Monday, December 19, 2011

Lamarck’s Legacy

A few years ago, I wrote an article that was published in Mass High Tech (yeah, yeah, I know. It’s a lousy picture…), the working title of which was “Cleantech Recapitulates Biotech.” Not surprisingly, that’s not the title it ended up with. I was making a reference to embryological parallelism, a disproven evolutionary hypothesis typically stated as "ontogeny recapitulates phylogeny," which suggested that embryological development (ontogeny) is a microcosm of the phylogenetic tree – different species' embryos pass through stages of “lower” organisms their evolutionary history as they develop into offspring (e.g., a human passes through the stages of chimp, ape, etc. on its way to becoming a human baby).

The MHT article highlights one of the key similarities between biotech and cleantech – the need to look to other industries for key executive management as the nascent industries are taking shape. It was originally written with another theme which was removed to shorten it for the magazine. The other point of similarity between the industries is the financing structure – the need for an early slug of venture cash, then long development timelines and hence the need for a much more substantial slug somewhere down the line, with no guarantee of success for many years. For those of us with some grey hair, it’s an old song. When the biotech industry was getting started, and every VC wanted to be in on the next Genentech, they were chasing biotech entrepreneurs with their checkbooks, with an eye on an IPO in a few years and a quick 5X ROI. As biotech has matured, and much of the low hanging fruit has been picked, similarly-motivated investors’ attention has turned to the sexier cleantech space.

Last week I attended a packed NECEC event at Choate on doing cleantech financing deals with large strategic partners. A great discussion with a number of industry luminaries like Bill Brady, Dennis Costello and Eric Emmons, and expertly moderated by Peter Rothstein. As I listened to the discussion, I was struck how this same discussion could have taken place (and probably did) 20 years ago in the context of biotech investment. The titles of the participants would have been the same; just the company names would have been different.

Well, there’s nothing like a good straight man. Just as I was about to make the observation (What? You thought I would attend a panel without asking a question?), Doug Zingale saved me the effort. Andrew Lackner, with GE Capital, made the comment that the difference is that cleantech is much more diverse. It includes everything from biofuels to smart grid to wind to solar, and all things in between. I would argue that the comparison is flawed. The correct one is between cleantech and life sciences (which I consider to include everything from biotech to diagnostics to med device to health care IT). If we compare just biotech against biofuels, for example, the comparison is effectively the same. However, there are two key differences.

First, a lot has changed in the last 20 years. In those days, pre-clinical companies went public; now you need Ph IIb data to do an A round. When those early biotech investors realized that Mother Nature would be the final arbiter of success, not market size and penetration and reimbursement, and that it would be 10 – 15 years before the answer was known, many became disillusioned and started looking for investments with shorter horizons. It didn’t help the life sciences industries that all the Internet opportunities came along. Some of that corporate memory has been carried into cleantech investing, and is why many more businesses look like project finance than company formation.

Second, at the end of the road with a biotech investment, you end up with a product that someone will pay you thousands of dollars a year to inject in their veins. At the end of the road with a cleantech investment you end up with a commodity. If you miss your numbers by $0.02 a gallon or KW, you’re screwed.

After the panel I spoke with Doug for a minute, who made the interesting observation that yes, it’s a commodity, but it’s worth trillions of dollars. We didn’t have time to finish the conversation (but we plan to), but I would counter that prior to the patent running out, Lipitor® was good for almost $11B of revenue for Pfizer. That’s one company with billions in revenue from one product. Trillions, yes, but it will be spread over hundreds of companies, since it’s clear that no single company will own the market for production and distribution of all cleantech products.

Still, the problem is that regardless of the similarities and differences between the industries, it’s mighty tough to get investors’ attention on a multi-year, hundreds of millions of dollars investment when they can fund the next Angry Birds, which will be profitable in about 15 minutes and will cost a lot less to get to market. What we need is to get some of the “venture” back into venture investing.