What are the best practices to fund a cleantech company or developer’s pipeline?

The cleantech revolution has many similarities with other high-tech revolutions such as the IT and telecommunications markets and many lessons can be learned by the experiences gained here. Getting from the pilot plant or first few permitted projects into the mainstream can be just as fast changing, painful and risky as it was for hard disk drive technology, the quest of the “Holy Grail” in the internet killer application (which ended up being the web browsers and search engines and not a traditional application at all) or ADSL emerging technologies over other telecommunication access technologies like broadband coax or two way satellite were.

Time and time again we have seen that not always does the best technology in a given field become the market leader such as VHS over Betamax in video recording tapes, Thin Film over Ferrite/Oxide technologies in disk drives, and even others managed to leap frog over much larger and established industry players for example like Google over Yahoo. The world keeps changing at an ever increasing rate and the life cycle of cleantech businesses and technologies are no exception.

So what are the lessons learned by these industries where the, all too common it seems, Black Swan shows up (personal computers, IT and internet just to name a few) and what are the proven methods that we can take to practice in the cleantech markets? First we have to understand what the two basic principles that make success possible in the war to market entry:

1.    Speed to market
2.    Proper and timely funding

Being one of the first to successfully make the jump from an early adopter stage to the high growth mainstream market almost guarantees success in cleantech just as much as any other technology driven business. Early entry drives high market share and therefore high margins and market leadership. You don’t really even need the best technology and it doesn’t even need to work to perfection – you just need to get in there. How to get in there requires not only talent, hard work etc., it is fueled by proper and timely funding. You must raise only the amount of funds of the size and maturity of your business and market, learn how to keep lean and mean and avoid unnecessary dilution. How to achieve this is developed further below with some concrete examples but also very important is to keep your eyes peeled for the dreaded Black Swan because there are ways to roast this bird.

Speed to market

Leadership in disruptive technologies creates enormous value. In contrast to the evidence that leadership in sustaining technologies has historically conferred little advantage on emerging markets such as the pioneering disk drive firms, there is strong evidence that leadership in disruptive technology has been very important. The companies that entered the new value networks enabled by disruptive generations of disk drives within the first two years after those drives appeared were six times more likely to succeed than those that entered later.

Eighty-three companies entered the U.S. disk drive industry between 1976 and 1993. Thirty-five of these were diversified concerns, such as Memorex, Ampex, 3M, and Xerox, that made other computer peripheral equipment or other magnetic recording products. Forty-eight were independent startup companies, many being financed by venture capital and headed by people who previously had worked for other firms in the industry. These numbers represent the complete census of all firms that ever were incorporated and/or were known to have announced the design of a hard drive, whether or not they actually sold any. It is not a statistical sample of firms that might be biased in favor or against any type of firm.

The numbers beneath the matrix show that only three of the fifty-one firms (6 percent) that entered established markets ever reached the $100 million revenue benchmark. In contrast, 37 percent of the firms that led in disruptive technological innovation-those entering markets that were less than two years old-surpassed the $100 million level, as shown on the right side of the Table. Whether a firm was a start-up or a diversified firm had little impact on its success ratio. What mattered appears not to have been its organizational form, but whether it was a leader in introducing disruptive products and creating the markets in which they were sold. Only 13 percent of the firms that entered attempting to lead in sustaining component technologies (the top half of the matrix) succeeded, while 20 percent of the firms that followed were successful. Clearly, the lower-right quadrant offered the most fertile ground for success.

It is clear that early entry into a new technology or project development strategy is key for the cleantech industry just as it has been for others in the past.

Proper and timely funding

We have addressed in previous posts the need to understand the current financial and strategic position of the company, the business plan, the risks involved and their management, valuation, industry comparable performance, the forecast and a go-forward strategy and finally a clear exit or hold strategy for the incoming investors. Without a clear strategic vision (especially in such a fast changing technological, political and economic environment that surrounds cleantech) and a disciplined business plan, companies seeking capital will be very disadvantaged in their search for capital, operating in a reactive rather than pro active mode.

In addition, you need explore and develop the basic concepts used to establish the business valuation, and it cannot be over emphasized that the importance of securing buy-in among the stakeholders with respect to realistic valuations is paramount. Without a realistic sense of valuation, current owners or shareholders may cause management to expend significant time and organizational resources hunting for capital only to have a potential transaction fall apart in midstream due to unrealistic expectations.

There are some other observations and practical suggestions about startups, particularly ones that are
bootstrapped or ones that do not have institutional investors who tend to impose certain disciplines.

For example, there is an overall allure when investors are invited to participate in ventures where the business legal structure represents that the moneys at risk are limited to the amounts invested in the C or S corporations or the limited partnerships. It happens frequently with successful professionals and with groups of friends, family members or even local grants from innovation funds investing in a start-up venture. The common denominator is that these investors have large disposable income from their professional practices or trades, sums of inherited money, or easy access to family loans or innovation funds. The feeling of the small risk involved is particularly present when the investing group is composed of several individuals. The cash amount to be invested by each one is small in relation to their personal net worth or funds under management.

Regardless of the source of initial funding, the investors do not actively participate in the day-to-day running of operations. They believe it is only a matter of investing some money in a deal that a promoter indicates is a potential big winner. In many instances management is assigned to the venture's promoter. In other cases management is assigned to a rather inexperienced manager who is hired as an employee at a low pay scale. It is hands-off from the beginning.

Most of these investors do not have business experience and fail to request an evaluation of cash flow projections beforehand. They read some documents and charts with business plans ranging from short and rather flimsy narratives to various degrees of sophisticated presentations.

The allure of the limited monetary risk becomes a fallacy once the investors put their personal or their company’s assets as collateral in support of the venture's bank loans and equipment leases. And, without fully realizing it, the limited risk situation becomes an open-ended risk where homes, bank accounts, and investments in the investors' names are in jeopardy if the business venture goes sideways.

A better alternative for hands-off investors in start-ups is to obtain reliable cash flow projections and a reasonable determination of the capital required to fund at least the working capital for the entire start-up phase, including the payroll expenses of an experienced manager. It is much easier to confront the need in advance and make the investment with a complete understanding of the risk.

Comments

[Stephen Crosher]

Javier, insightful as always.

When discussing potential investments with funds, high net worth individuals etc etc we look at 4 main risk areas:
Commercial risk - is there a market and if so how big
Technology risk - does it really work
Management team - where are the gaps, how much does it cost to fill those gaps
Sovereign risk - are changes in legislation or standards going to affect the market size.

Fleet Renewables

[Diane Chambers]

Thanks for the info, Javier. We have all of that... We do solar energy .... WHERE do we find investors?
Diane Chambers
Bellatrix Energy

[Eddie Graves]

Diane,

My company, Harley Stanfield Inc, specializes in funding Green Tech business interest. I would be glad to talk to you.

egraves@harleystanfield.com or eddie_graves@yahoo.com. (I prefer)