Cleantech Finance Insider

Meeting of the Minds

The process of financing the ideas of entrepreneurs is simultaneously an art and a science. The approaches of the parties involved are so disparate that sometimes it’s hard to believe that they ever get a deal done. But they do.

Entrepreneurs by their very nature must be optimistic about their specific ideas. Investors, be they venture capitalist or private equity (project) investors are optimistic about their industries yet initially cautious, if not skeptical about the specific opportunity that they are being pitched on. They have, as the saying goes, “deep pockets, but short arms.”

For the investors, the evaluation process often happens in three stages.

Stage 1: Could this really be as good as the entrepreneur says?
Stage 2: What could go wrong to keep him from achieving those goals?
Stage 3: What’s it really worth to me?

Most entrepreneurs are good at presenting to the Stage 1 questions. They draw their energy from the prospects of realizing their vision for something great and out of the ordinary.

Some however, have trouble handling the second stage. It may seem that the questions suddenly went from appreciating the upside to dwelling on the negative and taking a generally pessimistic outlook on things.

What happened? Did the entrepreneur “blow it?” Generally no. In fact, as long as prospective investors are asking questions, the process is still underway. If the pitch has been well received and the opportunity for a noteworthy upside established, then the next big questions are around avoiding outcomes that derail that vision.

It is not necessary to know and control every aspect of the business, but investors will insist that entrepreneurs know and share what is known and what can be controlled as well as explain what is still to be understood and resolved. The more one can eliminate risk the easier it will be to raise funds.

Once it has been established in the minds of the investors that there is, in deed, an attractive opportunity whose risks are known, then we move to value. Stage 3 is the creation of the term sheet laying out the offer of investment subject to verification of assertions by the entrepreneurs, among other things.

Term sheet valuations will reflect the investor’s view (realistic, they’d say) of the opportunity in light of the remaining risks. It will also be chock-a-block with protections for the investors should things not go so well.

Once the entrepreneur has that term sheet and the advice of his legal counsel, the decision to proceed with funding is his. His job of convincing investors is done (at least for now).

All that remains is to deliver on his promises!

State of the Industry

Today's Wall Street Journal included an 18 page special section on "ECOnomics, creating environmental capital." I found it to be an excellent series of stories and interviews that capture the flavor of the financial community's interest in cleantech.

Perhaps most telling was the interview with Jeffrey Immelt of GE. He was asked why he has led GE into the "Ecomagination" era and emphasizing cleantech opportunities. "Was it PR? Was it personal conviction? Was it opportunism?"

His answer? "I work for investors. I don't believe in hobbies."

That was a more direct answer than I would have expected but I'm sure it was the truth. Entrepreneurs who are looking for financing will soon discover that there are very few people who will accept a lower rate of return to make targeted investments in environmentally sustainable businesses. There are considerably more people who will invest in opportunities that offer a better return, regardless of the ecological impact of the business.

The groundswell in venture and project finance for cleantech endeavors is not because of a wave of social guilt from the institutions making fund investments. In fact, as a fiduciary, pension funds, university endowments and the like are FORBIDDEN by law from making investments based on anything except risk-adjusted return on investment. Institutional investments in cleantech are up because of the widely held belief that this field offers some of the best moneymaking opportunities available today.

When meeting with your prospective investors, don't get confused on why they are there. Investors like to feel good about the businesses they help start. They HAVE to feel good about the returns that can be expected.

The Pitch

Yesterday I was with a local group of angel investors who hear seed investment opportunities in the clean energy space. I think that the biggest idea had the worst pitch.

In the venture investing arena, we hear tons of ideas, not many of them can meet the criteria necessary to get an investment, perhaps only a few percent. With in boxes always full of new business plans to review, there is always a temptation to look for the reason to decide to move on.

The entrepreneur was a young African-American man who carried himself with confidence and presented himself in a way that revealed his considerable intelligence.

He opened his pitch with "XYZ company is a minority/woman-owned business. I am personally committed to sustainable, green ....." I found myself struggling to stay open minded. Why did he open with the ethnic/gender background of his ownership and personal philosophy? If we (a mostly white group of angels) were to invest, we'd likely have to structure some kind of clever financial instruments to let him keep that designation and by the very nature of the setting only clean energy opportunities were to be heard. Even after refocusing, I found myself looking for and dwelling on the the "flaws" as I saw them in the presentation. It was 90% into the presentation before he got into the more compelling parts of the story.

After the presentation was concluded, we conferred privately about the opportunity. Most of us were put off by the presentation. One prominent angel, himself a successful, serial entrepreneur, told us that he had invited the presenter. He said that while the entrepreneur is admittedly unseasoned, he felt that there was a real idea worth investigating at least and proceeded to give us the "why should you care" pitch that we didn't hear in the formal presentation.

