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Clean Energy Trust Works to Replace Venture Capital

An arched doorway at the University of Chicago
Foliage obscures part of an arched walkway at the
University of Chicago. (Credit: Kat Friedrich, 10/29/2016)

Is the sun rising on a new opportunity in Chicago that may fill the venture capital (VC) gap for clean energy startups? On Aug. 1, the United States Department of Energy (DOE) Innovative Pathways Program announced funding for 11 organizations that are advancing emerging technologies and leveraging private capital. 

Benjamin Gaddy, director of technology development at Clean Energy Trust, spoke with Clean Energy Finance Forum about the award his accelerator has received. He also said his team’s projects are bringing fresh energy to the regional and national market.

CEFF: Let’s start with a description of the new investment model for which you received the award.

Gaddy: This is a really exciting program that the DOE is sponsoring through the Technology-to-Market Program and the SunShot Initiative. They’re funding 11 different programs, a subset of which is focused on new investment models to attract new sources of capital and to deploy that capital. We’re one of those.

The new model is an attempt to fix some of the issues we’ve seen with early-stage cleantech innovation.  We’ve seen over the last couple years that traditional VC is largely less effective. There’s a lot of appetite among nontraditional investors who want to do well financially while doing good.

This new investment model combines philanthropic capital with returns-oriented impact capital to create a new fund structure that essentially can overcome a lot of challenges those nontraditional investors would face in trying to do investment directly.

We’ve looked at some of those challenges those investors would face. They include not having access to a pooled, structured vehicle. In some cases, the investors can make direct investments on their own. But not all investors are comfortable making direct investments. It may not align with how they manage their investment portfolio. They may not have technical experts on staff who can do the type of due diligence they’d want to do to make sure that the companies they were investing in are scientifically credible and have developed their technology to the point where it’s an attractive investment. Pooled vehicles enable access for those investors.

And using the philanthropic support enables them to put all their money to work right away. It ultimately can offer 25-30% higher returns compared to a traditional fund structure.

Throughout this process, we’ll be publishing our playbook. This model is one we’re developing for cleantech. There’s no reason it needs to be restricted to cleantech.

CEFF: How would you say this model will help to resolve the issue of the exit of venture capital from cleantech?

Gaddy: What we’ve seen with the retrenchment of VC is that it’s really hit early-stage companies much harder than the later-stage ones.

So there’s still some activity for companies that are a little further along that got their initial investment during the first wave of cleantech investing in the 2006-2010 period. But now, since 2010, there’s been a huge drop-off in the amount of early-stage financing. It’s really limited the pipeline.

What we’re hoping is that investments targeted to the early-stage companies will create a robust pipeline of attractive investment opportunities for follow-on investors. We can’t say whether or not the traditional VC funds will return to the sector. We certainly hope that they will. But there are other interesting corporate VC funds that have been set up in recent years, funds that are associated with corporate partners. There are a number of impact-investing mission-focused but returns-oriented funds.

By creating this robust pipeline and showing there are returns to be had in this sector, we’re really hoping to drive activity, not only in the early stage but increasingly to the later stage as well.

CEFF: What are some of the issues that drove VC out of cleantech at first?

Gaddy: In part, there was a misalignment of expectations around time frames and exit multiples. A traditional VC fund makes investments for the first five years and then hopes to harvest returns from those investments for the next five years.

And with the types of investments they were making in cleantech, they were coming very early into cleantech companies and providing capital, but then expecting a huge amount of technology development to occur in a very short time. They weren’t able to see the returns they wanted.

In many cases, we were able to see that the public market really limits the potential to access the IPO. The likely corporate acquirers weren’t comfortable coming in and paying the kinds of multiples that a traditional VC fund would expect.

A lot of things have changed since then. The public markets are really more receptive to IPOs than they were during the first wave of cleantech in the 2008-1009 period. We are really seeing more mergers and acquisitions in the large utility and large corporate space on the energy side. Those mergers and acquisitions really haven’t trickled through to startups. But we think it’s an encouraging sign.

So that addresses what’s different on the exit side. What’s different on the company-formation side is that there’s a huge development in accelerators and incubators. Clean Energy Trust has been around since 2010 and has been building an ecosystem in the Midwest, trying to gather universities, national labs, corporations and philanthropists. And the companies that spin out of those research institutions.

We see similar accelerators and incubators, often in Los Angeles, all being tied together by the Incubatenergy Network. So there’s a huge amount of support for the early-stage companies, which is absolutely critical in planting the seed for the companies.

We’re also seeing that the companies are much more disciplined now than they were in large part in the first wave. The companies understand that there’s not going to be hundreds of millions of dollars for them to spend in venture capital in year one the way there was in the 2008 period. Companies are figuring out how to use shared resources at university labs and national labs and how to keep their spend to a minimum as they go through the technology-development process. A company can get to the same level of technological readiness for a lot less money than they spent in the first wave.

University of Chicago
Ivy covers some of the walls at the University of Chicago.
(Credit: Kat Friedrich, 10/29/2016)

CEFF: What are your primary partners that you are working with on this project?

Gaddy: We’re working with Arch Venture Partners, a venture capital firm that was founded at the University of Chicago. And we’re also working with the Kellogg School of Management. We also have a wonderful advisory board that will be helping us out throughout the process. This advisory board is constructed of expert venture capitalists and corporate VC investors who have been in the cleantech space for a number of years.

CEFF: There is a disparity where VC funding for clean energy has been concentrated on the coasts if it is available. Do you think that your work will be helpful?

Gaddy: Here at Clean Energy Trust, we saw the report from The Brookings Institution that said there was more funding available for cleantech companies along the coast. Traditional VC, housed in the Bay area, has really retrenched on the cleantech investing and is focusing on its historical successes in software and IT. It’s a great time for the Midwest to pick up some of that slack and really invest in these transformational companies.

This DOE project is not bounded in terms of its geography. But the [regional] work that Clean Energy Trust does invests directly at some of the earliest stages of a company, earlier than what this new fund will invest in. We recognize that there is a strong collection of universities, national research labs, and Fortune 500 companies here that is doing great research. And there’s a lot of manufacturing expertise. So we’re doing our part to connect those entities and try to grow the company formation.

CEFF: What do you think would be logical next steps to help to build out funding in the Midwest for some of these organizations that need an infusion of it if they are starting up or expanding?

Gaddy: The first thing that’s needed is continued support for their research and development from the federal government. In energy technology and science-based innovation, none of these companies could exist without early-stage research and development dollars from the federal government. The DOE’s budget needs to stay consistent. Over the last several years, ARPA-E has had a tremendous influence on the space in terms of starting new companies or supporting new companies at the early stages. So that’s an absolutely critical piece. Without that, we would not be having new company formation. So that’s the first step.

The second step is a bit of education to be had around what’s going on in the cleantech space now. A lot of investors who saw what happened in the first wave of cleantech investing have gotten scared away. We don’t think that’s the right response.

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