Venture Firm’s ‘Green’ Funds Top $1 Billion

New York Times - September 2, 2009

Menlo Park, CA — Vinod Khosla, the prominent venture capitalist who has been investing hundreds of millions of his own dollars in green technology companies for the last several years, will now invest other people’s money, too. Khosla Ventures, the firm he founded in 2004 after leaving Kleiner Perkins Caufield & Byers, announced Tuesday that it raised $1.1 billion in two funds that will invest in green technology and information technology start-ups. This is the largest amount raised by a venture capital firm since 2007 and the largest first-time fund raised since 1999, according to the National Venture Capital Association.

Khosla Ventures will make initial investments of $5 million to $15 million from its main $800 million fund. The smaller $275 million fund will seed very early-stage ideas with investments of around $2 million. “It’s really geared toward science experiments,” Mr. Khosla said. “The goal there is very much to take risks that nobody else will take.”

The new funds fly in the face of two of the prevailing investment philosophies in Silicon Valley. In response to diminishing venture capital returns, investors have been advocating small funds of only a few hundred million dollars and staying away from high-cost, high-risk alternative energy companies.

Mr. Khosla advocates precisely the opposite. Harnessing technology to address climate change will require the big risks that venture capitalists were once known for, he said. “We’re really about reinventing the infrastructure of society, which is the only way we’ll get the carbon footprint down, and we’re not afraid to fail.”

After a period of hyperactive investment in alternative energy start-ups, investors have been shying away from them, arguing that they cost too much. In the first half of 2008, venture capitalists funneled $2 billion into 139 clean tech start-ups. In the first half of this year, they invested only $513 million in 83 such companies, according to PricewaterhouseCoopers.

But Mr. Khosla said the notion that clean tech companies were too capital-intensive for venture capital was a myth. A start-up needs only a few million dollars to prove that its technology works, he said. If it does, it will attract interest from investors and big companies that may want to license the technology. “This is the 1980s style of venture capital — real technical risk with small amounts of money and small teams,” said Mr. Khosla, who co-founded Sun Microsystems. “Clean-tech companies taking large amounts of money — that’s project finance, not technical risk. That’s a differentiation most people have lost.”

Mr. Khosla, along with partners who have joined the firm, has been investing upward of $400 million of his own money in such companies. They include companies that reduce dependence on coal and oil, make materials like concrete or plastic in an environmentally friendly way and increase energy efficiency.

One company used less than $10 million to show that improved membrane chemistry could be used to make water desalination plants more energy-efficient. Another company is working on compressor-free air-conditioners. Calera, a third company, takes the carbon dioxide produced by burning coal and drives it through water to convert it to carbonate and then cement. Calera is already producing concrete at a pilot plant in California.

Mr. Khosla invests when start-ups are barely more than an idea, and expects many of them to fail. That strategy worked fine when he was investing his own money, but could have been a hard sell to outside investors, which is why the firm started a separate seed fund for these high-risk deals. “The terms I used to describe our seed fund were, ‘We don’t expect to be fiduciary all the time. We will often invest in things that have a high probability of failure,’ ” Mr. Khosla said.

To his surprise, there was more interest in that fund than the other. “We insisted on being in a fund like that,” said Joncarlo Mark, head of private equity investing for Calpers, the California Public Employees Retirement System fund, which invested $60 million in Mr. Khosla’s riskier small fund and $200 million in the big fund. “The opportunity to partner with Vinod in his science experiments to us is as attractive as having a later-stage fund investing in more established businesses.”

One reason Mr. Khosla’s investors are comfortable with the firm’s high-risk bets is that the partners have invested at least $100 million of their own money in the fund, Mr. Mark said.
To help the five partners invest the money, Khosla Ventures hired two new partners: Gideon Yu, former chief financial officer at Facebook, and James Kim, who ran the clean-tech practice at the venture firm CMEA.

When choosing partners, Mr. Khosla said his top priorities were finding people who had operational experience inside companies, not just M.B.A.’s, and technical expertise, two qualities he said were all too rare in Silicon Valley these days. He throws out résumés from English majors, preferring engineers who can have spirited discussions with entrepreneurs about technical risks.