Tyler and I wrote an article today for Forbes on the solar software market: Here Comes the Sun: How Software Makes Solar Energy More profitable. The content is below for your readership as well.

The first wave of solar innovation was focused on getting costs down. Now, the industry must look to software and automation to unlock the next phase of growth.

The solar industry is massive – and still growing rapidly

Solar is a $100 billion industry by enterprise value in the U.S. alone. In 2021, the solar industry installed 191 GW globally, more than six times the scale from 10 years ago. In that time, lighthouse success stories have emerged in the public markets. As of 2021 year-end, there are handful of solar companies publicly listed on U.S. stock exchanges with a total combined enterprise value of $86 billion, according to data from Pitchbook. Among them are Enphase, First Solar, SunRun, Sunpower, Shoals Technologies, Sunnova, and Array Technologies. Several large privately held firms focused exclusively on solar or with large business units devoted to the sun are achieving success as well.

Despite its exponential growth, the solar industry is still in the earliest of innings. In the U.S., less than 2 percent homeowners have installed solar on their rooftop. Solar accounts for only 3.4 percent of global energy production today. That figure is expected to increase tenfold or more by 2050. Even with further cost declines across the value chain, solar could easily become a multitrillion industry globally over the coming decades.

So, what could possibly slow it down? Despite impressive topline revenue and unit growth, many solar companies struggle with profitability. From 2019 to 2021, the top 10 public U.S. solar companies by market cap generated a median gross margin of 27 percent, EBTIDA margin of 11 percent and free cash flow (FCF) margin of -6 percent … not quite yet cash flow generating machines.

Many private solar companies face similar financial challenges as their public peers, including low gross margins and high OpEx budgets to drive growth, therefore requiring large amounts of cash to fund marginally profitable operations. Although significant negative cash flow is not uncommon among early-stage, venture-backed companies focused on building a product, developing customer relationships and scaling revenue, we’re seeing solar players up and down the value chain face similar challenges when it comes to achieving scale and profitability.

The primary challenges solar faces today:

• Solar customer acquisition is insanely costly, especially here in the U.S.
• Solar financing innovation has stagnated since early pioneering efforts in third-party ownership and solar loans
• Interconnection permitting is crippling close rates, whether large-scale solar connecting to the transmission network or small-scale solar feeding local distribution power lines
• Utility-scale solar developers need more than headcount, with talent shortages and lack of streamlined processes threatening future scale

The solar industry’s best chance to continue its torrid growth, while concurrently flipping on the profit spigot, is to embrace software and automation.

In particular, there are four software-based innovations I believe will transform the solar value chain:

1. Machine learning software can help automate and lower costs of customer acquisition

Customer acquisition is the single largest contributor to solar soft costs. In 2020, U.S. residential solar companies spent between $800 million and $1.5 billion on sales and marketing alone. Much of that expenditure still resides in traditional techniques such as cold calling, door knocking, radio ads, and the like. With homeowners spending $20,000 or more on residential solar arrays, there is no doubt that buying solar is a significant financial decision – and one that requires a human’s touch prior to close. However, I believe a considerable portion of the upfront customer qualification, lead generation, initial sales interaction and formal proposal generation can be done digitally, remotely, and much more efficiently.

Energize portfolio company Aurora Solar recently launched a groundbreaking new product that leverages satellite data, computer vision and machine learning models to identify optimal solar customers. Innovation like this will be key in solving solar’s customer acquisition cost problem.

• The solar financing market is ripe for disruption

Most U.S. residential solar projects employ financing of some form. As of 2021, cash purchases account for less than a fifth of all projects, while loans and third-party-owned Power Purchase Agreements (PPAs) are utilized in a majority of cases. The solar financing opportunity is lucrative, and a host of increasingly large-scale, dedicated solar financing companies have emerged, from GoodLeap and Mosaic for solar loans, to SunRun and Sunnova for PPAs.

However, a lack of innovation in solar financing over the past five years combined with low interest rates has led to excessively high financing costs being passed through to the customer. Solar loans, for example, have an average origination fee as high as 15 to 20 percent. This fee goes to cover things like customer acquisition, underwriting analysis, and kickback to the installers that bring financiers deal flow. Put into perspective, home mortgage dealer fees range from 0.5 to 1 percent, while auto loan origination fees (a similar ticket size purchase) range from 1 to 2 percent. Today, most solar financiers employ complex structuring techniques that ultimately benefit the financiers and the installers they provide kickbacks, at the expense of the customer.

