2008, 110 tracked deals.  In 2009, 86 tracked deals.  In Q1 2010, 27 tracked deals for an annualized rate of 108 deals.
• Transportation (which I assume is their catch-all for both Vehicles and Advanced Batteries):  In 2008, 40 tracked deals.  In 2009, 60 tracked deals.  In Q1 2010, 27 tracked deals for an annualized rate of 108 deals.
• Energy efficiency:  In 2008, 87 tracked deals.  In 2009, 120 tracked deals.  In Q1 2010, 39 deals for an annualized rate of 156 deals.

So energy efficiency indeed leads the way and has been coming on strong. 

But transportation has been growing quite rapidly as well.  And the venture capital love affair with solar is still far from over.  I see plenty of anecdotal evidence, in my conversations with colleagues among VCs, that folks are starting to turn against solar and vehicle and battery deals to an extent, but that may be a biased sample.  And also, the rapid growth of corporate venture dollars into the sector, and the need for follow-ons into existing portfolios may also be the reason why VC attitudes may be shifting but the dealflow isn't yet.

-------------

On another topic, I had the opportunity to review the recent Greentech Media report on Ultracapacitors, and it's a quite good report.  Not just the usual market overview, but some good meaty explorations of specific innovations and specific companies.  Tactically useful information for investors and industry participants.  Definitely recommended.

This past week I and several senior cleantech private equity investors were invited to DC for meetings with Administration and legislative staff to discuss climate and energy legislation.  We were there to provide input in meetings with Valerie Jarrett and Austan Goolsbee at the White House and also to connect with DOE staff and the staff of several Senate offices that are working on various alternative climate bills.

I've participated in such swings through DC in the past, but this one was particularly educational, and I thought I would pass along a few takeaways in case they're useful intel for any readers, since these things have a significant impact on the industry, no matter what side of the climate / energy debate they're on (note that these are just one man's impression of where things stand in regards to national climate and energy policy, I can't promise my impressions are right or even shared by my fellow investors in these meetings):

1.  Climate and energy legislation (CEL) is "next"... maybe.  By all appearances, the Obama Administration is gearing up to start making a push on this once health care is done, and as of tonight that appears to be the case.  However, there's also financial reform, economic stimulus/ jobs, schools, and a host of other issues that will also press for attention.  While climate and energy have been getting a lot of rhetorical attention from the Administration (they were quick to cite numbers about the number of times the President has talked about it publicly), it's clear that the White House's "A-Team" has been focused on health care instead of anything else for the first year-plus of the Administration.  But the early signals so far are that the next big push for this high-level group will be CEL.  We'll have to wait and see.  If we learned anything from watching the health care reform effort, it's that nothing is going to get through the current legislature unless the Administration gets actively engaged and even puts out their own legislative suggestions.  My impression from meetings at the White House is that they are now gearing up for such a role, but are still very much in the early stages.  In short, when you start seeing top Administration advisors on the Sunday talk shows talking about CEL, that might be the advanced signal that they're actually going to start pushing it.

2.  It probably won't happen this year.  Had a positive meeting with staff involved with Kerry-Lieberman-Graham, the emerging front-runner for CEL.  Not to say everyone we met with was a fan of that proposal, and in fact there was criticism that the language hasn't been released yet.  In this one meeting with someone actually involved in writing that bill, it came through that the effort is real and thoughtful and that there's a lot of work going on behind the scenes ahead of any language being released.  However, in that same meeting, in trying to figure out a pathway where the bill could jump through all the necessary hoops and get passed this year... Well, it was possible, but to my ears highly improbable, to expect anything to happen before midterm elections.  So my guess is most of the CEL discussion this year will actually be positioning ahead of a push in 2011.  Of course, that'll be after the elections, so who knows...

3.  "Revenue-neutrality" is going to be key to any proposal that moves forward.  Regular readers will know this is something I've pushed on this site in the past.  We met staff from 3 different senate offices, each of which were working on separate competing versions of CEL -- all three of which included some type of dividends back to taxpayers from the government revenues from credit auctions or from a carbon tax (as opposed to all the fees going straight into other government spending programs).  So I'm gratified personally to see that the idea has some legs.

4.  Expect "death by a thousand alternatives" in the CEL debate.  In addition to Kerry-Lieberman-Graham, there's also Cantwell-Collins, and we confirmed the rumors of Murkowski's staff working on a revenue-neutral carbon tax idea.  And none of them are going away quickly, it was clear.  Plus, Waxman-Markey did pass last year of course, setting up the same kind of Senate-House conflict down the road that marked the health care reform debate. 

