Cleantech Finance Insider

So, Where Have You Been?

I’m sure that my regular readers have noticed the absence of postings for a couple of months now.  I have a good excuse.  I moved my investment banking licenses under Source Capital Group, Inc. based in Westport, Connecticut. 

Because the regulator (FINRA) has seen some I-banking bloggers use the medium to sell or advertise some investments, it can be an issue.  Such selling is a big no-no in the securities world (we’re supposed to Know Your Customer) and firms are required to keep a Compliance Officer on board who is in charge of keeping things kosher.

Now that I’m settled into the new firm, and by the gracious permission of our firm’s Compliance Officer, I resume your regularly (OK, irregularly) scheduled web log.

In the renewables project finance world, the big question remains “is anyone doing any deals?”  If you were to try to guess by looking at the press releases, you’d say so.  I’m not so sure how many deals are actually being signed since the financial meltdown of this fall.  What we’re seeing today are deals that were very far along the investment process during the summer and have only just been publicized.

I’ve spoken to a friend at a big-name (and still standing) bank that does a lot of renewable project lending.  I asked him point-blank “are you guys loaning any money to projects these days?”

His answer was, “not really.”  My friend went on to add “we are working on deals, but to generalize, they are things that are very familiar to us, like the second phase of a wind farm that we’ve already loaned to the first time.  We know the people and the resource so it is easier to get through the credit committee.”

Another aspect that I had not anticipated is that for now, the banks that I’m talking to prefer LARGER deals.  You read correctly.  They really do still have money to put to work (at least some of them do).  So in addition to looking for deals that have components of familiarity to them, they want deals that are big enough to put a couple extra sets of eyes on to check and recheck the project’s viability.

But what about the equity players?  Because of the structure of most private equity funds, they have long term commitments from big institutions-pension funds, endowments, etc. that they can draw down as they need it.

The challenge is that most renewable energy projects are built with a mixture of debt and equity.  If the project is built with all equity, the returns to the investor may fall below the threshold required by the fund.

I will readily also point out that there are tax equity funds that invest in all-equity deals for the tax benefits they deliver.  The challenge that they face is that tax credits are only valuable if you have a tax liability.  There are a lot of tax equity fund investors who, thanks to Wall Street events, may not have or have doubts about their future tax liabilities.

So pretty much the whole industry is moving at a slower pace for the last couple of months.

When will it end?  When will things get better?

As the great Yogi Berra once said, “prediction is very hard, especially when it’s about the future.”

Based on the bankers that I’m talking to and the partners at the project finance funds, I think that we will see attitudes (and check books) turn a corner now that we’re in the New Year.  The continuing de-levering of the economy will mean that money will still be tight by 2007 standards, but new deals will start getting done with more and more frequency.

In the meanwhile, I’m focusing my time on clients who have all equity investment opportunities.  They aren’t as big as the levered deals of recent years, but at times like these fewer moving parts (especially when some of the parts are unavailable) make for easier deals to get closed.

Come on 2009!

Crossing the Cleantech Chasm pt. 1

Working in the field of clean technologies and renewable energy with all of the popular press coverage I often get asked "wow, things must be really looking up for you!" While I do stay busy enough to keep out of trouble there is a structural issue with the larger industry that concerns me.

In the '90s there was a fabulous book called "Crossing the Chasm" devoted to an analysis of how new technologies (especially software) get started and either thrive, stagnate or altogether die. It is a must read for entrepreneurs and technology marketers of nearly every stripe. The author, Geoffrey Moore, describes the first to buy as "innovators" and those that soon follow are "early adopters." The next stage of buying is by the "early majority" and this is where many products fail. The few who have a high degree of pain have already bought the product. Where the innovators and early adopters are separated by "cracks" in the bell curve of adoption, the early adopters and early majority are separated by a "chasm." 

While the structural reasons for the chasm are different for cleantech, ours is no less deep or wide. Sharp entrepreneurs with good ideas can raise funds to prove them out (usually from venture capitalists). Innovative technologies on the benchtop can also usually find the funds to build a small pilot plant to begin to examine the commercial promise therein.

