Investing in clean tech, the wrong way

The WSJ today covered the funding of a new car venture, Fiskers, to the tune of $528M in loans (Venture Capitol).  Sounds like a lot of money until it’s seen in the context of the DOE hoping to lend or give away more than $40B to clean tech businesses.  Or then again, maybe it is a lot of money.Fiskers is ramping up to build a new gasoline-electric hybrid vehicle.  They are a Finnish company, but with this new funding will be opening a factory in war-torn Detroit. What’s the deal?

The DOE hopes to lend or give out more than $40 billion to businesses
working on “clean technology,” everything from electric cars and novel
batteries to wind turbines and solar panels. In the first nine months
of 2009, the DOE doled out $13 billion in loans and grants to such
firms. By contrast, venture-capital firms — which have long been the
chief funders of fledgling tech firms, taking equity stakes in the
start-ups that will pay off if they go public — poured just $2.68
billion into the sector in that time, according to data tracker
Cleantech Group.

There are a number of reasons competing for why this may be the worst way to support clean technology and innovation.  I note a few.

DOE 2005-09 Appropriations (includes Recovery Act and Loans)1. The government is not equipped to invest in new ventures. 

In short, the DOE has only been in the clean tech investment business for a short time and, even then, only to sponsor basic research programs.

In the last year, the DOE’s budget has gone from $25B to over $71B. In the past year. Anyone who has managed in growth mode knows they have barely staffed up to spend this money, let alone developed the control systems (or experience) to spend it wisely.

I’ve met a number of the folks there and they are very sharp. But nobody can spend an extra $47B (or so) in a single year and do so wisely.

2. The Heisenberg Principle is alive and well in venture investing.

The Heisenberg Principle, or the observer effect, refers to the changes that the act of observing will make on the phenomenon being observed.  In this case, federal investments in clean tech are changing the phenomenon being observed (and invested in). But this is too weak a statement. Federal investments in clean tech are completely changing the way clean technologies are being developed and brought to market.

Some young companies are tailoring their business plans to win DOE
cash. Private investors, meanwhile, are often pulling back, waiting to
see which projects the government blesses. Success in winning federal
funds can attract a flood of private capital, companies say, while
conversely, bad luck in Washington can sour their chances with private
investors. The result is an intertwining of public and private-sector
interests in an arena where politics is never far from the surface.

Injecting grants and loans in excess of 5 to 10 times the amount of venture capital entering the clean technology industry is rewriting the rules entirely.

“The existence of an 800-pound gorilla putting massive capital behind
select start-ups is sucking the air away from the rest of the
venture-capital ecosystem,” said Darryl Siry, former head of marketing
at Tesla Motors Inc., a San Carlos, Calif., company that got a $365
million DOE loan in June to build high-end electric cars. “Being
anointed by DOE has become everything for companies looking to move
ahead.”

This means that, by getting involved and investing in particular companies, the DOE is not only attempting to pick winners, they are also, by default, picking losers since nobody wants to back companies that aren’t getting their own federal teat.

3. Investing in new ventures is not as easy as it looks in the business press.

In the shadows of all those stories of rags-to-riches entrepreneurs like
Jobs and Wozniak or Sergey and Larry, and the venture capitalists who
backed them, are the countless other companies who don’t make it.
Venture capital differs from other investment strategies primarily
because their investments can go to zero overnight.  That means,
essentially, VC’s must pursue a portfolio approach in which one in
twenty of the investments they make must succeed wildly enough to make
up all the losses from the others, and then some. Nobody talks about
the losers.  Or even the funds which failed to find that single home
run.  And right now, the entire VC industry is in a decade-long slump.

The DOE is co-investing in Fiskers with a set of well-known venture capitalists—among them the valley’s pre-eminent VC firm, Kleiner Perkins Caufield & Byers. Together with smaller investors, they put up nearly $160 million to get Fiskers up and running.  This investment is part of KPCB’s recent swing towards clean-tech investing (in addition to bringing Al Gore in as a partner).

Having the DOE co-invest—or take advice from—venture capitalists who do this for a living seems like a good idea.  But even the VCs are learning hard lessons about investing in clean tech. One of KPCB’s earlier “co-investments” with the DOE, Altarock, promised a new technology for drilling deeper wells for reaching geothermal energy.  The DOE put just $6M into Altarock, along with $30M or so from Google, Khosla Ventures and Kleiner Perkins Caufield & Byers.  The NYT covered their misadventures just yesterday (Running Aground).

on Friday, the Energy Department said that AltaRock had given
notice this week that “it will not be continuing work at the Geysers”
as part of the agency’s geothermal development program.

The project’s apparent collapse comes a day after Swiss government
officials permanently shut down a similar project in Basel, because of
the damaging earthquakes it produced in 2006 and 2007. Taken together,
the two setbacks could change the direction of the Obama
administration’s geothermal program, which had raised hopes that the
earth’s bedrock could be quickly tapped as a clean and almost limitless
energy source.

As one geothermal scientist explained,

Some of these startup companies got out in front and convinced some
venture capitalists that they were very close to commercial
deployment,” said Daniel P. Schrag, a professor of geology and director
of the Center for the Environment at Harvard University.

If it’s too easy to convince the VCs that energy technologies, like internet start-ups, are weeks or months from having a product on the market, then how will staffers at the DOE do better at picking the winners?

4. Finally, what’s the return to the government (and us) in investing in early stage ventures? 

The DOE seems to be acting under the belief that either (1) they are able to pick winners or (2) their investments in individual ventures will advance an entire sector. I’ve already argued they, along with professional investors, are having trouble picking winner. And I’ve already argued that by swinging their $47B checkbook around, they’re picking losers as well as winners.

So will the DOE’s individual investments advance the development of entire fields, like hybrid cars, geothermal, or solar?  Here their experience in investing in basic research is not simply irrelevant but downright dangerous. Since the federal government got into the basic research game 50 years ago, a dominant justification for the relatively poor connection between particular research projects and desired outcomes has been that each project contributes to the pool of general knowledge from which future research project benefits. Knowledge spills over freely and everyone benefits.

Investing in early stage ventures is very different.  Knowledge doesn’t spill over in this arena. The lessons learned in one company are neither published nor, for that matter, advertised. Especially not the tough lessons (ie failures).  Quite the opposite—in many cases there are strong disincentives to sharing either good knowledge (potentially valuable intellectual property) or bad news (dissuading future investors, employees, and customers from joining in).  Consider how Altarock has shared news of its misadventures.

But the company, whose project at the Geysers was located on land
leased from the federal government by the Northern California Power
Agency, has held information about its project tightly. Not even the
power agency has been informed of AltaRock’s ultimate intentions at the
site, said Murray Grande, who is in charge of geothermal facilities for
the agency.

“They just probably gave up, but we don’t know,” Mr. Grande said. “We have nothing official from them at all.”

Investments in early stage companies will either win big—for the company and their investors—or it will fade away and the lessons will be lost with the money. Government funding does best when it creates a broad and strong platform of knowledge and technology which others can access, learn from, and continue to add to.

Investing to advance clean technology is a complicated game. Energy is an old and established sector, with expectations for technical performance and reliability to make the internet look like child’s play. Picking winners and losers in the early stage ventures just coming into the clean tech markets is dangerous. There are better ways to waste money than this.