ESP Newsletter: Issue 3

Issue 3 - April 2011


The State of the Venture Capital Market

The venture capital market is shrinking; the venture capital market is growing. The venture capital model is broken; venture capital will generate disproportionate returns in the next economic cycle. All the returns will be generated by the top firms in Silicon Valley; venture capital firms serving underserved geographies will outperform the class. You can hear all of these opinions, and many others, in commentary about the venture capital industry today.

What is one to make of these varied and sometimes conflicting messages? The Early Stage Partners team continues to believe in venture capital as a class of capital, particularly early stage venture capital. We believe in our approach to investing. We believe in our portfolio, which is maturing nicely. A number of ESP portfolio companies are outperforming their peers and we didn’t lose a single company during the economic downturn.

In the Midwestern geographies in which we concentrate our investing activity, entrepreneurship is burgeoning. Demand for early stage venture capital is greater than supply. Terms are favorable and the entrepreneurial ecosystem is supporting the formation and growth of many companies. There is a greater understanding among entrepreneurs of what it takes to drive venture-backed companies to profitability and exit.

At the same time, there is turbulence in the venture capital industry overall. Top firms are raising larger funds than they projected. Other firms are struggling to raise any capital at all. The National Venture Capital Association estimates that one-third of firms that existed ten years ago will soon depart the industry. We are clearly in the middle of a shift in the venture capital industry. What it will look like at the end of the cycle, nobody can predict.

Early Stage Partners is committed to being successful in whatever environment in which we operate. Our model has evolved and will continue to evolve. One reason that we didn’t lose any companies during the economic downturn was that we spent a lot time financing portfolio companies from non-traditional sources such as wealthy individuals, family offices, and angel networks. Venture capital financing dried up, and we innovated. That’s what entrepreneurs do, and one of the principal reasons that we are passionate about working in partnership with outstanding entrepreneurs is that we’re entrepreneurs ourselves.

The next two years will be interesting times for the venture capital industry. We look forward to continuing to share our progress with you.

We keep a running tally of portfolio company successes with updates to our Web site (, though we try not to overwhelm you with information. By registering for our RSS feed on the Web site, you can be instantly notified when we add exciting news—usually a couple of times a month.

Partner Profile

In this issue, we are pleased to profile Richard Stuebi, who leads our cleantech investment sector.

Q:  Richard, “cleantech” is a term that is increasingly widely used, yet to many people it’s somewhat intangible or elusive. How does ESP define “cleantech?”

A:  We use a pretty expansive definition: “cleantech” is the set of technologies that contribute to supplying the modern world’s demands for basic resources in a manner that is more economically and/or environmentally efficient than current approaches. By basic resources we mean energy and water, though technologies to improve land management would also fit that definition.

Many technologies that we consider to be cleantech also fit into other commonly-used venture capital technology segments. For instance, ESP portfolio company Linestream Technologies has developed breakthrough algorithms to improve production efficiencies and yields for industrial process control. In an economic sense, this improves yield, enhances quality, and improves profitability, but it also—and this is where cleantech comes in—reduces energy consumption and therefore operating costs.

Q:  How is cleantech different from other sectors that have historically been the center of attention for venture capital firms, such as software and high technology?

A:  Cleantech is benefitting from many of the advances that are propelling venture investments in other sectors—notably information management and advances in materials science—but cleantech investment opportunities are different in at least two key respects.

First, most cleantech opportunities are significantly affected by regulation. When Apple invents a new product, or Oracle releases a new software enhancement, these companies don’t need to consider the role of government actors very much. On the other hand, if you’re developing a new pollution control device, you need to know EPA regulatory requirements. If you’re developing a new power generation or “Smart Grid” technology, you need to know electric utility regulations. These regulations sometimes are a barrier to adoption of a new technology, meaning that a change in the regulation would be beneficial to adoption, but they can also be a barrier to entry for competitors that helps a company to defend its market position once established.

Second, many cleantech innovations require significant amounts of capital to develop—and more importantly—to implement in a few demonstration sites to prove the merit to potential customers. For instance, a number of companies backed by venture capital are working on innovative biofuels technologies and it will take tens or even hundreds of millions of dollars to demonstrate the technology in full scale. In contrast, many technologies companies require less than ten million dollars to achieve significant scale.

Q:  What is ESP’s approach to cleantech investing for early-stage companies in the Midwest?

A:  We focus on companies that are beyond proof-of-concept and beginning to sell their product or service to paying customers. There are a lot of interesting ideas that are still at the “science project” stage but haven’t yet been proven to be workable products. We are pleased to provide advice and encouragement to the entrepreneurs developing those technologies, but at that stage they don’t fit our investment profile.