I hope that's a helpful download for anyone wondering what's going on in terms of CEL in Washington, DC.  Many thanks to the good folks at the Clean Economy Network for arranging the day, and to the team at the Administration that invited us to provide our input.

Most high-profile cleantech VCs will tell you they're looking for breakthrough technology.  The "black swan".  The "grid parity".  The "unicorns". (Okay, I made that last one up, but it wouldn't surprise you to see some VCs talking like that, would it.)

But there's an alternative model -- that the winners in cleantech will be the integrators, those combining proprietary and non-proprietary technologies into systems, rather than those innovating breakthroughs at the component level.

Absolutely, there's value to further innovation at what I'm describing in this column as the "component level" but which can be pretty important.  Cheaper solar cells, better battery chemistries, more efficient LED chips -- all these have value that I don't mean to discount.

But at the end of the day, all such innovations will need to be integrated into products, if not systems, intended to cannibalize existing markets and applications. 

I would argue that the "economic rent", or the real economic value, is going to be captured by the system integrators, not the component innovators, however valuable those component innovations are.

Why?

First of all, the existing markets don't know how to use such component innovations.  Adoption is slow. Lighting fixture OEMs have shown themselves to not be able to incorporate solid state lighting into their product portfolios either rapidly or effectively.  Solar installers have little interest in the latest hot but unproven solar cell technology.  Utilities don't want to risk reliability in the pursuit of efficiency improvements.  The markets aren't automatically incorporating innovations into actual products in a timely fashion.

Secondly and relatedly, component manufacturers don't have the point of contact with the customer.  By having to work through channel partners or other influencers, the component manufacturers lose sight of what the customers really care about.  When it comes to lighting, does the customer really care about how the fixture puts out light, and how much total light is sprayed out from the fixture in all directions?  No, they care about the amount of light that is delivered to where they need it -- on the manufacturing floor, or workers' desks.  All of a sudden, directionality matters.  If you're just selling LED chips, do you get that message from customers? No, but the integrators do.  And designing a system to meet a customer's specific needs becomes do-able to them.

Thirdly, the component manufacturers are delivering, for the most part, a commodity.  In solar or other generation technology? Kilowatt-hours.  In water? Gallons. In batteries it gets a bit more complex, but essentially it comes down to the amount of power that can be stored, and how quickly it can be released. There are lots of ways to accomplish this.  But from the customer's perspective, they want a comprehensive solution, not just the commodity or process itself.  All these components are best used when managed intelligently.  That's what the integrators do.  That's not what a solar cell manufacturer, an LED chip manufacturer, or a battery manufacturer necessarily do.  The integrators will be able to cherry-pick each such innovation as it comes along. Plus, customers will have specific needs for their products beyond just the basic commodity being delivered.  And the integrators will be developing products that not just accomplish the main mission, but do it with the right mix of other attributes.  And the smart integrator will also be future-proofed -- offering customers the promise that the components may be evolving rapidly, but the core system being bought will be stable for several years to come.

Finally, integrators are at the point of contact between products and services.  And I believe that is where the money is going to be made in cleantech.  Component innovation by itself is just building a better mousetrap and expecting the world to beat a path to your door.  Maybe one such innovation catches on, but many such pure tech bets will end up disappointing, even if the tech makes sense on paper.  Meanwhile, services without technology innovation are from the VCs' perspective low-margin and slower-scaling.  But at the intersection between those you find the integrators, who can latch onto access to new technology to drive installation and implementation services that can create a sticky customer relationship with good win-win margins for both vendor and customer.

So what kind of system integrator is best positioned to take advantage of these factors? An attractive system integrator will combine some proprietary technology with off-the-shelf components.  Ideally, the main tech engine (LED chips, solar cells, battery cells, etc.) are treated by the company as a flexible input.  And the proprietary technology comes in the form of controls or other "ancillary" features that actually make a significant difference to customer value.  This gives the company an edge versus competing integrators, but allows them to take advantage of the rapid innovation cycle at the component level.

Such thinking may not go over well in a venture community that values component-type ARPA-E fund-able intellectual property more than it values systems-level IP and know-how.  But it's what I've found so far to hold true in the cleantech sector.

