Cleantech Finance Insider

Crossing the Cleantech Chasm pt. 2

Over the last few months, with the precipitous rise in petroleum prices, we've seen the call from many politicians and thought-leaders for an "alternative energy Manhattan Project" or "the renewable energy equivalent to the Apollo program."

At the risk of sounding ungrateful for the attention to the industry that I work and personally invest in, I think that this is misguided.

These two historically significant exercises in national will had a key point in common that is critically missing from the requirements of the next energy solution. Both of these efforts were based on MNO budgets. Money No Object. They were about the demonstration of our political will and technical capabilities, not about cost effectiveness or affordability.

If it was determined to be in our national interest to build a 100MW photovoltaic power-plant in orbit above the earth and to microwave the power down to a receiver station in the Mojave desert, we could do it.  The question is would it be easier and cheaper than two frame 7F, 50MW GE gas turbines?  Probably not so much.

The unique challenge is that we need to develop not only novel solutions to our energy supply problems but to do so in a way that is either directly cost competitive or close enough that relatively modest public policy efforts can make them so (e.g. tax credits, feed in tariffs, etc.).

The problems we face with petroleum is two-fold. First, is the high and growing demand for a product whose price is controlled by a cartel. From a pure Michael Porter competitive forces viewpoint, if you can't find an alternate supplier you had better find a substitute product.

The second problem is the more talked about issues of climate change. The high and getting higher levels of CO2 in our atmosphere are at best, worrisome and at worst, disastrous. Compounding this problem for us is that, on a statistical basis, most people in the world don't care.  

They care about getting out of poverty. They care about food, clean water and better transportation - immediate needs for family and self that overwhelm what might be in so many years. In short, the renewable energy solution that they need is the one that is cheaper than fossil fuels.

In each case, as painful as price increases around crude oil are, they make us that much closer to a cheaper  solution to both problems around the world as well as at home.

Now that we have admired these world-class problems, what might the US government (or other capitalism-based government do to solve them?

In part 1 of this story, I identified a chasm of funding for new technologies. They can best be characterized as projects too expensive to attract venture capital and too new to attract debt.

If I may criticize my own industry, others in it tend to call for government intervention (subsidies, credits, etc.) all too often to help our cause. Since I have been relatively quiet on this topic, I now feel that it is my turn to ask.

There has been a program in the US Federal Government's Small Business Administration to invest in venture capital. I know because Fluke Venture Partners, where I am a limited partner has the SBA as a special limited partner. The SBA takes a special position whereby they get a limited but preferred return on their investment. FVP gets to nearly triple the size of their pool of investable funds. The other limited partners get the prospects of the lion's share of the returns after (and only after) the SBA takes their cut.

While this SBA program is now being curtailed, I think that it or a similarly structured debt fund is an excellent approach for solving our new technology funding chasm-the chasm that impedes the commercial scale deployment of new, innovative energy technologies.

Now some will say "aren't there government loan guarantee programs that would accomplish that?" Actually, no. While there must be exceptions, every loan gaurantee program that I've come in contact with was either administrated directly by a government agency (=very risk adverse) or by a commercial bank that lacked depth of industry or technology experience.  In both cases, guarantees seemed to go to the firms that did the best job of schmoozing the administrator rather than advancing the state of the industry.

The creation of such a project finance fund would allow the government to direct where the money goes generally - project finance for first commercial scale (call it 50MW) use renewable energy technologies while allowing talented fund managers with real track records to pick those projects that have the right mix of talent, technology and risk mitigation.  

But this is a presidential election year, small chance of that happening.  Oh well.

Curb Your Enthusiasm

No this post isn't devoted to a sitcom about comedy writers but is instead directed at entrepreneurs who are pitching their ideas to prospective investors, especially the professional kind.

As I've posted on before, the cleantech entrepreneurial team (or any team for that matter) will need to exemplify a balance of passion and pragmatism. One of the ways this can manifest itself early in the fund raising process is investor meetings.

Earlier this year I was talking to a group of executives from a company that had a small pilot plant for turning a waste stream into potentially profitable recycled products. Their pitch to me went something like this (10 minutes compressed into one paragraph):

"We've got this secret process that takes waste XXX and turns it into AAA, BBB, and CCC valuable products. We can show you our pilot plant. We know where there are acres and acres of XXX that people will be ecstatic to pay us handsomely to get rid of. We figure we can get $aaa, $bbb and $ccc for the output. It's a license to print money. Are you going to invest in us or not?"

This was so wrong in so many different ways, but let me try to break it down. First, the executives were confused about the role of the meeting. I was there as a prospective placement agent, to help them find investors, not acting an angel. Secondly, they were confused about the role of the investor meeting had this even been one.

When you are meeting with prospective investors it is important to be cognizant of the realistically achievable goals. Investment in a project or venture is not an impulse purchase. What is an achievable goal of an investor meeting? Curiosity.

