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Cleantech magazine, a Cleantech Investor publication

FREE CONTENT: GREEN DRAGON

'Green Dragon' Doug Richard

Doug Richard discusses his views on the cleantech sector and the conclusions of the Library House research report, ‘Cleantech Goes Mainstream’.

First published in Issue 3 of Cleantech magazine, September 2007. Copyright Cleantech Investor 2007

Q - How do clean technology companies differ from other technology sectors such as IT or biotech? How does the regulatory framework impact innovation?

A - In terms of the regulatory framework, clearly there are differences between cleantech and other technology sectors. Within energy generation, the viability of the sector is underwritten by the very favourable regulatory framework provided by green certificate schemes and feed-in tariffs. The latter, in particular, have been key in the adoption of clean energy technology, especially in Denmark and Germany. They work by guaranteeing an above market price for electricity generated using clean technologies. The degree to which investors can rely on a favourable regulatory environment is key to the success of clean energy generation. In other areas, regulation is also key. Emissions trading, the climate change levy and other policy measures are designed to put pressure on companies to increase energy efficiency - creating a market for companies tackling this aspect of cleantech.

Q - How does the regulatory framework impact innovation?

A - Inevitably, the regulatory framework for cleantech companies is very important because climate change strategy relies on developing and using new technologies before they become economically viable in the absence of state intervention. However, this is not unique to the cleantech sector: healthcare is also heavily dependent on procurement by state run agencies and approval processes by state bodies.

Q - What are the implications for return on investment if a cleantech business is established with strong social/environmental principles?

A - This shouldn’t be a problem providing entrepreneurs focus on the business opportunity and do not allow their business judgement to be clouded by their general attitude to climate change and the environment.

Q - Library House statistics show that the public sector in the UK participates in over 45% of cleantech deals. How do you view the role of government in driving the development of clean technology?

A - As in all technology sectors, the role of government should be in funding basic research and proof of concept funding to ensure that world class basic research is delivered in the cleantech area and the outputs of this research are commercialised where appropriate. Proof of concept funding is grant or very early stage equity funding for a company (or academic ) to develop its technology to a point where it is proven to work in a technical sense. At this point, the company may become an investable proposition for VCs or other private sector investors. Investors are willing to take on market risk or general business risk (e.g. Is there a market for the product? Is the management team any good?), but are generally unwilling to take on significant technology risk. By providing proof of concept funding, the government can ensure that there are plenty of proven technologies for VCs and entrepreneurs to take to the next level in a commercial sense.

Q - What is the importance of organisations such as NESTA and the Carbon Trust?

A - NESTA and the Carbon Trust have an important role to play in providing early stage funding to cleantech companies. Hopefully this funding will allow young companies in the sector to develop to a point where private sector VCs see the opportunity to make a decent return and invest.

Q - To what extent is technology innovation driven by legislation rather than financial incentives (the stick vs. the carrot)?

A - Legislation does not always have to represent a stick. For example, the feed-in tariff regime in which companies are guaranteed a certain price for electricity generated from renewables, is very much a carrot for cleantech companies in the energy generation sector. A look at the relative costs of emissions trading (which I guess is a stick) compared to feed-in tariffs by the German Alternative Energy Association revealed that the former is far more efficient at cutting carbon emissions. Maybe carrots are more effective than sticks?

Q - Is the UK government doing enough to support the adoption of clean technologies?

A - One suggestion in our report is that feed-in tariffs have been far more successful than green certificate schemes (currently used in the UK) at driving the adoption of renewable energy. The Conservative Party has announced that it will consider introducing feed-in tariffs if it is elected. Library House believes the Government should do this as soon as possible.

Q - Library House points to a lack of specialised cleantech funds – at least in Europe. Will specialist funds emerge in the sector?

A - I think it is likely that funds focused on cleantech investment (similar to US based Khosla Ventures) will ultimately emerge in Europe. However, timing will depend on the size of the opportunity -which depends on European governments supporting cleantech innovation at the proof of concept stage- as the US does with its SBIR scheme. The framework programmes of the EU are designed very badly for small companies. If European cleantech VC is to thrive then the general approach to innovation in Europe needs to improve.

Q - The Library House report was entitled ‘Cleantech Goes Mainstream’. Are mainstream investors entering the sector?

A - They are - the report was titled in this way to indicate that VCs have shifted sideways into the sector (i.e. many VCs invest in the sector to some degree but there are few specialists focused solely on cleantech). The biggest institutional investor in European cleantech during 2006, by number of deals, was 3i Group, a very mainstream investor.