I'm not one to flog corporate green marketing stuff, but in this case I'll make an exception.  I can't attest to the validity or accuracy of the presentation, but I've found the numbers being shared by Exelon, and their general attitude about green energy and stakeholder engagement, to be encouraging.  You can see a good example here (note: link opens a large pdf).   I'd be curious to hear what Joel Makower thinks about it...

I'm intrigued by two things in particular in this report:  First, I'm pretty interested in their presentation of their carbon abatement cost curve (pages 3-4).  I think they've done it in a funny way, and not necessarily the way I'd like to see (for example, they put some green power techs way down the curve but a closer look shows that net of incentives they should actually be much further up the curve).  And as I noted to a colleague at the event, it's a bit funny that utilities like Exelon spent years talking about how cheap nuclear power is, but now that the government is actually willing to throw money at it, they talk about how expensive nuclear is, and gimme gimme gimme.  But with those kinds of caveats, I really like this kind of cost curve analysis and wish it was a requirement for all major utilities.  And note how crucial energy efficiency, existing nuclear plant improvements (not new-build), new natgas plants, and wind power (net of incentives) are for this utility.

Secondly, on their website, I'm gratified to see a clear indication that they see environmental strategy as an area where they can actually create a competitive advantage, not just something to be managed to avoid downside risk.  I can't tell you if they truly believe that and act that way, but the message itself is very much in line with arguments we were making a decade and a half ago in the business sustainability movement.  And it still holds true today.

John Rowe of Exelon spoke at the MIT Energy Conference, which is what drew my attention to the above literature.  But Rowe's speech was also pretty interesting, coming out strongly for pricing carbon and against renewable energy standards.  Below are some quotes I jotted down (apologies for any scribble-induced inaccuracies):

"Every $10/ton in the price of carbon to us is an extra penny per kwh we'll have to charge.  It would cost us an additional 5-10 cents, from our current 11 cents per kwh average, if we were asked to do all new nukes, wind and solar [under a renewable energy standard, for example].  The public is willing to believe the [climate change] problem is real.  Most people polled, however, didn't like carbon tax or cap and trade because they thought it would cost them money.  But they loved the renewable energy standard, because they thought it was free."

"I support the renewable energy standard of Bingaman, but that's because he recognizes the limits of how far we can go.  You run real risks when setting energy policy by mercantilism, we're not good at having Congress pick technologies.  We need carbon cap and trade and a moderate level of support for specific policies.  We need to harness the market.  It's better at correcting mistakes than government is.  But the market needs to be constrained by policy as well."

"The EPA has clear mandates to regulate carbon, mercury, coal ash, and new source performance.  Coal-burning power plants have to navigate a labyrinth, it's an endless series of hammer blows on existing coal fleets.  The EPA is frustrated that they can't synchronize these regulations, to shut down smaller less efficient plants and do more with newer cleaner coal plants, but they don't have the authority to do so.  It's an expensive mess, which will reduce carbon, but neither effectively or efficiently."

"We can't make sense of nuclear with $5 natural gas.  We need $8 gas and $25/ton carbon in the forecast for it to make sense... The key driver of change is the cost of natural gas.  Gas you use to back up wind power became cheaper -- that's what made wind cost effective."

"Some significant portion can be solved by efficiency and upgrading nuclear plants.  After that, the next thing is natural gas, replacing inefficient gas or coal.  It's much cheaper than sexier things we would want to do.  After that, wind, then new nuclear.  Solar is still very expensive."

"One advantage these new technologies have is that they can be implemented smaller scale.  As innovation happens, it's not as big of a problem for the utility.  Nuclear plants take so long to build that the utility is really worried about picking a wrong technology.  Nuclear's problem is that it's big and chunky."

"Every month or so I call up my friend Rahm Emanuel and ask him if it's time to push for a carbon tax yet.  [He makes it clear it's not going to happen.]  So it looks like cap and trade, if anything.  In order to get to a bill that could work, you'll need to put in a price cap, some kind of $10-20/ton collar, with a real escalator in place.  Need to put in a renewable energy standard like Bingaman's, with something similar for nuclear, and then you have a good start."

......

It's always fun to wander the exhibit halls and poster boards at tech-driven conferences like MITEC and ARPA-E.  Here are some tech development efforts that caught my attention:

Low temperature solid oxide fuel cells -- research at the University of Maryland, to bring SOFC operating temps to around 400C.  High conductivity electrolytes, and novel electrode materials.  ...Although now that Bloom has solved all problems for SOFC forever, you have to wonder what the point is...

