Choosing between R&D or VC

Venture capital investing is a high-risk, high-reward game.  Those of us who play it are accustomed to the odds:  Maybe one in ten investments becomes a big success, whereas maybe three or four go out of business all together.  This leaves five or six that do OK but not great.  We work to make this wide range of results, taken together, yield an attractive portfolio return for our limited partners who invest in our funds.  Anybody who thinks this is easy hasn’t tried to do it.

Recently the U.S. government ventured into quasi-venture capital investing, and I’m more than a bit worried about this.  I don’t worry so much as a taxpayer because I doubt that the investment results will be favorable, although this is a minor factor.  I mainly worry as a long-term investor in the energy sector, because the inevitable high-profile government-backed failures that will occur will cause an unfortunate investor backlash against this potentially very valuable sector.

We need fundamental transformation of our energy supply and consumption. To achieve this, we often hear calls for “Manhattan Project” or “Apollo Program” equivalent efforts to be taken on by the government.  In response to this metaphor, Congress commissioned a report* noting that both Manhattan and Apollo peak funding levels reached 0.4percent of Gross Domestic Product (GDP), whereas energy R&D funding  by the government has only reached 0.1 percent GDP once in the 35 years since the Department of Energy (DOE) was formed.  The report notes that Manhattan and Apollo had clarity of mission and goals that haven’t yet been articulated for energy, but concluded that any way you look at it, energy wasn’t getting the support and attention it deserves from the U.S. government.  The unanswered question is: How should this support be given?

Here is where the Manhattan-Apollo-Energy comparison breaks down.  The government was the customer for Manhattan and Apollo and demand for finished projects was established because the government wanted it. In other words, demand was not driven by consumer desires and profitability was never even part of the lexicon for either program.  Both programs were paid for thanks to a belief in expectations of future returns described in general societal terms.  Financial successes later came as a result of both programs; Manhattan gave rise to civilian nuclear power, and Apollo led to thousands of commercial products. But these commercial endeavors arose through long and circuitous routes and were not created by the original government-chosen teams.  In other words, the world-class, world-changing Manhattan and Apollo technologies served their original purposes in their original programs, but commercial success followed later and was led by commercially oriented management teams.

Energy supply and consumption, on the other hand, are driven from the outset by private enterprise’s responses to consumer demand.  And return on financial investment is required all along the way.  Financial success depends on accurately predicting demand and then creating products and companies to address it.  Naturally this task requires management teams chosen for their track records of commercial success. 

Finding, building and supporting such management teams is venture capital’s main stock in trade, whereas government generally doesn’t have much experience doing this.  The recent government financing of some energy-related startups shows this lack of experience and also unnecessarily exposes the entire sector to the political fallout that will follow commercial failures.  Picking commercial winners and losers is not the government’s business, nor should it be.

The new energy sector needs our government’s support to come from our government’s sweet spots:  basic R&D funding first, streamlining regulatory pathways second.  Manhattan and Apollo are shining examples of how much the federal government can accomplish along these dimensions in a short period of time.  The private sector, of which we venture capitalists are a part, has the commercial experience to take the results of these programs and turn them into new companies and even whole new industries.

*   “The Manhattan Project, the Apollo Program, and Federal Energy Technology R&D Programs:  A Comparative Analysis,” Deborah D. Stine, Congressional Research Service, 2008, Document RL34645.

Maurice Gunderson is Senior Partner, Energy and Materials, at San Francisco-based venture capital firm CMEA Capital. He has a life-long passion for anything with moving parts, especially engines, and is a strong proponent of new and innovative energy sources and technologies. He can be reached at Maurice@cmea.com.