Cashing in on cleantech

Plenty of clean technology companies are taking advantage of venture capital interest in the sector to raise financing. But how easy will it be for investors to profit down the line? Jess McCabe looks at the prospects for successful exits

Venture capitalists are pouring money into clean technology companies as never before. But finding companies in which to invest is the easy part.The degree to which investments can be monetised at the other end, the so-called ‘exit’, will dictate whether the emerging ‘cleantech’ sector continues to attract VC investors in the future – and, for the most part, investors are upbeat.

“We’re definitely not concerned about exit opportunities. On the contrary,” says Andrew Musters, who is responsible for cleantech investment at Netherlands-based asset manager Robeco, which launched the first fund-of-funds in the cleantech sector in 2004. Robeco’s first fund is rapidly approaching its final closing, and the bank is now considering launching similar products to follow it.

In particular, Musters says there are good indicators that the sector is maturing. “Serial entrepreneurs” are beginning to invest in cleantech, and they are attracted by the business case underpinning improved resource efficiency and environmental solutions, in contrast to the ethical concerns which formed the primary motivation for early investors.

Cleantech fund managers seem optimistic that the surge of interest in the sector will allow venture capitalists to make good on their investments. Tucker Twitmyer, a partner at Pennsylvania-based cleantech venture capital fund EnerTech, says: “We have been investing in this sector since our firm’s founding in 1996, over 10 years ago. The opportunities for exits have never been as good.”

Gina Domanig, of Sustainable Asset Management Group (SAM) in Zurich, agrees: “I think the window is open to companies that are self-sustaining… We started our fund back in 2000. We certainly have companies right now that are in the process of planning the exit and some in the process of implementing it.”

Nasdaq – onerous listing requirements, but still attractive for larger firms

Venture capitalists will usually seek to make their exit eight to 10 years after their initial investment, either through selling the company on to a larger corporation interested in acquiring its technology, listing it on a stock exchange or selling it on to another private equity firm.

One factor fuelling this confidence is the number of large corporations which have begun to buy up just the sort of cleantech companies that venture capital funds have been nurturing. General Electric, Siemens, BP, DuPont and 3M have all announced that they are actively seeking acquisitions.

“With commodity prices going through the roof… it’s really becoming a critical element in large corporations’ business operations,” Musters says. “A natural exit mechanism is coming because of budgets set aside to buy clean technology firms.”

“Many large companies have started alternative energy initiatives,” agrees Wal van Lierop, chief executive of Vancouver-based fund Chrysalix, adding that the industry was “set up for a very good M&A [mergers and acquisitions] climate in the years to come”.

It should be no surprise to see a majority of venture capitalists exiting their investments through acquisitions, van Lierop says, pointing out that even during the late 1990s, when the internet bubble led to record numbers of technology companies listing on stock markets, 80% of exits were via acquisitions.

But not everyone is convinced that finding a corporate giant on the look-out to buy up clean technologies presents the best prospect. Twitmyer says that initial public offerings (IPOs) are his fund’s “primary exit route”.

“We’re seeing interest in our portfolio for both vectors,” he says, when asked if there was a trend towards IPOs or trade sales.

When it comes to choosing a stock exchange on which to list, VC funds face a number of possibilities – each with its pros and cons. For example, Nasdaq has recently set much tougher conditions for companies wishing to go public, on the back of the Sarbanes-Oxley Act – US federal legislation requiring public companies to adhere to much tougher corporate governance and disclosure rules.

Domanig says that it is not worth listing a company on Nasdaq unless it has a valuation of at least $200 million, while van Lierop puts the figure at $100 million and says that Nasdaq’s role in listing young companies has been “virtually eroded”. Rob Wylie of London-based private equity firm Wheb Ventures agrees that the “cost of compliance is so onerous it’s just not worth it”.

"We have seen AIM take on the role of later-stage venture capital"

However, Nasdaq can still provide an exit route for larger firms.Twitmyer maintains that it “continues to be a very attractive exit point”. Five of EnerTech’s portfolio companies are in discussions with bankers about a potential listing and, although Twitmyer declines to name them, four are looking to go public on Nasdaq and one on the Alternative Investment Market (AIM), the London Stock Exchange’s junior market.

