Published 12 November 2012

Private venture capital and Cleantech

– Prerequisites and obstacles from an investor perspective

The study comprises risk capital investments in unlisted companies in early and growth stages (venture capital, VC) and also investments in unlisted companies in mature phases (buyouts). This delimitation means that the study does not take up other types of risk capital, such as business angels and companies’ own investments and international capital. State and municipal investments are also excluded.

The study takes up such issues as: What are the venture capitalists’ driving forces for and obstacles to investing in cleantech? What would make them invest more in cleantech?

These questions are analysed with the help of (1) a statistical description of the formal venture capital market’s development between 2007 and 2012 and (2) interviews with eight Swedish venture capitalists with investments in cleantech.

At less than 1%, venture capital accounts for only a small proportion of all investments in Sweden. In all, SEK 31 billion a year was invested between 2007 and 2012, of which 872 million a year was invested in cleantech. Despite their relatively small share, venture capital investments may be of great importance when it comes to commercialisation of innovations, which in its turn can contribute to structural transformation and economic growth. The strength of venture capital is that it tries to identify innovations with high growth potential.

When formal venture capitalists go into new or rapidly growing businesses the relationship between venture capitalist and entrepreneur is characterised by information asymmetry. In order to "secure" their investments, the venture capitalist will therefore often take an active role in the business they have invested in. The venture capital investments thus become relatively long-term and contribute to development of the investment objects.

What are the venture capitalists’ driving forces for and obstacles to investing in cleantech?

Venture capitalists are interested in investments in cleantech because the segment is characterised by high expectations and substantial market expansion.

Empirical data of all risk capital investments (both VC and buyouts), irrespective of industry, over the 2007-2012 period show a dramatic reduction in risk capital investment in unlisted companies – in particular in the earlier phases. This general decline, however, has not affected cleantech to any great extent. On the contrary, cleantech has increased its share of venture capital investments slightly since 2010. In terms of share of the venture capital market, cleantech has lost 18% since its peak year of 2010, to be compared with other segments’ 32%. This trend bears witness to a possibly more stable willingness to invest in cleantech than in other segments, but it should be interpreted with caution since the cleantech segment accounts for only a small proportion of the total risk capital.

Investors perceive that valuations of investment objects in the segment have begun to fall to reasonable levels, that there is a willingness on the part of industry to invest in technology that benefits society and that the segment will grow in importance as demands for energy- and resource-efficiency increase. Confidence in long-term political initiatives, however, is low

What are the obstacles to venture capital investments?

General obstacles to venture capital investments, which also have consequences as regards investments in cleantech, are primarily economic uncertainty and a weak market outlook, leading to reduced venture capital investment on a broad front, and risk aversion, which means that venture capital in general is shifting towards development phases which involve less risk.

This development is borne out in interviews with investors who say that the financial crisis has brought with it reduced access to risk capital and a higher degree of risk aversion, which has also affected the cleantech segment. They also say that they have instead returned to the investment segment where the risks are judged to be lower and where they have invested successfully before.

Figures from SVCA for 2007-2012 show that investments in the earliest phase, i.e. the seed phase, have almost completely disappeared from the venture capital segment. Investments in start-ups fell considerably between 2007 and 2010 and have risen slightly again. Investments during the expansion phase have taken over investment in seed and start-up businesses during the same period.

What are the specific obstacles to investment in cleantech?

The risk capital investors interviewed pointed to the following specific obstacles in the cleantech field:

  • That returns are not higher in cleantech than in other segments, at the same time as the risks are higher. Historically low profitability, with very few profitable divestments, has also made it more difficult to attract capital to venture capital funds.
  • That many investments in cleantech are dependent on the direction of government policy more than in most other segments. This means that the so-called "regulation risk" is higher. The profitability of investments in renewable energy engineering may for example be entirely dependent on carbon dioxide tax levels.
  • The fact that cleantech is associated with capital-intensive investments in the energy system raises an entry barrier against risk capital companies who do not have sufficient capital and instead prefer to invest in less capital-intensive projects.
  • Cleantech is perceived as a long-term investment category associated with high development costs and thus involving higher risk than short-term investments.
  • The capital-intensive investments are judged to be generally more expensive to scale up, i.e. it is more expensive to increase production. This can be compared to the mature IT sector that is held up as relatively attractive with its short lead times and significantly lower scale-up cost.

What does the investors’ decision-making process look like?

The investors say that cleantech investments are assessed in the same way as other investments.

For many risk capital companies, in particular those focused on early phases, capital-intensive investments on the other hand constitute an entry criterion that means that the investment is not subjected to investment assessments.

The criteria that are then considered crucial are, regardless of the type of investment:

  • Strong underlying organic growth within the market segment
  • Strong potential market position with potential competitive edge
  • A competent, driven management team at the companies one is planning to invest in.

What type of public interventions would increase investors’ interest in cleantech?

Even if the intention of this study was not to analyse what specific type of public intervention might increase investment in cleantech, the interviews do give an insight into the investors’ own perception of the public sector’s role.

The investors interviewed say that they do not attach any great importance to public interventions but instead emphasise the general criteria for an investment decision. First and foremost they say that all forms of selective public interventions may prove to be hindrances if they make it difficult to predict future returns. The reason for this is that it is impossible to know whether support and regulations will remain in force over the political terms of office.

The venture capital investors say that they instead prefer general interventions aimed at promoting entrepreneurship and the venture capital sector in general. For this reason. among others, the investors interviewed say that the venture capital deduction proposed by Government in its budget bill might contribute to an increase in investment supply, primarily through more investors being able to become business angels. This is also considered to contribute to increased investment in the cleantech segment.

General conclusions

What the investors interviewed say is that cleantech, in particular in the energy sector, is less attractive for private venture capital, the reason being that investments in the cleantech

segment, and primarily in the energy sector, are perceived as being capital-intensive, long-term and difficult to scale up, and that risks related to technology and government policy are higher. According to the investors interviewed, private venture capitalists with limited access to capital therefore prefer less capital-intensive investments that give a faster return and involve less risk.

One question to analyse further is how public interventions in the field of environmental engineering might look and how different forms of financing and support can best complement each other if present investment volumes are judged to be too small.

segment, and primarily in the energy sector, are perceived as being capital-intensive, long-term and difficult to scale up, and that risks related to technology and government policy are higher. According to the investors interviewed, private venture capitalists with limited access to capital therefore prefer less capital-intensive investments that give a faster return and involve less risk.

One question to analyse further is how public interventions in the field of environmental engineering might look and how different forms of financing and support can best complement each other if present investment volumes are judged to be too small.

(1) Cleantech is defined as environmental technology that has commercial potential in addition to environmental benefit.

Title
Private venture capital and Cleantech – Prerequisites and obstacles from an investor perspective

Serial number
Report 2012:10

Reference number
2012/011

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