As a VC, not every investment is a winner, here are three that ultimately didn't make a return, and the lessons gained. Nelson Mandela said “I never lose, I either win or learn”. Unfortunately, in a bad deal, money is lost forever. Can the lessons learned be used to make it back in the future? That is the aspiration. It was an expensive education on several investments such as the ones below during the cleantech boom, then the spectacular bust which had caught many people off-guard.
Whilst investor’s money was lost on these deals – the effort to do well was absolute – we did many other great deals which left us with healthy returns overall. Hindsight is 20:20. Many funds made similar mistakes during the time of the terrible cleantech boom then the subsequent bust (I am not using this as an excuse but to show it was a systemic misunderstanding of cleantech by all investors at that time). On both sides - investors and executives - we suffered from some things we should have predicted and risks we could have mitigated and some others that just blindsided us completely.
Whilst investor’s money was lost on these deals – the effort to do well was absolute – we did many other great deals which left us with healthy returns overall. Hindsight is 20:20. Many funds made similar mistakes during the time of the terrible cleantech boom then the subsequent bust (I am not using this as an excuse but to show it was a systemic misunderstanding of cleantech by all investors at that time). On both sides - investors and executives - we suffered from some things we should have predicted and risks we could have mitigated and some others that just blindsided us completely.
President Barack Obama visiting the Solyndra headquarters in Silicon Valley in 2010. After taking $535 million in government funds, the company eventually declared bankruptcy, unable to compete with companies in China that were producing lighter, more efficient and cheaper products to scale.
Solyndra – solar panel maker from the US. Took in $100’s of millions – lost it all in spectacular fashion. The bellwether company for cleantech if you ask me – a perfect example of the hysteria, bad analysis and then tragedy.
Value proposition to customer: Cheaper solar energy – a cylindrical panel of thin film solar which needed less polysilicon.
Why the company did not reach the desired exit in the time we initially considered?
We got into this company day 1 at a high valuation we believed it warranted. We could back it up with a financial model and expert analysis (you always can! – my job was to build them – now I know better). It was all on the promise of the future based on a gross margin > 50% at enormous volume sales. Any strong tech company needs >50% gross margin. We paid a huge sum of money for technical and commercial DD from top research firms. All turned up trumps (it’s amazing how you get told what you want to hear when deal fever takes hold – always take DD with a pinch of salt – these “research firms” have no skin in the game just a sweet fee).
Then a triple whammy effect took place in the market. We should have seen some of these coming perhaps:
1. Chinese producers (who were most likely getting subsidized by their government) flooded the market with cheaper panels.
2. Also polysilicon (the main raw material of solar panels) took a tumble in price making the competition’s product cheaper.
3. Feed in tariffs around the world for solar from Governments which had been overgenerous started to get rowed in. The market size shrank.
All this occurs as the company was getting ready to IPO and had started making significant sales however not at the efficiency of panel and thus cost per watt production needed. The IPO bankers realized they could not IPO a company on negative margins that promised 50%. They finally decided to pull it and saved a lot of money via the “light analysis” public equity investors (I used to be one - I know it!) so it was a blessing for them at least.
It created a perfect storm of headwinds: a market size backed by government subsidies taking a hit, whilst raw materials for competitors backed by powerful Governments got cheaper and the company underperformed in production.
Result: We lost the full investment as the company went into liquidation. Tragedy all round. The Chinese producers laughed all the way to controlling the market.
Lessons learned: A commodity industry (especially one backed by government subsidies) does not care that you have the funkiest technology – it only cares about cost. Commodity markets where you can’t differentiate are brutal. Also don’t scale while you are losing money for reasons which CANNOT be fixed by economics of scale from growth (these can be hard recognise at times however the gross margin and contribution analysis will lead you to the answer as to whether growth is your issue or something systemic is wrong).
A larger tombstone list (finally the word can be used properly) of the solar market is here.
Nanofoil from Reactive NanoTechnologies, Inc. The company was acquired by Indium Corporation in 2009.
Reactive Nanotech
Value proposition to customer: Reactive Nanotech had a new methodology (Nanofoil) of joining metals where high temperature was not needed and this could be applied locally thus potentially saving lot of money for semi-conductor and solar companies.
Why the company did not reach the desired exit in the time we initially considered?
Market adoptions did not occur as we estimated (euphemistically speaking there). I can actually point back to customer calls in due diligence where a customer said “Sure, we intend to buy $1-2 million of this in the next couple of years….” Good intentions don’t cut it. More like $0. Ever since, I am wary of customer calls as a method of due diligence. As customers are in no way legally bound by these calls – not hard say they “potentially intend” to do big business. I would probably say the same in good faith to get my potential future tech supplier financed.
(TIP: Read The Mom Test - good pointers about hearing according to the quality of questions you ask in market research).
Result: We eventually sold the company not making the sought after return to an industry player who could afford more patience. After market adoption was terrible and we struggled to keep doing bridge rounds.
Lessons learned: Market adoption especially for hardware products in markets where things have been done the same way for decades and no one is thinking it is a real problem will be slower than a kid waiting for Christmas. Fact.
