A couple weeks back cellulosic ethanol hopeful Mascoma quietly pulled its IPO after it had filed to go public. It’s safe to say that the abysmal performance of the 2011 crop of biofuels IPOs, that included Solazyme, Gevo and Kior, did not help Mascoma’s chances of finding public money. Gevo’s been a particular stinker, losing over 80 percent of its value, though Kior is down almost 70 percent from its IPO pricing.

My colleague Katie Fehrenbacher has analyzed the various issues related to high levels of risk and companies like Kior. With no revenue at IPO and no significant revenue on the horizon until the company built a capital intensive production facility costing tens of millions, Kior has carried a significant level of risk for a publicly traded company.

I mention the high risk world of biofuel investing and the fact that these companies went to public markets seeking capital because two years after the 2011 class of biofuels IPOs, cleantech investors find themselves in challenges situations where it’s difficult get IPOs done. And without those investors having access to liquidity and returns, late stage companies are having harder times finding capital to push through the commercialization phase of growth.

What happened?

The IPO market all but dried up with just three cleantech IPOs in 2012 and overall cleantech VC dropped by a third. IPOs are critical for venture investors to find liquidity and produce returns, as is significant M&A activity. But IPOs that significantly underperform the market make it harder for other companies in that sector to attract VC or to go public themselves.

Of greatest concern is that as financing for cleantech gets tight, the brightest startups will struggle to find early stage capital and those companies nearing the path to commercialization will find it hard to find scaling capital.

Many of these financing issues are cleantech specific. It’s worth looking at Matthew Nordan’s analysis of the state of cleantech investing but some of the key points he makes are:

• 1) The current value of cleantech funds is about 90 percent of what LPs put into those cleantech specific funds, versus about 123 percent for the overall venture sector.
• 2) The number of cleantech IPOs is lagging and their aftermarket performance is poor.
• 3) Cleantech companies tend to take longer to IPO or get acquired and require more capital to get to profitability than say, internet startups.

IPOs and long term investors

So what to do about the problem? I spoke recently with Mona Defrawi, the founder of Equidity, a startup that has built a platform to connect promising later stage startups with buy side investors. These are the investors who would typically buy IPOs, but who now are getting access to data on later stage startups so they can consider investing in growth companies a couple years pre-IPO at attractive valuations while giving up some liquidity by doing private deals.

Defrawi has some strong opinions about how the overall IPO system is broken, much of which she blames on decimalization, short term trading, Sarbanes Oxley, and the inability to have stable markets post IPOs because there aren’t enough long term investors sticking by companies through an IPO. The net result is a world where it takes close to ten years to go public versus about 5 years in the 90s, something that has a rough impact on venture capital firms that need liquidity and need to show LPs a return. Defrawi put together an infographic to detail her view of the IPO market and to promote Equidity:

Equidity launched its list of 135 GrowthSTARS in February. These are companies that Equidity wants to be the foundation of its list of companies that it can connect with long term investors pre-IPO. Scanning the list, it included a few cleantech names such as Bloom Energy, Opower, oDesk, and BrightSource. Some of the companies on the list, like Opower, I wouldn’t think would have any trouble finding capital given its continued success. Though other names like BrightSource, which specifically has had to ditch its IPO plans as it struggles with the competitive move to solar PV technology, may need capital to survive before it ever reconsiders a public offering.

But regardless of how attractive the various companies on Equidity’s list are, the real point of interest is that Equidity wants to offer up these companies to buy side investors before the IPO, particularly in a world where venture capital has grown somewhat tight.

There are other efforts to increase liquidity pre-IPO from the likes of SecondMarket and AngelList. Equidity is another such effort though it’s trying to do so at a much larger investment size and not with a focus on making a market pre-IPO but on bringing the big public investors into private deals pre-IPO.

And if Equidity is one small step toward making it easier for cleantech companies to get later stage capital and attract investors that will stick with the company post-IPO, that could aid a recovery in the upstream venture capital that’s needed to finance the next generation of cleantech startups.

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Most cleantech start-ups require a lot of capital. The average VC-backed company that goes public in this sector raises about $120 million through five rounds of financing along the way.

Every time a CEO seeks new investment, she walks a tightrope. On one hand, she wants to raise capital at a high valuation to minimize dilution. On the other hand, she doesn’t want the valuation to be too high, because if the company loses steam it risks a “down round” ahead – i.e., raising the next round of capital a lower share price than before.

