January 13, 2021
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The Cleantech industry is at the vanguard of confronting some of the most important challenges of our time. From energy storage to waste management, clean technologies are transforming the way we interact with our environment. However, Cleantech has long been considered an investing black hole where it’s impossible to make money.
Here steps in Jason Holt, former staff scientist at Lawrence Livermore National Lab, serial entrepreneur, and a seasoned investment advisor. With the changing state of the industry, Holt believes that investors need not fear the Cleantech industry. He recently spoke to Propel(x) about how he approaches due diligence, what investors should look for with Cleantech companies, and what the future holds for the industry.
Propel(x): Maybe we could start off with you just telling me a bit about your background, how you got involved in the Cleantech industry.
Holt: I got started in the early 2000s. I was working at Lawrence Livermore National Lab as a staff scientist, and although a lot of the work that goes on there is defense related, I was working on a project that was kind of off the beaten path in water purification. In 2006, our group published a high-profile paper in Science on the concept of water filtration with nanotubes. The outside interest that generated in the investment community got me thinking about whether I should make the leap and figure out how to commercialize the technology.
Two years later I spun out NanOasis, my first startup. We had a good 4 year run with this company and built up some valuable intellectual property, which we sold to another company in 2012. Wasn’t exactly the spectacular exit we all hoped for at the outset, but was a tremendous learning experience nonetheless. Then, I basically had a one year startup hiatus where I was trying to figure out what to do next. I started working with a renowned venture capitalist named Tom Baruch, which gave me a unique perspective on the startup investment process and how things look from the “other side of the table.” One of the sectors we did a deep dive on was building efficiency. Around the same time we started that analysis, I met scientists at Lawrence Berkeley National Lab who were looking to commercialize an electrochromic glass technology and wanted a co-founder who had been through the startup lifecycle before. The market potential, business model, and technology sounded compelling enough that I joined them as a third co-founder later that year.
Propel(x): What do you think has been the biggest change in the cleantech industry in, say, the last five years or so?
Holt: As an investment sector, I think it has become viewed as toxic and I think that’s really unfortunate because the macro picture and market potential has not changed substantially. There is still money to be made, but it needs to be used in different and more intelligent ways. Venture investment in the sector has remained pretty flat the last several years. And right now the handful of cleantech entrepreneurs that are still out there have been hearing the mantra: “Don’t even bother with VC money.” At this point, most of the people that I know who are in the process of starting up their companies are looking at family funds or related institutions where investors have a much longer term investment horizon, not driven as much by expected rates of return. The investment clearly has to make money – there should be a big ROI, but the ROI doesn’t need to be delivered in 3-5 years, subject to the norms of your typical venture fund.
Propel(x): I know you help many VCs conduct their due diligence processes. Could you tell me just a bit about how you approach that process?
Holt: There are generally stages or funnels I would pass any prospective company through, to make sure that neither the entrepreneur nor investor’s time is wasted. The first funnel is thematic alignment with the investor. If an investor does 90% life science deals, then pitching them an energy deal is probably not time well spent for anyone involved. The next level tries to get at answering whether the entrepreneur truly understands the market and channel they are proposing to enter and at least some preliminary validation of their business model. There are a lot of entrepreneurs out there that operate on a “build it and they will come” basis. They may be so enamored with the technology that they don’t realize, for example, that their business model is one that’s just inherently going to conflict with some large player downstream in the value chain. And that player may be exactly whose support you need to reach the end customer. I’m a big proponent of the Customer Discovery Process popularized by Steve Blank and now implemented widely in startup incubators and other such organizations. If an entrepreneur has talked to 100+ potential customers and other stakeholders associated with their product, they are undoubtedly going to learn something that will radically alter the business plan they had to begin with.
Coming from a very technical background, there is a natural tendency to gravitate towards technology screening when first viewing an investment opportunity. In reality, I think most investors approach in exactly the opposite fashion, with the technology coming at the end–which I have begun to adopt. To put in bluntly, do you really care how it works if it’s not solving a problem anyone cares about?
If all of the other upfront items check out, you do eventually get to examining the technology, its differentiation as well as the strength of the intellectual property position. One thing I’ve come to realize, however, is that you often find companies with virtually identical technology, or identical enough as far as the marketplace is concerned, and the difference in the success of company A versus company B comes down to things like a novel business model or a strategic partnership that blocks a competitor from gaining access to the market. Business execution can often trump technology – something that took me a while to wrap my head around.
Propel(x): How has sharing your expertise with these investors helped you as an expert in this field?
Holt: I heard this from some of the very first VCs I talked to, but what some of the best of them possess is pattern recognition. After reviewing 100s of business plans, which I’ve now logged, you begin to internalize what those patterns of success are in the highest performing companies. One characteristic I see among such companies is an awareness of the ecosystem they need to create to succeed. Many of the companies I look at are in complex channels where you really don’t control your own destiny in terms of delivering your product to the end customer. Successful companies craft critical upstream and downstream partners who are vested in your success through either direct equity investment, joint development agreements, or combinations of the two.
