Gambling on Green

Grays Harbor, a foggy bay 90 minutes outside Seattle, has been known for two things: paper mills and the rock star Kurt Cobain, who was born there in 1967. Both are memories now, and in recent years the area had fallen on the hard times familiar to blue-collar communities across the U.S. But Grays Harbor is showing new color, thanks in part to the Seattle biofuel company Imperium Renewables, which just opened the nation’s largest biodiesel plant there. The four-month-old refinery positively gleams (and smells vaguely like lawn clippings because of the vegetable oil used to make the biodiesel). As he scales a 500,000-gallon (1.9 million L) holding tank, plant manager Sid Watts can’t conceal his pride. He points to the dock, where ships bring in vegetable oil from places like Indonesia and Malaysia, and to the rail terminal, where trains will help transport 100 million gallons (380 million L) of biodiesel a year to Imperium’s customers. Watts is happy to see his refinery jump-start the economy of Grays Harbor, but he knows the benefits of Imperium’s green, low-carbon fuel will be felt well beyond the town. “It just makes you feel good to work on something that’s helping the planet,” he says. “That matters to us.”

None of this would have happened, however, without a spark of venture capital. That came from Martin Tobias of Seattle-based firm Ignition Partners. A restless ex-Microsoft executive, Tobias thought software had maxed out, and by 2004 he was looking for the next big thing. He found it in the emerging clean-tech sector — which encompasses renewable energy, environmental efficiency and water — and discovered the struggling start-up Seattle Biodiesel, which had just been launched by a former airline pilot. Tobias injected badly needed capital, eventually buying 20% of the company and becoming CEO of the renamed Imperium Renewables. (“Less local,” he explains.) More funding came from angel investors and successful rounds of venture financing, and today Imperium is set to break ground on new plants in Hawaii, Pennsylvania and Argentina, and is preparing to go public. With Imperium, Tobias knows his money is making a difference. “Investors want to do something good, and they want to make money,” he says. “Clean tech is a way to do that.”

Once the province of those with long hair and short credit lines, today clean tech is a prime target for the smartest — and richest — investors in the world. Green investment by American venture-capital firms reached $2.6 billion in the first three quarters of 2007, the highest level ever recorded and nearly 50% more than the total for the whole of 2006. The European clean-energy sector is already producing winning companies in countries like Germany and Spain, and in rapidly growing China nearly 20% of all venture capital was channeled into clean companies in 2006 — double the percentage in the U.S. Green start-ups searching for cash “have gone from a desert to drinking from a fire hose,” says Nancy Floyd, head of the alternative energy–focused venture-capital firm Nth Power, which also has invested in Imperium Renewables. Like Tobias, Silicon Valley stalwarts who helped power the IT revolution see clean tech as an investment opportunity that could have no ceiling — and that comes with the side benefit of potentially saving the world. Vinod Khosla, famous for being a co-founder of Sun Microsystems, has put massive bets on biofuels, while his former partners at leading venture capital firm Kleiner, Perkins, Caufield & Byers (Kleiner Perkins) have belatedly followed in a big way, investing more than $270 million in the green-tech sector and hiring Nobel prizewinner Al Gore as an active partner. As Kleiner Perkins’ Bill Joy told a recent gathering of clean-tech CEOs in Boston, “We really do believe that energy and green technology is the largest economic opportunity we’ve seen so far this century.”

That capital is already paying off. Revenues for companies in solar energy, wind, biofuels and fuel cells surged from $40 billion in 2005 to $55 billion in 2006, according to the research group Clean Edge. Clean energy–related companies raised over $10.3 billion in ipos in 2006, up from $4.3 billion in 2005, and hot new companies such as First Solar, whose stock jumped from $25 to $215 in the past year, are angling to become green Googles. In turn, green venture capital in the U.S. is projected to rise to $18 billion by 2010, according to Nicholas Parker of the research group Cleantech Network. “There are huge problems facing us, and the only way to solve them is through innovation,” says Khosla. “That’s what venture capital does best.”

The new new thing
For CEOs who founded clean-tech companies before this explosion of interest, the sudden materialization of capital can seem too good to be true. When Tom Todaro launched Seattle-based Targeted Growth, which uses genetic engineering to greatly enhance the yields of crops, he thought the company’s ability to multiply the amount of feedstock available for biodiesel or ethanol would make it a star of the emerging biofuels sector. But it was the late 1990s, when clean tech made up less than 1% of total venture-capital spending, and investors weren’t interested. “I went begging to friends and families and small investment firms,” Todaro recalls. “At one point we were 90 days away from having to cut back operations.”

Though they couldn’t be more different from former dotcom darlings like
 Pets.com, clean-tech start-ups were hit hard by the vaporization of venture capital in the wake of the tech and Internet bust of 2000. Funding for green venture capital plunged over the next three years. But it wasn’t just flashbacks to that meltdown that initially kept venture capitalists cool on clean tech. Starting up an Internet company required relatively low levels of capital — at least before you started buying your employees massage chairs — and dangled the possibility of a quick and lucrative payoff. Cracking the energy sector, with its powerful incumbent companies and forbiddingly high capital costs, requires a more patient investor. “There may be some VCs willing to finance a $100 million project plant, but most can’t,” says Howard Berke, a veteran tech entrepreneur and co-founder of the solar company Konarka. “It could mean a longer [wait] for returns than what early-stage venture capitalists are accustomed to.”

The tide began to turn in 2004, thanks partly to rapidly climbing oil prices that instantly made alternative energy more competitive, and partly to government action in the U.S. and elsewhere that provided support for clean tech. The Gore-approved narrative of climate change — as both a threat and an economic opportunity — penetrated the venture-capital community. Adam Grosser, a venture capitalist at the Silicon Valley firm Foundation Capital, struggled to convince his partners that they should expand beyond their traditional IT focus into clean tech. “When I first proposed it, my partners scoffed,” he says. But Grosser persisted, and today clean tech accounts for 10% of Foundation’s portfolio. “This is not a problem that is going away soon,” he says. “This will be a trend like PCs were for the 1980s and networking was for the 1990s.”

