VENTURE CAPITAL STRATEGIES: GLOBAL TRENDS 2008
INCINERATION, INDUSTRIAL ECOLOGY, INSTRUMENTATION
Investing in Sustainability and Turning Resilience into a Venture Capital Category
Jim de Wilde (www.jimdewilde.net)
Rotman MBA Venture Capital Strategies class
To be given:
January 17, 2008
Imagine the following world of the year 2018. The entire mega-complex of Toronto is a self-containing ecosystem where all the waste that is produced is transformed into energy through an endless loop of interconnected sewage systems. Waste is incinerated, recycled or neutralized through a bioremediation process. Food products are scanned for nutritional value and contaminant indexes at local produce where a price mechanism has differentiated between consumers who want (cheaper) biotechnologically-enhanced products and (more expensive) organic produce consistent with a nutrient model. Air quality is similarly monitored and real estate values consist of an internet oxidation index. A new oxidation system adds 10% to the commercial real estate value of a piece of property because of a premium for enhanced air quality. Land-use planning creates a new financial market for land-use investing, calibrating market rates for biofuels versus food and pulp and paper and inventing a futures market for conservation which makes the Indonesian and Brazilian sovereign wealth funds new players in global capital markets. Wilderness area has now a global ban on any deforestation since the 2015 preservation of oceans and forests treaty, which created an international risk market for compensating ocean and forest maintenance technologies. All this is monitored on-line through a Google maps industrial ecology system.
These are potentially the new disruptions, as powerful as broadband, or the commercializing of genomic knowledge. Companies today that are being created for aspects of this market become large, the Google of waste incineration, the Genentech of contaminant measurements. Like IBM and HP, companies like Monsanto and Novartis are evolving from being chemical or pharmaceutical companies into being part of this new sustainable technology economy.
In the new capital markets of Dubai, Singapore, Malaysia, Shanghai and Mumbai, the next generation of venture capital is starting to take form. The first wave of venture capital (in Shanghai, in Malaysia, in India) is localized business models for the digital revolution. The second wave is the commercialization of local knowledge or the backing of local entrepreneurial talent (herbal remedies in China, film industries in India). The third wave will be the collaborative venture capital networks of the new global economy, MBAs from INSEAD, Wharton, HBS, Rotman applying intellectual skills to the next generation of knowledge being produced in the scientific communities of these countries. The fourth wave will be the kind of collaborative deal-making which we are just starting to see: Singaporean capital backing an Indian film maker to create an Asian media centre in southeast Asia, Malaysia capital co-venturing with Gulf Capital to create an alternative energy investing capability in Dubai and Abu Dhabi, European capital investing in a film industry in India with a global market reach.
At some point a fifth wave will take place of truly global investing: collaborative financing of next generation companies. The Google of instrumentation will have a very different financial engineering than the first Google
Resilience is to the next generation sociologists of science what chaos theory was to the previous generation. Chaos theory gave rise to open source and to networks of collaborative learning and decision- making which made social networks the core to venture capital strategies operating at the frontiers. Resilience has given a new meaning to social systems and environmental engineering. I have argued for a while that industrial ecology was one of the next “big things”, while disliking the expression “next big thing”. There are many next big things and what is big in Copenhagen will not necessarily be big in Bangalore. Canada has a suite of environmental deals ranging from waste-to-energy to alternative commercialized electrochemistry in the Ballard tradition. Canada has an engineering-driven venture capital community, with our core competences in electrical utility management and telecommunications hardware creating historical opportunities like TransAlta, Hydro Quebec and Nortel.
This means that our innovative activities are clustered in spaces different from that which would define an economic innovation geographical map of Copenhagen or Helsinki. As innovative sources develop in China, India and Malaysia at a rapid pace, those of us who examine global innovation and commercialization opportunities have to work backward from the concept of inventive sources to the concept of new demand structures.
The two related phenomena as we start 2008 are the new sources of capital formation taking place on the planet and the potential for new sources of disruptive technology commercialization to begin anywhere. In Slovenia, companies are being created around engineering innovations in UAVs (unmanned aerial vehicles). Silicon Valley is an enormous cluster of digital technology, but as much of the telecommunications-digital revolution becomes commoditized, new technological innovations: industrial ecology, noise cancellation technologies, industrial biotechnology for remediation, industrial ecology for waste management and agricultural planning may originate in Ljubljana or Bangkok. The related phenomenon is the changing pattern of capital formation in the world triggered by the importance of sovereign funds. In 2008, much capital is vaporized without being transformed into productive investment. The billions of dollars provided to the Angolan or Gabonese oil industries lack a domestic capacity for capital formation. Fortunately, new pools of productive capital formation are taking place, for example the Emirates models, in Abu Dhabi Investment Authority and MASDAR and the role of Dubai as a pool of institutional capital. Those people committed to economic development and energy security have to ensure that the next generation of wealth is turned into productive investment capital, an investment fund that cooperates with other institutions in seeding new sources of commercialized innovation.