Down rounds dilute the ownership of common shareholders (the founders and employees) quite substantially unless they’re explicitly protected. This is because of anti-dilution provisions designed to protect the existing investors, who hold preferred shares; these terms are part of nearly every institutional financing and are too complex to discuss here. Down rounds can dilute those investors as well, but as long as they can pony up their share of the incoming cash, they can maintain their level of ownership. Common shareholders don’t have this luxury.

Conventional wisdom holds that CEOs should strive for the highest possible share price every time they raise money, because their number one job is to prevent dilution, and down rounds are rare events that only happen in mediocre companies.

A while back, I decided to test whether this actually holds true in cleantech. It’s particularly germane in this sector because of the large amounts of money that must be raised and the many rounds of financing required to reach the finish line.

To perform this analysis, we need time-series data on the share prices of privately-held, VC-backed cleantech start-ups. “But Matthew,” you protest, “private companies rarely publicize their valuations, and they certainly make sure to keep down rounds a secret!” In nearly every case, you’re right, but there’s one instance in which companies are legally required to publish a historical record of their private share prices: When they file to go public.

In a happy coincidence, we can presume that companies angling for an IPO have also had some measure of business success. So by examining the SEC filings of public and aspiring-to-be-public cleantech start-ups, we can determine whether successful companies always raise money at ever-higher prices, or whether they tend to stumble along the way.

From trawls through SEC filings, I’ve been able to identify 24 such VC-backed cleantech companies for which private share price histories can be reconstructed – 15 that have gone public since 2000, and nine more that have filed an outstanding S-1. (A handful of additional companies didn’t make the cut because they went public on a foreign exchange with different reporting requirements, they raised only one round of private financing, or they had a really complicated history that I couldn’t untangle.) Here they are:

You can chart the share price trajectory of each of these companies on a line chart. The x-axis of the chart is time in months, and the y-axis is share price. Each inflection point on the chart represents a fundraising round (Series A, Series B, etc.) at which capital was raised. The lines between the inflection points represent the intervals of time between fundraising events. For the companies that have filed an S-1 but have not yet gone public, the last point on the chart represents the share price at the most recent private financing. For the public companies, the last point is the share price at the IPO.

Looking across these 24 companies, three patterns emerge:

The first pattern is the build, where a company raises successive rounds of financing at steadily higher prices with no single round standing out. This is a good situation for the entrepreneur because it minimizes dilution. A venture investor with 20/20 hindsight would want to play this scenario by investing early and having sufficient follow-on capital to maintain the position, because the earliest investors tend to make the highest returns (both on a cash-on-cash basis and an IRR basis). Biofuels/chemicals company Gevo is a good example of a build:

The second pattern is the pop. In this case, a company raises capital at a modest uptick each time, except for one round where some extraordinary event sends the share price soaring. Entrepreneurs love this situation – particularly if the pop comes late, because it mitigates dilution right when big money is required! A venture investor, in hindsight, would want to get in just before the pop. Demand response pioneer EnerNOC is a great example: Its share price spiked 5.5x from its Series B-1 round to its Series C round, owing (as far as I can tell) to a really hot 2006 summer that broke demand response records.

The third pattern is the stumble. This is the position that no start-up CEO wants to be in, where something goes wrong – unexpected technology hurdle? cancelled deal? management shakeup? – and new financing gets raised at a lower price than before. Theoretically a venture investor with perfect judgment would recognize the dip as a buying opportunity, but in times like these it’s exceedingly difficult to discern a hiccup from free-fall.

A123Systems is a good case study: The company attracted more than $100 million at a big uptick in May 2008 in anticipation of an IPO, but had to raise another $100 million at a lower price the next year when the IPO got delayed.

So, of these 24 companies, how often did each pattern occur?

• Builds happened a third of the time.
• Pops occurred one-sixth of the time.
• Half of the companies stumbled. This is the most common pattern. And these are the successful companies that ultimately filed to go public; just imagine the others!

The conclusion for cleantech entrepreneurs: Watch what you wish for – you just might get it.

Every time you raise financing there will be a chorus of voices in the boardroom encouraging you to raise the biggest round possible at the highest valuation. Sometimes this will indeed be the right decision, and if you’re certain that it is, you should shoot for the stars. But often – according to this data, at least half the time – it won’t be.

Should you get over your ski tips in valuation, you’ll set yourself and your team up for disproportionate dilution in the future, where your only defense is the mercy of your board. These are the cases where it’s in your personal self-interest to raise the appropriate amount of money at a sustainable valuation from people that you trust – not the largest amount of money at the highest possible price from whoever’s willing to pay it.