Geothermal electricity coupled with CO2 sequestration -- being researched at the University of Minnesota.  Essentially using CO2 as the working fluid.  I'm not sure how restrictive the geological and geographic requirements would be, however...

Nano-dipole PV -- research at the University of Toledo.  This ARPA-E finalist is pursuing "fourth generation PV" in the form of "junctionless PV."  This nanoparticle approach is at the very early stages, but they will be testing it with existing thin-film PV materials as well as some new systems like liquid PV, and enhanced photoelectrochemical cells.

Thermoacoustic cooling technology -- research at PARC looking to more than double the efficiency of traditional vapor compression systems for air conditioning.

Carbon labeling -- the Carbon-Efficient Supply Chains Research Group at MIT is working on developing methodologies and labels to be able to help consumers better understand the carbon impact of products they buy.  First off?  A banana!  Why?  I don't know...  But it would be interesting to see some rating system that could be broadly applied at the retail level.

Microchannel reactors for Fischer-Tropsch -- We're seeing more efforts to capture syngas from distributed waste streams, but what to do with it when F-T based plants to generate liquid fuels are typically so big and expensive?  New research into microchannel reactors might be able to bring economically-viable FT reactor scale down by 80-95%.

Higher power density flow batteries -- While flow batteries remain too expensive for broad use as a grid-scale energy storage technology, United Technologies Research Center is working on technologies brought over from PEM fuel cells to bring flow battery power density up 4x or better, which would thus significantly reduce system cost.

At ARPA-E, listening to Jim Woolsey talk about the possible important role of natural gas in any effort for both "energy independence" and climate change mitigation in the U.S.

It reminds me of a personal opinion I've been sharing with peers for a while now:  That Oil & Gas need a divorce.

Historically, in the U.S. it's been a single industry.  "Oil&Gas", practically all one word.  You put a hole in the ground, and sometimes one comes out, sometimes the other comes out, so many large producers do a bit of both.  You can see how a marriage of convenience, at the very least, would be natural for the group.  Represented by the same industry servicers: Trade associations, lobbyists, PR efforts, organizations, research, etc. 

But the universe of oil and gas producers is not monolithic.  To use the parlance of Wall Street, there are "oily" producers and "gassy" producers.  The "oily" ones have been larger and have largely driven the industry's public positioning over the past few decades.  Which works for the overall group when priorities are in alignment.

But energy independence and climate change are creating a serious divergence of interests.  Oil is an imported commodity in large part, natural gas is domestic and seemingly abundant.  Natural gas fired generation, and transportation, has a very different carbon emissions profile than coal, or oil, the two incumbent fuels in each category respectively.

The problem is that the "oily" part is still driving the overall "Oil&Gas" community's positioning and perception.  So in climate change legislation that's been proposed, coal gets significant incentives to go "clean", but natural gas fired generation gets relatively little support.  There's significant opportunity in the U.S. for natural gas fueled transportation, but other alternative fuels get more support.  Switching home heating and appliances to natural gas from oil or even coal-fired electricity would make a significant emissions and efficiency impact, but the incentives have been underwhelming to date. 

Longtime readers will know I'm an "all of the above" proponent -- we need a robust mix of clean and cleaner energy sources if we're to make any kind of impact on our energy challenges.  Certainly, in my mind, natural gas has a very important role to play, as the most available already-scaled solution representing at least some improvement on the incumbent oil and coal fuels.  The natural gas industry, in my opinion, actually stands to gain significantly from many of the climate change policy ideas being thrown around in DC.  Some experts have described it as the best "bridge solution" to carry us through to an eventual low-carbon energy system.  But right now, the natural gas industry seems to be getting tarred by the same brush being applied to the oil industry.  And the "gassy" players seem to increasingly recognize that as a problem.

There are now some efforts out there to provide a voice specifically for the natural gas industry.  I expect to see even more such shifts going forward.

I've stolen the title of this post from a very funny line delivered by Daniel Nocera (MIT, SunCatalytix) at the ARPA-E Summit in DC this morning.

Yes, I'm attending the first ARPA-E Summit, and I'm glad I did.  It's proving to be one of the best events of the year, in the cleantech sector.  A who's who list on stage and amongst attendees, a great mixing bowl for researchers and practitioners and investors, and some really impressively innovative ideas.  Kudos to the organizers at the DOE and CTSI, among others.

