iSight - Investing in the global future

A clean future

2006 was the year that clean technology entered the Venture Capital mainstream. Cleantech, as the sector is often known, became the third largest investment category after software and biotech. With new dedicated funds and established investment houses targeting the cleantech sector, the market is set to grow further – in the US, a survey by the National Venture Capital Association found that 92% of VCs expected increases in cleantech and energy investment in 2007.

Smart investors see cleantech as more of a theme than a strictly defined market sector, however. “Cleantech is very broadly defined, but it’s about delivering solutions,”says Joern Pelzer, 3i Venture Capital partner based in Munich, Germany. “It’s anything that helps to make things more effective and efficient in terms of resources.”

The theme is defined by the problems it addresses: climate change; energy dependency; pollution; and unsustainable urbanisation. While none of those problems are exactly new, they are increasingly being recognised by governments and corporations as ones which demand attention and investment, and create a strong demand for new solutions.

Those new solutions, in turn, fall into four broad categories – energy, air and water, waste management and technologies thatsupport these categories.

The largest is energy, which includes alternative energy, power and distribution management and energy storage, and accounts for roughly half of cleantech investment in the US and three-quarters in Europe. “We see high demand for all kinds of energy production, leading to solar energy and other alternative forms of energy, and also leading to ways of making existing energy sources more efficient,” says Pelzer.



Energy generation, including solar, biofuels and wind power, is particularly strong in Europe. In Germany, government subsidies have boosted demand by making solar power more competitive to conventional electricity. Other areas include efficiency improving technologies, infrastructure and storage, such as fuel cells – an efficient means of storing energy produced by renewable production methods that has been called the holy grail of cleantech.

Pelzer identifies solar energy group Konarka and SFC Smart Fuel Cell as outstanding investments in the clean energy area (see box). Other 3i investments include GES, the world’s leading independent builder and servicer of wind farms, and wavepower specialist Ocean Power Delivery.

The second category is air filtration and water treatment and purification – by desalination or other means. Increasing urbanisation means that demand for clean water is increasing steadily, particularly in India and China.

Third, increasing urbanisation and continuing pollution are forcing demand for waste collection, treatment and recycling defined as third category disposal. The final category is the underlying supporting technologies that can assist the energy, air and water as well as waste management industries. Technologies in this category include sensing and remote monitoring, process innovations and new materials. “This is definitely the broadest area of them all, but it’s an area we’d definitely like to look at further,” says Pelzer. Existing 3i investments include catalysis groups Nanostellar and hte, as well as DeepStream Technologies, a producer of energy-managing electronics which the World Economic Foundation has selected as a technology pioneer for 2007.

Investors look to clean up
All these areas hold the potential for sustained growth and the returns demanded by the Venture Capital industry. A growing awareness among governments and corporations about the huge potential costs of allowing emissions of greenhouse gases and other pollutants to continueunchecked means that the market is real and growing. Carbon trading schemes in Europe and parts of the US, as well as the high prices for oil and gas, mean that there is an immediate value in reducingenergy consumption.

“Investors are usually looking for criteria like market sizes and growth rates, high degrees of change in established industries, the fabric of entrepreneurs and new technologies, and it’s clear that cleantech meets these criteria” says Marko Maschek, 3i Venture Capital partner in Boston, US. “Unlike the nanotech hype at the start of the millennium, investors are making money in cleantech-related opportunities today. Some early investors, especially in solar and biofuels, have generated returns that are comparable to the multiples achieved by the top quartile Venture Capitalists in the heyday of the Internet.”

It is an area where 3i has established expertise. Although the “cleantech” label is relatively new, 3i has a long history of partnering companies which would fall under its banner – from oil and gas companies in the 1970s, through semiconductor and clean manufacturing technologies in the 1990s, to the new generation of alternative energy and water treatment businesses.

The global nature of cleantech innovation and demand means that 3i is well placed to identify new technologies and businesses. “You need a global reach to find these opportunities, so we are very well positioned to source the deals out of our existing offices,” says Pelzer.

In many areas such as solar cell production, investment partners also need to be prepared to back heavy capital investment at an early stage in the company’s life. Investors must be well resourced, both in terms of capital and in the ability to deliver innovative financing solutions.

The diversity of technology and business models in cleantech also plays to 3i’s crosssectoral expertise. “The combination of inter-disciplinary teams is key,” Pelzer notes. "Because 3i has that in-house, and experienced investors in all these areas, we can assess the deals carefully and spot the right opportunities.”

The right opportunities
The key to the right opportunity in cleantech is the end market or customer base. In cleantech, markets break down into three categories, not all of which are suitable for Venture Capital investment.

First, for many areas in energy, waste, water and air treatment, the customers are utilities and municipal authorities. “The purchasing cycles in these end markets are very long, the appetite for innovation is relatively low, and the track record of major innovation is not outstanding,” says Ali Erfan, 3i Venture Capital partner in London, UK. “For early stage companies that have big disruptive technologies, it’s a very difficult story.” Companies addressing such markets can be good investments for longer-term infrastructure investments, however

The second category is the industrial market, with technologies such as efficiency management and waste treatment. Industrial customers typically have shorter adoption cycles and a greater need for performance gains than utilities, so are more likely to buy into new technologies. “All of that bodes much better for early stage companies, as well as later stage,” Erfan notes.