We also strongly favor companies that are capital efficient—meaning that they don’t require tens or hundreds of millions of dollars, to be raised in many rounds, for the business to become self-sustaining. We see those types of businesses, which often require large investments in capital assets, to be more suited to project financing than to venture capital.

As an example, we are a founding investor in Arisdyne Systems, which is using patented cavitation technology to improve the efficiency of feedstock preparation for the biofuels industry. Arisdyne sells to existing biofuels refiners—improving their efficiency in a quantifiable way. This type of company better fits our investment criteria than a capital-intensive biofuel production facility itself.

Our brand of venture capital investment is therefore different from some of the large, well-known coastal venture capital firms that invest tens or hundreds of millions of dollars in cleantech companies. As an emerging, mid-sized venture capital fund in the Midwest, we don’t have that amount of capital to invest.

Q:  What makes for an attractive cleantech investment for ESP?

A:  Most venture capital investment opportunities can be considered as having four risks: technology, market, people, and finance. We like to see companies that have proven technologies, pre-existing engagement with customers, and a clear and defined path to profitability. We like to see an established, stage-appropriate management team. We can help with the financing risk, both with our own capital and with the investment partners we coalesce. Of course, finding investment opportunities with all of these attributes is easier said than done and, like other venture capital firms, we tend to invest in only about 1% of what we see.

We expect that, for most of our investments, the exit path will be acquisition by a larger company. One of the attractions of cleantech venture investing is that there are a number of larger multinational corporations with strategic interest in cleantech and, in the current cycle, ready access to cash and financing for acquisitions. For us to achieve our targeted return on investment, we need to be selective in what we invest in, obtain favorable terms, and manage the timeline to profitability and exit.

Q:  Going forward, what are ESP’s ambitions and vision in cleantech?

A:  The Midwest is underserved by venture capital. We have established a nice position in our region, and would like to cement our position as the leading cleantech venture capital firm in the Midwest. This enables us to see all the best opportunities, to attract limited partner capital, and to attract other venture capital firms from outside the region into our investments. We also want to be seen as the “go to” venture capital firm for Midwest cleantech entrepreneurs. All of this is done to maximize returns to our investors.

Q:  What advice would you give to aspiring cleantech entrepreneurs?

A:  Some themes have emerged in the ten years I have been working with cleantech entrepreneurs.

One is that the technological innovation that the entrepreneur has birthed may be wonderful, but unless someone is willing to buy it, raising capital is an uphill battle. Cleantech entrepreneurs need to relentlessly focus on the economics of the customer value proposition, which typically means that the product or service offers the customer an increase in profitability.

A second observation is that cleantech entrepreneurs have to intrinsically accept that the markets they serve are not unfettered and “free.” There is substantial regulatory intervention in virtually every segment of the energy, water, and environmental arenas, so engagement with officials in the public sector—both bureaucrats and politicians—is often a prerequisite for success. Cleantech is not the place for entrepreneurs who are unable or unwilling to engage in that way

Q:  Thank you, Richard.

Portfolio Company Profile: MAR Systems

When Early Stage Partners hired Richard Stuebi to lead cleantech transactions, a central reason was his experience in understanding the landscape of cleantech technologies in Ohio—through his work with the Cleveland Foundation and NorTech—in the U.S. and internationally. He brought with him an established network of contacts at large companies, in government, in the non-profit world, in the investment community, and in early stage companies.

Shortly after joining Early Stage Partners in mid-2009, Richard identified MAR Systems an interesting opportunity. The company was developing a commercial system to more completely and cost-effectively remove mercury from water, particularly industrial effluent, based on technology licensed from the U.S. Environmental Protection Agency.

The capture of mercury from the environment is an area ripe for innovation. Mercury is a powerful neurotoxin that accumulates in animals (especially fish) that are exposed to it, leading to bioaccumulation of mercury in humans via food consumption. Mercury is found in trace amounts in many mined materials such as coal, and as a result, many industrial activities cause mercury to be released into water streams. Available treatments for capturing mercury from water have been very expensive and insufficiently effective in removing mercury from the environment. New technologies for dealing with mercury in water were clearly needed.

MAR Systems had been nurtured from its launch by JumpStart and Cleveland angel investors from an idea with a license to a technology to a company with a demonstration system and early customer interest. In late 2009, Richard led the first institutional investment in the company, coalesced additional investors, and has continued to be a leader in the company’s financing activities. He serves on the board and is instrumental in the building of the management team and the development of the company’s strategy.

MAR Systems in now demonstrating in a number of industrial sites the ability to remove toxic mercury from industrial effluent at increasing scale. The Company’s proprietary media binds mercury into an insoluble form that makes it safe for disposal in landfills. The Company recently received additional investment capital, which should enable it to build a larger base of paying customers.

Please visit the ESP Web site ( for further information about the Company and to sign up for RSS feeds that will keep you updated as MAR Systems and the other ESP portfolio companies progress.

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