Value proposition to customer: Reactive Nanotech had a new methodology (Nanofoil) of joining metals where high temperature was not needed and this could be applied locally thus potentially saving lot of money for semi-conductor and solar companies.
Why the company did not reach the desired exit in the time we initially considered?
Market adoptions did not occur as we estimated (euphemistically speaking there). I can actually point back to customer calls in due diligence where a customer said “Sure, we intend to buy $1-2 million of this in the next couple of years….” Good intentions don’t cut it. More like $0. Ever since, I am wary of customer calls as a method of due diligence. As customers are in no way legally bound by these calls – not hard say they “potentially intend” to do big business. I would probably say the same in good faith to get my potential future tech supplier financed.
(TIP: Read The Mom Test - good pointers about hearing according to the quality of questions you ask in market research).
Result: We eventually sold the company not making the sought after return to an industry player who could afford more patience. After market adoption was terrible and we struggled to keep doing bridge rounds.
Lessons learned: Market adoption especially for hardware products in markets where things have been done the same way for decades and no one is thinking it is a real problem will be slower than a kid waiting for Christmas. Fact.
The Jatropha crops cycle in D1 Oils.
D1 Oils
Value proposition to customer: Grow an inedible crop called Jatropha in African cheaply, which (apparently) does not need much water or nutrients and would grow like crazy on a dry rock even (turns out not quite…). Supply thousands of farmers with seed to grow it alongside other cash crops and take it to a regional mill. Make Biodiesel (another commodity - seeing a trend? ) Simple.….not quite.
Why the company did not reach the desired exit in the time we initially considered?
Another triple whammy we should have predicted at least elements of or gauged the risks better:
Execution of this business model was very difficult – getting thousands of farmers to grow an in-edible crop they were not familiar with which took (estimated) three years to mature. Easier to grow your normal food and cash crops than wait.
Jatropha yields did not come in as expected – turned out it needed a little more water and nutrients and time to mature than planned. Jatropha didn’t think growing on a dry rock was much fun.
The food for fuel argument of growing crops to run cars instead of feeding people did not help the market case - especially when it came to government backing subsidies. Whilst the oil price was high – fine but once oil starts coming down. Bad news.
Result: D1 Oils shares plunged on the AIM market from a 2005 high of 565p to stand on Sept 2011 at 1.8p. Catastrophic.
Lessons learned: First - a repeat mistake - An uneconomic biofuels market backed by Government subsidies - second time we fell for that one.
If a business model is very complicated to execute relying on an unknown technology and thousands of different uncontrollable independent actors – it will struggle. Uber works in this environment but their technology and value proposition is sound to both sides (as of now). This value proposition of D1 Oils was totally unproven before lots of capital was spent to roll it out.
Value proposition to customer: Grow an inedible crop called Jatropha in African cheaply, which (apparently) does not need much water or nutrients and would grow like crazy on a dry rock even (turns out not quite…). Supply thousands of farmers with seed to grow it alongside other cash crops and take it to a regional mill. Make Biodiesel (another commodity - seeing a trend? ) Simple.….not quite.
Why the company did not reach the desired exit in the time we initially considered?
Another triple whammy we should have predicted at least elements of or gauged the risks better:
Execution of this business model was very difficult – getting thousands of farmers to grow an in-edible crop they were not familiar with which took (estimated) three years to mature. Easier to grow your normal food and cash crops than wait.
Jatropha yields did not come in as expected – turned out it needed a little more water and nutrients and time to mature than planned. Jatropha didn’t think growing on a dry rock was much fun.
The food for fuel argument of growing crops to run cars instead of feeding people did not help the market case - especially when it came to government backing subsidies. Whilst the oil price was high – fine but once oil starts coming down. Bad news.
Result: D1 Oils shares plunged on the AIM market from a 2005 high of 565p to stand on Sept 2011 at 1.8p. Catastrophic.
Lessons learned: First - a repeat mistake - An uneconomic biofuels market backed by Government subsidies - second time we fell for that one.
If a business model is very complicated to execute relying on an unknown technology and thousands of different uncontrollable independent actors – it will struggle. Uber works in this environment but their technology and value proposition is sound to both sides (as of now). This value proposition of D1 Oils was totally unproven before lots of capital was spent to roll it out.
Prove the value proposition beyond a reasonable doubt before rolling out not during!!! The new tech mantra of GROW GROW GROW is fatally flawed if there in one kink in a business model. The bad effect and cash drain will multiply with the growth and you will fail as it is very difficult to fix mid-stream in my experience.
Managing capital is a privileged position of great responsibility. Unfortunately bad investments happen in VC - the risk/ return model demands it. Everything will not go your way with every investment no matter how hard you try. Some mistakes in the above list could possibly have been avoided, however optimism and a lot of capital believing in a new future of cleantech world had a strong psychological grip. Cleantech has righted itself since this time and in the main, fixed the risk/ return model, the expectations and the scaling before readiness. Wisdom that is too late for the companies above but applicable in the next round of investment.
By John Rowland
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