THE NEW VENTURE CAPITAL ENVIRONMENT FOR THE CLASS OF 2008
The venture capital scene globally is in a new phase now. The success of Silicon Valley has been its extraordinary ability to organize the capital and generate the social networks required to construct the digital revolution. Its competitive advantage in these areas is unequalled and the financing of spaces like monetizing social networks, developing the clusters for producing the best practices for online advertising, creating the infrastructure for web media remains unique. But the origins of a new global capital market, defined by institutional investors which are either sovereign funds like Temasek or sophisticated investors like the holding companies that characterize Indian globalizing capital have created a different economic environment within which venture capital strategies develop.
In this new world, new sources of capital dictate new patterns of venture capital investment, new sources of innovation (Peruvian nature-based pharmaceuticals, Slovenian companies that have next-generation drones for aerial surveying, Finnish open-source software that provides smart roads through traffic management, Indian companies which create new media content) and new sources of capital for the next sectors of commercialized technology in alternative energies, sustainability infrastructure, and innovations in health care.
For MBAs assessing venture capital strategies in the 2008-2018 market, the globalization of inventive source has many implications. Those who advocated alternative energy investments a decade ago were ahead of the curve (and in some cases too far ahead of the curve to sustain a technology until the character of the market became clear). We are starting now to look at the next stage of global growth. That doesn’t mean that digital companies will not continue to be created and make investors at several stages of the investment-cycle very happy. It certainly doesn’t mean that the CleanTech wave has crested. It just means that there are categories which do not exist now and will produce significant returns for the successfully formed companies in these spaces. Today, I would like to look at three potentially new venture capital “spaces”, where deals can be made, technologies commercialized and companies created: “industrial ecology”, “instrumentation and sensors”, “incineration and waste management”.
Industrial ecology, incineration, instrumentation as it measures contaminants in the food cycle and product-development supply-chain all become areas in which a focus on sustainability creates major venture capital opportunities.
The globalization of demand also requires that venture capital firms understand how exits, second-round investments, collaborative financial engineering and a new pattern of global demands structure the deals we are making.
The “clean tech” revolution has actually been under-hyped, but key areas (smart grids, wind power, solar batteries, for example) are already well-invested. (I say “underhyped” because the full impact on new investment in food, transportation and urban design is just beginning.) We are beginning to understand the scope of the field. The buzzwords for the next decade of venture capital investment come from a mixture of sustainability, resilience, alternative energy supplies. The “resilience engineering” field is an exciting intellectual backdrop, which has to be translated into the practical language of investment decision-making. For me, the category leads to several investment implications: industrial ecology, or the technologically-enhanced view of land-use which underlies the economics of bioenergy and sustainable agriculture. How can we maximize land-use and compensate economic decisions (“how do we pay Indonesians NOT to clear rain forest?” Is the real question that should have been addressed at Bali? If a carbon trust creates a monetary value in protected lands (“mountain gorillas” and “orangutan” reserves are an example of this), at what point does the international system so create an investment opportunity (think the perfume-crop farmland of Provence) that is , intrinsically, an investment opportunity. How is this investment opportunity calculated? How do we decide whether to use land for bioenergy (a Brazilian opportunity), or protein-per-acre maximizing agricultural production. If we think of land-use as the next bandwidth, we are looking for a Moore’s Law that tells us what to invest in.
Here are some of the emerging trends in 2008 that venture capitalists aspiring to a global perspective can monitor:
(i) It isn’t bandwidth that is finite any more; it is land use. This is the first implication of “industrial ecology”, commercializing scientific innovations which accommodate high value-propositions in limited geographical areas . Anything which produces high yields of protein in a small space is a highly bankable investment. I talked last year in this course about algae-to-energy and in the intervening year, one of the great case studies is Greenfuel, with its notion of “farming” algae for transformation into biofuels. Another is to look at Dave Berry’s work from MIT. Berry is a partner at Flagship Ventures in Boston.
(ii) Biofuels makes Brazil sustainably prosperous if it can manage the industrial ecology and land-use issues. Investment clusters in Brazilian biofuels include case studies like AltraBiofuels and Infinity Bio-Energy . The McKinsey Quarterly report on “Betting on Biofuels” makes the argument for a Brazilian industry which manages the business models necessary for a tropical biofuels industry (and makes some useful distinctions about the limits of land-use tradeoffs for growing biofuels (as opposed to turning biowaste into fuels) in non-tropical markets) .