The idea of ARPA-E, of course, is to try to get the energy landscape shift Nocera was referring to, to happen more quickly.  To fund breakthrough, but practical innovation, that otherwise wouldn't get funded.  It hits directly at one of the capital gaps I've described before, at the very early stage, where VCs and angels and other private sector funders aren't fully able to get involved, for reasons I laid out a while back.  So it's an important effort.  In many ways, ARPA-E is just following in the footsteps of DARPA, another successful government program, and one that typically gets very strong support amongst legislators.

But while you can sense the optimism in the crowd here at the summit about this program and what it's doing, ARPA-E is going to face quite a few challenges going forward.

1. Demonstrating economic impact:  The work being sponsored by ARPA-E is necessarily forward-looking.  It's about investing in technology and commercialization efforts that are too far out or risky for the private sector to fund.  In theory.  But in this economic climate, the pressure will be on all programs to demonstrate economic impact, specifically jobs.  These technology development efforts don't lead to too many jobs being directly created.  Perhaps the funding helps hire another engineer or two at each company, but realistically, it's a bank shot to get to jobs growth -- we innovate and commercialize something that then eventually creates jobs once it starts being rolled out.  But here's the crux of the challenge -- many of the manufacturing jobs that get created via this innovation, when it happens, will be overseas.  This is just the way the world works, I'm not criticizing ARPA-E for this.  But my guess is others will, at some point -- and specifically when an ARPA-E recipient outsources manufacturing and gets visibly "outed" for it.

2.  Demonstrating additionality:  "Additionality" means a very specific thing in the carbon world.  It means proving that carbon emissions reductions wouldn't have already happened under the status quo.  ARPA-E is going to face a similar challenge.  Among the ARPA-E grant recipients are several startups that were already pretty well-funded by VCs.  It raises a critical question:  Is the role of ARPA-E to fund projects that wouldn't have been funded otherwise?  Or is it simply to accelerate development of ideas, regardless of how or if they've been funded to date?

If ARPA-E is only supposed to fill the capital gap, then there's a problem when it provides additional capital to a high-profile venture-backed startup.  The private sector had already demonstrated its willingness to put money into the development effort, so what's additive about ARPA-E's role, and why wouldn't they have better-deployed the money into something else with breakthrough impact potential but no venture funding to date?

On the other hand, if ARPA-E is only to fund efforts that haven't been able to get venture funding yet, doesn't that create a selection bias issue, where the agency is only funding ideas that the private sector has rejected, perhaps at times for good reason?  And why shouldn't the agency support really important ideas regardless of their funding status, because additional capital and visibility still helps?

Again, my point isn't to criticize ARPA-E, which I believe has done a great job to date.  But I do think the conundrum posed by these questions will be a challenge that the agency will continue to wrestle with going forward, and will likely face some scrutiny over at some point.

3.  Demonstrating good selection judgment:  This dovetails with the second point from above.  ARPA-E has been flooded with requests and applications for funding.  It will continue to be so, and many worthwhile efforts therefore won't get selected, it's impossible to back every deserving project.  And so as the agency staffers choose one recipient over another, it raises the likelihood of the agency getting criticized for their choices -- either as being wrong, or as showing favoritism.  The agency, as far as I've seen, has worked hard to help avoid this, bringing in a significant number of outside reviewers as part of the process, and now also reportedly providing a lot more transparency to the process.  This is very good.

But still, sooner or later one of these efforts will utterly and visibly fail.  VCs are used to this, but elected officials are not.  So sooner or later, competency of selection will be a debate that arises, whether justified or not.

And, sooner or later, someone is going to ask why a wealthy VCs' portfolio company just got more "free money" from the government.  This goes to that second point above, and has already been the subject of some external criticism.

Finally, sooner or later there will be an example of where the visibility inferred upon an ARPA-E grant recipient is perceived as having disadvantaged some other startups in the same subsector.  Government intervention affecting the competitive landscape, in other words.  There's a legitimate counter-argument to be made that any legitimacy for one player in a subsector generally helps all players in the subsector, but still, I know from talking with contacts at the DOE that they're already being bombarded with complaints from elected officials whose constituents were denied in their grant applications, etc.

I'm a big fan of the ARPA-E effort.  And, knowing some of the people involved, and knowing some of the major process overhauls they've been going through to try to get it right, I think we'll look back on the early days of ARPA-E as a really standout effort in terms of the level of execution of this versus other government programs in other policy areas.  I just also know that nothing is ever executed flawlessly, and thus ARPA-E will likely eventually face some of the criticisms I've described above. 

