Seeking greener pastures

Peter Grubstein, founder and managing member of cleantech-focused NGEN Partners, began his career as a leather tanner. Surprisingly, the experience taught him many important lessons he would later apply to venture capital.

?There are a lot of analogues of the evolution of what's going on in our cleantech fund to the leather tanning industry,? Grubstein said during a recent interview in NGEN's New York office. ?If you look at what was successful, the profitable tanners were more like dairies. They were clean, they were bright, they didn't smell, and there was no mess, because they were recycling absolutely all of the chemicals and using all of the off-product.?

Grubstein's career trajectory in the tannery industry was also an indicator of things to come. He started out running a small tannery, then moved on to a larger tannery, which he grew and sold for a handsome profit. Grubstein's operational expertise in manufacturing led to an offer from a buyout shop in 1983, and for the next twenty-odd years he stayed in the financial sector.

?I think you're probably going to find that the people who are rushing into this space will probably not stay.?

He worked with a variety of investment structures, gradually moving from highly leveraged buyouts to growth equity deals to, finally, venture capital. In part due to a distaste for making companies ?sick with debt,? Grubstein found a home in the VC world, and in 2000 he set up NGEN, one of the earliest venture firms to focus on environmentally friendly technologies.

When Grubstein was running a tannery, success depended on his understanding of the materials involved. The requirements of successful cleantech investing are not entirely different; in order to spot a good deal one needs a solid understanding of the science behind solar cells or photovoltaic technology.

With this in mind Grubstein chose to open NGEN's first office in Santa Barbara in order to access both student and professorial talent at the University of California Santa Barbara. The university has one of the top environmental studies programs in the US, and is the nation's center for materials sciences.

In its early days, NGEN had the thought that it might also be able to incubate technologies coming out of the university. But Grubstein found that it often took years to prove the durability and utility of these technologies, too long a time horizon for a venture firm. The truly scalable deals were always latter stage.

NGEN Partners

Investing in the future
Apart from corporate investors, NGEN's funds are backed by several funds of funds, a large number of foundations, and some family offices.

The firm was also selected by the California Public Employees' Retirement System in 2005 as the first fund manager for the $250 billion pension plan's Environmental Technology Program. The program, launched in 2004, was charged with placing $200 million with funds that invest in environmental technology solutions. CalPERS committed $15 million to NGEN in conjunction with the program, to be invested in businesses that create new advanced polymers and plastics, energy and environmental technologies, and advanced displays and electronic technologies.

?NGEN has a proven track record of supporting companies that are developing environmentally friendly products such as more efficient catalytic converters, improved solar power platforms, wastewater treatments, and ?smart? fabrics that detect disease,? Mark Anson, CalPERS chief investment officer, said in a statement at the time. ?We're pleased to be able to break new ground in this emerging cleantech sector. We believe NGEN promises attractive longterm investment returns.?

CalPERS spokesman Clark McKinley said the pension could not comment on NGEN at this time, as its investment with NGEN's 2005 vintage fund is still too young. Indeed, the firm has yet to realize an investment.

But regardless of the returns the fund generates in the future, NGEN has already fulfilled the program's investment mandate, having assembled a portfolio of technologies that sound like the most hopeful science fiction. Grubstein shows a palpable excitement when discussing these investments.

One portfolio company, Venture Vehicles, is currently developing a serial hybrid vehicle. The car will be powered by both an internal combustion engine and an electric battery; the battery will run the car, while the sole purpose of the engine, which will get around 100 miles per gallon, will be to recharge the battery.

?What you would do is go to a gas station every 300 miles and buy three or four gallons of gas.?

?You won't even have to plug it in,? Grubstein says. ?What you would do is go to a gas station every 300 miles and buy 3 or 4 gallons of gas.?

The car will likely hit the market in 2009, by which point Grubstein said he expects more comparable vehicles to have been developed. The car and its peers will take advantage of what NGEN sees as an overall shift in the automotive industry towards promoting smaller and more energy efficient cars.

Weathering climate changes
The cleantech industry is particularly influenced by broader energy industry trends, as well as shifts in the political climate. There are countless regulatory issues, such as the extension of investment tax credits for alternative fuels for one, that have the potential to impact NGEN's investments. It has taken the Bush administration a few years longer than NGEN anticipated to acknowledge global warming, Grubstein said, and of course no one can predict what action the next admninistration will take on the issue.

NGEN certainly follows trends in Washington DC, and Grubstein has written letters and made phone calls in support of various measures, but on the whole the firm is not overly concerned with regulatory issues. NGEN has no representatives in the capital, and primarily relies on its portfolio companies to keep themselves abreast of legal and regulatory matters. The firm can afford to be blithe about developments on Capitol Hill, Grubstein says, because its portfolio is balanced to weather any changes in political mood.

Similarly, the firm factors in oil price cycles to its models. Not that many years ago NGEN was dealing with oil prices as low as $10 per barrel. The world has changed since then, Grubstein admits, but oil prices are cyclical by nature and he believes it is not unlikely that prices could come down to $40 or $50 per barrel. The price of commodities such as corn can influence NGEN's bottom line for investments in the biofuels space as well.

Despite the risks of the industry, NGEN has seen an influx of competitors as the cleantech space has become more competitive over the years. Again, Grubstein is unperturbed by this trend.

?I think you're probably going to find that the people who are rushing into this space will probably not stay,? he says, ?because it does require expertise, and also the pricing has become quite high.?

NGEN has stepped away from some of the areas of more intense competition in the sector. The firm's proactive deal sourcing strategy has also helped it to avoid paying too much for a company.

Once NGEN identifies a sector that it likes, the firm assigns a team to spend two or three months researching the sector. If the team comes back with positive findings, NGEN will do a second and more thorough analysis of the sector, in order to understand where the sustainable profits lie and to identify the key players in the industry. NGEN will meet with the management teams of between 10 and 50 of these key players to discuss the companies' financial needs and economics. After all this, NGEN may decide to make an investment if it sees a good fit. The key element of this strategy is that it is very proactive, Grubstein says, and enables NGEN to find deals rather than waiting for deals to come to the firm.

?All deals look good in a vacuum,? Grubstein says. ?What this provides is context, so that you're not a blind man feeling the side of an elephant and wondering if it's a trunk or if it's a wall.?

NGEN will likely be going back to its limited partners for a third fund in the near future. Its first fund was a $70 million, 2001 vintage fund; its second was a $180 million, 2005 vintage fund. The funds are invested along a two to three year cycle, so the next fund will likely be a 2008 vintage. The next fund will be ?much larger,? Grubstein said. The firm typically invests with large syndicates, so as the size of NGEN's bite increases it will not necessarily look at bigger deals, but will instead look to contribute a larger portion of the overall deal.

?We're trying to control [the portfolio companies] a little bit more, and that requires more money,? Grubstein says.

He also said NGEN is undergoing a fairly strong shift from being a strategic investor to being a financial investor. One of the key differences between NGEN's first fund and its second fund is that now more of its investors are entering the cleantech space because they believe there is money to be made there, not because they are looking for a source of alternative deal flow to diversify their portfolios.

?As the industry evolves, the ?green? here is the making of money,? Grubstein says.