By 2006, the clean-tech sector was absorbing 11% of all venture capital in North America and Europe. Investors started knocking on Todaro’s door, and they haven’t stopped since. “We went from hat in hand to not being able to return investor calls,” Todaro says. The company won millions in financing, and has just announced a deal with a firm called Green Earth Fuels to develop 100 million gallons (380 million L) of biodiesel by 2010. Says Richard Kaufman, CEO of the international sustainable investment company Good Energies: “There is just a wall of money out there now.”

No single venture capitalist may be more responsible for that shift than Khosla, who formed Khosla Ventures in 2004 in part because his Kleiner Perkins partners were still hesitant to dive into clean tech. Khosla had no such fears, and he has emerged as a clean-tech evangelist. “By 2000, I felt that software and other businesses were reaching a dead end,” he says. “But energy was an area where there were large markets that could benefit from innovation.” Khosla hasn’t held back — in the first nine months of 2007, Khosla Ventures participated in 14 deals worth nearly $70 million. He has spread his bets along a range of clean-tech sectors, with a particular focus on biofuel start-ups such as Range Fuels, which is close to commercializing biofuel out of agricultural residue like wood chips, rather than food crops. Nothing has paid off big for him yet — in fact, prices for corn-based ethanol, which Khosla has also invested in, crashed in 2007, largely due to overproduction. But Khosla, who sees corn as a stepping stone to superior cellulosic ethanol, is undaunted. “This is a great market with great fundamentals,” he says.

Still, the dotcom bust casts a shadow, with fears that once again too much money is chasing too few good ideas. The drive to go green, so strong today, could rapidly lose momentum if oil prices were to drop significantly, and it hasn’t escaped notice that clean tech has yet to produce a bank-breaking success like Netscape, which made Kleiner Perkins a fortune. “Everybody with a dollar thinks they’re a clean-tech investor now,” says Foundation Capital’s Grosser. “A ton of people could lose a lot of money on solar or biofuels.” But defenders point out that the burgeoning energy needs of China and India mean that oil prices are unlikely to fall to previous levels, while the political push to put a higher price on fossil fuels through emissions caps or a carbon tax will make renewables a neccesity. “It’s either a very important hedge against the future, or it could become the future,” says Peter Bance, CEO of Ceres Power, a London-based fuel-cell company.

Big names from the mainstream business world are migrating into the clean-tech sector — because they want to help the planet and their bankbook. Lois Quam, a pioneering health-care executive, who was last year named one of Fortune‘s 50 Most Powerful Women in Business, joined the Minneapolis-based investment bank Piper Jaffray to guide its rapidly growing alternative-energy portfolio. “You see so many good companies and entrepreneurs entering this space,” says Quam. “This is the biggest business opportunity for this country.”

Prophets of profits
That’s a message much of the rest of the world has already absorbed. Though the U.S. is easily the biggest player in green venture capital, Europe may be ahead on clean tech itself, thanks largely to the kind of generous government subsidies that have yet to be enacted in Washington. The enormous capital expenditure required to compete in the energy market makes government support all the more important. Many of the world’s top solar and wind companies — like Germany’s Q-Cells and Spain’s Iberdrola — are based in the E.U., and with the region set to enact even stricter caps on carbon emissions, this head start is unlikely to disappear soon. “Europe is the clear leader in clean tech, from a market side, but also the technology side,” says Felix von Schubert, a partner at London-based investment firm Zouk Ventures.

But both Europe and the U.S. may be less important than the nation that will soon be the world’s top CO2 emitter: China. Cleaning up China is both the biggest challenge to green tech and its biggest opportunity, and venture capitalists are staking their claim, with their investments in green companies in China rising by 147% to $420 million between 2005 and 2006. Much of that money is being channeled into meeting China’s ravenous energy needs — especially solar, which already has a homegrown success story in billionaire Shi Zhengrong, founder of Suntech Power. Water conservation and filtering is a growing field, too — a reminder that clean tech is about more than just carbon emissions. Another difference is the faster payoff for green investment in China, driven by lower fixed costs and intensifying demand for clean energy. “All clean ventures in China are nearly immediately profitable,” says Roman Shaw, founding partner of Shanghai-based venture-capital fund DT Capital. “That rarely happens in the U.S.” But while China is almost certain to become the world’s biggest market for clean tech — the government is calling for 15% of the country’s energy to come from renewables by 2020, the same target that President George W. Bush has threatened to veto in the U.S. — the nation’s businesses have yet to show that they can create green innovations on a large scale, rather than buying and selling those developed elsewhere.

That pressing need for innovation is the ultimate challenge for everyone involved in the green sector, including the venture capitalists funding it. Some environmentalists like to say that we already have the technology we need to defeat global warming. This is not true. Creating the advances needed to rapidly decarbonize our energy supply — at a price the developing world can afford — will require the investment of countless billions of dollars for research and development. At the moment, we’re not even close to victory, but many of the best, smartest and richest investors around have now joined the battle. At the end of a presentation on Kleiner Perkins’ green-tech initiative at this year’s TED (Technology, Entertainment, Design) conference, an invitation-only gathering of global thinkers, legendary venture capitalist John Doerr silenced his audience when he briefly broke down, pondering the future his 15-year-old daughter would face if nothing were done to stop climate change. “We face irreversible and catastrophic consequences,” Doerr said. “We must act and we must act decisively.” Investors like Doerr have financed revolutions before. Let’s hope they spark another.