I hope that when that time comes, members of the cleantech research and investment communities will stand up and support it as the very valuable program it is.

For some reason, I started looking over an experienced cleantech investor's presentation on distributed generation today.  It's pretty fascinating.  I'll pull out a few notable quotes and points:

• "Micro-generation technologies are the wave of the future"
• "No technology breakthroughs are needed.  It's a manufacturing challenge."
• "Micro-generators and micro-grids will 'strand' T&D assets"
• "The costs are already in the range."
  • "Conventional systems: 100kw power master is $1500/mo full maintenance lease (~2 cents / kwh); $0.05-0.06 / kwh depending upon load factor at $4.00/mmbtu natural gas"
• "Wall Street is getting the message"
• And then this quote from an analyst at Morgan Stanley / Dean Witter: "...distributed or micro-generation... will have decimated the electricity distribution monopoly by the middle of the next decade."

Did that last, pretty dated citation give away the punchline?  The presentation I'm looking at has nothing to do with this week's breathless news coverage of a certain natgas-fired distributed generation technology... It's a presentation by Bob Shaw of Arete Corporation from the 1998 Aspen Energy Forum.  (I apologize, I can't provide a link to the full presentation, I've been holding onto a hard copy for about a decade now and can't find it online.)

I just think this presentation provides a very welcome reminder of a few important facts cleantech investors always have to keep in mind:

1. To a certain extent, we've been here before. 

In the late 1990s, there was a wave of energytech IPOs, many including distributed power generation technologies such as microturbines and fuel cells.  There was an incredible hype cycle that, in conjunction with a generally bubbly tech stock market, allowed a lot of companies to IPO even with negative margins and relatively low revenues.  With perhaps a couple of exceptions, many of those stocks later cratered.  Some of the companies are still around, but have been through a lot of retrenchment. 

I don't want to feed too much negativity here, I'm personally more optimistic about the state of today's energytech community in terms of economic value propositions, etc., than the maturation level of companies in the 1990s look in retrospect.  I believe Bob wasn't wrong, just visionary / early.  But those who ignore history truly are doomed to repeat it, and flame-out IPOs don't do any favors to anyone except potentially the early investors who got to exit quickly. 

Let's hope today's cleantech investors remember the lessons from a decade ago.

2. Overhyping any company does the entire cleantech sector a disfavor. 

"Hey, look at the attention that company's getting from the media for making bold claims.  We should do the same thing with OUR company!  And so we need to move more quickly!"  Overhype thus feeds a boom and bust cycle that encourages VCs to push their portfolio companies into high-risk, high-profile, high-valuation, high-cashburn trajectories that sometimes work out but often take otherwise promising companies and push them so far that they break.   

It can also redirect government funding and corporate partnerships away from alternative, deserving solutions.  Often solutions that exist elsewhere in the same investors' portfolios...

And what's more, when that single company's overhype doesn't pan out quickly enough, it turns opinion actively against support for the entire sector. 

So overhyping a company may get everyone all excited, but it easily backfires, and when it blows up it hurts everyone in the sector, not just that one company and their investors. 

PR is an important tool for VCs and for startups, but how do you decide when it goes too far?  It's an open question, one I don't know the answer to, but it feels like cleantech investors and startups are pushing the boundaries of it right now.

3. At the end of the day, we are investing in technologies that produce commodities. 

It's not enough to just find the very best solid oxide fuel cell distributed generation system, of which there are actually many to choose from already, which some journalists appear to have forgotten this week.  It's not about the best SOFC technology, it's about supplying kilowatt-hours (or joules of energy, or liters of clean water, etc.) at the right price and in the right way for each application.  And there are often many different ways to supply these commodities. 

Let's take a 100kw SOFC-based natgas-fired powergen unit designed for distributed generation, to pick a random example.  Well, that application's been around for a while, actually, it's the microturbine I mentioned above.  And the application is also supplied by distributed solar.  And small wind.  And diesel gensets.  And, unless you're truly off the grid for some reason, yes it also competes with centralized grid-supplied power production.  Not to mention negawatts in the forms of demand response and energy efficiency retrofits.  Any given technology solution for this application is going to have to compete with ALL of these other alternatives, not just within their own category.