When the firms begins to look for money to build that first fully commercial plant, that is when they fall into the chasm. Consider how long have we all read about the promise of cellulosic ethanol yet how few commercial plants have been built.  In this case the chasm isn't a challenge of product marketing, but one of finance.

I often (all too often) find myself telling a client that his technology looks great and that banks will line up to loan him money to build the 2nd, 3rd or 4th plant in the series. "But why not the first?' they ask. "If the banks won't give us the money, can't we just go to the venture capitalists and get it?"

These questions form the crux of our dilemma.

A cursory examination of renewable energy news will quickly reveal word of big banks both domestic and especially European who are lending hundreds of millions of dollars to build wind or solar power projects. The difference between the deals you read about and that of our erstwhile entrepreneur boils down to confidence and familiarity.

The manufacturers of the panels or turbines in the deals we read about are large companies. They can and do offer performance or availability guarantees. Those companies are big enough to make good on their guarantees if needed.  Just as important, these deals are not novel. Banks don't have to ask themselves "Is this going to work?"  Instead the questions are much more in the vein of comparison. "Does this deal look enough like the others that we've seen that we should feel OK making the loan?"

The reason that banks look at the problem this way is that their upside is their interest payments. Their downside risk is default. If the project is in default, they must try to sell it to recoup their principal. If the plant went into default due to some unforeseen technical problem, who would want to buy it?  In short, for new technologies the banks have the risk exposure of a venture capitalist with much more limited prospects for reward.

Well what about building the plant with all equity from venture capitalists? While VCs are much more familiar with taking on the higher risks, very few cleantech projects offer the "home run" big return possibilities that are the mainstay of the VC industry.

For an energy project to have such returns (depending on capital costs), you might have to make power at $.02-.03/kWh and sell it at $.10/kWh. There just aren't very many opportunities like that out there (but if you've got one, please contact me ASAP!).

That leaves us with the cleantech financing chasm-projects that are too novel to attract debt financing but don't offer the stupendous returns that attract venture capital.  What's a developer to do?  Next time I'll weigh in on some ideas to solve this problem. 

Where Do Things Go Wrong, Part 2?

The top ten list (in no particular order) of reasons seemingly good cleantech projects die continues. We pick up where we left off last time at number 6.

6.  The technology is unproven at commercial scale.  This is real challenge in the cleantech space.  Promising developments in the lab just are not going to normally get funded on a large scale.  The best example lately is cellulosic ethanol.  There have been news articles about breakthroughs at the small scale for over a decade but no one has built or is even contemplating constructing 100 million gallons/year plants that dominate the corn ethanol production space.  What pilot scale or small commercial plants that are being built are almost all taking advantage of big government grants or loan guarantees.  The bottom line it that it will be nearly impossible to build the first big plant of any given technology.

7.  How else can I say this, the investors just aren't that into YOU.  I've blogged before about "bankable" entrepreneurs and how certain qualities seem to attract money.  Ultimately, investors are investing as much in you, the developer, as in the project itself.  This doesn't mean that all hope is lost.  Development can be a team sport and a good developer won't be afraid to go out to recruit the talent that the investment community perceives to be missing.  Much of the time, the unspoken question from investors is "Can this guy manage and complete the project?"  If you can find someone who has just successfully managed the construction of a project like yours, then your team can become very bankable even if you, alone, are not.

8.  The project just has too many moving parts.  Consider a plan to develop one parcel of land to have both wind and geothermal power production.  One piece of land.  One transmission upgrade.  Greater efficiencies in O&M.  What's not to like?  Well investors are not very comfortable with such deals.  Most renewable energy projects will use a combination of debt and equity to reach financial attractiveness.  There also is a tendency for investment analysts to specialize in one technology over another.  So both the equity guys and the debt guys will have multiple people judging the project.  There may not be any one who feels comfortable endorsing the entire project.  Anyone of them saying "no" kills the deal. This is especially true for the debt investors who are looking at default risk.  For them, two technologies looks like twice the risk.  There is no credit given to a project that only goes a little broke.

