ARPA-E 2017

Commercializing Energy Innovation

Last week the energy innovation community gathered outside Washington, D.C. for the eighth ARPA-E Summit. The event brings research and commercialization together in a way that few other events do. ARPA-E staff pitch their ideas for the future of energy, transportation, cities, and food. Leading scientists explain how they push the frontier of innovation in energy and materials. The technology showcase lets ARPA-E awardees highlight the progress they’ve made over the course of their 3-year grants.

But the Summit doesn’t just spout techno-optimism. The conference balances technical sessions with panel discussions, keynote speeches, and fire-side chats that offered practical advice on how to commercialize those innovations. It was fascinating to understand how these experts think about building and scaling cleantech companies.

I had the honor of moderating a panel featuring some of the smartest people in the field:

  • Ira Ehrenpreis of DBL Partners, a Director on the board of Tesla and one of its first investors;
  • Mike Biddle of Evok Innovations, who built one of the world’s leading advanced recycling companies and now is an early-stage investor; and
  • Michael Horwitz of Greentech Capital Advisors, an expert on mergers and acquisitions in the cleantech sector.

The discussion was lively and featured plenty of tales from the trenches. The summit also featured an excellent discussion with Ajay Royan of Mithril Capital Management, which he co-founded with Peter Thiel and has $1.5B under management, and a panel on alternative capital solutions that featured Jeffrey Sirr of Munich Re, one of the world’s largest re-insurance companies.

Throughout these sessions, the conversation kept returning to the importance of Risk, Markets, and Team. Of course, startups in any sector have to think about these factors but the investors explained why the nature of energy and cleantech has a multiplying effect on these challenges. As Ajay put it: You have to focus on quality of market, then product, then founder. It doesn’t work in the reverse order. The biggest problem in commercializing hard tech is the friction cost associated with entering the market. He calls this “artificial friction” and emphasizes that this makes it more challenging.

What follows are some of the most interesting things I heard at the Summit—things I think anyone in the sector should keep in mind as they build and grow their business.

On Markets and Market Adoption

Ajay channeled Warren Buffett in his focus on the market first: If you put a brilliant team up against a tough market, the market always wins. He emphasized repeatedly that energy is so tough because it’s a commodity. It’s difficult to price a premium product. In any industry, he said, new products hit a barrier of market access. Even if it’s a great product and it works well, no one adopts it. Energy startups need to think about how they will break that wall, even on day one. How will they ease that friction? According to Ajay, the only way to do that is through product. He offered a particular challenge to energy startups: If you have a great innovation that then needs a whole support mechanism and consulting firm to work with customers to get it adopted, it’s not likely to work. This really matters because even though you can show—analytically and through pilots or demonstrations—that this product works, you end up spending all your capital on adoption friction costs. So then you need to raise another $100 million just to get the product in the customers’ hands. So what’s the result? New innovations aren’t being adopted as fast as they’re being created.

Perhaps Ajay would be interested in the solution proposed by Jeffrey Sirr of Munich Re who has been exploring new ways to insure against the risk of adopting new technologies. For instance, suppose an energy storage startup had a new flow battery technology and found a customer who was interested in the improved technology, but was unwilling to take the risk that the batteries didn’t live up to expectations. Munich Re would do their technical due diligence and underwrite the performance of the batteries. If the batteries failed, the insurance policy would pay out and make the customer whole again. This approach seems like it would assuage at least some of the fears of technology risk. Of course, insurance adds cost, but Jeffrey maintains that the insurance underwriting can also help secure less expensive debt to finance the project which may make up for the additional cost. A general overview of these types of mechanisms can be found at the Climate Policy Initiative. This is an exciting space to watch and it will be interesting to see if the model is sustainable for earlier stage smaller deployments.

On Team

Ira, Mike, and Michael acknowledged the realities of the cleantech markets, but for them this means the team is even more important. When they evaluate an investment, they ask themselves whether this team can “stare death in the face and survive.” Each shared a story where the company would have gone under but for the extreme resilience of the founding team.

For founders, the message is clear: you have to be fully committed to the business. As Ira said “This company can’t be the second or third most important thing in your life. If you want to make it, the company has to come first.” Building a business, especially in this sector, requires complete dedication and investors need to see that commitment.

On the Sector and Investment Theses

Based on his evaluation of the Market, Ajay shaped a contrary investment thesis at Mithril. “Cleantech was being talked about as religion. But most people in the world were still going to use oil and gas, and 20% of power was nuclear. This is where we started spending time.” He went on to emphasize that it is key that the underlying product is “long on technology”—meaning that as technology improves in the future, the product gets more competitive, not less. He used solar as an example—emerging technologies like thin-film solar were “short” innovation. As Chinese manufacturers glutted the market and costs came down the learning curve, the new technologies couldn’t compete. He likened this to companies in the IT sector: Cisco would be hurt by foreign innovations in router technology, while Facebook, Apple, Netflix, and Google can all take advantage of it.

On Long Technology Development Cycles

Mithril isn’t afraid of long development cycles—they have invested in nuclear fusion startup Helion Energy. When asked how they can make decisions about a company that has such a long road ahead, Ajay said you have to do all the underwriting up front. He says they treat diligence meetings as board meetings that will happen in the future. He asks the founders “What is it that you would talk about at a board meeting next week?” What challenges are you facing right now? What are the strategic decisions you need to make in the next 6 months? He emphasized that this is good for founders too, because “capital is marriage and you want to be with investors who you can talk to about the really thorny issues.”

As for the long time-horizon, Mithril has the added advantage of being structured as a 12-year fund (as opposed to the more common 10-year fund). Here, he channeled Buffett again: “Time horizon arbitrage is avail to all of us. If you can operate rationally on a five-year horizon, you are in an elite category.” It is certainly an open question whether a 12-year fund is long enough for breakthrough energy technologies that still have 5+ years of R&D before they’re commercially ready. If 12 years isn’t enough, those companies must find other ways to fund their development in the interim.

On Exits

Venture capital is a high-risk, high-reward business. At the end of the long road of technology commercialization, a startup turns into a successful business selling product and delighting customers. But, for companies backed by outside investors, that reward can only be realized when the startup goes public or gets acquired. One of the biggest problems facing cleantech companies and their VC investors in the last decade was the lack of acquirers. It looks like things may be changing. According to Michael Horwitz, there has never been more activity in cleantech M&A than there is today—this is great news. The pathways to IPO, unfortunately, may not be looking any brighter. As Ajay put it “you have to be the last company that matters in your market before you can go public” and contrasted this with the go-go market in the mid-1990s: “Go read S1 filings from ’95.”

I’m very grateful to Danny Cunningham at ARPA-E for the invitation to moderate the panel and to the rest of the ARPA-E staff who made the event a success.