This originally appeared at Rob’s Greentech Media blog
International markets are melting down, the Fed is stepping in with a big emergency rate cut, and everyone is talking about the R-word. So what would a recession mean to cleantech venture investors and startups?
There are four potential scenarios being discussed by investors:
1. There are those who argue that, in a recession driven in part by high energy costs, alternative energy generation and energy/ water/ materials efficiency plays can look even more attractive. This argument suggests that cleantech markets can be somewhat counter-cyclical, and that government stimulus plans could provide a short-term boost to startups. Furthermore, the argument goes, the stark challenges facing incumbent energy and resource markets could prompt venture and project finance investors to turn even more to cleantech as they run away from other tech sectors more affected by a downturn.
2. A second scenario accepts many of the above factors, but weighs that against lessened spending by corporate customers, and generally more difficult financial markets, and balances it out to suggest a “business as usual” outcome for cleantech startups and their investors.
3. A third scenario is more negative, but tempered by the countercyclical factors from the first scenario. Those arguing for a slow-down in 2008 point out that exit windows for investors and startups will be much narrowed, if not closed. And that corporate customers, who continue to drive most of the markets for cleantech, would tighten their purse-strings. Cleantech might be a bit insulated from the magnitude of macroeconomic bad news because of some countercyclical features, they argue, but an ebbing tide lowers all ships regardless.
4. And the fourth scenario being (carefully) discussed is the gloom and doom scenario. Those fearful of this kind of outcome point to the market downturn of 2001+, when publicly-traded energy tech stocks lost most of their value, energy tech venture capital investments fell by more than half from their 2000 peaks, and much-anticipated market transformations (such as “a DG world” and visions of fuel cell cars all over the highways) were delayed indefinitely.
Each of these scenarios could hold true, but we’re thinking that the third seems most likely. Tough to maintain optimism in the face of everything going on with the economy. And while there are some mitigating factors that may help insulate cleantech markets from the worst of it, it seems likely that investors and customers will be forced to back off a bit if the economy really does stumble. And yet this time around, unlike in 2000, much of the venture activity in cleantech has focused on technologies that are more ready for prime time and on real market needs, which makes it tougher to believe the worst scenarios.
So what would a 2008 like that third scenario look like?
1. Some sectors will be hit worse than others. Any startup dependent upon sales to or through new home builders, for example, could be pretty hard hit. Others, such as biofuels perhaps, where regulatory mandates now in place will continue to provide an impetus for further adoption, may be less hard hit. Startup management teams will be scrambling to control things as best as they can; investors will be paying even closer attention to the effects of macroeconomic conditions on particular end markets. It’ll be company by company, but some sectoral trends will be visible as well.
2. Remember when we talked about how 2008 was going to be a critical year for cleantech investors in terms of the first real wave of exits? Uh oh. Exit windows just got a lot harder to squeeze through. Where this will really hurt will be the high profile, high-cash-burn startups that have been going all out to try to get to a quick IPO. Any company’s expectation that an IPO in 2008 could provide necessary additional funding and an exit for investors just took a bit hit. For companies now in this precarious position, those making real operational progress will probably still be able to raise necessary funds to carry them through, but perhaps not at the hoped-for valuations. And others will be shaken out. Capital efficient startups whose management teams are focused on achieving cashflow breakeven, on the other hand, will be somewhat insulated by being able to wait out any temporarily unfriendly market conditions.
3. This time last year, I predicted that while cleantech venture deal numbers would go up in 2007, fewer mega-deals would mean that the overall dollar totals would remain pretty flat. “Never wrong, but often early,” huh? That prediction may have been meant for 2008 instead of 2007. In fact, it wouldn’t be surprising to see dealflow in terms of both dollars and deals take a hit. But I’m also not expecting a mass exodus of generalist VCs from the sector, and the specialists aren’t going away, and the long-term market fundamentals remain as attractive as ever. So I would expect a pause/ slowdown, but not a screeching halt in cleantech venture activity. Nevertheless, in all likelihood, in some sectors where high-growth expectations have driven particularly high valuations and big round sizes lately, we might see some reconciliation there as investors become less willing to price upside returns potential out of their deals… All of this is much of a guess as ever, but there you go, for what it’s worth…
It’ll be an interesting next few months, that’s for sure. Fingers crossed…