Bridging the Valley of Death - The Role of Governments

Vancouver, Canada (GLOBE-Net) - Venture Capital and private equity investors remain bullish in every cleantech sector according to the Cleantech GroupTM With a remarkable $1.25B of investment in renewable energy, water, air, and sustainability in the first quarter of 2008 alone, the growth potential for most environmental sectors will continue to rise. But investors are demanding that risk factors - often based on regulatory uncertainty or policy unpredictability - be identified and reduced. This article looks at the important role public funding agencies must play to help companies move their technologies from the test bench to the marketplace - a journey described as ‘the valley of death".

Cleantech investments are on the rise and there are now almost 100 clean tech companies listed on the Canadian TSX Venture and the senior TSX exchange, with a market value of more than $13 billion as of the end of 2007.

"It’s a growing sector and we’re seeing more of it all the time, so it’s something that we thought the investment community would appreciate us focusing on," says Kevan Cowan, who heads the TSX Venture Exchange. "Certainly behind the scenes a lot of institutions are telling us they really see that as the next wave or one of the next waves."

Investors are interested in the steady returns from companies that produce power from wind farms, solar and other clean sources such as geothermal and water, and in the big gains possible from bets on companies with new technologies that can help reduce emissions in other sectors according to Cowan.

Clean energy sectors receiving the most attention from investors in early 2008 were cellulosic ethanol, reaching a new investment high and concentrated solar power (CSP) which surpassed its 2007 total with $115 million invested in the quarter. Other emerging investment sectors included innovative lighting technologies and energy efficiency for homes and businesses. These sectors are expected to receive continued VC attention and increased investment in the coming year according to the Cleanteach Group.

But even with commodity prices booming and oil soaring, investment concerns abound, particularly for start-up companies.  Worries about the financial system’s stability have made some investors leery of the kind of junior company in which the Venture exchange specializes.

Unproven technologies, combined with the hundreds of millions of dollars in costs to build projects such as solar plants, biodiesel facilities or wind farms also make investors skittish.

"There is a real gap in the market now," according to Dan Goldman, chief financial officer of Chicago-based GreatPoint Energy, which has a technology to convert coal into cleaner-burning gas.  The gap, known as the "valley of death" is a deep and wide gulf of money supply and demand in the marketplace for young and unproven enterprises. 

From day one, start-up and early-stage entrepreneurs, risk falling into "the valley of death" if they do not secure adequate funds to cover negative net cash flow in their early months and years of new business creation and growth. 

This gap poses a significant challenge for cleantech venture capital firms and other early-stage investors accustomed to the speedy and relatively low-cost paths to commercialization for traditional technology companies, such as software developers. 

"Two guys in a garage doing a software deal don’t need a lot of capital," said Todd Glass, who co-chairs the energy and clean technology practice at law firm Heller Ehrman LLP. "If you compare that to somebody building a new wind project, to deploy that at a scale that really makes sense you are talking about $50 million to $100 million."

"There is a need in the market for financing vehicles that will take that first project risk," said Goldman.

The biggest VC deals have also skyrocketed in size, widening the funding gap. In 2006 and 2007, the biggest early-stage funding rounds for alternative energy were both about $200 million, according to the Cleantech Group. In the four previous years, the biggest deals were much smaller – between $25 million and $50 million.

But investors, from venture capitalists and private equity firms to Credit Suisse and Google have been gearing up to fill the funding gap.  In November, 2007 Google announced a plan to invest hundreds of millions of dollars in renewable energy, including "breakthrough" technologies.

Dan Reicher, the executive in charge of Google’s green energy push, said in an interview with Reuters that since that announcement, "there are even more technologies hitting the ’Valley of Death’ and in need of capital… we have a long way to go before we have really cracked the code on this." Google has yet to announce an investment in that part of the market, but Reicher said the company was "in the middle of this process on a couple of fronts."

A report released in April 2008 by US National Advisory Council for Environmental Policy and Technology, entitled EPA and the Venture Capital Community: Building Bridges to Commercialize Technology, suggests that the government has a larger role to play in closing the valley.

