Continuing with my "all Solyndra, all the time theme", I want to expand upon what I wrote in my last post:
I am a huge fan of Tim Harford's Adapt, and indeed am now attempting to write a book of my own on a related theme. But it isn't a brief for hog-wild speculation on any sort of project. Scale matters--you can't take billion-dollar fliers on too many ideas. Appropriateness matters--retirees shouldn't put their living expenses in tech stocks. And the potential payoff matters--we should not invest billions to develop a slightly better form of white-out, or into experiments that have a 1-in-a-trillion chance of developing a low-cost way to turn lead into gold.
Obviously there are exceptions to this rule, but broadly, you shouldn't think about late-stage the way you think about an angel investment. Commenter Circleglider, who's in the business, had a lengthy discussion of this the other day:
While venture capital is of course a form of private capital, private equity firms and funds typically invest at later stages of a company's growth cycle (see this diagram for an example of what types of investors participate at the various stages of a company's growth cycle).In fact, as far as I can tell, the bulk of the late stage (post DOE's conditional approval of the loan guarantee) funds were supplied by one source: Argonaut Ventures, an investment arm of the George Kaiser Family Foundation, with another $50 million supplied by the foundation itself. Together, those two entities provided at least $388 million out of $949 million worth of the non-government debt and equity financing, or about 40% of the total.
This model assumes a stepwise function where, upon significant events, increases in a company's valuation are linked to decreases in investment risk. The private capital market is segmented based upon this stepwise function, with firms investing larger sums at later stages with lower risk.
Early stage investors (angels and venture capital) must evaluate opportunities based on very little hard data. Factors such as market size and growth, management team and technology assets drive decisions. At this stage, things like five-year pro forma financials and balance sheets are pretty much meaningless. Because investing at such an early stage is a very high risk endeavor, intangibles drive decisions and relatively small sums are invested (anywhere from $100K to $10M).
Venture capital funds don't expect every deal to succeed. Portfolio return rules-of-thumb can vary from 80/20 to 60/30/10, where maybe only 10% of all investments turn a profit. For the overall portfolio to succeed, those 10% must perform spectacularly.
Later stage private equity firms invest in on-going concerns after basic risks about markets, technology, management and business models have been resolved. Over an entire portfolio, most deals are expected to make a profit. This means PE firms can invest relatively large sums ($10M to $1B), and are comfortable with much more modest returns. Because PE firms invest in relatively mature companies, they can apply more traditional analytic methods.
Normally, internal process controls help prevent bad decisions at all investment firms. However, when these controls are either ignored or non-existent, it's usually the PE firms that fail spectacularly. This is because they can invest much larger sums (and therefore loose much larger sums), and because they assume their targets are on-going concerns (and are therefore amenable to traditional analytic methods).
Green technology occupies a special niche here in Silicon Valley. Yes, some VCs invest in green deals. But most don't. This is because these deals are not viewed as being able to stand on their own merits - for any of them to succeed, market distortions are required, typically in the form of government subsidies, tax credits, mandates, regulations or funding guarantees. This means that green deals are basically political deals - whether or not your deal works depends entirely upon what happens in Sacramento or Washington. So VCs who do invest in green deals are comfortable with these distortions, and factor them into their investment decisions.
Solyndra appears to be the result of a combination of many of these factors: certain investors were comfortable with the political aspects of the deal, they were institutionally predisposed to assume the Company was an on-going concern, and very large sums were available for investment. As a class, it appears that the total exposure of VC firms in Solyndra was around $150M (data from Solyndra's S-1 filing with the SEC). Private equity firms, however, appear to have sunk nearly $650M into Solyndra.
This is a really spectacular failure. Yes, similar things have happened in private markets before. But they've usually been associated with market bubbles. Maybe there's been a bubble in green tech - if so, only a select few got the fever. And one of the preconditions of participation was a willingness to ignore fundamentals and accept the necessity of direct government action in order for any individual deal to succeed. Some may call that a wise national industrial strategy. Others call it crony capitalism. I call it stupid.
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