Entrepreneurs need to structure their presentation to tell their story while piquing the curiosity of the listeners. After learning more of the backstory, I think that I know how that same opening line might have been followed in a way that would have had us all leaning forward in our chairs.

"XYZ company is a minority/woman-owned business. Our target customers are Fortune 500 members who are regularly fined for missing regulatory mandated MBE/WBE purchasing quotas. The US addressable market for our product is measured in the billions of dollars annually."

Now, I still might have been incredulous, but I would not have had any trouble listening as carefully as possible through the entirety of the presentation.

The old saying "you only get one chance to make a good first impression" is never more true than in the entrepreneur's pitch to a VC.

Cleantech Luxury

Whenever I look at a prospective cleantech project or start-up company, I look at what part of the market they are trying to capture.

If you’ve read my other posts, you’ve seen my bias for cleantech with a strong economic case. The fact of the matter is, not all successful cleantech projects or companies actually have an attraction based on economics. There are some companies doing very well selling cleantech luxury.

Late last year my wife and I decided to start shopping for a new car of which she would be the primary driver. Her stated objective for this car? Get the most economical vehicle out there. What was her first choice to look at? The Toyota Prius. Now don’t get me wrong, Toyota has done a wonderful job of executing on this well designed automobile. When looking at the capabilities of the vehicle – 5 seats, modest cargo, there are several cars to compare it to. Most of those cars (non-hybrids) are at least $5000 cheaper. I wondered how long it would take to make that extra money back based on the great fuel economy the Prius gets?

I won’t bore you with the spreadsheet (yea, I did one), but at even today’s record gas prices and my wife’s average annual driving of 18,000 miles, it’s going to take a very long time to recoup that money. I'm not alone in this view. The most famous cleantech VC, Vinod Khosla has weighed in on my side of this topic link.

Any automobile purchase includes a certain degree of emotional attachment but few ask for (and get) as much of an emotional premium as Toyota has for their Prius. When someone intentionally pays more for an item to feel better, it is, by my definition, a luxury product.

There are many other such green luxury products. Most home photovoltaic installations fit that description as would carbon offset services and even bottled water.

The difficulty that I have with investing in luxury cleantech boils down to fact that you are placing your bets on the Marketing Department, not cost-saving feature, patents, trade secrets or manufacturing cost advantages. Creating and sustaining a company based on better marketing sounds just too risky for my money. More and more often, such marketing-driven cleantech products are being labeled as "greenwashing."

Some have succeeded (Howard Schultz did OK in the coffee shop business) but the entrepreneurs out there need to realize that without an economic case for their product, or at least a minimal economic premium for it, he is going to have an uphill battle to get funding.

Biodiesel Bad Press Day

Thanks to a reader for the following link from the NY Times link. For those who didn't just come back from reading the story, it tells of biodiesel plants that have been found to be spilling partially processed biodiesel and co-products into local streams in Alabama and elsewhere. The locals are rightly outraged at the pollution but they are doubly outraged that a "green" company would or even could cause such pollution.

There is much to like about the production of biodiesel. It has a strongly positive greenhouse gas profile compared to petro-diesel. It promotes diversity of supply to lessen the geopolitical pickle we have with petroleum and the feed-stocks are generally sourced in the local agricultural community.

It is no wonder that the idea of getting into the biodiesel business is so intriguing to so many people. It attracts people who would never dream of running a chemical plant or refinery, yet that is exactly what it takes to make biodiesel.

If you are going to process millions of gallons of fluids each year, some of it is going to spill. You're going to have to have the engineering, process controls and operating discipline in place to minimize, contain and mitigate those spills.

In addition to citing spills, there is a specific mention of the intentional dumping of glycerine. What isn't widely known about the biodiesel production process is that for every 50 gallons of biodiesel you make, you get 11 gallons of glycerine.

Finding a market for the glycerine can be a huge advantage to a producer. With the dramatic increase in biodiesel production, there is generally a glut of glycerine these days. Some are finding themselves lucky to get rid of it without cost. And some, as this story shows, are so desperate to get rid of it that they'll break the law.

I don't know any particulars of the plants in question beyond what is stated in the story. But where ever we have human endeavor there will be foul ups - some from lack of attention to detail, some from greed and some from incompetitence.

Biofuel development is a hard but nobel field to work in. Ultimately however, it is no more nobel than those doing the work.

Keys to Success, Part 3

The third key success factor in renewables is the ability to make the product “bio-compatible.”