The third, and most interesting, area is the consumer market. “The issues and concerns around cleantech have reached, or are about to reach, an inflection point in terms of consumer consciousness,” says Erfan. “Consumers are making purchasing decisions with the environment or energy saving increasingly in mind.” That means that even early-stage cleantech companies with the right technology and the right brand will be very attractive to VC investors.

But for the next few years, the emphasis will be on later-stage investments. “Some might have taken a decade to get to that point and are on the verge of significant growth, and they need funding to fuel that growth,” Erfan says. “But we will undoubtedly make some early stage investments in things which come in and are very compelling. We’re always looking to be surprised.”

While 3i takes a stage-agnostic approach to technology investment, the general rule is that the earlier the investment, the more revolutionary the technology has to be. As in any area of technology, strong IP and patent protection are vital.

The quality of the management is also vital in attracting VC investment. Cleantech currently has a shortage of experienced entrepreneurs, although there has been a small influx of talent from other areas such as IT and semiconductors. For the right market opportunity, a VC investor can help build a strong management team as part of its partnership approach. “Finding a strong CEO can be challenging, but it’s definitely something we are familiar with,” says Pelzer.

The final consideration for venture investors is the exit – VCs look to make their return by exiting from their investments, typically after around five to seven years. Because of the nature of the cleantech sector, investors are prepared to partner companies for longer than in other sectors, but they will still want a profitable exit at some point. Some companies will find a natural home on the public markets, where there is currently strong appetite for cleantech companies. Others, particularly those selling to utilities or industrials, will make good acquisition targets. Valuations are still uncertain because of the relative youth of the market, but companies which can demonstrate scalability should be able to achieve high multiples of current turnover.



Red hot sector
Cleantech in all its forms is expected to become one of the biggest creators of wealth and jobs of the 21st century, with the total market predicted to reach $186 billion by 2012. As with any hotly-tipped investment category, some industry watchers have cautioned about the risk of a bubble developing, to the long-term detriment of the sector. There’s less chance of that happening in cleantech than in other hot sectors, however – the broadness and geographical diversity of the theme means that cleantech should avoid the frantic competition for deals and gross price inflation of the IT boom of the 1990s.

“There might be exuberance in some subsegments, but in general this theme will mature and go through the cycles just as any other investment sector did before it,” says Maschek. “What sets cleantech apart is its global nature and its magnitude. Investors will need deep technical expertise and a global outlook.”

Cleantech also has an aspect that goes beyond making money, Maschek believes. “After the disillusionment with the current geopolitical policy, cleantech might well be the rallying cry for a new start, that captivates people’s minds creating a global community that cares about the livelihood of our planet,” he says. “In any case, cleantech is here to stay.”



Konarka is pioneering the third generation of solar cell technology. Most solar cells use large silicon wafers to turn sunlight into usable electricity. A second generation of cells, which use thin-film semiconductors as a cheaper and lighter alternative to silicon wafers, is now entering the market.

But Konarka takes a radically different approach. The Massachusetts firm has developed what it calls “power plastic” – nano-engineered photovoltaic polymers that can be printed directly onto a flexible polymer film.



The resulting solar cells are lighter and far more flexible than traditional cells, and can be produced using standard roll-to-roll printing techniques. Their efficiency today, is still less than that of traditional solar cells, but the production cost savings means that they are far more affordable. They can also utilise a wider range of the light spectrum, so can generate power from artificial light and not just from sunlight.

The technology was first developed by US army researchers, and Konarka continues to work on military applications such as electricity-generating tents. The power plastic can also bring immense benefits to developing countries and areas with limited power infrastructure. There’s also huge scope in consumer applications – sun shades that power your air-conditioning and clothing patches that keep your mobile phone charged are just two of the possibilities.

3i led a $20 million financing round in February 2006. Konarka is using the funding to accelerate its growth, increase R&D and continue its global partnering strategy.



SFC Smart Fuel Cell produces what its name suggests – market-leading fuel cells for a host of consumer, industrial and military applications. With the support of 3i, SFC has successfully commercialised its technology while most competitors are still in the development stage.

The cells have been seized on by the leisure market, to power lights and appliances in motor homes, sail boats and holiday cabins. Industrially, the cells power off-grid sensors, traffic control and monitoring systems, by themselves or as a back-up to solar panels. SFC’s portable fuel cells were also recently approved by the US Department of Defence as a power source for the field equipment carried by individual soldiers.

The group manufactures all its cells and fuel cartridges at its headquarters near Munich, Germany. The cells run on pure methanol, make no more noise than a PC, emit an exhaust comparable to what a small child breathes, and are much lighter than conventionalbatteries of equivalent power. They fulfil zero-emission requirements.

SFC has been partnered by 3i since its launch in 2000. 3i has led three successive funding rounds, and helped the firm establish contacts with industry leaders. SFC continues to invest in R&D to produce smaller and more efficient units and develop new applications, including in consumer electronics.

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