This article is written by Madhu Mallah who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

“We could definitely make a flying car – but that’s not the hard part. The hard part is, how do you make a flying car that is super safe and quiet? Because if it’s a howler, you’re going to make people very unhappy.” -ELON MUSK

Introduction

Everything is about starting when it comes to setting a business or making money through the business. Raising capital for startups needs funding, and where does these funds come from? It comes from the investors who like to invest their capital in such startups with a long-term growth perspective and the capital invested by the investors is known as Venture Capital. The investors investing capital are known as Venture Capitalists. Nevertheless, the traditional Venture Capital is different from Venture Capital in the Cleantech Sector. The venture capital in the Cleantech sector involves more technological risks and it tends to be very capital intensive.

Investing in the cleantech sector now plays an imperative role in accelerating the commercialization of new energy technologies to make the world a better place in the future. The SIDBI venture capital, Tata Cleantech, Blume ventures, Nexus venture partners are some of the green investment banks which provide investments of VC to the Cleantech sectors. This article will cover all the aspects of the Cleantech sector like what is Cleantech sector, stages of VC in Cleantech sector, how it differs from traditional Cleantech sector and the barriers faced by the investors.

What is Venture Capital?

Venture capital emerges the investors financing the start-ups, rapidly growing or have potential for high growth. It is a form of investment and funding in small early stage companies where investors invest their capital in highly risky projects with the intention of earning high rates of returns. An immature, high-tech company who is in its early stage of funding and not ready to make a public offering can seek venture capital. Venture capital is one of the most modern ways to enter into Indian capital market. Venture Capital firms finance these companies both early as well as in later stages for maintaining a balance between risk and profitability.

What is the Cleantech Sector?

According to the Cleantech group (http://www.cleantech.com/), a Cleantech company is a company whose primary focus is on clean technology. Cleantech companies generally produce any product, service or process that provides the society with no hazardous values. It benefits the world via reduced environmental degradation and better health and quality of life outcomes.  It significantly forms a clean interest in energy generation, which raises the awareness of global warming and climate change. Such a business sector includes high-growth industries such as solar, wind, water purification and biofuels. These Cleantech sectors are accompanied by venture capital funds and land use organizations.

What is venture capital under the Cleantech sector?

The threat of climate change has drawn a lot of attention to the need to reduce anthropogenic carbon emissions, especially by reducing the use of fossil fuels. This emphasis has brought a significant amount of human and financial resources to bear on developing technologies in the clean technology (Clean Tech) industry. As the traditional venture capital reflects the investment returns, the investment of VC in the Cleantech sector has higher risk, and it does not fit in like traditional VC investors.

Stages of Venture Capital under Cleantech sector

There are four stages in the Cleantech process, the first and second stage includes technology research and technology development. The third and fourth stage includes manufacturing and scale, and roll out, respectively. The government finances the funding of capital in the stage one and the later stages are funded by venture capital funds or by private equity. Mergers, acquisition, and private equity finance in the stage three and four. Venture capital plays a very imperious role in financing such Cleantech companies for developing the technologies. The small companies usually first go through the early stage financing and then later stage financing. The early stage financing contains Seed capital, startups and the later stage contains the expansion stage and bridge stage.

1. Seed Capital Stage: The first stage of growing the plant is sowing seeds, and only then plants grow and provide us flowers, likewise, in venture capital first the startups needs the early stage seed capital to implement their idea for a product or a service that has a potential to grow in future and develop a successful business down the road. The amount of seed funding is generally small and used for research and product development and expansion. By creating such prototypes, they attract additional investors in later funding rounds. Likewise, the company oorjan (Cleantech sector) raised a seed investment of $450,000 from globevestor and others in 2017. Also, in late 2019 the cleantech company OxyGarden raised a small seed round of $70,000 from unknown investors.
2. Startup stage: After the seed capital round, once the company is done with the research and a devised business plan the company is generally ready to develop the product. In the startup stage the business is prepared and now they begin to advertise and market their product to potential customers. Startups are generally the idea of business setup by the experienced person in which they have knowledge about. It can be defined as a young company founded by entrepreneurs to develop a unique product and sell in the market. The finance in startups is much higher, so the amount of funding is much higher than the previous round. The venture capitalists see the results of the market research to determine if there are enough consumers to buy the product.
3. First Round: This stage arises after the seed and startup stage, in the first round the company’s product has started being sold. The company needs enough funds in this round to meet the growing needs of the business. The funds, which are received in this round generally goes into manufacturing products, sales, and other marketing. The amount funded in this round will be significantly higher than the previous rounds. The venture capital firm will give a green light towards the next stage if the startups hold its own product against their competition.
4. Expansion round: This round is to expand the business more globally as well as in manufacturing. At this stage, the startups are at a growing stage and the goal is to scale the business and expand the market share. The venture capital in this round might be needed for marketing globally or for overseas manufacturing facilities. The venture capital firms will then evaluate if the startup is able to compete with their competition in the market and if the management team has made the expected cost reduction.
5. Bridge stage: The primary goal of bridge stage is to transition into a public company so that the investors can exit and make profit. This funding round requires financing for Mergers, Acquisition or for Initial public offerings. This stage is also known as the mezzanine stage.

