The coming revival in venture capital: 'Clean tech' will lead the way

Posted Nov 3rd 2006 5:19PM by Peter Cohan
Filed under: Other Issues, Private Equity, Next Big Thing

The last three decades have oscillated between private equity and venture capital. Right now, VCs are down and private equity is up. But 'clean tech' -- technologies that save energy and otherwise allow for a cleaner, greener world -- could revive VCs in the next decade while private equity licks its wounds.

In the 1980s, private equity was king. LBO firms were able to borrow huge amounts from banks and the junk bond market to finance hostile takeovers. The LBO boom ended badly with the collapse of junk bond king Drexel Burnham and overreaching in the form of the bidding war for the largest LBO in history --- RJR Nabisco.

In the 1990s, private equity imploded and watched with envy as venture capital prospered. It wasn't until the middle of the decade that VC firms like Kleiner Perkins were able to prosper from their investments in the Internet – beginning with the 1995 IPO of Netscape. The dot-com boom ended badly in 2000 with NASDAQ plunging -- it's down 54% from its March 2000 peak of 5,038 to its current 2,327.

In the current decade, private equity has rebounded and venture capital continues to suffer from the over-investment of the 1990s – with the exception of Google Inc.'s (NYSE: GOOG) 2004 IPO. Only 37 startups have managed to go public in 2006 -- the fifth bad year in the last six.

The M&A market is slow for startups, too. There have been only 269 mergers this year, with an average value of only $100 million. That means 2006 is likely to be the slowest or second-slowest year for startup mergers since 1999.

Meanwhile things for private equity firms have been spectacular. As of November 2,278 private equity funds had raised $177.89 billion. That bests the record set in 2000, when 630 funds raised a total of $177.75 billion. This year leveraged buyout funds have collected 66%, or $118.05 billion, of the capital raised so far, whereas venture capital firms have collected only 13%, or $23.7 billion.

Back in 2000, VC firms were responsible for 40% of the total.

Will VC firms rebound in the next decade? It looks to me like the best hope for that is in clean technology. The reason is that companies are investing in clean technology -- a key requirement for a new technology wave. With companies like Google getting five to 10 year paybacks from investments in energy saving technologies like solar, VC firms are shoveling funds into a variety of alternative energy technologies.

VCs invested $2.29 billion in clean technology during the first nine months of 2006 -- more than twice the $1.1 billion of the first three quarters of 2005, and it has already surpassed the $1.6 billion invested for all of 2005.

It should be a while before we know whether VCs will rebound in the next decade, and if so, whether cleantech will lead the way.

But if past trends are any indicator, in the 2010s private equity firms will have their comeuppance and VCs will spring back.

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, and a Professor of Management at Babson College. He has no financial interest in Google.

Tags: clean technology, cleantech, CleanTechnology, Drexel Burnham, DrexelBurnham, goog, google, LBO, private equity, PrivateEquity, RJR Nabisco, RjrNabisco, Venture capital, VentureCapital