Financials: what does it take to be Masters of the Universe?

Venture capital is losing its impact. Corporate R&D is unproductive. So what’s next? Can outsourcing, X Prizes, citizen crowds, and Internet billionaires offer the incentives it takes to unlock the next explosion of innovation. CalPERS realized a 0.0% return over a decade in the venture asset class, and it will be slashing its $2.1bn allocation into venture capital. Venture has been the most disappointing asset class over the past 10 years as far as returns.

A new way to fund innovation seems to be in order, and it may be different for IT and Energy VC. MIT’s Sep’12 report gives examples. On the Web, it’s never been cheaper to start a company. You can outsource software development, rent a thousand servers, and order hardware designs from China. The bets are getting smaller, but also more spread out and numerous. The U.S. Securities and Exchange Commission (plan to) allow “crowdfunding” — it will let companies raise $1 million or so directly from the public, every year, over the Internet. (This activity had previously been outlawed as a hazard to gullible investors.)

Citizen crowds have far less to offer in capital-intensive domains such as manufacturing, pharmaceuticals, and energy. Innovation in these sectors requires investments in the tens and hundreds of millions of dollars. What’s more, the payoff time is more often measured in decades than in months. Yet R&D funding in these industries is also in transition. Manufacturers, for example, are pooling resources with government help to try to gain an R&D edge in newer areas such as new energy infrastructures.

Investment teams must have Critical Capacities that enable them to take good decisions in the often counter-intuitive area of resource efficiency. Sleek electric vehicles turn out to be coal-powered; proper Life Cycle Analyses demonstrate that deploying a technology more than offset the efficiency gains from operating it. As the public gets wiser and better informed, the short-term gains achieved by the champions of these opportunistic businesses may be wiped out by a backlash on reputation that the serious companies can ill afford. Investing in these waveriders is a dangerous game for companies that do not realize the fundamentals, and may be perceived to have deceived the public.

To identify the hazards and to avoid or overcome bad decisions, financials must master some elements.

First Principles:
A proper assessment of new technologies against first principles is key to distinguish from hype, and is a critical capacity for any management firm to whom such decisions are outsourced. Studying David JC MacKay’s: Sustainable Energy – without the hot air would be a good start.

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An Architectural Vision — X-industry, X-continent, X-discipline:
Resource efficiency technologies often require integration with other technologies, sometimes from different industries. This is complex. What is needed is a vision of the shape, its constituent elements and how these components interact with each other. If you have an architectural vision, then you can build a decision framework from which you can derive clues for a robust portfolio. If well informed, financials are optimally positioned to command such technology neutral investments.

Effective Bridges, crossing cultures between start-ups, listed companies, government entities, financial investors:
Culture differences between start-ups, sovereigns, strategics and financials are a major complication on the road to commercialization of a new technology. Governance, leadership, management and operations need dynamic optimization, as parameters change over the life-cycle of the start-up and its relationships.  

Investor teams, successful in energy and infrastructure innovation in the area of Resource Efficiency and related x-industry systems integration will have a deep understanding of the technology in its context well beyond the experience of successfully managing an SME. They have hands-on experience of working on interfaces (industrial, cultural, or discipline-wise), an appreciation of what value means for different financial stakeholders, and understand path-dependence.