Propel(x): Could you talk a little bit about some of the common mistakes that you see investors making, especially when they’re evaluating a clean-tech opportunity.
Holt: It feels to me like there’s still a bit too much herd mentality out there, and you could say that’s pervasive in investing, not just Cleantech. Although I’m sure there are many investors who could point to individual successes that have happened as a result of piggy backing on another’s deal, the question I have is, how many more failures have happened in those instances? The latter set of data is probably more substantial and harder to come by! There are firms out there that tell you right up front, “We don’t lead rounds.” And they basically look at the quality of your lead investor and conduct very limited or no due diligence themselves. From a company’s perspective, that’s great. It would be a hassle to put the company through a different due diligence process for each new investor. But sitting on the investors’ side of the table, I think that approach leaves a lot to be desired and undoubtedly has led to good money following bad. I think each investor really needs to conduct their own diligence process, guided in part– but not entirely–on the materials generated by a lead.
Propel(x): Putting yourself in an investor’s shoes for a moment, what are the top three things you look at when you are evaluating a startup?
Holt: The backgrounds of the founding team have a strong correlation with the ultimate success of that company. For example, if you started off with a couple of technical cofounders and you don’t bring in a third founder who has some business background, it’s often negatively correlated with success. That’s something I look for that is often hard to find. Often with founders who are fresh out of grad school, they’ll pair themselves up with someone who’s fresh out of business school. But what inevitably happens is they end up relying on investors for strategic advice. And while you can probably get a lot of excellent advice from investors, I think you can’t outsource strategy, especially in the early stages of a company. Also, that advice does not take the place of hitting the pavement and talking to those 100+ potential customers and stakeholders I mentioned earlier.
I also look for a demonstration that they understand the market they’ll be operating in and that they are addressing a true pain point validated by the voice of the customer, not just an internally-generated hypothesis. I also want to see at the outset a sort of stage gate development. Can they find a niche market to prove out their product and business model hypothesis, all the while minimizing the capital spend? Once they’ve done that, they can use it as a launching pad to tackle the much larger markets with more complex product requirements. If you try to force a company into chasing the home run right from the outset, you’re invariably going to spend a lot more capital than you would have had you proceeded more methodically. Start small. Prove it out. If you end up being wrong about the product, business model, or any number of things, which almost invariably happens, you can really minimize the cost of those mistakes and give yourself an opportunity to get it right on the second or third try.
When I do get around to examining the technology, I try to get a sense of the prior art from a preliminary patent search. Something that is especially alarming for some really early-stage companies is that many just have a concept on a napkin and have not sought out any IP protection or are not in the driver’s seat to license the foundational technology if it’s coming out of a university or national lab. In Cleantech or anything “hard technology” oriented, the IP can be the most valuable asset of the company. The prior art search is intended to get a sense for whether the company is entering a very crowded space in which achieving freedom to operate is going to be difficult. Knowing that a true freedom to operate analysis from a patent attorney is prohibitively expensive for a company just starting out, I think it behooves an investor to do their own such analysis, as limited in scope as it might be.
Propel(x): And then what trends are you most excited about in the cleantech field right now?
Holt: Right now I’m working with my colleague on analyzing the energy storage sector. With solar and wind energy having come rapidly down the cost curve, the next barrier to further increasing its penetration among our energy mix is cost-effective, reliable storage, addressing the intermittency issue. In the battery storage segment, you continue to see companies proposing radically new chemistries and while some may succeed, the failure rate is probably very high. The most interesting opportunities, I think, are in companies that come up with manufacturing innovations to greatly reduce the cost of production, especially reducing the CapEx that has to be outlaid when that company begins to scale. This gets at the heart of criticism about Cleantech companies. They aren’t universally expensive to build and you CAN make money from investing in them, if you pick the right ones.
Even more exciting are those companies, whether in storage or other sectors, that can make use of contract manufacturing and never have to put a shovel in the ground to build their own factory. Returns on investment can look very attractive in those cases.
Another trend that we’re excited about is the application of artificial intelligence and machine learning to the data-rich problems in these fields. A company that is doing some really interesting work and tackling this problem head on is Citrine. The ability to predict the properties of materials before you make them, and mine vast proprietary datasets to deliver insights that would take an engineer weeks to months to generate manually are just a few of the things the platform can provide.
Propel(x): What role do you see angel investors playing in furthering cleantech innovation?
Holt: With traditional venture capitalists still regarding the sector as radioactive, angels have a big role to play in ensuring that the valley of death from initial concept to technology validation can be bridged.
There is a tremendous amount of potential capital available from the angel community, but the key is to streamline the diligence and investing process for this group. And this is where I think platforms like Propel(x) are doing a great service to this community.
Propel(x): How do you think that the cleantech industry will change over the next ten years?
Holt: As we have seen in solar and other sectors, I think there will be some degree of consolidation in energy storage. There are just far too many companies out there and too little capital to see a meaningful number of them through to mass production. The market will need to pick the winners, down-selecting the most promising technologies and companies in order to hit aggressive targets like the Renewable Portfolio Standard in California, that specifies for 50% of the state’s electricity to be generated by renewables by 2030.