Different investors will want to drill down on different parts of your plan. You will not and cannot know what all of those are in advance to cover in your PowerPoint. The only reasonable goal will be to tell a compelling story about your opportunity and ASK for questions. If you aren't getting any questions, you aren't getting any interest.

One of the main criteria I use in vetting prospective clients for fund raising is how will they perform in front of investors that I connect them with. I not only have an responsibility not to waste investors' time with bozos, but spending time on deals that will never get funded is just a waste of my time too.

The main way that I vet such deals is to put on my VC hat and ask the questions that I would ask if I WAS investing my own money in the deal. In the case above, I drilled down on the scalability of the pilot plant and the threat of competitors.

When I asked about the engineering challenges of scaling the pilot plant by 5x, the CEO replied, "there's absolutely no problem." That is pretty much always the wrong answer and investors will generally feel lied to when told that. Either the company doesn't know what the problems might be or they are afraid to tell me. 

Eventually I did learn what their engineers were most concerned about. It turned out to be some mechanical engineering issues with the XXX handling system. Fairly simple mechanical engineering problems at that. OK, now I can begin to believe that you have thought about the problems and they are solvable.

"We have no competition." Oh man, those are the ultimate non-starter words with investors. If you have no competition then there must not be any need for your product. You either have competitors or substitutes or both and you need to be honest and well versed on how you are differentiated from them.

In many cases, the investor will already have an idea of who else is playing in the space because he's already taken meetings with such companies. Further, saying that you have no competition can sound like you aren't even looking very hard. If you don't know of other competitors, you need to cite the substitutes and tell the investor "We haven't seen anyone else with an approach like ours to the problem. Have you heard of any?"

I guess that the best way to frame the process is that you should present yourselves as informed optimists with a winning idea. Encourage good questions and take them seriously. Use the questions and your answers to engage the investor in substantiative dialog about the opportunity. It will take more than one meeting, but when the flow of questions begins to subside, then you may approach the funding questions, if the investor hasn't raised them already.

When Silence is Golden

I had a friend ask me "why would a company ever want to be in 'stealth mode'? Isn't it important for the company and their products to get known ASAP?"

  

While it is only natural for an entrepreneur to want to tout the value and promise of his idea, sometimes that can be counterproductive to his long term success and even make raising money more difficult. Take the case of the wind farm developer. He has to lock down his options on use of the land before he can get any financing. The louder and longer he talks in the community around the site, the harder and more expensive those rights will be.

A similar case can be made on the technology venture front as well. I was at a major trade show some while back and a bootstrapped new company (which I'll cleverly call NewCo) had made a big commitment to exhibiting at the show.  It was touting a very innovative product for sale to utilities to help them meet some vexing environmental requirements at a very reasonable price.  As a cleantech investor, I was interested in learning more about the company behind the product.

If you are old enough to remember Tom Peters's book "In Search of Excellence" you'll also recall his advice to practice "Ready, Fire, Aim" execution of ideas.  The underlying premise of which was that companies tend to over-analyze their moves rather than making an educated guess, get it in the market and adjust from there.

This start-up was more following the execution plan of "Fire, Fire, Fire."  The show floor had every alpha and beta product they could box up.  Getting samples to the handful of utilities who showed real interest was taxing production capabilities. They did however, generate a lot of booth traffic with the product including inquiries from prospective competitors.  

Some of those prospective competitors even came back to the booth multiple times to talk to the young engineers who were flattered to have such attention and intelligent questions asked about their creation.

While I'm pretty sure there were some utilities who signed up to test the product, I haven't seen any word of purchase commitments and it's probably too early to expect them.  Also with development times as they are I still don't know if new, competing products are being feverishly engineered by more well-established companies in the field.  Nonetheless I was struck by this idea.  What if NewCo had taken a different approach?

Dream with me, for a moment if you will.  What if NewCo were able to quietly identify the types of utilities that would have a natural inclination to try their product?  They might also quietly strike up product evaluation arrangements. By taking on the prospects in a more controlled fashion, they could allocate scarce production units to the most promising utilities all the while keeping their financial "burn rate" under tight control.

When the Pacific Gas and Electric or other marquee utility is ready to put up the big purchase order, it is time to prepare the PR blitz. It's also a great time to get get serious with the venture capital community.  

On that well-planned day, NewCo announces its product, a big name launch customer and a war chest of money to build out production capabilities and its sales force.  The prospective competitors are saying to themselves "where the hell did these guys come from?" and berating their R&D staff for not having developed it first.

As long as NewCo can build on this early momentum and continue to land customers, the existing players can only try to play catch up until one of them finally says "we can't continue to let this growth opportunity elude us.  We have to buy NewCo out."

And that, ladies and gentlemen, is how entrepreneurs make money in the cleantech game.

The PowerPoint Pitch

Between talking to energy project developers approaching my investment bank (EverGreen Pacific Capital) and energy technology entrepreneurs pitching me at the Northwest Energy Angels group, I see a lot of PowerPoint presentations. Most of them bad.