Solar financing represents a ripe opportunity for software innovation. Employing a more transparent sourcing approach and data-driven underwriting that reduces loss ratios could bring these fees down to as low as three percent for the solar customer. Dramatically lowering solar financing costs would improve the accessibility to a broader demographic group, encouraging more widespread adoption. At some point, a software-enabled disruptor will see the vast amounts of revenue generated by leading solar loan providers as an opportunity that can’t be ignored.

•  Simulation techniques can drastically improve interconnection inefficiencies

Getting solar energy connected to the existing power grid is not easy nor cheap. Nearly half of residential solar customers cancel their solar purchase due to delays in permitting and interconnection. Large-scale solar farms in the U.S. currently wait two or three years for interconnection to the transmission network. As a result, only 25 percent of proposed solar projects that apply for interconnection ultimately make it to commercial operation.

Why? Utilities and transmission operators must evaluate and study renewable energy interconnection to ensure power grid reliability before approving any interconnections. Unfortunately, this process is anything but efficient – relying primarily on manual engineering efforts and outdated analysis tools. The slow and clunky interconnection process can have a significant impact on solar providers’ bottom line. In our own analysis of SunRun, we estimated $200 million of revenue lost due to interconnection and permitting delays. Add to that another $30 to $50 million in customer acquisition costs for projects never installed, and we’re looking at a potential net profit loss between $70 and $100 million.[1][LK1] 

The good news is that readily available software tools that leverage cloud computing advances and AI-based simulation techniques can compress weeks or months of analysis time to minutes. If you’re interested in learning more about software innovators addressing interconnection, this blog post covers the topic in detail.

Utility-scale solar developers finally adopt software and automation at scale

Utility-scale solar developers have traditionally been slow to adopt dedicated vertical solar software. Most firms have employed a mix of home-grown applications with off-the-shelf software from legacy vendors or new cloud-entrants. Oftentimes, these tools are combined with in-house customization and bespoke integrations.

Instead of investing in software and automation, fast-growing solar developers have responded to rapid growth with equally rapid hiring. Careers in engineering, supply chain, finance, legal and data science have boomed in the large-scale solar industry. More jobs in solar is a win-win, but hiring is not the solution for achieving long-term scale and sustained growth, especially with talent wars at an all-time high. The solar industry simply cannot scale to the level needed to meet U.S. clean energy goals by relying on headcount growth alone.

So what is the solution? Dedicated, holistic efforts to embed software and automation that is tailored for the utility-scale solar value chain. Some examples:

• Satellite-based computer vision techniques to rapidly assess land feasibility for solar
• Purpose-built engineering and design software that incorporates the nuances of large-scale solar farms like land grading, vegetation and local weather patterns
• The latest technological advances such as bifacial modules, advanced tracking systems and novel inverter technology

We have seen early signals that leading solar developers are dramatically expanding IT and analytics budgets, from single digit millions to tens of millions of USD annually for the largest firms. A solar software unicorn could be built by solely focusing on utility-scale plants – the recent acquisition of AlsoEnergy by Stem for $695 million is a recent indicator that we are close!

The sun also rises

Solar’s first wave focused on bringing PV module and power electronics equipment hardware costs down through materials R&D and manufacturing scale. The second wave will be about embracing innovative, customer-friend business models to stimulate adoption by homeowners, businesses, and power companies. My prediction: solar’s next wave of winners will be defined by embracing software to generate profitable growth as the industry matures.

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[1] These are Energize’s own estimates and are based on nonproprietary, publicly available information.

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On Friday Invenergy announced a $3 billion minority, growth equity investment from Blackstone. Existing capital provider, CDPQ, and Invenergy management retain majority control, and Invenergy’s management remain in control of all operational decision making. The press release can be found here. Invenergy was a founding partner to the Energize Ventures story. The Invenergy cofounders, Michael Polsky and Jim Murphy, have seats on the Energize investment committee and provide me with invaluable firm-scaling insights.

Blackstone is at the pinnacle of private markets investing. Blackstone has traditionally focused their infrastructure investments on the traditional hydrocarbon markets, but that focus is changing. The firm has actively discussed (as recently as their Q3 earnings announcement) their intent to deliver more capital to the energy transition.

