General market venture capital investments in 2002 are expected to post their weakest showing since the year of funding spanning 1996 through 1997. Mirroring this trend, when the books are closed on 2002, the energy sector will have seen only $500 million (with some estimates as low as $210 million) in venture capital financing, off 37.5 percent from the nearly $800 million for all of 2001, according to Nth Power, a San Francisco-based venture capital firm which specializes in energy investments. Unlike capital raised in the publicly traded financial markets, VC deals are private with many deal amounts undisclosed. As a result, annual VC totals only reflect disclosed amounts. The software and information technologies sectors blew away all other industry groups with a combined $10 billion in disclosed VC deals on the year. The energy sector has traditionally lagged behind these and other groups in the volume of venture capital raised. VC firms and other market participants tend to focus almost exclusively on later-stage start-up operations, on the verge of introducing commercial products. These mostly privately held companies compete against other like firms for first, second and third rounds of financing, with the ultimate goal of a balance sheet worthy of the IPO market.
2002’s decline in energy sector VC financing extended last year’s trend, which was down 36 percent from 2000’s record $1.2 billion in VC investments. Roughly 25 venture capital deals were closed within the sector in 2002, less than half the amount seen in 2001. This trend is likely to continue into 2003, as the sector and overall market conditions remain mired in uncertainty. However, despite the market’s baleful situation, firms with intriguing business were able to obtain financing.
AnAerobics Inc., a New York-based privately held company that generates renewable fuel through a process of waste treatment, secured one of the year’s largest deals. The company received $16.7 million in first round funding from a group that included Alliant Energy Resources (also privately held), several venture capital firms and individual investors. Pentadyne Power Corporation, a maker of flywheel power systems, which are expected to be a viable alternative to commercial batteries, received an undisclosed amount of second round financing. Solena Group, a Washington D.C.-based, privately held firm which developed technology to convert organic feedstock into synthesis gas employed as an alternative fuel in integrated combined cycle gas turbines, raised $10 million in an undisclosed round of financing.
At current levels, the venture capital raised within the sector will represent slowest activity since 1999. In spite of this, there were some encouraging developments among venture capital funded companies. The overall liquidity market for venture-backed firms appeared to be on the rebound, as seven of these companies (includes all industry groups) raised $609 million from initial public offerings in the third quarter. This is up from $345 million in the previous quarter. The median amount of venture capital invested in each deal also grew larger, to an average of $6.7 million in the third quarter of 2002. This, is part, could be the reason behind the downturn in the overall dollar amount of VC deals during the year: as firms received larger sums in earlier rounds of financing there was less need for further rounds of funding, diminishing aggregate totals. Firms were also apparently doing more with less as the time between financing rounds increased from an average of 9 months in 2000 to 17 months in 2002. Venture capital firms have also become much more selective in the companies in which they choose to fund. Nth Power said they review business plans from over 500 energy-related businesses each year and usually invests in only 5-10 of these firms.
Regardless of market conditions, venture capital remains readily available to those sector firms with viable commercial products. Conversely, companies still in the concept, research and development phase saw seed round funding virtually dry up in 2002, as VC firms became less willing to fund nascent-stage startups.
Don Diaz, Contributing Editor
Diaz is an independent industry analyst with 15 years of experience in the financial and energy markets.