(iii) Investing in agriculturural productivity becomes a cornerstone of the new sustainable industries. Major disruptions will come in food production and sustainability. The health-environment-agriculture triad will merge into a sector where significant innovations will take place: the development of new food sources, the innovation for sustainable pest control, bioremediation and soil sustainability. While most innovation within the health triad is now coming from corporate venturing (Monsanto and Cargill on Renessen., for example), there are new companies being backed in areas like biodegradable food packaging (e.g. Novomer), environmental sustainable pesticides (e.g. EcoSmart, part of an interesting venture portfolio from the Boston-based venture capital firm Rockport) , and, of course, efficient allocation of land-use from reforestation to bioremediation and re-fertilizing contaminated soils. Another innovation not usually seen as an “agricultural productivity” application is the development of Google maps as an instrument in land-use management. Google’s efforts to develop new areas may go beyond energy and into finding commercial applications for monitoring land-patterns.
(iv) The best venture capital strategies anticipate market demands for new technological applications and design companies that meet these needs. Reliable instrumentation is now one such category. The global supply-chain has broken down recently in terms of consumer confidence in regulatory effectiveness, creating the opportunity to develop a market for technologies that measure food toxicity, contamination in manufactured products, especially toys. A case study of a new bucket of investments is the Lead Contamination bucket. Specialized Technology Resources, Intertek, SGS, Vaisala are all companies which define the competitive structure of this space. Other forms of specialized instrumentation and sensoring are reshaping diagnostics in medicine and regulatory approaches to pollution. LabNow is an example of sensor technology being commercialized, from, in this case, the University of Texas at Austin.
(v) The category of resilience gives rise to some extremely interesting thinking about systems design, architecture and self-sustaining ecosystems. Its concrete application is in the area of waste-to-energy, the simplest energy concept (throwing debris onto a bonfire) turned into advanced technology by innovations in incineration technologies, especially the ceramics and advanced materials used in their construction.
Incineration has produced some valuable business models, e.g. Preseco and Ze-Gen.
Ze-gen is a case study of a company in waste gasification.
As we have already discussed, the global financial community is creating different kinds of deals, designing new companies and business models driven by the availability of capital. A brief survey of trends in India, China and Malaysia demonstrate the extent to which globalization of capital markets is going to have an impact on the next generation of entrepreneurship and fund creation.
(vi) Shekhar Kapur has created many extraordinary pieces of film as a director (Elizabeth, Bandit Queen). He has also started to transform the global film and new media industry by putting together a Singapore based fund for Asian media. An excellent analysis is available at Knowledge@Wharton (registration required). The innovation of the fund reflects the growing trend of developing new business models for the most entrepreneurial of sectors, i.e. film. Kapur may have gambled correctly on Singapore being the convergence matrix for Asian creativity, from Chinese music to Indian film. More significantly for this discussion, it is an example of a business model disruption to existing markets and a venture capital backed approach to the development of new entrants into the global sector. The success of the Indian Film Company listing on AIM reflects a similar emergence of new players in the global film industry.
(vii) Chinese venture capital is moving rapidly from the replicating Expedia for Chinese consumer business model and is developing the early stages of a network for commercializing original Chinese ideas and competences. Some of the next stage activities are still the formula (nothing wrong with it) of sophisticated U.S. and European venture capitalists backing Chinese entrepreneurial talent in the Chinese equivalent of You Tube like Youku. Some of the next stage activities are a continuation of the best practices of Intel Capital in backing Chinese technological startups. The membership list of the China Venture capital association shows the scope and changing pattern of Chinese venture capital to one which is now much more focused on new Chinese opportunities, especially in a field like CleanTech.
(viii) Malaysian venture capital at first blush looks like it is in the stage of replicating the digital architecture of other countries in its own activities. The significance of Malaysian private equity in terms of its role in partnership with private
equity in the Gulf region. First Floor Capital has a portfolio that looks like a best-practices mix of early-stage activities in a rapidly-growing emerging market, a Chinese herbal therapies company, a bioinformatics company, a travel logistics company etc.
(ix) The Gulf region is increasingly supplying capital to global markets, as attested to by the Citicorp refinancing, but the areas of economic activity linking Gulf finance with new sources of venture capital is only beginning to be analyzed. MXV Capital has a base in Doha. An excellent blog on Gulf private equity is Zawya, which also provides an excellent analysis of the current state of venture capital in the Gulf region.
(x) Resilient engineering opens up opportunities for engineering innovations in repair with innovative technologies. De-rusting sewer pipes, developing innovations in asphalt for highway repairs are a multi-trillion global marketplace. Too frequently investors miss the opportunities presented by industrial renewal. Innovations that change the air quality of building add commercial value to the real estate market. Innovations that create heart-saving glass for architects and new lighting systems cut energy costs as dramatically as innovations on the supply side. Innovations that enable 100-year old infrastructure to continue to function by coating pipes save billions of dollars of urban renewal. The excellent Booz Allen report in Strategy and Business assesses this market. Resilience becomes a critical new category for investment in a market where it is inconceivable that existing infrastructure can be replaced.
