VCs in the Energy World

Venture Capitalists have been extremely successful in the digital arena. Moore’s law has benefited nearly everything digital.

The energy arena is very different, and the question is open as to whether VCs will be successful in this arena.

The VC model assumes that one or two out of ten investments will be hugely successful and that another three or four will achieve some success. It’s expected that one or two will fail completely and that the remaining few will remain in operating purgatory.

VCs get their money from pension funds, university endowment funds and others. These investors expect very large returns on their investment, in a relatively few years.

For the most part, VC-backed companies haven’t had to make large investments – their businesses have generally not been capital intensive until after the IPO when the public company can access the money market.

The VC gets its payoff with an IPO for its one or two big winners and by selling the best of the rest to existing companies.

The digital world has been very kind to VCs in that IPOs have been bountiful, and existing companies have needed the technology that the VCs remaining businesses have developed.

Now look at the energy world where the businesses are generally capital intensive and where reliability of existing systems is critical. There’s no Moore’s law that causes existing technologies to be outdated every eighteen months; in fact, most technologies last for decades.

There are exceptions: Smart meters, software and battery charging stations, to name three.

In addition, many energy technologies have been around for years and are not readily susceptible to technological breakthroughs.

Batteries are the obvious product that fits this category.

Small, incremental improvements are the norm, such as using flexible turbine blades as opposed to more or less rigid blades with shrouds. But large existing companies do this type of incremental development where quality and reliability are crucial and the company has to stand behind its product.

Energy requires fundamental research in physics and chemistry, something that doesn’t fit the VC model.

For example, if a new extraordinarily thin electrical insulation was developed that was also flexible, inexpensive and impervious to chemical and ozone attack, it would be a disruptive technology that would revolutionize the manufacture of motors, generators and transformers, but such a material will probably be developed in a laboratory and not by a VC.

VCs aren’t in business to conduct scientific experiments.

It’s true that private capital has supported inventors and new technologies, but this has been patient money not looking for short-term gain.

It used to be that laboratories in industry, such as at General Electric and AT&T, would do fundamental research. Unfortunately these labs are now focused on applied research.

Today a chemist won’t mix compounds together and be surprised when a new material emerges. This is essentially what happened when Daniel Fox at General Electric’s laboratory in Niskayuna invented Lexan. It didn’t happen overnight and was preceded by considerable research.

It then took an entrepreneur within GE, named Jack Welch, to commercialize it using GE’s resources. His film of a bull-in-a-china-shop demonstrated the superior qualities of Lexan, and Lexan became a resounding success.

Another reason why energy isn’t the domain of VC firms is that it takes years, and sometimes decades, to develop and demonstrate the suitability of a product or process.

A recent example is the development of fracking for extracting natural gas from shale. In the early 1980s, George P. Mitchell, a Houston-based independent oil and natural gas producer began to wonder whether it would be possible to extract natural gas from shale. It took nearly twenty years for him to develop the process for accomplishing this feat.

The energy arena is so large that one would think that VCs could make profound contributions. They grabbed cleantech as the segment that might be amenable to their strengths, but thus far they have not had great success.

It’s possible that a VC will produce a winning company, but it’s going to be far more difficult than VCs originally thought.

There is a role for government in funding fundamental research now that industry has decided not to. Government can do this through its many laboratories and through universities.

A university could spin off a company with a new technology and that company might then be backed by a VC.

Government shouldn’t try to commercialize technologies or support nascent companies. Selecting winners isn’t something government should attempt to do. Government bureaucrats are motivated by ideology, not market forces. That’s the genesis of Solyndra and other failed energy companies like it.

The market place is the best means for identifying the technologies and companies that will be successful.

First Solar has been a winner for the investment arm of the Walton family, which bought the company from its founders and then took it public with an IPO in 2006. The market place will determine its ultimate success.

VCs have invested in solar and bio-fuel companies, mostly without success.

It will be interesting to see whether VCs will have any big winners in the energy arena, but governments shouldn’t make bets using tax payer money.

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