“The situation is improving dramatically in various ways. The IPO market is opening or has been open for quite a while on the AIM, but is now also opening on other markets, in particular Nasdaq,” says van Lierop, noting that there are indications that a number of larger cleantech companies are preparing for flotation, including two biofuels producers, Illinois-based Aventine Renewable Energy, and South Dakota’s VeraSun.

Most firms looking to go public have migrated towards AIM, although there are other options – many solar power companies have chosen to list in Frankfurt (see Environmental Finance, November 2005, page 17), while the Toronto Stock Exchange has been attracting a cadre of mostly Canadian cleantech listings.

Going public on one of these smaller markets is not without its own difficulties. Large shareholders in a company that has not earned revenue for up to two years cannot sell their shares for at least a year after listing on AIM, for example. Some brokers also impose ‘soft lock-ins’ to prevent large shareholders from selling up soon after a float and affecting the company’s valuation.

Some argue that listing on AIM in particular is not really an exit, because there is a lack of liquidity in the market.“Very few IPOs on AIM have achieved much of an exit,” cautions Mark Thompson, the London-based director of equity research at stockbrokers Canaccord Adams. Driven by the stock exchange’s own rules on listings, flotation on AIM is more about creating an opportunity for an exit six months to two years down the line, he says.

To some extent, Thompson adds, companies seeking capital are migrating towards AIM, rather than towards venture capitalists, to take advantage of listed-equity investors’ enthusiasm for the environmental technology story.“We have seen AIM take on the role of later-stage venture capital,” he says.

But there has also been an increase in activity from venture capitalists whose investments in fuel cell companies in the late 1990s and early years of this decade, partly spurred on by the Californian energy crisis, are just starting to mature. These funds are now looking to exit, Thompson says, bringing large numbers of firms of variable quality onto the market. “Some of them are under quite a bit of pressure,” he says.

Gina Domanig, SAM Group: "The exit window is open to companies that are self sustaining"

Wylie also raises doubts about the value of AIM as an exit strategy:“Flotation is actually about raising money. People say that the AIM market is illiquid and that is primarily because most of the companies that list on AIM don’t do particularly well for the first year or two.”

Although there has been a significant increase in investment in environment-related stocks on AIM, this is mostly accounted for by large firms buying up cleantech assets such as wind farms, rather than investing in technology developers,Wylie adds.

But not everyone is concerned about the limitations of AIM as a suitable exit route. “The AIM market has matured, and has really become the preferred market for early-stage companies to do an IPO, and clearly we need to recognise that the venture capital world appreciates an early IPO,” van Lierop says. “We will do more exits on the AIM. It’s very clear the industry needs an early-stage market. It is taking over the function that the Nasdaq used to have.”

He argues that there has been an influx of money going into the exchange from all over the world.“If you had spoken to me two years ago, I would have been way more sceptical about the AIM.That is because, at the time, the impression that we had in North America was that companies went to the AIM as a last financial resort. Much more money is coming to the AIM and if you follow the stocks… liquidity has gone up phenomenally.”

Another option for VC funds is to find another fund to take over their cleantech companies – known as a secondary buyout. Musters says this is a "phenomenon which, over the past years, has become much more important as an exit mechanism”.

But, while the outlook may be rosy for now, what happens if there is an economic downturn? Cleantech firms will be hit by a general decline in market confidence, Thompson at Canaccord says. But in the past, economic slowdowns have not closed AIM to IPOs in the same way as other exchanges, partly because there is still a market for companies offering unique solutions to particular problems, he adds.

Musters is more optimistic, arguing that although cleantech would be hit by any economic downturn, the fundamental drivers behind the boom – such as the increasing scarcity of natural resources – will remain in place. “Cleantech is one of the sectors that will be hit the least because of the necessity of the transformation to a more sustainable economy,” he says. “The world is becoming a more crowded place.”