Recent Research: Lessons from the first cleantech bubble and the role of venture capital and governments in clean energy

From 2005 to 2008, the clean technology industry experienced a venture capital boom where the share of total VC investments in clean energy technologies tripled before falling dramatically. Many studies have concluded that the boom and bust in cleantech as an equity investment focus was because clean energy does not fit the venture capital “model.” A recent study from the National Bureau of Economic Research explores other possible reasons for the failure of venture capital to remain interested in clean energy.

The NBER researchers propose that a lack of demand for clean technologies impacted investors’ decisions, especially when coupled with the failure of the cap and trade bill in Congress in 2009. Additionally, they suggest clean energy firms may be unable to earn oversized profits rapidly – a priority for VC investors – due to difficulties differentiating products and increasing market power. A third concern or explanation the researchers explored is the role of governments and public sector investments in funding clean energy startups.

The study uses firm-level data on funding activities and startups from Crunchbase, a source that collects its data through self-submission, data analysts, and machine learning. The data used consists of nine Crunchbase datasets. The researchers narrowed their scope to include 149,358 companies operating in three broad sectors: clean energy and electric vehicles, biotechnology, and information and communications technology (ICT). These sectors were selected because they represented 59 percent of startups launched between 2000 and 2020 and received about 75 percent of the equity funding recorded by Crunchbase.

The first stage of the study focused on identifying the underlying causes of the venture capital failure in clean energy. The researchers hypothesized that if a) uncertain early market demand, b) lack of the proverbial hockey stick revenue growth curve of any pitch for capital, and c) real/perceived governmental influence in clean energy entrepreneurship,  are the reasons behind venture capital’s clean tech failures by 2008, then the less time- and capital-intensive digital energy startups should perform better and attract more venture capital money than clean tech. Additionally the researchers tested to determine if it’s true that if financial constraints have more influence the clean energy sector, then investors will “leave money on the table” and cause a higher venture capital premium.

The study found that even though digital energy startups initially outperformed other clean energy startups, venture capital investment in digital energy has also been lacking. As returns for digital energy declined after initial success, there was reduced VC investment in the industry. The researchers also concluded from the model that venture capital investments were not “leaving money on the table” in the clean energy sector.

The researchers further explored whether changes in expected demand and, particularly, federal policy support can partially explain the clean energy boom and bust. They saw the death of Senator Ted Kennedy in 2009, providing a natural point for examination because Democrats lost their filibuster-proof majority in the Senate with his death and comprehensive climate bills which were expected to create greater demand for clean energy technologies were suddenly much harder to pass. The researchers contend that demand-side policies play an influential role in private equity funding of clean technologies. When venture capitalists expect lower policy support, they are less willing to invest in clean energy startups, resulting in less market potential for those products that do receive investment. The researchers assert that politicians must focus efforts on creating a policy environment that offers continued demand for clean energy products to provide adequate support to clean energy startups.

An additional impediment to venture capital success in clean energy, the researchers examined is the struggle to earn high margins due to difficulties differentiating products. Companies in renewable energy struggle to differentiate the electricity they produce from electricity produced by fossil fuel industries. However, some clean energy sectors like electric vehicles have been able to differentiate more successfully. To determine if the energy sector offers outsized returns, the researchers investigated the return to Series A investors in the industries of interest and the exit value of startups that received Series A funding.

The results showed that clean energy startups are less likely to provide returns on investment at or above 10 times the initial investment. According to the study, about 2.1 percent of ICT startups and 2.6 percent of biotech startups that received Series A funding returned at least 10 times the amount invested. Only 1.6 percent of clean energy startups returned similar results.

The differences in outsized returns were even more drastic. The most successful clean energy startup returned about 56 times the capital invested, while 36 ICT startups and 3 biotech startups returned over 100 times the capital invested. These results indicate that lack of market demand for clean energy products may be  a significant factor contributing to the failure of greater venture capital investment in clean energy. However, the results did not determine if outsized returns would be possible after addressing demand issues.

The researchers then returned their focus on the role of the government in supporting investments in clean energy and increasing demand for clean energy technologies. The researchers found that while it would be ideal for the government to implement market-based policies like a carbon tax or cap-and-trade system to incentivize investments in clean energy technologies, implementing these policies has proven difficult. This finding led the researchers to explore the roles public sources of investment capital may play in stimulating demand and complementing the private VC market.

Public investments may address two typical high-risk, market failures in innovation finance. The first is the technological “valley of death” between developing a basic concept and creating a viable prototype. The second is the commercialization “valley of death” which happens after verifying a prototype but before proving the product commercially. The report states that public investors provide an average of $0.72 million to clean energy startups before receiving Series A funding and $15.4 million after receiving Series A funding.

To test the impact of early-stage public investments, the researchers determined if receiving public investments in the first two years of a startup’s launch made it easier to secure Series A funding and reach exit goals. The results found that public investments have a slightly more significant effect than private seed funding. According to the report, early public investments saw a 21.4 percentage point increase in the probability of securing Series A funding compared to private seed funding, which only saw an 11.4 percentage point increase. The results did not indicate that early private seed funding helped startups receive later-stage, post Series A financing. Therefore, while early-stage public investments can help startups overcome the technological “valley of death” and get Series A funding, there is no evidence that it can help companies overcome the commercialization “valley of death.”

Next, the researchers assessed the impact of late-stage public investments. Results showed that companies with Series A funding and public investments were more likely to exit than those with only private Series A funding.

Looking forward with a clear understanding of what went wrong with venture capital investments in the cleantech boom and bust in the late 2000s could help policymakers and investors better understand how to make a second cleantech boom more successful. However, the researchers expect VC investments in clean energy to continue falling behind investments in other cleantech sectors because of continued difficulties in product differentiation. The report encourages governments hoping to increase support for clean energy startups to shift their focus toward creating demand-side policies that make investments in clean energy more attractive to venture capitalists.

The research paper, The Role of Venture Capital and Governments in Clean Energy: Lessons From the First Cleantech Bubble, by Matthias van den Heuvel and David Popp, is available for download here.