On ESG. So, what I’d say on that is I think the most relevant areas for us are three areas. We actually talked about this at our Board meeting this week. In the energy credit and energy debt areas, if you went back in time, there was much more orientation toward hydrocarbons and E&P. That — a lot of those activities we’ve deemphasized in a significant way over the last 3 years or 4 years. And we’ve been doing much more around the energy transition and have great success. We announced a big transmission line of hydro-power from Quebec to Queens a few weeks ago. We put an investment into a public company called the Array Technologies, which moves solar panels. We did a preferred with warrants. So, we’ve had a lot of success in that state.

And I would expect the next vintages of our energy equity and energy debt funds will be heavily oriented toward the transition, toward sustainability. I think investors will react well. And I think similarly, we’ll do more in infrastructure, another way investors can play it with us at Blackstone. So, there is a lot of investment demand. And then I would say in some of our more liquid structures and areas, some of the things we do in insurance on asset backs, I think you’ll see more there. So, I think overall as an asset class, the demands for capital are enormous and I think a lot of it will come from private capital. So, I think that bodes well, but it’ll be expressed at our firm in multiple areas.

Jonathan Gray, President & Chief Operating Officer @ Blackstone

Invenergy Renewables is now one of the largest (if not the largest) privately held renewable energy developer in the world. To-date, Invenergy has built 175 projects totaling 25,000 MW and Invenergy is currently developing the largest wind and solar sites in North America.

With more of Invenergy’s customers: utilities, corporations, banks… all looking to own more renewable assets to meet their decarbonization goals, Invenergy is in a fortuitous position where demand for energy assets exceeds the current development cycles. This investment pairs Blackstone with CDPQ as the two premier capital partners enabling Invenergy’s growth.

The Invenergy team is pleased to welcome Blackstone, a leader in the renewable investment space, as our partner. We greatly value our long-term relationship with CDPQ and are thrilled to continue to accelerate the clean energy transition with Blackstone’s additional investment and capabilities.

Jim Murphy, President & Corporate Business Leader at Invenergy

For Energize, we are quite fortunate. We have had a tremendous learning relationship with Invenergy. We get to learn what technology their engineers need to meet the scale of the renewable energy revolution. CDPQ, a premier pension fund, has also already been a foundational partner for Energize and we continue to learn and provide value to their global footprint. With Blackstone now as a new “cousin” I am looking forward to how Energize can begin to become a thought partner to Blackstone and their infrastructure portfolio. The energy transition is still in the early innings.

Earlier this morning Axios published an analysis on the ongoing consolidation in the climate modeling arena.

You can find the article here.

Energize made an investment in the space in early 2019 when we led the Series B in Jupiter Intelligence. Our belief then was that new climate modeling techniques, enabled by the newest data sources and latest machine learning models would outperform older systems.

As evidenced by this article, the incumbents: mega firms like S&P, Moody’s, McKinsey… they are all scrambling to keep up with the changing expectations of their own customers. Most of the incumbents have now acquired a newer generation technology start-up. The prices for these M&A events range from undisclosed to $2 billion.

We still believe Jupiter is the best of this generation and that they will be a big, standalone company. Here is a snippet from the article on Jupiter.

If you have followed this site, you have seen me post some positive endorsements about Ford. I’ve been quite consistent that I think they are the most proactive incumbent automotive OEM to pivot to the electric vehicle movement. In addition to taking their flagship vehicles and making them EVs (Ford F-150 and Ford Mustang) the firm also made a commitment with Sunrun to deliver full-home electrification solutions. The net is that they are “burning the combustion engine bridge” and making the commitment to electrification.

I think Ford will be successful because they are a trusted brand with a diehard following and they aren’t being subtle about their interest and dollar commitment to EVs.

When Ford CEO, Jim Farley, launched the electric Ford F-150, he projected 40,000 cars per year in interest. In September they increased that total to 80,000 vehicles and just yesterday they nearly doubled the figure again: Ford is now building capacity to meet over 150,000 electric Ford F-150s per year.

While Tesla is the undisputed leader in electric vehicles, I think Ford’s trajectory is the most exciting and is going to be the clear #2 player in EVs over the next decade. And they might even make the move to #1. The company’s stock is up 181% in the past 12 months, so I think the market is starting to realize the company’s commitment and opportunity.