So in that light, take a look at this analysis by Lux Research, and then take a look at the specs for microturbines on this page.  Looks to me like the new-new thing everyone is all excited about this week is happily about twice as efficient as the status quo natgas microturbine tech (at least when CHP isn't an option, whereupon the efficiencies would be much more comparable), but also costs about 10x as much in upfront costs.  If this comparison is correct, that's great progress, but hardly a panacea. It's not a miracle, it's not even the assured wave of the future, because there are plenty of other ways to supply kilowatt-hours where the costs are comparable and going down quickly.

Let's celebrate progress as a very good thing in general.  Thus, the progess getting so much attention right now is indeed encouraging.  Especially since I am indeed a believer in the vision of natgas-fired distributed generation, including SOFCs, as an important part of the future solution.

But I've seen where the vision of a DG-driven electrical grid has already taken a lot longer than very smart investors once thought it would, and I've also seen where overhype can be pretty damaging to our sector.  So please forgive a pretty jaded post on the hot topic du jour...

I've heard many cleantech investors say some version of the following:  "Don't invest in any company that's totally dependent upon utilities as its customers."

The admonishment reflects a basic fact -- utilities move slowly.  Terribly slowly.  They move in "utility time", where purchasing decisions are made slowly, if at all.

I spoke with one entrepreneur lately who had been working with a utility to be included in a rebate system, and now looked to be locked out.  When the entrepreneur spoke with a sympathetic exec at the utility, the answer was "oh, we know you should be included, but that's okay, you can just re-apply in six months."

Six months is an eternity to a startup.  That delay could be deadly.

When I talk with entrepreneurs who are looking to work with utilities as a customer or as a channel, I urge them to look at other models.  I see entrepreneurs get very excited about being included in a beta installation -- a few homes or a subdivision.  The entrepreneur is often viewing this as a two-step process: If we prove ourselves out in the beta, then we get a big rollout opportunity.  But what they don't know is that the beta will be done on Utility Time, and thus it'll be a couple of years before it is deemed a success or not.  And even then, the response might be "Great, we'd now like to include you in a slightly larger trial project."

The cleantech startup landscape is littered with the carcasses of cleantech startups who had been successful at landing utility betas...  and then ran out of cash while waiting for the promised large-scale rollout.

Thus, many cleantech investors learn to avoid investing in startups that are directly dependent upon utilities for success.  But insidiously, the government dollars flowing in the sector are having the effect of EXPANDING the influence of utilities upon startups.  These dollars often go into rebate programs and demonstration projects, which are basically expanding Utility Time to cover even more of the sector.

If a rebate program or a demonstration project is given federal dollars, the utilities are going to be a critical decision-maker, and often THE critical decision-maker, in determining who gets to be included.  And they make their decisions in Utility Time.  And they don't always make the right decisions to begin with.

There's an institutional bias at utilities against emerging technologies, for example.  In an earlier part of my career, I was a consultant for electric utilities, and worked closely with senior execs in that industry.  Good folks, well-meaning folks, often very dedicated individuals.  But totally disincented to put their careers on the line by trying anything new.  Even if "new" wasn't really that new.  Cost savings are nice, but keeping the lights on and avoiding customer complaints were more important.

Let's see how this might play out:  The cleantech VC puts in an investment into a company that isn't going to be selling to utilities.  Let's say it's an energy efficiency technology sold to industrial customers.  The economics are compelling.  And then the local utilities are given significant rebates to encourage energy efficiency.  Great, right?  Not unless the VC-backed company is quickly included in the program.  Otherwise, there's the scenario where someone at the utility decides that alternative approaches are given rebates, but the new tech isn't included in the rebate program.  All of a sudden, the startups' compelling economics don't look so compelling when a lesser technology is granted rebates but the startup isn't. 

Yes, this is suboptimal -- the utility sees less energy savings when lesser technologies are encouraged by selective handouts, and ratepayers therefore see higher costs.  But that's not an unusual scenario, it happens all the time.

Or take another scenario, where the startup is happily included in the rebate program -- but the program isn't actually started for several months while the utility coordinates with other utilities or perhaps works through a regulatory approval process.  Well, in that case, why would potential customers sign up for the startup's products or services before the rebate program kicks in?  And so the startup experiences months of delay, thanks to the "good news" of being included in the program.

Again, delays can be deadly for startups.

Cleantech investors need to be aware of these and other ways that utilities insinuate themselves into the day to day operations of cleantech startups.