Remember, the share price that really matters is the one at the very end.

Tune in tomorrow for some parting thoughts.

Matthew Nordan (@matthewnordan) is an energy VC investor at Venrock, one of the oldest and best-performing VC firms. Earlier, he co-founded and led the energy tech analyst firm Lux Research and forecasted technology futures at Forrester. There’s more where this came from at mnordan.com.

Images courtesy of Amyris and GigaOM.

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Given the success of the previous funds, Khosla Ventures does not anticipate any change in strategy. Khosla Ventures will continue to do Internet, mobile and the clean tech ventures roughly in the same ratio as previous funds.

Khosla has said his firm’s biofuel portfolio contains about $1 billion in “liquid profits” – those are tradable, public shares – thanks to several companies that have gone public over the past year, including Amyris, Gevo and KiOR.

Khosla previously raised $1.3 billion for two funds: Khosla Ventures III and Khosla Ventures Seed Fund. The Khosla Ventures III fund, with $1 billion, is a more traditional venture fund looking to invest in early-, mid- and later-stage firms, while Khosla Ventures Seed Fund has been using $300 million to invest in early-stage startups, which Khosla described in 2009 as looking for “highest risk projects,” that “often cannot find any other funding.” Those two funds were one of the first times Vinod Khosla turned to external investors, and he was previously largely using his own funds to invest in startups (pretty unusual for a VC).

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“You have incredible uncertainty and volatility in the public markets. The window is effectively closed except for the most exceptional companies that are clear leaders in their fields and really want to push through some headwinds to go public,” said Sheeraz Haji, CEO of Cleantech Group, during a conference call to discuss third-quarter venture investment numbers last week. “The performances of IPOs have been poor.”

The global market saw 14 cleantech-themed IPOs during the third quarter of 2011 that raised $1.7 billion, and 11 of them took place in China. The number showed two more IPOs than the previous quarter, but the total amount raised plummeted 23 percent. Share prices had dived as much 56 percent for all but one of the 14 companies, Cleantech Group said.

China may remain a more fertile land for IPOs, but it has problems. In fact, the government is now struggling to prop up its stock markets; a division of China’s sovereign wealth fund began buying shares of the country’s large banks on Monday.

At the Renewable Energy Finance Forum in San Francisco earlier this month, investment bankers also gave a downbeat view. The still-struggling economy and budget fights at the federal government are two big factors. Solar remains one of the top draws for venture capital investors, but the sector has fared poorly this year. It hasn’t helped that many public solar companies missed their guidance and posted declining profits or even losses earlier this year, and their market capitalizations fell off dramatically between March and September, said Amy Corinne Smith, head of global cleantech investment banking at Jefferies & Co.

“Solar is probably one of the most challenging subsectors right now. We are in an unfortunate situation right now where there isn’t a lot of visibility,” Smith said.

Tech IPO filings overall have slowed down, though there was a surge last month. The first two weeks of September saw 11 IPOs (cleantech and non-cleantech), while the second half of the month saw six, including four from cleantech companies, according to Renaissance Capital. That brought the total of pending cleantech IPOs to 13, Renaissance Capital said.

Several of them are biofuel companies that have managed to push out their public debuts (three of them have been from companies backed by Khosla Ventures). While the biofuel IPOs made money for investors, their stocks haven’t performed well. Share prices for some of these companies, such as Gevo and Solazyme, have fallen by half or more since their IPOs.

The four cleantech companies that filed S-1′s in September were from biofuel producers Fulcrum BioEnergy and Mascoma, green chemical maker Elevance Renewable, and bioplastic product manufacturer Trellis Earth Products. None has made a profit.

Other pending cleantech IPOs that could continue to be delayed include green chemical developer Genomatica, solar equipment developer Enphase Energy, smart grid tech company Silver Spring Networks, biodiesel producer Renewable Energy Group, and solar power plant developer BrightSource Energy.

Photo courtesy of Image of Money via Flickr

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The report, requested by Congress, says the U.S. is unlikely to meet the national Renewable Fuel Standard, created by Congress in 2005, that calls for gradually increasing the nation’s supply of alternative fuels from 9 billion gallons in 2008 to 36 billion gallons by 2022. Alternative fuels, which must be made from renewable sources, include ethanol, cellulosic ethanol (using non-food crops), biodiesel and hydrogen.