Q - How does the UK financing environment compare to the US?

A - In general, quite poorly. Europe as a whole is lagging the US by a larger and larger margin as each quarter passes. Although the UK is the largest market for cleantech VC in Europe, it is still less vibrant than the US. However, this is a general problem with European venture capital rather than one specific to cleantech. The poor state of the financing environment is highlighted by the fact that, in 2006, US investors participated in more European cleantech deals than investors from any European country except the UK.

Q - Elsewhere in Europe, are governments doing enough?

A - No. Europe has led the international response to climate change and been at the forefront of political debate. However, when it comes to supporting innovation at the grass roots, which is where the problem will ultimately be solved, there has been little action. If Europe is serious about innovation, why does it have a framework programme so totally unsuited to small companies and which puts cross-border collaboration ahead of innovation in the priority list? The US has been criticised for its political response to climate change – but when it comes to investing to solve the problem it has left Europe in its wake. EU and European governments need to focus on how they can configure their economies to better support innovation and especially venture capital. VC is three times more effective at stimulating innovation than corporate R&D. Europe will always remain at the sidelines in technology if the view persists that small companies and VC are just a sideshow, that the real work gets done in corporates.

Q - There are concerns in the US about a ‘cleantech bubble’. Do you see signs of a bubble in the UK?

A - No, I think there is little danger of that. I think the problem is the opposite – not enough good opportunities for VCs in UK cleantech. Much of the exuberance in the US is being driven by the biofuels space which is less significant in the UK and Europe.

Q - Library House splits clean technology into four broad sectors: Electricity, Industrial, Transport and Buildings. Which sectors does Library House expect will see the fastest growth?

A - That split is really just to breakdown our areas of consumption. We look at cleantech in terms of the energy chain: upstream/exploration, generation, infrastructure and consumption (efficiency). Currently generation is enjoying the strongest growth in Europe. The major problem in climate change is delivering enough electricity without releasing carbon dioxide – this challenge becomes all the more acute if we choose to electrify transportation in an effort to cut out fossil fuels there. The biggest opportunities are where the biggest problems are: in electricity generation.

Q - Within the sub sectors, can you point to examples of innovative technology being developed by British companies?

A - In the upstream sub sector, Surrey based TMO Renewables, the bio ethanol technology company has just raised £15m from VCs and private individuals to scale up its technology which allows the conversion of biomass to bio ethanol. It is one of the most promising companies in this space and the market is potentially massive.

In energy generation, the Imperial spin-out Hydroventuri has an exciting technology and is backed by Synergis and British Energy Plc. It has developed a means to generate electricity from small streams of water including small scale hydro power in rivers and tidal flows. The company is currently seeking pre-IPO funding and is looking towards an AIM flotation in late 2008.
In infrastructure, UK-based Intelligent Energy is a key player. It has developed a fuel cell powered motorbike and has a novel business strategy for expanding the ‘hydrogen infrastructure’ - it plans to sell hydrogen fuel generators to filling stations allowing hydrogen to be sold from forecourts without much initial capital cost. Intelligent Energy’s fuel cells are also about to be used in the world’s first ever fuel cell powered flight. The plane has been designed by Boeing and will fly later this year. Intelligent Energy was originally a spinout from Loughborough University and has raised almost £40m in funding.

Q - What are the biggest challenges for a start up clean technology company?

A - Finding a route to market is a major problem for cleantech companies. When you are developing entirely new technologies there is always a challenge about how to enter an often untested marketplace.

Q - From a personal perspective, as an early stage investor (think: dragon in the Dragons’ Den), what key attributes do you search for in a start up clean technology company?

A - I see no fundamental difference between a cleantech start up company and a company in any other sector. There are three stages of an early stage company. The first is the inception stage. The second is the angel investor stage, when the investment level is in the region of the ‘hundreds of thousands’. The third stage is the critical point when the business is ready for its first institutional investment. For a business to be investable, it must offer the potential to grow fast enough and large enough to justify the involvement of an outside investor. An entrepreneur needs to make an investment case which demonstrates the pace of growth and the absolute opportunity before I would consider investing. If a business does not offer these features, it is not to say that it isn’t a valid business opportunity for the owner/entrepreneur. However, without scalability and a significant total potential market, it is not appropriate for an outside investor to become involved.

Doug Richard is the founder and Chairman of research company, Library House, which published a report entitled ‘Cleantech Goes Mainstream’ in April of this year. Richard appeared in the second series of the BBC television series, Dragons’ Den.