Khosla’s bet on cleantech looks speculative

September 9, 2009

If the world is counting on innovative companies to solve global warming, we may be in trouble. Venture investment in cleantech is slumping. Venture capitalists in the US poured $2 billion into 139 cleantech start-ups in the first half of 2008, according to data from PricewaterhouseCoopers. In the first half of this year, venture investments in the sector plummeted to $513 million in 89 companies.

Of course, venture investment in general has gone off a cliff, from over $15 billion in the first half of 2008 to $6.8 billion this year. But it seems odd that cleantech, the new, new thing that VCs seek, has plunged more than the average.

Some of the slide can be attributed to a sensible response to economics. In the middle of last year oil was north of $120 a barrel. Today it’s $68. That makes alternative energy a much tougher economic proposition, whatever one believes about the importance of reducing carbon emissions globally. What about government regulation to make alternatives more attractive? Drive east on I-580 from Silicon Valley and you’ll get to the Altamont Pass. Nearly 5,000 small wind turbines were installed there in the 1970s because of a favorable tax break for wind power which eventually lapsed, pulling the rug out from under the nascent wind industry. It’s a powerful reminder that fiscal policies can be fickle and a bad foundation for an enduring company.

With energy generation a tougher proposition, the VC investment that remains is shifting to energy efficiency. Some of the Valley’s blue-chip VCs are eager to pump Silver Spring Networks, which makes software and services for a smart energy grid. There’s grand talk about 1.5 billion electricity meters needing to go digital over the next several years. But it’s hard to see Silver Spring or any of the other current portfolio companies being the next Netscape, EBay or Google — the kind of venture home-run that really sets investor hearts beating faster. Given the scale of the energy industry — about $1 trillion in the US alone — there should be plenty of space for that kind of transformational business hit. It hasn’t happened yet.

At the root of the cleantech bust is that there are fundamental science problems that need to be solved before many of the current ideas are investable. For all the strides in solar power, photovoltaic cells are still too inefficient to be cost-effective. No one has cracked the problem of energy storage for solar, wind and tidal energy. Carbon sequestration is a regular mantra in political speeches — particularly for legislators from coal-producing states — but it’s still a largely theoretical exercise.

Venture capitalists, for all their rhetoric about pushing ground-breaking innovation, are bad at science projects. In fact, one of the most damning verdicts a VC can offer is to tell someone that their start-up idea is a “science experiment”.

There’s one Silicon Valley grandee, however, who disagrees. Vinod Khosla made his first fortune as a founder of Sun Microsystems, a famously brainy place in its early years. He went on to be a star partner at Kleiner Perkins Caufield & Byers, with personal hits like Juniper Networks and NexGen/AMD, as well as flops like Dynabook. For the last five years, he has been investing a few hundred million of his own money, in nearly 40 cleantech start-ups as well as IT companies. He told Sarah Lacy earlier this year that cleantech would “clearly” create ten Googles. Now Khosla Ventures has raised $1.1 billion in two funds, the largest first-time fund since 1999 and the largest amount raised by any fund since 2007.

The two funds are split into an $800 million main fund which will make initial investments of $5 million to $15 million. It’s the second fund, of $275 million, which sets Khosla apart. It will be targeted at seed investments of up to $2 million, which he told The New York Times will be “geared towards science experiments”. He added, “We will often invest in things that have a high probability of failure.” Khosla knows that bucks the VC trend, but believes he is returning to an earlier, more pioneering era of venture investing with his approach.

Perhaps. But for all Khosla’s history of brilliance and good fortune, I’m skeptical. I don’t applaud the herd instincts on Sand Hill Road, but there’s a good reason most VCs have wandered away from investing in science. Progress in science doesn’t happen on a forced schedule, with investors eager to see a return. It most often thrives in an open environment, where results are shared through peer review, which is a problem for those who are jealous of their valuable intellectual property.

There will be an even bigger cleantech venture boom, but it’s only going to happen after a lot of science gets done in universities and national laboratories, not in venture-backed companies.

Lance Knobel is an independent strategy advisor and a writer based in the US. His professional site is at www.lknobel.com.

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