Struggling cellulosic biofuels

The report notes that producing enough next-gen, or cellulosic biofuels, will be particularly difficult. Sure, the Renewable Fuel Standard is creating a market by mandating 16 billion gallons of cellulosic biofuel by 2022, but the producers could fall short of that goal because of some known and hard-to predict hurdles, including: the need to convert more farms or other types of land to grow feedstocks, the high cost of converting the tough cell materials of a plant into fuel, and the dependence of growers and biofuel producers on government subsidies.

The country has no large-scale cellulosic biofuel refineries today. Cellulosic biofuels, at current production cost estimates, also can’t compete with fossil fuel prices. The federal government has doled out hundreds of millions of dollars in grants, loans and loan guarantees to help increase feedstock production and help build refineries. Recipients of these government funds are planning, and just beginning to build, processing plants. Poet recently clinched a $105 million Department of Energy loan guarantee to build a cellulosic ethanol plant in Iowa that will use corn husks, leaves and cobs.

Most of the renewable biofuels produced today are ethanol made from corn, which also is used for food for humans and animals. There has been no shortage of debates about “food v. fuel,” and the controversy isn’t just about corn.

The report noted that cellulosic biofuel production requires crops as well, and a lot of research is taking place to maximize the yield of plants such as switchgrass and sweet sorghum. Some cellulosic biofuel makers want to use wood chips or non-edible part of a food plants, such as corn stalks and wheat straw, but even those will need to be grown. The need for more of these “energy crops” will likely require more conversions of existing farm and pasture land or uncultivated land, which will fuel more debates about food prices. But the report cautioned that the impact of biofuel production on food prices is a complex question that is hard to quantify.

Do biofuels reduce greenhouse gas emissions?

All these land conversions raise a good question about whether or not biofuels reduce greenhouse gas emissions. How cellulosic biofuels will stack up against fossil fuels in reducing emissions over time is hard to gauge and depends on land conversion and production processes. Research already indicates that corn ethanol isn’t a better replacement for fossil fuels; the use of ethanol could increase air pollution, and its water use — from crop growing to fuel production — is higher than conventional fuels.

The biofuel industry’s growth still relies heavily on government help, and that could greatly affect the pace at which they reach the renewable fuel goals. Will biofuel producers be able to build a long-lasting business? Will investors shy away at first signs of reduced government support? Those will be persisting questions especially when policy is attempting to drive adoption.

Like other capital-intensive cleantech businesses such as solar manufacturing, the biofuel industry found it tough to raise private dollars to build processing plants after the financial market collapsed in 2008. The outlook has brightened over the past year as many technology producers lined up public and private investments to build their first large-scale plants (using non-food crops). Some of them held initial public offerings, which creates the impression that the age of cellulosic biofuel has arrived. Venture capital firms such as Khosla Ventures can now point to some successful exists for their portfolio companies. Biofuel companies that went public over the past year include Gevo, Amyris and KiOR.

The report recommends more research and development work to increase both the density of energy crops grown on a given land and the amount of biofuels that can be converted. The report’s authors noted that Congress asked them to layout challenges and ways to reduce the negative impact of the renewable fuel mandate on prices and animal feed, food and forest products. But the task didn’t involve coming up with suggestions to change the mandate in order to achieve greater greenhouse gas emission reduction or to compare biofuels with electricity for powering cars.

Images courtesy of Kior, Amyris, Nancy Qian.

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Khosla said his investment firm’s biofuel portfolio contains about $1 billion in “liquid profits” – those are tradable, public shares – thanks to several companies that have gone public over the past year.

“For those people like Peter Thiel who said cleantech investing is a disaster, I can say we have generated huge profits,” Khosla said during a fireside chat at AlwaysOn’s GoingGreen conference in San Francisco on Tuesday. “Not many funds have generated $1 billion in profit.”

Thiel, who made his name as a PayPal co-founder and investor, said at a tech event earlier this month that clean energy and transportation investments have been a big failure so far.

Khosla has faced criticism for his numerous bets on biofuel companies. The biofuel industry, like some other cleantech sectors, have experienced tough times in recent years as many companies dealt with technology development hurdles or tried to raise money to build refineries when private capital was hard to find.

The federal government has lent some big help with loans and loan guarantees from the U.S. Departments of Energy and Agriculture, and some of Khosla Ventures’ companies have benefited.

Starting last year, several of Khosla’s biofuel startups began to file for IPOs. Since then, some of them have made their public debut, such as Amyris, Gevo and KiOR. Mascoma filed to go public about two weeks ago and aims to raise $100 million.

