Konarka Technologies

Alternative Energy: Venture capitalists are betting on fuel-cell and solar-cell technologies.

By Brad Stone

Nov. 17 issue The most incongruous trait of Californias governor-elect is not his massive, middle-aged muscles or film-studded resume, but the car he drives. In the environmentally obsessed Golden State, where wind farms dot the rolling hills and solar panels cover building roofs, Arnold Schwarzeneggers fleet of Hummerseach operating at 15 miles a gallon or lessnearly passes for cardinal sin. So it was no surprise when, on the campaign trail last month, Arnold got religion for alternative energies like hydrogen and vowed to wean one of his own Hummers off gasoline. I want to show Detroit it can be done, he said. Today his nascent administration is trying to keep that promise.

COLORADO MECHANIC and environmentalist Fred Robinson says he was asked to bid for the work and submitted a design to allow the Humminator to run on natural gas and pure hydrogen. Cost of the conversion, according to Robinson: $400,000. Yes, well, keep working on it.

Arnold, it turns out, isnt the only one getting caught up in this crusade. Up and down the ranks of Silicon Valleys most esteemed venture-capital firms, well-heeled investors are starting to contemplate the possibility that alternative energy might drive the next tech boom. Computers, software, the Internetsome VCs want to add fuel cells and photovoltaic solar panels to the list of runaway technologies that have generated immense wealth.

Motivated partly by the California energy crisis, Middle East instability and recent East Coast power blackouts, $1.7 billion has flowed from VC coffers to clean-technology companies since 2000, according to the trade group CleanTech Venture Network. But the VCs, predictably, are not attracted to clean energy merely because of the world-changing implications. Theyre not tree huggers, says Ned Godshall, who recently courted investors for his New Mexico hydrogen firm MesoFuel. You have to show them they can make a load of money.

Veteran observers of the alternative-energy industry probably think theyve heard this song before. In the late 90s, while dog-food dot-coms were all the rage, alt-energy companies were quietly fashionable as well. A few even went public during the boom, but today their stocks prices are in the compost pile and their decision to go public looks unwise. Unlike todays energy start-ups that are attracting broader interest from a variety of blue-chip VC firms, those companies were largely funded by niche investors who specialized in energy markets, and by utilities and oil companies looking to keep one eye on the future while they capitalized on the status quo.

Ironically, the turbulent ride of yesterdays energy mavericks may be piquing the interest of traditional VCs whove historically invested in silicon and software. Everybody agrees the clean-energy industry will be huge, but no dominant company has emerged. If one of our firms has a breakthrough, we could end up with a monster company, says Tim Draper, a partner at Draper Fisher Jurvetson. That thinking is contagious. Two CleanTech Venture Forums this year, where investors mingled with energy entrepreneurs, were sold out.

The newer start-ups are taking a conservative approach. Instead of world-changing technologies that wont be on the market for at least a decade, the new companies are pursuing incremental advances, hoping to return investment dollars in a few years. For instance, Polyfuel, in Menlo Park, Calif., operates in a market that VCs know and trust: consumer electronics. The firm is developing components for fuel-cell batteries that will convert methanol into electricity for PDAs, laptops and cell phones.

Though traditional fuel cells are still too expensive for homes and cars, consumers already pay a lot for batteries. Polyfuel CEO Jim Balcom says that with gadgets performing more and more functionslike taking pictures and playing songsenergy requirements are exceeding the capabilities of regular batteries. Fuel cells are the only solution, he says. Polyfuels high-profile VC investors include Draper Fisher and Mayfield Capital.

Solar power is another new playground for the venture capitalists. The global market for panels that convert sunlight into electricity is decades old, with sales of panels growing at a 30 percent annual rate. But solar panels are still far too expensive, and the industry is thriving mainly because it gets help from large government subsidies and purchases that help promote clean energy. For example, in a recent project, the city of San Francisco sold bonds to help cover its Moscone Convention Center with solar cells. The city will earn the investment back over a decade of energy savings.

Todays venture-backed solar start-ups want to make cheaper and more efficient solar panels that will be appealing even without government help. Palo Altos Nanosolar, part of the uber -hyped wave of nanotechnology companies, is seeking to create microscopically small material to form a solar cell thats a thousand times thinner than todays technology. Its partly funded by Benchmark Capital, a firm that has also backed Yahoo and eBay. On the other coast, Lowell, Mass.-based Konarka, whose backers include Draper Fisher and ChevronTexaco, is also developing a plastic solar cell designed to be cheaper and lighter. Chairman Howard Berke likens his product to a photovoltaic Saran Wrap.

None of this means that hunting for money in Silicon Valley is easyonly thats its possible. For the first time, many VCs have hired associates with energy expertise to evaluate clean-technology companies. Energy entrepreneurs describe encountering open doors at VC firms, but say they must clear high bars to assuage investors skittish after the dot-com bust. Godshall of MesoFuel, which is developing a portable device to make hydrogen, an abundant energy source, recently reaped $4 million in funding. But the process was grueling. We had to kiss a lot of frogs, he says.

VCs have plenty of reasons to mix wariness with curiosity about alternative-energy companies. The movement to deregulate energy has all but died in states like California, muddying the future of the industry. Federal subsidies for clean energies like hydrogen are up in the air. Electricity from fossil fuels continues to be cheaper than anything that comes from alternative sources. And theres the inherent difficulty in developing new energy technology. This sector takes more than two guys in a garage writing software, says Dan Rastler of the Electric Power Research Institute, a Palo Alto research firm. In other words, changing the world with an innovative Web site is easy compared with saving the world with a clean renewable energy source that actually requires scientific or technological ingenuity.

With Elisa Williams