And utility execs need to understand this dynamic, and need to engage cleantech investors and startups to make sure that these obstacles aren't standing in the way of their corporate progress.  Because at the end of the day, state public utility commissions are going to be asking "why did our ratepayers end up not seeing the energy savings they could have, and was it because of delays caused by utilities?"  And "We tried, but we were too slow" isn't going to be an acceptable answer.

Utility execs need to talk with cleantech investors often.  Otherwise, the road to energy hell will be paved with good intentions.

Totally whimsical thought of no value this morning:

At what point will we start seeing a wave of cleantech startups named with the same kind of randomness as Web2.0 startups appear to be?

Mint, Foursquare, Meebo, Swivel, PopJam, StuffBuff, etc. These are the kinds of company names you see in just a cursory glance at TechCrunch, one of the websites chronicling the rise of Web2.0 startups.  The names appear to have little to no actual meaning, they're just intended to be different-sounding and memorable and have easy-to-find URLs.

Meanwhile in just the solar space alone, cleantech has so many company names that just confusingly run together.  SolFocus, Solar Power Partners, Solar Century, Solar City, Soltage, SunEdison, GroSolar, Calisolar, Solaicx, Solyndra, NanoSolar, Sierra Solar, SoloPower, Solexant, etc.  Every once in a while a name that's a head-scratcher (MiaSole? Day4?), but typically names that are intended to be more descriptive than creative.  And the advanced lighting space is no different.  How many different ways can you use "LED" in a company name?  Or what about 'A123'?  I mean, c'mon...

It's already near-impossible for anyone outside of the cleantech VC echo chamber to tell all these companies apart by name.  Pretty sure even most insiders get confused often, although none of us would ever admit it (okay, I admit it).

So when will we see a wave of cleantech startup names that are intended to be catchy and have a short URL, and have little to no relationship to the technology itself?  Is it an indictment of, or to the credit of, the marketing skills of your average cleantech startup team? And what will the emergence of names like Brightboy and Flurby and SolFood and such in cleantech tell us about the mainstreaming of cleantech, when it happens?  Will it be a sign that cleantech investing has truly jumped the shark? 

Random questions on a snowy Tuesday.  If you read this far, don't say you weren't warned.

Like many of my cleantech investor colleagues, at one time or another I've ended up spending some significant time on opportunities in the green building materials space.  Green building markets in the U.S. are expected to triple by 2013, LEED certification is becoming a de facto requirement in some sectors and regions, and since buildings are responsible for something like 39% of all energy consumption in the U.S. any materials that can impact that have a big potential economic opportunity.

I was having a conversation with an experienced realtor this weekend, and mentioned green buildings to her.  "Oh, I worry about those," was her response.

First of all, she worries about untested materials having some kind of unforeseen unhealthy effect, like releasing formaldehyde.  She brought up asbestos type fears. 

Secondly, she described how when she had bought a house some years back, it had some kind of advanced siding material (I'm not even sure if it had any green attributes at all).  The material worked as advertised -- it held the paint well, she never had to repaint the house, and she thought the siding did protect the house from any interior damage.  But unfortunately, the material developed small (sounds like superficial) cracks, so she ended up replacing all of it.

But most importantly, to the realtor this all came down to impacts on price.  Impacts on price from perceptions that may or may not have a real basis in fact (ie: the formaldehyde fears from above).  And in the case of the house she bought with the new siding material, she described how she drove down the price of the home when negotiating with the seller, because "this stuff is horrible!"  The advanced materials didn't add to the home's value, they detracted from it.  Because of flaws that sound like they were more superficial than real.

I think VCs sometimes have a tendency to become convinced that early adopters of a new technology presage mass adoption in short order.  Certainly in some high-end residential and commercial markets, new green building materials are seeing really good adoption even in a down market.  And I do think the long-term market opportunity for green building technologies is strong. 

But my conversation over the weekend was a good reminder that there are some serious challenges in getting the main body of the market comfortable with any new tech or materials, green or no.  And that if there's a chance it'll negatively impact pricing, most developers won't want to touch it. 

VCs investing in green building techs and materials will therefore need to take special care to make sure they're not just investing in something that will be simply a high-end niche product.  That means not just validating the economic value proposition.  And it means not just double-checking that there's nothing unsafe about the materials.  It means also working hard to evaluate the market's perception of and openness to the product, to understand just how difficult it will be to introduce the new product to the channel.  Even if it's cheaper and works better and has a few early "wins", it still may see very slow adoption.