However, the drop may signal a regrouping rather than a retreat from the industry as many VCs rethink their investment strategies after the 2008 economic collapse. After unsuccessful experiments in financing large-scale projects, many VCs are exploring new approaches in how they select which start-ups to back, according to a new report from Lux Research.

Titled "Navigating Through Scale to Successful Exits: A Compass for Biofuel and Biomaterial Investors," the report notes that scale remains the biggest barrier to a successful exit for companies in the space.

VCs tried to surmount this barrier by financing large-scale plant construction, but saw poor returns. Now, instead, VCs are looking at companies with more capital light business models, more flexible process technologies, and new geographies.

"The 2008 economic collapse erased any lingering illusions that VCs could make quick money in the biofuel industry," said Samhitha Udupa, an analyst at Lux Research, and the report's lead author. "In its wake, VCs have explored more strategic approaches - but not all of them are equally promising."

Lux Research categorized funding opportunities by process technologies - like fermentation, gasification, chemical processes, genetic modification, and algae - to gauge where future funding may be headed. Among its key observations:

+ Heavy investment in conventional biofuel production has changed trajectory. VCs started out in 2004 with small early stage investments in emerging technologies. But in 2006 and 2007, they took a sharp U-turn, and made several sizable early stage investments in ethanol ventures focused on more established processes. Since 2007, the direction changed again and VCs have sought more varied, and more strategic deals in emerging technologies such as synthetic biology, oleochemical processes, and gasification.

+ Recent financing rounds have shifted from enormous size to strategic value. While 2007 saw whopping investments in companies with little or no technology differentiation, recent financing has begun backing more innovative technologies. Key investments in 2009 funded technologies that are flexible on inputs and end products rather than betting on a guaranteed ethanol market. For instance, Kleiner Perkins explicitly declared its plans to minimize investments in pure-play ethanol companies - a trend that's driving the shift to smaller B and C round deal sizes.

+ VCs turned to new geographies for novel business models or semi-proven technologies. Europe and the rest of world began attracting VCs' attention in 2007. Representative deals include the $4.7 million Series A round in Israeli open-pond algae company Seambiotic, and the $30 million Series A round in U.K. cellulosic ethanol firm TMO Renewables. 2007 also saw VCs make sizeable investments in Brazilian cane ethanol, such as BRENCO's $200 million Series A round. VC interest has also spread to countries in Africa and Indonesia, chasing opportunities in biodiesel from tropical crops like palm, castor bean, and jatropha.

"Companies that are likely to see a successful exit - like Solazyme - will have more capital light business models, relevant and high profile business partners, and flexibility on the front and back end of their technology," said Udupa.

"Navigating Through Scale to Successful Exits: A Compass for Biofuel and Biomaterial Investors," is part of the Lux Biofuels and Biomaterials Intelligence service.

Clients subscribing to this service receive ongoing research on market and technology trends, continuous technology scouting reports and proprietary data points in the weekly Lux Research Biosciences Journal, and on-demand inquiry with Lux Research analysts.

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