This is not to say that the presenters aren't smart or committed or are in some way lacking in intellectual or physical capacity needed to succeed. It's just that "the pitch" (as VCs and other investors want to see them) tends to run contrary to the way that good entrepreneurs think. It is like asking a new parent to tell you about their baby - but don't take more than 30 seconds!

I was recently reminded of an excellent rule of thumb from the VC Guy Kawasaki. He calls it the 10/20/30 rule. Your pitch should be no more that 10 slides, take no more than 20 minutes and have no text smaller than 30 points. I'll post the link for you to read.

There are many good reasons for following these rules as Guy discusses. I'd also add the old show business adage, "always leave the audience wanting more." You need to make me curious about the further details. Don't try to guess where I want to drill down. Every investor gets curious and subsequently comfortable about opportunities in different ways. The pitch must only serve as the appetizer to the information banquet we wish to dine at, not the prix fixe meal.

I promise that distilling your story down to fit the 10/20/30 rule will be difficult but it will show the investor that you respect his time and that you are able to identify and focus on what's really important. If you do it right, it will also generate real interest and curiosity about your idea. For entrepreneurs at a first meeting in search of risk capital, that's as good as it gets.

Don't Make Me Beg

I was talking with one of the founders of a very large renewable energy private equity fund the other day. The conversation turned to a favorite topic of mine, entrepreneurial success factors (see some of my earliest posts). I asked him what the biggest reason was that project developers with good ideas get turned away by his firm. He immediately said that it was because they won't or haven't fully committed their ideas to paper in a business plan.

That was very surprising to me. Not because I always see good business plans associated with the opportunities that I consider but because I felt that I MUST be unlucky in finding so many entrepreneurs with writers' cramp.

I (and every other financial professional) know that business plans are out of date as soon as the laser printer spits them out. We also realize that you can't know everything that will happen in year 2 at the beginning of year 0.

What we don't know is how do you think. How deeply and comprehensively have you considered the problems before you? No one needs a business plan if everything goes well. The problem is that inevitably, everything doesn't goes well.

We know that entrepreneurs are busy. So are we. To begin with, we shouldn't have to pepper you with every question we can imagine about the business just to get a basic understanding. It is up to us to figure out if you are the kind of person who is really committed to his idea or just committed to raising some money. Are the day-to-day activities of the founder and his team dedicated to today's tactical sales opportunity or are they trying to realize the bigger, longer term value of the firm? The plan, by identifying that vision of value can give a great leg up on that answer and be a valuable tool for management priorities as well.

Most people think of risk capital investors as looking for "home run" investments that generate huge returns. It is true that we all do that. What is just as important is that we are also looking for deals and the entrepreneurs behind them that will find a way to salvage something of the opportunity even after the original plan has been dashed by circumstances beyond their control.

The investment decision-making process includes not only understanding the proposed business but understanding what is known and unknown about that opportunity. The internet bubble days of raising millions based on something drawn on a paper napkin are long gone. These days, and for quite some time to come, the absence of a basic business plan is itself an item of implicit investment risk.

Everyone can appreciate a persuasive business pitch. If you really want to get the pros reaching for their checkbooks, put it in writing!

Who is Bankable?

Much of the time, the cleantech entrepreneurs that I work with are new to the space. That’s not too surprising given the relative newness and growth of the sector. Many are even new to the energy arena altogether. It is only fair to wonder how investors look at these entrepreneurs and what makes some more immediately “bankable” than others.

I’ve blogged before on my keys to success but I’d like to drill down today on what specifically makes the fundraising process easier for some entrepreneurs than others.

At the top of the list of qualities is having made money for investors in other endeavors. There is nothing sexier to venture capital or project finance equity investors than making money. That’s what makes people like my fellow Northwest Energy Angel, Martin Tobias link, look like Heidi Klum link to risk capital investors. Martin grew the Internet media company Loudeye and took it public in 1999. It made a ton of money for his early investors. When he later joined Imperium Renewables, a start up producer of biodiesel, it soon had over $200 million in growth capital available to it.

OK so we can’t all be Internet millionaires. What else do investors like to see? If you can’t show that you’ve made big returns, at least show that you’ve been a responsible steward of other people’s money. P&L responsibility is best but having managed big project budgets well is a fine feather in the cap.

The last quality of bankability that I'd like to mention today is demonstrated ability to create influence that extends well beyond ones actual control. As a manager of a start up company, every other company will be bigger than yours. No one really needs you or your product for their success but your company will need the cooperation and business of others. Have you faired well when your responsibility was high yet your authority was low? You could be bankable!

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.

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.

Where do I begin...

You can't pick up a newspaper these days without reading about this start up getting millions of Silicon Valley VC money for a new energy company or hundreds of millions of private equity and bank loans for a biofuel plant or windfarm.

What is going on here? What makes for a winning cleantech start up? How do good-sounding ideas go wrong? Where should we be heading as a nation (or planet) when we look for our cleantech solutions?

I'll be tackling these and other topics of interest in this blog. I welcome your feedback and ideas.