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Why VCs love clean tech

June 18, 2010

VCs are flocking to clean tech. I’ve heard a lot of explanations that more or less amount to, “Of course – there’s money to be made!” But when I thought more about it, I think there’s a lot more to it than that. What’s more, unpacking this phenomenon a bit could provide important insight into where startup investing is heading in the near future. So, why are VCs so gung-ho about this emerging industry?

Bigger numbers: more money to invest, and more investment money needed

Venture capital is a tiny asset class compared with hedge funds and private equity firms. Clean tech is a path to bigger numbers. Startups in this space require much more upfront investment than high-tech software startups. If VCs can convince institutional investors that the industry warrants investment, they can raise bigger funds, have more assets under management, and potentially reap larger returns in absolute dollar amounts. On top of this, there’s another numbers issue: big VCs have already been raising larger funds, and are looking for places to spend their money. As I’m about to talk about, software may not provide that outlet.

Today’s high-tech startups don’t need VCs as much

Back in the day, software startups required significant investment in servers and significant time to get a substantial product launched. Now, start up costs have plummeted. Cloud infrastructure like Amazon Web Services scale as you grow. Lean startups are all the rage. Powerful development tools, a willingness for consumers to try “beta,” and a move towards bite-sized “apps” and single-function consumer internet sites mean startups can launch quickly and grow while they’re in market. This means that entrepreneurs can bootstrap their startup themselves. Or they can tap into the growing network of angels. Either way, high-tech startups need VC money less these days.

Today’s high-tech startups don’t interest VCs as much

Conversely, VCs aren’t as interested in high-tech startups either, in part because they are trending towards being (crassly) these cheap little software apps. The ease of entry means that there are a lot of them. This makes it harder to pick the winners ahead of time. That so many of them rely on building a network effect (and then figuring out a revenue model) only makes it harder. What’s more, there’s been much chatter about the lack of big ideas, that most entrepreneurs these days are going for base hits. I also have a theory brewing that in some specific respects high-tech is becoming a mature industry, with lower prospects for growth. Finally, high-tech startups may not need as much money, but VCs still have money they need to spend. Take this altogether, and it makes sense why high-tech startups interest VCs less these days. By contrast, clean tech has more barriers to entry, fewer players, and bigger stakes. No wonder the VC money is pouring in.

Leaving a legacy

This one’s obvious yet often implicit. People like John Doerr and Vinod Khosla have made their money. Now they want to leave a legacy. Making solar power ubiquitous is simply more appealing to them than driving Groupon adoption. See Doerr’s TED talk if you don’t buy my reasoning – it’s called “John Doerr sees salvation and profit in GreenTech”:-)

Clean tech is mysterious, new and shiny

Not to be overlooked. After all, that’s often what attracts people to the startup world in the first place! The veterans have “done” tech, and have for the past decade or three. They’re looking for the NEW NEXT BIG THING. And that appears to be clean tech.

So what does this mean for startup investing? A shift in emphasis

Here are some final thought starters on what this means for startups and investors.

  • If you agree with the forces at play here, it makes sense for the rise of angel investment to continue. And the best of them will continue to become more professional to fill this growing funding gap, potentially to the point where we’ll have to subdivide “angels” into a few distinct categories.
  • Alternate VC models will also continue to gain prominence. Maybe seed-stage incubators are just one example of this.
  • If you want to go for the big bang business that VCs back, think big, and potentially think beyond high-tech to industries like clean tech.
  • Finally, if clean tech doesn’t live up to its growth promises, maybe there will be a return to high-tech – or maybe another industry will take up the mantle of “Home of the Next Big Thing.”

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