Khosla held up KiOR as a case study for success during his talk. KiOR priced its shares at the lower end before the IPO, and its shares closed flat after first days’ trading. KiOR’s shares have moved up in recent weeks, and the company has roughly a $2 billion in market capitalization. The company’s technology converts biomass into a substitute for crude oil, and it raised money to build a second processing plant.

A few of Khosla’s companies haven’t fared as well. Khosla will tell you that he expects many startups to fail, and failure is an ingredient for eventual success.

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Codexis vs Gevo

Solazyme vs Amyris

Kior

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The money will come from the U.S. Departments of Agriculture and Energy, as well as the U.S. Navy, and it will go to biofuel producers over the next three years that promise to pony up at least the same funding amount to build commercial plants. The project came as a response to a plan laid out by President Obama in March of this year to reduce the country’s reliance on imported oil.

Agriculture Secretary Tom Vilsack said the initiative is unusual because it brings together three agencies to tackle three thorny obstacles that have prevented the mass production of biofuel. The agriculture department will work on securing feedstocks while the energy department will look for the right technologies. The Navy, which as a huge fleet of ships and planes, will be the customer.

The Navy aims to replace half of the fossil fuel-derived energy with domestic fuels, said the Navy Secretary Ray Mabus. That goal will require 8 million barrels of biofuel per year by 2020, he added.

Fuel produced from the initiative also will be used by the private sector. But the government is emphasizing the needs of the military to have a strong source of domestic fuels.

Private opportunities

Details of how the money will be doled out and who are the likely beneficiaries haven’t been worked out. The three secretaries said they want to distribute the money evenly across the country to help create jobs in rural areas and provide a new source of income for farmers and ranchers.

The secretaries also said they are looking for technologies that will turn non-food feedstocks into drop-in replacement for existing fuels for jets and diesel fuels. Drop-in replacement fuels by definition should easily blend with or completely replace fossil fuels, and ideally they wouldn’t require any special infrastructures for its delivery from the refineries to customers.

There already are companies working on fossil fuel replacement technologies, such as Gevo, KiOR  and Solazyme(szym), which has produced fuels from algae for field tests by the Navy.

The Navy has been testing biofuels from Solazyme and others. It also announced a similar cross-department biofuel initiative with the agriculture department before. In 2010, the two agencies signed an agreement to share “technical, program management and financial expertise.”

Both the agriculture and energy departments have given many loans and loan guarantees to biofuel producers in the past two years. Biofuel producers have relied on government for financial support because they aren’t able to secure private money, or do so cheaply, for their first commercial plant.

Although the federal government has mandates to gradually increase the amount of biofuel in the nation’s supply, whether the money is well spent remains to be seen. Many of the recipients are working on setting up the plant. Biofuel production and sales haven’t jumped substantially in the country partly because producers are finding it difficult to nail down their processes of converting biomass into fuels. Another issue has been finding investors willing to finance refineries.

Image courtesy of Solazyme

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A few of the stocks I covered yesterday are still down — like EnerNOC, but that’s due to company-specific issues. Most are slightly up, though many didn’t return to the trading levels pre-market sell-off. Here’s a run down on where the stocks I covered yesterday are at this morning:

Solar

• Solar panel maker SunPower up 3.06 percent.
• Chinese solar panel maker Suntech rises 4.13 percent.
• Thin-film solar maker First Solar is still down .40 percent.

Biofuels

• Biofuel maker Gevo is back up 10.87 percent.
• Algae oil company Solazyme is up 3.07 percent.
• Biofuel maker KiOR is down even more: 3.50 percent.
• Biofuel maker Amyris is up 0.75 percent.

Electric car and batteries

• Lithium ion battery maker A123 Systems is up 11.70 percent.
• Electric car maker Tesla Motors is up 5.67 percent.
• Battery maker Ener1 is up 6.75 percent.

Smart grid

• Smart meter and network maker Itron is up 5.14 percent.
• Demand response company Comverge is down even more, by 1.38 percent.
• Demand response leader EnerNOC crashed even more, by 36.98 percent . (Yesterday’s market crash is combined with EnerNOC’s own weak earnings statement and a downgraded position to hold by a prominent analyst).
• Smart meter and network maker Echelon is back up by 5.51 percent.

Random:

• Car sharing company Zipcar is up 2.75 percent. It hasn’t fully recovered from yesterday.
• Clean Energy Fuels, which makes natural gas infrastructure for gas-powered cars, is still down by 5.80 percent.

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