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Venture-Capital Firms More Picky About Cleantech Investments

While cleantech has taken its lumps with venture capital flows slowing all around, the sector is still getting a lot of investor attention.

Sheet of US one hundred dollar bills
Don Farrall | Digital Vision | Getty Images
Sheet of US one hundred dollar bills

“We haven’t noticed a diminished enthusiasm for investing in cleantech,” says Dave Miller, a partner in KPMG’s VC practice, who heads the firm’s Northern California cleantech group.

Cleantech venture capital investment in the first three quarters of 2010has totaled $5.73 billion, according to research firm Cleantech Group LLP, putting it slightly ahead of 2009’s full-year total of $5.69 billion.

While that growth is impressive, investment in the third quarter was down by 30 percent from the previous quarter and 11 percent from the same period a year ago, according to the MoneyTree Report, prepared by PricewaterhouseCoopers and the National Venture Capital Association.

The data could be interpreted as a sign of growing sector maturity—with more experienced cleantech investors focusing on smaller, follow-on funding rounds for more proven companies, rather than writing big checks for brand new start-ups.

"Cleantech is getting the largest share of venture capital of any sector, but that's by itself not necessarily an indicator of sector frothiness,” says Dallas Kachan, managing partner at cleantech research firm Kachan & Co.

He points out that various investor surveys suggest that VC funds and their limited partners still seem to want cleantech exposure but that “investments of the last year have been made mostly by a shrinking pool of entrenched investors.”

Kachan adds that VC investors in the sector now are looking for later-stage companies and closer exits. KPMG’s Miller agrees, saying he sees “more B- and C-rounds than A-rounds.”

“More of those funds than ever before are going to shoring up mature companies," Kachan says. "Is there a lot of capital on the sidelines, watching and waiting? Either way, the herd actually investing has thinned."

While cleantech entrepreneurs were as starved as any for capital during the recession, the sector also got little help from policy-makers.

Despite pinning big hopes on Democratic control of Congress and the White House in 2008, a lack of direction on climate change and energy policy from Washington has dampened investor spirits.

“I think there is a bit of concern [that] we haven’t seen policy momentum towards a price on carbon,” says Josh Becker, co-founder of New Cycle Capital, a VC fund that invests in the sector. “Some of that has cast a bit of pall over the space.”

A House-passed, cap-and-trade billthat would have spurred sector growth stalled in the Senate in 2009, and the partisan impasse brought on by the health care debate saw the scrapping of any energy bill that could also have bolstered cleantech.

But there could be some light at the end of the policy tunnel.

A need for job creation—to reduce high unemployment and to rebuild a moribund manufacturing sector—along with concerns over long-term energy security has made discussions of government support of the cleantech sector more bipartisan.

The post-election Congress will have to sort out how that support will be applied, but some legislation will likely be brought forward.

KPMG’s Miller says that “support for cleantech isn’t ideological now.”

That said, investors’ current focus on deploying capital into the sector’s strongest companies favors those emerging firms that can generate revenues -- no matter what the political climate.

“It’s going to weed out who are the real cleantech investors,” says New Cycle’s Becker. “People are going where the money is.”

That means segments like energy efficiency—which save energy users’ money by reducing power bills—and energy storage—which bolsters the reliability of already-built or planned intermittent renewable energy sources like wind and solar—are more attractive currently than ethanol, some renewable energy concepts or carbon-emissions-reducing technologies.

KPMG’s annual cleantech VC sentiment survey showed 31 percent of respondents picked energy efficiency as this coming year’s most popular segment for investors, followed by energy storage at 24 percent.

“When you look at global energy situation, improving efficiency and increasing storage is considered a good investment,” says KPMG’s Miller.

Likewise, companies focused on building greener transportation infrastructure are also attracting capital, including advanced biofuels that are exact chemical copies of their fossil fuel counterpartsand recharging stations for an anticipated new fleet of electric vehicles.

Despite this environment of more cautioned investment decisions, KPMG’s survey still sees bullishness amongst VC investors.

In 2009, 38 percent of survey respondents said they expected VC investment in cleantech to increase by more than 20 percent for 2010. In the most recent version of the survey, 33 percent saw that 20 percent growth target achievable in 2011.

Combining that outlook with a focus on maturing market participants could promote sustainable cleantech growth, say sector watchers.

“There’s been a lot of interest in cleantech,” says KPMG’s Miller. “But it’s not a bubble.”