Venture capital firms play clean tech catch up

Energy – and the oil that helps produce it – is becoming an increasingly valuable commodity. We may curtail our energy use, but there are so many of us – including rapidly developing, high-population economies such as China and India – that in real terms demand can only grow. Businesses offering alternative energy products stand to make a mint as the problem escalates. So why aren't we investing more in them?

Despite all the media hype about the recent boom in clean tech investment, the European Social Investment Forum (EuroSIF), which monitors investments in sustainable products and industries, maintains that the level of venture capital investment in sustainable industry is relatively small.

According to its recent study, Venture Capital for Sustainability 2007, the venture capital for sustainability sector (which EuroSIF calls 'VC4S') had committed just €1.25bn in total by the end of 2006. By comparison, European funds stemming exclusively from venture capital in 2005 amounted to €20bn.

Moreover, there is significant evidence to suggest that clean tech firms that do secure VC backing are under-funded. In 2005, the average investment in a single deal among VC4S funds was €3.8 million, compared to an average per-deal investment of €6.5 million in the broader venture capital community.

All of this points to the fact that VC4S is still a nascent area of the private equity community that needs to be nurtured, but the good news is that that could soon change. At the turn of the decade, VC4S funds were barely even on the radar, now they are expanding at a staggering rate and their effects are being felt in every sector of the green business movement.

EuroSIF divides VC4S into three key areas. The smallest sector involves focusing investments purely on corporate social responsibility (CSR) within a particular company. The recipient may not feature sustainable products or services as its main business, but may use the venture capital to help bolster environmentally friendly processes. Almost four times as much is invested in targeted economic impact, where funds invest in specific regions that are seen as underprivileged to help stimulate sustainable economic development.

But by far the largest area of sustainable venture capital investment is in clean tech, which attracted roughly half the VC4S money available in 2006. It's an ill-defined term that many advocates say goes beyond the more focused "green " technology category that developed during the past 20 years – clean tech now extends far beyond renewable energy technologies and is more about driving broad efficiencies into business sectors while also reducing ecological impact.

"We have reached the point now where by applying some technology across a broad area, we can actually do things more efficiently, using fewer resources and less energy, and make things less expensive," said Claude Haw, managing partner at Venture Coaches, a venture capitalist firm specialising in IT and clean tech deals.

But if European clean tech is booming, it is nothing compared to the US market, according to EuroSIF executive director Matt Christensen. "In the past 12 months you've had a bunch of VCs in California saying that this is the future – Schwarzenegger bet his career on it, and universities are pushing academics to research it," he said. "Clean tech has now hit its stride in the US, so it's on a quicker curve than in Europe."

According to the National Venture Capital Association in the US, the latest figures show that the US venture capital community poured $2.6bn into clean tech in the first three quarters of this year. If that trend continues through this quarter, it will have almost doubled its clean tech investment in a single year.

It's interesting that Christensen should bring up Arnie. California's clean tech companies have consumed the most domestically invested VC4S capital (43 per cent) this year and Haw wishes that everyone else would follow the former Terminator's lead and go out on a limb a little more. "We want to be more like California as a country – it's driving the clean tech wave," he said. "Let's use all this technology that we have in the national laboratories and universities, and get it out into small companies."

Europe is doing its best to get up to speed, but part of the disparity in available private equity for clean tech ventures between Europe and US could stem from cultural differences that will be difficult to overcome.

In Europe, governments have taken the Kyoto protocol seriously and are trying to kickstart developments in clean tech by piling public sector funds into private initiatives. "Europe has had the lead on state-funded development in this space, because there was a bigger viewpoint in the EU politically that these products were important for sustainable capitalism," said Haw. One example of this is the UK's government-funded Carbon Trust initiative, which uses its investment arm to inject money into early stage companies designed to reduce carbon emissions.

"There were no such incentives in the US," Christensen pointed out. But while some US start ups may wish for more federal support, the US government's relatively hands-off approach to funding has left more dynamic private investors to pick up the slack.

Which region is investing the most may be a moot point. In a globalised economy, the money can come from anywhere, and it's worth noting that almost a billion dollars of US clean tech VC investments went into foreign companies thi s year, including a $500m deal in the Netherlands.

But regardless of where the money comes from, the incentives for private investors on both sides of the Atlantic are increasing. When oil was at $50 per barrel, the community didn't really pay much attention to the clean tech sector, said Christensen. But the price of oil has nearly doubled in the space of a year, prompting a further flurry of activity in the VC4S sector.

"Long term, this is a nice area to make money in," Christensen concluded. " There might be certain cycles where you get a bit of a bubble, because so much money is kicking in right now. But over five years, you're looking at a nice return."