"Equity gap" threatens UK clean tech
As growing number of clean tech start ups struggle to attract backers, could the UK be about to miss out on the much touted "low carbon boom"?
The UK government has repeatedly stated that nurturing a profitable clean tech sector has the potential to generate both urgently needed carbon emission reductions and the sustainable economic growth that will be required to tackle the impending social and economic effects of climate change.
But despite the government's setting of ambitious targets for greenhouse gas emissions reductions of at least 60 per cent, and potentially up to 80 per cent, against 1990 levels by 2050 that signal real commitment to developing a low carbon economy the UK private investment community is still largely failing to provide risk capital to clean tech start-ups.
The UK is home to the largest private investment market in Europe. However, much of the recent expansion in the industry has been in private equity, where investments are focused on mergers, acquisitions and financial re-engineering of established companies. This does little to stimulate the technological innovation that is urgently needed in the clean tech sector. UK venture capital investment has in fact declined over recent years even though the number of companies requiring risk capital has increased. Appetite for risk in the UK capital markets is low and while the funds are certainly available they are not being invested at the rate that is needed to place the UK at the forefront of the clean tech revolution.
The ongoing collapse of wholesale capital markets is certainly a contributing factor, but the roots of the apparent stalling in Cleantech investment are not limited to the finance industry.
Clean tech companies looking for early-stage investment often find themselves caught in the equity gap between the sums offered by business angels and the larger investments available from venture capital funds. This is often because the risks associated with commercialising new technologies are considered too high for venture capital investment, but in order to reduce the risks and demonstrate that the technology is viable companies require significant working capital. Even with stated interest from potential customers some companies still fail to attract investment because of the high capital expenditure requirements for scale up to manufacture. Private finance deals do happen, but early stage companies may have to accept severe dilution of their equity to secure the funds if the investors feel that the deal is high risk.
Government assistance is available but can be difficult to access. The UK government recognises that the equity gap is most evident for those looking for funds of between £250,000 and £2m, but clean tech developments are often capital intensive, and the problem of the equity gap can easily extend up to £10m.
And even where government funding and assistance is available it is apparent that there are difficulties faced by companies wishing to access it. For example, funds are administered by a large number of organisations and each source of funding may have different criteria for eligibility and stipulate different terms and conditions for how and when the investment is deployed. As a result management teams can find themselves spending excessive amounts of time chasing after relatively small investments.
One company PA has worked with recently estimated that the management team spent a total of 45 person days competing for a government grant which resulted in an award of just £15,000. In our experience it is common for the management team of a UK start-up to spend upwards of 60 per cent of their time looking for funding, to the detriment of the technology and business development. Even when public funding is obtained the overhead spent on reporting can be higher than that for equivalent amounts of private funding.
Moreover, government investments are most often made on a matched fund basis and so clean tech companies still face significant challenges in securing investment of risk capital. Matched funding guidelines are also often re strictive and confusing.
Meanwhile, those clean tech companies turning to the private sector for investment are failing to gain the confidence of the investment community and their potential customers. A common problem facing the sector is that its very definition is vague. The traditional definition of environmental technology encompasses those technologies that protect the natural environment through the control or remediation of pollution. However, almost any technology or service with an environmental purpose or efficiency advantage over an incumbent could now be classified as clean tech. The overall picture is confusing for all concerned and as the sector develops it is likely to fragment, allowing specialised investors to find profitable niches.
And clean tech firms often fail to help themselves when it comes to pitching for backers. Environmental damage - particularly climate change - is an emotive subject and as a result many clean tech start-ups are managed by teams who are passionate about the environment. But while this commitment has many benefits, a common complaint from the investment community is that companies are often too focused on environmental benefits and fail to construct and demonstrate a compelling business case.
Equally, private investors are generally not interested in companies where the business plan relies heavily on legislative drivers, including those reliant on carbon credits, or those that do not hold the promise of high returns. Many such companies fall within the loosely defined clean tech sector and whilst they are unlikely to attract venture capital they may well prove to be a vital ingredient in the overall mix that is required to meet the Government's ambitious emissions reduction targets.
In today's climate even companies with strong customer interest may find it difficult to fund the scale-up to volume production. PA is aware of a number of opportunities for UK clean tech companies which have evaporated due to the lack of a clear manufacturing strategy. Early stage companies are often unaware of the level of contract manufacturing expertise available in the UK that can be readily accessed at the business planning stage to provide credibility for both potential investors and customers.
Despite being well understood this situation has remained unchanged for years. Forum for the Future published a 2007 report showing the UK clean tech sector to be in a strong position, having captured more than 30 per cent of European clean tech investments in the preceding year. It made a number of recommendations tp imporve further on this performance and address the problems faced by start ups, but two years on little has changed.
A 2008 survey of UK clean tech companies by the news service Greenbang also displayed a growing level of frustration at the low appetite for risk of the UK investment industry and the support being offered by the Government, with many respondents stating that they would consider moving their businesses out of the UK to countries, particularly the US, where funding was perceived to be easier to secure.
Public investment in clean tech is growing rapidly in the US. In recent months the Obama administration's stimulus package has generated a tremendous level of activity, dwarfing the levels of investment in the UK and EU. The UK is now at risk of being left behind in a market that is estimated to be worth $2 trillion by 2030.
So what should be done? Government, clean tech companies and the investment community must work together to lower the barriers to commercialisation of low carbon technologies.
Government can further simplify the process for accessing public funding by harmonising selection criteria and commercial terms across all funding bodies and increasing the clarity with which the scope of each body is communicated to the clean tech community. The UK could also invest in public goods - enabling infrastructure such as a shoreline DC grid and demonstrator projects for priority technologies - as a procurement mechanism for early stage products, possibly by adopting a model based on the US Small Business Innovation Research grant programme. Having either central or local government as a first customer would make a big difference to many start-ups.
Government could also absorb more risk in the early stages to stimulate private enterprise and as a way of providing training for the UK's emerging " green collar" workforce. Setting clear mid to long term legislative frameworks that are immune from political vagaries would also remove uncertainty that sometimes prevents the investment community from taking a longer term view. Another idea recently mooted by Lord Mandelson would be the establishment of a "new 3i" (or 3e - environment, energy and efficiency?) to stimulate investment by providing a lead investor for new clean tech ventures.
Equally, clean tech companies must become better at identifying, quantifying and communicating risks to investors. They should demonstrate access to experienced management teams and proven serial entrepreneurs wherever possible. Life Sciences start-up companies, for example, generally draw on strong science and technology advisory groups - but we do not see the same happening for clean tech companies.
The UK is also home to a wealth of contract R&D and technology development organisations that can provide rapid access to commercialisation expertise and cross-sector industry knowledge - avoiding the costly process of reinventing the wheel.
Finally, clean tech companies should focus on taking their core proposition to market, developing the business plan and refining the management team pitch, being wary of the potential distraction associated with spending too much time chasing grant funding for non-core activities.
The ability of the venture capital industry to fund the development of early stage technology businesses has dramatically declined since the heady days of the late 1990s and despite widespread acknowledgement of the problem, nothing has yet filled the void. It may be some time before this model becomes viable again. The investment community must continue raising funds and at the same time strengthen relationships with government to understand legislative drivers. Partnering with competent technical organisations for risk mitigation may also help to stimulate investment. We have noted an increasing interest in coaching clean tech companies to help them develop sustainable commercial and technical business plans, and this should be expanded.
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