Just as in implanted medical devices or drugs, success requires much more than proper technical function. You have to engineer your solution to peacefully coexist with its surroundings. Ignoring the entrenched business practices, mindsets and regulations of the existing industry can and will trigger an “immune system response” that virtually guarantees failure in the market.

In the case of renewable transportation fuels, standards are set by the ASTM. If your biodiesel or ethanol does not meet those standards, you aren’t going to have much of a market. Many state governments are big buyers of biofuels. Inevitably, they too have their unique requirements for their vendors to meet. Meeting those standards undoubtedly increases production costs as does documenting your processes to prove compliance. Anything less however, will eliminate your product from consideration.

All power producers have interconnection standards that govern how non-utility generators hook up to the grid. State regulatory bodies, IEEE, Underwriters Laboratories and utilities themselves all have a hand in these complicated standards. Without complying with those standards, no utility will connect to your generator and no one is going to buy your electricity.

Even such broadly popular and well established renewable energy technologies such as wind power are running into perceived incompatibility problems. The intermittent power that wind delivers and how it interacts with the admittedly stretched transmission grid pose ever-growing problems for further production. One Canadian utility has called for a maximum 20% of total generation from wind and another has turned down offers of 3000MW of additional wind power while they spend one billon dollars on grid reinforcements.

Industry standards is the easiest to understand bio-compatibility issue but far from the only one. "But that's not the way we've always done it" could be the most discouraging words a new energy entrepreneur could ever hear. All to often, prospective buyers of new energy products or technologies have little incentive to take the risk of trying something new. When I meet with entrepreneurs and they show me their pipeline of prospective customers, I always ask "who's bonus would be affected by the successful use of your product?" All too often the answer is silence, followed by the names of entities not involved in the buying decision.

Nearly every aspect of the traditional energy business is full of established industry standards and practices. The successful entrepreneur in this space has some uniquely difficult challanges as he seeks to develop substitutes that are both disruptive enough to generate high returns for investors yet not-to-disruptive so as to trigger the immune system response from the stakeholders who also write industry standards.

Success will follow to those who can effectively answer these questions:

How are you getting and keeping an “insider’s view” of the compatibility issues in the industry you will be part of?
What resources can you tap into to avoid inadvertently stumbling over the ‘third rails’ that exist?
Will you maintain enough independence from the industry and friendly market participants to actually change it?

This won't be easy but financially, geopolitically and environmentally it will be essential. For those about to "launch", I salute you!

Keys to Success, Part 2

Last time we explored the first key success criteria for renewable energy startups. Today we move onto the second. I believe that key is the ability to identify and target real economic buyers for your product.

Newspaper reporters and eco-enthusiasts run to embrace the latest “green” idea. A long term successful company will have to meet real-world financial hurdles to adoption. Will real people and real companies on real budgets buy it and continue to buy it?

A new renewable way of generating baseload electricity that costs $.20/kWh to operate will have a difficult time gaining widespread market acceptance. A new renewable way of generating baseload electricity that costs $.20/kWh to operate in remote Alaskan villages where power currently costs $.40/kWh, will have all of the business they can handle for quite some time.

Most often the way new products bring down their costs is by identifying and capturing the segment of the market that can and will afford their product. These revenues will sustain the company until the product is refined and/or production scale increases bring down costs to make them more broadly competitive.

The current situation with investment tax credits and production tax credits point to the precarious place that many renewable energy projects find themselves in. Until there are long-term tax credits or better, widespread, formal carbon markets offering forward, commodity-type options, predictable cost/value comparisons that businesses must conduct will be problematic. Investors will continue to look at your marginally cost effective energy solution with one eye on your plan and the other eye on the calendar as they contemplate looming incentives sunsets.

This isn't to say that there won't be any winners who lack an economic value proposition. I believe there will be. There is a market for voluntary carbon credits. There is a market for carbon footprint mitigation. They are, primarily "feel good" products. People are spending their money to feel better (or less guilty) about themselves. This is also the definition of a luxury product. Start ups rarely earn venture capital type returns in luxury products do to the need for broad, high impact marketing, distribution channels and flawless execution. Luxury tends to be the domain of the larger, better established concerns.

The "greenness" of your product will still matter. It will gain consideration and early adopter purchases that will allow you to drive down the cost curve to the mass market value proposition. But getting there won't necessarily be easy. You'll have to ask yourself some tough questions.

Have you identified markets that would welcome your products based on price and performance alone, without consideration for its “greenness” or “sustainability?” If not, how will you find those markets? Do you have access to the expert advice to help you target your products properly?

Will you be ready for changes to your product’s competitiveness when likely carbon markets are legislated (cap and trade or carbon taxation or similar)?

The answers to these questions will separate the cottage industries from the corporations of tomorrow.