What are the barriers of venture capital under the Cleantech Sector?

The traditional venture capital varies from the cleantech venture capital in three barriers; in accrual of benefits, increase in risks involved, market opportunities and exit.

First barrier: Firstly, the cleantech firms are non-excludable and nonrival because such investments have a strong public good component. Therefore, if anyfirm were to adopt cleantech investment thus improving air/water quality, it benefits everyone, including competitors. Such consumption of benefits with improved air/water by the other firm makes it non-rival.

Second barrier: The second one is an increase in risks and market growth opportunities, while all VC investments are risky; the cleantech investment evaluates more risks. Generally, the Venture capitalists finance in the small companies where less risks are involved and in the companies, which produce more consumer-oriented products. Nonetheless cleantech companies produce more of renewable or non-renewable e.g. (electricity generation, energy efficiency, composite materials, wastewater treatment) where it is tougher to assess the risks and market growth opportunities.

Third barrier: The third one is that the cleantech sector has a weak exit mechanism and creates a blockage in innovation thereby reducing take-off. Generally, energy-producing firms have not been active acquirers of promising cleantech startups. Nonetheless, in the other sector the incumbents acquire the target companies easily. Therefore, cleantech’s weak exit mechanism may dissuade the investors from investing in the cleantech sector.

Despite these barriers to investment, cleantech investment has countervailing forces at play. Formal and informal institutions, Oil prices movements and government’s sustainability stance may each counter such barriers by increasing the benefits that may accrue to the venture capitalist thereby countering the public good characteristic of cleantech.

Types of Venture Capital

Venture capital is generally of three types, organized or institutional venture funds.

1. Angel investors set up the venture capital funds, those are the ones with high network individual investors and not the one pitched with the venture capital firms.
2. Venture capital subsidiaries of corporations; such capitals are funded by the major financial institutions, commercial banks, major corporations, holding companies or other financial firms.
3. rivate capital firms/funds; Most of the early stage companies are financed by private venture capital institutions, where the firms pitch the investors and companies and then these venture capitalists invest their capital in startups with little or no history, expecting a higher rate of interest return in future.

The Venture Capital Process under Cleantech sector

1. Idea Generation: The first important thing is to generate the idea of the business plan, which may be for the development of technology with the aim of filling the gap in the market. This is generally known as the Research and development stage.  The entrepreneurs need to be ready with the knowledge of the business and therefore the entrepreneur will approach the venture capitalists with a plan. The venture capitalists will receive such a proposal in the form of a business plan. Such a well-managed business plan helps the entrepreneurs to get the attention from the VC’s in procuring funds for the business.
2. Introductory meeting: Succeeding the preceding study done by the venture capitalists if they find the project profit making or worthy, the venture capitalist and the entrepreneurs have one to one meeting session to discuss the project in detail. After the meeting, it is on the VC if he wants to move forward with the later stage. This is the ‘creation’ stage of the company.
3. Deal Negotiation: Once the meeting is conducted between the venture capitalists and the entrepreneurs, and the VC’s are satisfied with the business plan they move forward with deal negotiation. Here they negotiate the terms and conditions of the deal and formulate it in a manner so that it is beneficial for both. The terms and conditions include the rights of venture capital and entrepreneurs, amount of investment, percentage of profit held for both parties, etc.
4. Post Investment activity: Once they wrap up the deal and finalize the terms and condition of the investment, the venture capitalists take part only during the situation of financial risk. The venture capitalists take up the rights and the duties of the same by becoming a part of the venture. The venture capitalists only take part in the enterprise by a representation in the Board of directors and make sure that the enterprise is working as per the plan.
5. Exit Plan: The Venture capitalists sell their shares in the stock market at the higher price, once the company reaches the profitable stage. The other options can be IPO, acquisition by some other company or purchase of the venture capitalist share by the promoters or outsiders.

Conclusion

It is evident that there are fewer Cleantech technologies and these companies cannot be captured by the venture capitalists, but the next decade’s renewable energy venture capital investment strategies would indeed be different from those of the previous two decades. The scope of this field will depend on the ability of the VC community to adjust to the particular characteristics of the sector. To spur the next wave of breakout renewable energy firms, it will require a more diverse group of players and funding models that integrate new private and public funding sources. The research identifies that though the investment of venture capital in the Cleantech sector has a high level of risks, the government should strengthen the encouragement of VC in the Cleantech sector.

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