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Investors still crazy for cleantech

It’s hard not to wonder if the cleantech sector is a giant bubble about to burst.

Earlier this month, the Cleantech Group reported that while the overall volume of venture deals sank last year, investments in cleantech companies totaled $8.4 billion, up nearly 40% from 2007. In Q3, VCs poured $2.6 billion into cleantech, a quarterly record.

“It looks like a bubble, but you have to remember that, historically, venture has ignored the area and the government ignored the area, and you had underinvestment by corporates,” says Ira Ehrenpreis, a general partner with cleantech investment firm Technology Partners. “Just to keep pace with energy growth will require some $20-plus trillion of investment.”

Kleiner Perkins Caufield & Byers and Khosla Ventures were among the most active cleantech investors in 2008, each funding at least 18 companies as of Dec. 10, according to preliminary data from Thomson Reuters (publisher of PE Week). Khosla committed an estimated $116 million to the sector, often to ambitious startups, such as solar energy company Ausra, biofuel developer Amyris Biotechnologies and diesel engine maker EcoMotors. For its part, Kleiner Perkins put an estimated $113 million to work.

Going forward, expect more VCs to follow the lead of Draper Fisher Jurvetson (DFJ), which invested in 19 cleantech companies as of Dec. 10, but committed just $50 million to them—half as much as either KP or Khosla.

Reaction to the U.S. recession is unavoidable. The Cleantech Group predicted in December that the failure rate of early stage cleantech companies could double from a typical 20% to about 40% in 2009. “We’re going to see big, later stage investments get pretty squeezed,” says Rob Day, a principal at @Ventures.

After all, a number of pre-revenue late stage deals were predicated on the idea that there would be an active IPO market in 2009, which is not likely to be the case.

“The most promising startups that were funded in 2008 will prove to be the capital-efficient ones, those rooted in a more traditional VC model,” says Day. “I think those will be looked back on as being pretty prescient.”

Ben Kortlang, a partner at Kleiner Perkins who focuses on growth-stage cleantech investing, said last week that the environment, pre-September, was falsely optimistic.

“A lot of investing was happening in the late stage clean tech space that wasn’t well understood,” said Kortlang, who was speaking while a panelist on “Financing the Cleantech Build-Out,” which was hosted by PE Week affiliate publication Venture Capital Journal.

“I don’t think we’ll return to that environment. You’ll see smart, more patient, company-building-type investors who understand what they are investing in and are willing to invest for a five-year period. The cleantech space needs to reset its expectations.”

Indeed, with a retracting economy putting the squeeze on capital-intensive companies, more investors are looking for startups that can have a meaningful impact with less capital. One example is DFJ-backed BioFuelBox, which turns waste-derived feedstocks into fuel. DFJ Managing Director Jennifer Fonstad says that BioFuelBox has a “smaller distributed model. It’s not nearly as capital intensive as you might think.”

Demand-response opportunities, which measure where energy is being used at any given time, are also receiving a good deal of attention. For her part, Fonstad is interested particularly in software and services startups that are emerging to manage lighting systems.

New cleantech firm One Earth Capital sees a host of demand-response opportunities in the field of agriculture, beginning with Puresense, which has developed a technology to enable farmers to make better-informed decisions about irrigation and fertilization through water and chemical monitoring. One Earth invested $2.75 million in the startup last year.