New environments of global venture capital:
The horizons of global venture capital are, of course, without limits. The generation of venture capital firms as a core ingredient of economic development is reflected in the Malaysian venture capital community, the Brazilian venture capital association, the transplanting of core venture capital skills to the construction of the digital architecture of China, through Chinese Venture Capital Association activities and the rise of firms like Chengwei .
The mixture of globalization of the source of capital (the Dubai-Malaysia, the Indian capital market and the restructuring of the global stele industry) creates a second new reality of the global venture capital markets. The strategic aspirations of sovereign funds and new sources of capital formation will affect the supply of capital and the demand for new innovations. Alternative energy investment is a significant component of Gulf Venture capital thinking.
The third dimension is the creation of new innovation and ideas to commercialize. The global content industry is currently being restructured by Asian creative talent. Kapur’s Asian media investment strategy is the most daring case study for a global industry restructuring involving this model.
The next wave of venture capital, commercializing economic disruptions and innovations is already well under way in the categorization of the new energy infrastructure which is being created. As always, one must emphasize that there are many innovations in the digital architecture still to take place, but in terms of India and China, we know that there is a need for business models like Expedia, Razorfish, Yahoo to be adapted to Chinese and Indian circumstances. We should take seriously the point of Lelich that the Chinese business architectures will differ from the template of Silicon Valley digital architecture, but that was true of European venture capital in the 1997-2002 period where successful companies emphasized different characteristics than the U.S. template, where technological advantages made wireless video, wireless service delivered product more relevant than PC-based internet delivery systems from the beginning.
The next wave is a world of designed sustainability, where resilience is investable. It is a world of industrial ecology, well-managed instrumentation technologies and design and a system of integrated environmental management that invests in the conversion of waste to energy.
The real challenge is to see how these two trends are fused. The model going forward is a Dubai-Malaysia backed incineration technology company, accessing market opportunities in an increasingly environmentally-oriented Southeast Asia. The traditional skills of venture capital: deal-identification, financial engineering, construction of virtual management skills, collaboration with the social networks of innovation in the space where the innovation is being commercialized will all apply. They will just have additional players with different characteristics.
FROM LAST YEAR’S CLASS
Message for MBAs wanting to do venture capital:
For MBAs starting a career in venture capital, I would make three actionable recommendations from this analysis:
(i) Differentiate between backing local winners and thinking you are commercializing a disruptive technology. There is plenty of room in the market for a Tunisian social networking site or a small power generator out of local biofuels in Trinidad. Venture capital is critical to economic development in the new global economy. But these strategies and skills-sets are different from those at Kleiner Perkins or Nth Power. One can learn a great deal from analyzing the portfolio strategies of successful venture capital firms.
(ii) There are real opportunities to create value in new spaces (digital educational products for broadband, conversion of biological sources for new fuel sources). Especially in Canada, venture capitalists need to be aware that the next generation of value-creation is never a repetition of the past. By assessing social trends and demands, the next generation of venture capital will succeed. This is different from the commercialization of pent-up supply of new technology that launched the 1990s venture capital boom, i.e. the internet and satellite telecommunications.
(iii) Regardless of whether one is involved in the digital economy or commercializing a new knowledge-source, it is essential to understand the commercialization networks involved in the new product-area. The practice of venture capital requires assessing where a company fits into a regional demand or a global technology niche. There are a finite number of disruptive technologies, and many other ways to create value. All require a sophisticated understanding of knowledge-networks, technology commercialization networks and marketing and distribution networks. That is why the symbiosis between venture capital and B-Schools will continue.
Keeping Up with Venture Capital activities
There are many great sources of information about venture capital strategies and venture capital portfolio strategies now.
The re-emergence of Red Herring is a significant step. The alumni of the original Red Herring crowd have emerged at Always-On combines with the decision of another Red Herring veteran, Jason Pontin to take the MIT Technology Review into a new space as essential reading for serious venture capitalists.
The globalization of brands, like Red Herring have replaced the networking that took place around groups like First Tuesday in the hey-day of the venture capital led boom. There are extremely useful venture capital analysis websites like Venture Beat , Om Malik, the great technology writer formerly of Business 2.0, who now writes at GigaOm.
Chris Anderson’s The Long Tail builds on the themes he has articulated in his book and with Wired magazine.
John Battelle’s successes in journalism at Wired, the Industry Stand make his blog frequent reading for venture capitalists.
There is even a blog about venture capital blogs.
Also anything by Matt Richtel, the technology reporter for the New York Times is essential reading.
For discussion of European private equity, Real Deals is useful.
An excellent overview of venture capital trends as they apply to CleanTech can be found in Patrick Burtis of Amadeus Capital’s PowerPoint. Another excellent presentation can be found in Dixon Doll’s speech to the Chinese Venture Capital Association (2007).