New energy in venture capital

Electric Perspectives, Nov/Dec 2000 by Frankel, Adele

Suddenly, venture capitalists are investing in everything from distributed generation to online energy exchanges-and many utilities are joining them to cultivate future earnings growth.

Since the 1960s, venture capitalists have invested alongside management in young, rapidly growing companies that hold the promise of becoming significant economic contributors. They purchase equity securities, help develop new products, and generally take high risks in anticipation of high rewards. And often that reward is very high-some of the companies that have benefited from venture capital now have the bluest of chips, like Digital Equipment Corporation, Apple, Intel, Microsoft, Federal Express, and Genentech.

In recent years, venture capital firms have focused on information technology and Internet companies-from the young start-ups of recent legend to high-tech companies at later stages of their business cycle.

But venture capital has kept away from energy companies. The reason is simple-the energy industry, with its traditionally high levels of regulation, is considered slow-moving, without that entrepreneurial oomph needed to spur technological innovation. Moreover, the industry requires large sums of capital up front and offers only low returns on investments.

As deregulation and industry restructuring progress, however, prospects for high-growth technology companies in the utility industry are evolving. Venture capital firms-private partnerships or closely-held corporations funded by other corporations, pension funds, endowment funds, foundations, and other investors-are beginning to take notice, establishing funds focused largely on technology companies servicing the utility industry. In fact, a small number of such firms devote themselves solely to energy investments.

Utility companies, as well, see opportunities. Facing competition, tighter margins, and lower revenues in their traditional business, they realize that they must find new ways to raise income and also must look at new technologies to become more efficient. Many conventional utility companies have set up venture arms to finance high-growth companies such as Internet exchanges for oil, gas, and power; utility bill presentment and consolidation; and other business-to-business e-commerce services. In addition to the internet, many dollars are being poured into companies that develop alternative energy sources, especially fuel cells and other types of distributed generation.

Relatively speaking, venture capital investment in energy technologies is small, considering that investments in the Internet are in the billions. But in the past five years, the surge in venture funding cannot be missed. In 1999 a whopping $682 million was spent on energy, in contrast to a mere $50 million spent in 1995. (See Figure 1.) It promises to increase.

Most of this capital has been going to online energy exchanges, but there has also been an increase-from $3 million in 1995 to $20 million in 1999-in funding for alternative energy ventures. (See Figure 2.)

Venture capital investments for 1998-1999 also show that individual energy-related companies receiving financing obtain on average $1 million to $5 million, but in some cases as much as $50 million was received. Proceeds from these rounds of financing are typically spent on physical and technological infrastructure, development of business-to-business e-commerce, telecommunication, and research and development of alternative energy sources.

More than giving utility companies a financial stake, such investments also gives them a stake in the technology itself and the future of that technology. Investors are predicting that the energy industry will experience a giant boom mirroring that of the telecommunications industry after its deregulation.

Venturing Out

Although energy companies can invest in preexisting venture capital funds, they often prefer to establish their own funds. This gives them a chance to review business plans for themselves and receive a glimpse of the latest technology which they can choose to incorporate into their own companies to become more efficient.

Avista Corporation is an archetype of a long-- established energy company that has under-- gone major transformations to stay afloat in the reorganized energy market. Expanding beyond its traditional roots in the energy industry, Avista Corporation has created affiliated companies like Avista Advantage (an e-commerce source that consolidates and analyzes customer energy bills), Avista Labs (a developer of modular proton exchange membrane-PEM-fuel cells), and Avista Communications (a provider of telecommunication services).

Last April, Avista formed a new affiliate company Avista Ventures, which seeks investment opportunities in start-up, development-stage, and rapid-expansion phase companies that will complement the parent corporation's affiliated companies and provide them with essential tools to help them expand.

Avista has allocated $100 million to fund energy-related projects. Michael B. Cahill, president of Avista Ventures, attributes the change in focus partially to the deregulation of the energy market and partially to the need to find solutions to energy supply shortages and high customer prices. To Avista Ventures, the parent corporation has already committed $10 million to $20 million for 2000 and a similar amount for next year. The venture firm plans to invest directly into five or six companies each year. "We intend to provide `smart money,' a venture capital term for the involvement and guidance that accompany the money invested into a company," states Cahill. "Although we currently have minor stakes in the companies we invest in, we are looking ahead and only choosing companies that we can form strategic alliances with in the future."