The role of the regulatory community is important in clean technology development and commercialization. Early-stage investors are looking for a minimum of 3 to 5 years of certainty regarding investments contingent on governmental influences.

The key recommendation of the report is to develop and enforce regulations.  According to the report, the existence of regulations stimulates technology investment while the lack of regulations can retard investment. The regulation of carbon and climate change-related pollutants is paramount if there are to be advances in investment in new technologies to address climate change issues.

The report also suggests that the early-stage venture capital community should have direct, routine communications with the government and technology developers on environmental technology issues of mutual interest.

This is an issue that Canada’s Dr. Vickie Sharpe, President and CEO of Sustainable Development Technology Canada (SDTC) understands all too well. Quoted in a March 2007 article by Trevor Marshall in Backbone Magazine, she notes "There’s an area in development and demonstration- particularly in the demonstration area, which is expensive-that is not funded," Sharpe said. "Companies get to this precommercialization funding gap-often called the Valley of Death-and they cannot make it through because the risk and the amounts of money are too high for the venture capital industry."

This is the point in the innovation chain where governments must also strengthen their financial support (e.g., loan guarantees, grants, revolving loan funds) and work to reduce risks for new technology development during the pre-commercialization period.

Not unlike the US EPA report that urges governments to take steps to streamline permitting for commercial scale-up of new, innovative environmental technologies, SDTC funds technologies with demonstrated potential to both meet market demand and help achieve Canada’s environmental goals. The Fund provides financial support, applies a rigorous due diligence process modeled on those used in the venture-capital world, and supports entrepreneurs with business advisory services. In doing so, SDTC de-risks clean technologies and helps prepare them for downstream financing.

The valley of death is a serious concern to many industry leaders and government agencies such as SDTC are essential if cleantech industries are to reach their full potential.

An additional hurdle for many of these start ups is the gap between policy and regulation or administrative procedures says Dr. John Wiebe, President and CEO of the GLOBE Foundation.  Too often companies find themselves going through lengthy and costly approval processes that were designed for yesterday’s technologies.

The numbers suggest that the will exists to fund start-up cleantech companies, but with the high level of uncertainty in the absence of regulation, the valley is too wide and the canyon too deep.  According to Dr. Richard Meyer, President of CIC Photonics Inc., today the canyon’s depth for technology entrepreneurs is from $500,000 to $1,000,000 or more.  Its width ranges from $2,000,000 to $10,000,000, dictated by the minimum investment that VC firms prefer to invest to match their costs of management.

The message has not been lost in some quarters. In November of 2007, the Ontario government created a $165 million venture capital fund with four of the largest institutional investors in Canada to help keep high-paying jobs and local innovation from flowing out of Ontario. OMERS Administration Corp., RBC Capital Partners, the Business Development Bank of Canada and Manulife Financial Corp. agreed to contribute $75 million to the fund, with the other $90 million coming from the province.

In April 2008, BC Economic Development Minister Colin Hansen announced the BC Renaissance Capital Fund, which will be overseen by a team of venture capital fund managers from six major VC companies. The $90 million venture capital fund is aimed at giving a much-needed boost to fledgling companies in the province’s technology and life sciences sector.

The government of Quebec has established the FIER (Regional Economic Intervention Fund) program to promote the development of the Québec venture capital industry. The FIER program focuses on the creation of public-private regional and sectoral investment funds. At the regional level, 30 FIER-Regions funds had been accredited in Québec as of February 1, 2008. These funds overall represent $279 million in capitalization, one-third of it from the private sector.

In April of 2008 the Government of Alberta Introduced the Alberta Enterprise Corporation Act.  The fund will be independently managed, and mandated to develop a locally managed venture capital industry specifically supporting knowledge-based companies in Alberta, while improving access to early stage venture capital. $100 million has been allocated to the fund through Budget 2008 to co-invest in a number of early stage capital funds focused on areas including information and communications technology, life sciences, green technology and nanotechnology.

These are all good measures and we encourage governments to continue to develop and support these programs.  Now let’s tackle the administrative burden and streamline some of the processes that keep the technologies from being implemented.

Canadian VC funding sources:

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