Yesterday I wrote about the return profiles for emerging managers. That Pitchbook data showed how emerging, specialist managers outperformed the market. This morning one of my teammates shared an article about how LPs are thinking about Fund allocations in 2022.

This data, shown below, indicates that LPs are looking to allocate more capital to emerging managers. Given that most investment firms in the broader energy and sustainability markets are on a newer vintage fund, this likely means more capital coming to the sustainability and technology markets. Energize is seeing an increasing number of excellent investment opportunities, so I firmly believe this capital can be deployed successfully over the coming years.

I saw an analysis recently on performance details around “Emerging Managers”. Emerging managers are investment firms, like Energize, that are in the first 3-4 flagship funds, and within 10 years of founding. Most of the below data came from Pitchbook, a data platform owned by Morningstar. The key takeaways are below:

• Contrary to conventional wisdom, there is little differentiation in step-ups between larger emerging manager funds ($500 million+) and smaller funds.

• Also contrary to conventional wisdom, emerging managers do not consistently outperform established managers, although there are some nuances. First funds exhibit the most performance variation, while second funds underperform and third funds slightly outperform. However, these trends vary significantly by vintage. Very large emerging manager funds ($1 billion+) perform in a tighter band, with less outperformance. Additionally, first-time funds return capital more quickly than second and third funds.

• Since the global financial crisis (GFC), specialist emerging managers have outperformed generalists. (This point is a pillar for Energize – industry expertise and access is a big driver of our returns)

• At each stage of progressing from Fund I to II, III, and IV, about one-third of managers fail to raise the subsequent fund. The success rate for subsequent fundraises increases modestly as fund number increases.

• Because managers often begin fundraising well before they have realizations from their previous fund, LPs primarily look for persistent strategy execution when deciding whether to reup with an emerging manager. Failure to raise a subsequent fund can often be traced to early portfolio losses or key personnel turnover. (Do what you told your LPs would do!)

The Energize team is going to release a more formal summary of our 2021 activities. I can’t wait to share more about that – and about some key events we have underway. (We have 4 investments to announce in Q1!)

There is a lot of change and growth in the market. With so many moving parts it is easy to get disoriented. The times may change, but the basic rules stay the same. And the most important rule is to work with great people, who you trust.

Energize began 2021 with 10 team members. Right now, we have 19 team members (16 onboard, 3 scheduled to start in Q1). Our 2022 team plan has us around 25 by year-end. Why the growth?

We believe the unique characteristics required to be a successful asset manager at the intersection of sustainability and technology necessitates an entirely new type of firm. And we are building that new firm from the ground up. These new team members will help us serve our most important stakeholders: the entrepreneurs. We intend to double down on our commercial value-add, but also grow our platform to better serve the entrepreneurs all the way to their IPOs. We will also better emphasize our approach to sustainability: financial and impact returns are very aligned within our investing thesis, and we are going to help our portfolio better elevate those insights. Of course, we will also grow the investor ranks with 4-5 new investors hires in 2022. Most of these jobs will be posted here.

Our team has been tracking the carbon markets and what voluntary and regulated structures may grow into over the coming years.

Like with any growing asset class or trade-able security, there are several parameters around measuring and quality that need to be confirmed. A recent McKinsey report highlighted the market size opportunity and the key details for the voluntary carbon markets. That report can be found here and we thought it was a good summary of the structural improvements required to create a more scalable carbon market.

Building on other recent work aimed at developing the voluntary carbon market, in particular that of the Task Force on Scaling Voluntary Carbon Markets (TSVCM), the paper proposes six steps to address these deficiencies:

