Despite the flood of headlines announcing $400 million cleantech venture funds and rumblings of the sector’s overvaluation, cleantech investments comprise just 11 percent of total U.S. investment, and worldwide venture capital and private equity investment in the space dropped from $3.7 billion in Q1 2007 to $2.4 billion in Q1 2008, according to New Energy Finance. All hype and speculation aside, cleantech is still considered a risky investment by many investors’ standards, including venture capitalists.

“VC funding traditionally works really well for technology companies with high margins, but cleantech businesses, for the most part, bring in longer-term returns, typically with lower margins,” says Barry Cinnamon, CEO of Los Gatos–based solar installer Akeena Solar (Nasdaq: AKNS). Cinnamon also points out that cleantech companies often continue to need expansion capital, which is not consistent with today’s venture capital investment patterns.

Many of today’s cleantech companies tend to be heavily reliant on factors beyond investors’ control, ranging from fuel prices to tax credits and federal incentives, which makes them inherently risky. Unlike the dotcoms to which cleantech companies are often compared, cleantech companies also rely on the viability of a particular technology and the company’s ability to build products at scale and cost. In many cases, neither technology nor commercial viability can be proven right out of the gate.

Venture funds that invest in cleantech tend to stick to more established sectors, such as solar and biofuels, or energy-efficiency plays that resemble the more familiar software deals of yore. Venture investments in cleantech are also migrating toward later-stage deals, according to a recently released Ernst & Young report, which noted that later-stage deals made up 43 percent of financing rounds in the first quarter of 2008. Echoing a sentiment heard frequently in recent months, Richard MacKeller, managing director at Chrysalix, a Vancouver, B.C.–based venture fund focused on early-stage energy plays, says there is simply too much money chasing too few deals in the cleantech market.

The result is a dire need for funding at the extremes—early stage research and development and late stage project financing—as well as for the large number of cleantech companies that don’t fit neatly into the existing venture capital mold, which demands high, short-term returns. Fortunately, a host of new financial models is emerging to finance underserved segments of the cleantech market.

In the beginning
Federal funding for early-stage research has been steadily cut over the last few years, and startups have turned to private capital to fill the gap. But venture firms’ “early stage” funds have swollen to numbers that push them away from true early-stage investments, which require smaller but vital amounts of capital, says Jon Bonnano, chair of the Keiretsu Forum’s Clean Tech Committee and president of renewable energy startup Principle Power.