1. Define net-zero and corporate claims: Agreement is needed on NCS standards and certification under one commonly accepted international-standards body. This would provide a more solid foundation for companies to make and validate claims concerning targets for carbon reduction and compensation, and to show precisely how they intend to attain net-zero emissions.
2. Highlight good practice for supply: To address public concerns about the validity of NCS in achieving real and permanent carbon reductions, practitioners need to publicize recent progress in establishing good practices—for example, more rigorous measurement and verification methods and advances in sustainable land-use policies.
3. Send a demand signal: Carbon emitters should agree to prioritize high-quality NCS credits with large co-benefits: this would send a powerful demand signal to build confidence and solidify pricing across carbon markets, and it would encourage policy makers and credit originators to increase the project pipeline.
4. Improve market architecture: Standards, infrastructure, and financing need to be developed to support the growth of NCS producing tradable credits, as set out in the recent TSVCM report. Necessary steps include the creation of carbon reference contracts that allow prices to reflect co-benefits of NCS, a radical improvement in the availability of quality market data, and the development of centralized carbon exchanges.
5. Create regulatory clarity: Policy makers must focus on turning national and corporate carbon-reduction targets into actionable plans, underpinned by binding regulation. Clarity is also needed around how NCS projects can be accounted for within national carbon-reduction goals, how to integrate voluntary and compliance carbon markets, and how to organize the international transfer of carbon credits.
6. Build trust: There is a need for greater collaboration among stakeholders in order to address the perceived credibility issues of NCS. A coalition of high-level champions can help amplify the call for high-quality, high-ambition NCS.

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As I wrote to my team, the banks showing up are a proxy for the readiness of the market. The scale of the carbon markets will create many banking & fee opportunities for the investment banks. And when they show up, they will bring institutional process, credibility, and capital to help address a number of deficiencies labeled above.

There are a few notable firms in the venture landscape that have emerged with a bang over the past 5 years. One of those firms, Lux Capital, is led by Josh Wolfe and Peter Hebert. While the Lux Capital name is now well-know, the firm’s journey really is a “20 year overnight success”.

Lux Capital was founded nearly two decades before deeptech was a common term. At the time of their founding, most of venture capital was moving away from hardtech and towards internet businesses. The firm has managed the cycles and is now symbolic with meaningful innovation.

The Lux Capital team has been a friend to Energize since our earliest days. I first met Bilal Zuberi (Partner at Lux) when Energize invested in Nozomi Network’s Series B in 2017. Bilal had co-led the Series A and has been a tremendous thought partner on that investment over the years. In 2019, we co-led a Series A into ZEDEDA… where Juan and Bilal took board seats. Over the years we have also become closer with Brandon Reeves. Last year, when Energize was growing both Peter Hebert and Josh offered me and our team great advice. Peter even met with a few of our teammates in the Bay area a few months ago to provide advice on the next stage of growth for Energize.

The net here is that the Lux Capital team are great people with great ethics and drive. We are fortunate to have them in our ecosystem. I suspect we will do more together over the coming years…

Earlier this month, Peter Hebert sat down with Samir Kaji on the “Venture Unlocked” podcast. I strongly recommend you listen.

Lux Capital’s co-founder Peter Hebert on the firm’s 20 year journey, creating multi-generational success, and the changing dynamics in VC 

In the podcast you will hear about how to build a great investment firm, how to support great talent, what traits to optimize for in a hew hire, and how to keep a world-class culture. Check it out.

The past 2 years have seen great volatility in the software (and broader) markets. As shown below, COVID unknowns, digital adoption accelerating, and then a hype bubble popping have caused troughs and peaks in valuation multiples for software companies.

Looking at the following charts below from Goldman Sachs and you can see that we are still near all-time highs for these software multiples. There are a few narratives going around to be bearish on software stocks over the coming year, that could drag these multiples down even more:

1- interest rate increases. Software stocks tend to be about long-term investments with distant payoffs. Interest rate increases increase discount rates on those future earnings, lowering present valuations.

2- uncertainty in budget direction. Are we going back to the office? Hybrid? What IT systems should corporates invest it today? This uncertainty may hurt purchases for enterprise-scale software purchases.

3- distraction of outliers in growth rates. Some large software companies (Snowflake, for example) have re-accelerated sales above the $500M revenue level. This is a rare feat. These companies get major multiples (40x+ run-rate revenue) and become a beacon for other firms… and receive a lot of coverage in the press. However, most firms below 60% do ultimately fall in the 8-12x revenue multiple range.

My takeaway here is that we still may see more multiple contraction in the coming year(s). But, as the pandemic proved, software businesses are the most resilient to system shocks, and therefore have the staying power to live and grow through cycles.

A mentor frequently tells me “time is a natural form of diversification” – meaning to invest at a consistent cadence regardless of current position in the cycle. At Energize, we are maintaining our cadence, but continue to model out-year exit outcomes at historical multiple averages so that there is no multiple appreciation required to hit our targets.