9.  Officials who ought to cooperate, don't.  This is an easy one to get caught on.  Working on cleantech project development tends to make the entrepreneur very popular at cocktail parties.  You are admired in the community.  It doesn't mean that everyone is willing to help.  One of the biggest projects that I have ever worked on (a high voltage transmission line) was counting on an agency of the Federal government to make a bid on use of the line to fix some serious reliability problems and enable the importation of significant new supplies of renewable energy.  How could a governmental agency not support the idea?  The question that every developer needs to ask is "whose bonus is increased or promotion insured by helping me?'  In this case, there was no one.  Four years and $15 million in preliminary work later, there is still no deal.

10.  I know that I said that these are in no particular order but I did save this for last because I'm running into it more often than ever.  The project won't get done because it is politically out of favor.  I've had more than one biomass project lately that is getting the cold shoulder because some investors don't want to get caught up in the food vs. biofuels debates.  These projects are using wood waste or other energy crops grown on land unsuited for food crops.  It doesn't matter.  Perception IS reality. More and more, if the feedstock was grown in soil it is being blamed for increasing costs at the grocery store.  Investors don't want that kind of PR black eye.  Developers of biomass based energy projects will have to be very careful to stay in front of the perception wars on this one.

In part one, I mentioned that every successful cleantech project seems to die ten times before it finally lives.  While I haven't covered all of the possible causes of death, I hope that I've illuminated enough of them that you will be able to anticipate some, understand the others and bounce back from them all.  I wish you success.

Where Do Things Go Wrong, Part 1?

One of the ways that I try to help overly optimistic entrepreneurs to get their arms around the business risks their energy projects face is to ask them to imagine that its two years from now and they are being interviewed about the tragic failure of such an impressive firm.  What are you telling the reporter about where things went wrong?

I've heard successful project developers say that every good project "dies" 10 times before it truly lives. 

Most of us have heard the stories about Fred Smith, founder of Federal Express getting a C from his Business School professor for the idea of FedEx.  He also is famous for having flown to Las Vegas and played blackjack until he had won enough to make the next payroll for his company. Clearly, even great ideas may not be immediately recognized and certainly are not guaranteed a smooth ride to long term profitability.

Let me then try to summarize the "top ten" (with apologies to David Letterman) reasons that good projects die.

1)  Can't get the product to market economically.  For electric power projects, this is most often a transmission access problem.  Either the transmission line that is "right there" is already fully loaded or the costs of extending the lines to the project are just too onerous for the project to afford.  For biofuels projects the problem is more along the lines of transportation of the ethanol/biodiesel to a blender where the composite fuel is mixed and made ready for retail sales.

2)  "No problem" permits become insurmountable problem permits.  I've seen projects with significant environmental benefits get caught up in local politics that resulted in previously issued air quality permits being revoked over some very dubious reasoning but undeniably heavy politicking.  

3)  Window of time to raise funding isn't long enough.  This may sound self-serving as someone who does project finance fund raising but it is important to realize that there are several forces that are at odds here.  Developers naturally want to show their project to be as complete as possible.  Landowners, once they are made aware of the prospective value of their property, don't want to give long options to develop.  Prospective investors HATE feeling rushed.  The net-net of this is that developers need to begin their search for investors while they have at least six months of "runway" left.  Better to show them a deal that isn't yet fully cooked than one that's about to spoil.

4)  Off-takers are not "credit worthy."  It isn't enough to make your energy at a market competitive price.  Investors will want to see that the parties that you are selling to have deep enough pockets that they will make good their promise to buy at the agreed price even if the prevailing market price goes lower.  In the electric generation sector, this means that there is a strong preference by investors to see power purchase agreements with utilities rather than re-marketers.  On the biofuels side, it means a preference for deals with big oil rather than small, local retailers of B100 or E85.

5)  Investors just aren't that into your project.  As nice as the project looks on paper, the returns promised just don't seem to get investors to bring out their checkbooks.  Often times that means that you will need to look at bringing in a strategic investor who stands to gain a big supply contract, market stature or other value in addition to the basic IRR of your project.  Warning to developers, this usually means that you will need another six months of runway time to find, woo and close such investors.

Next time, I'll finish off this top ten list.  Until that time, I wish you good luck.

Foundations of Project Energy Finance pt. 2

We continue the topic started last time on the key components in raising money for an energy project (as opposed to an energy technology company.)

A business plan that describes the opportunity, the need and the prospective financial performance

Control of the land for the project by ownership, right of way or most likely, option

All necessary permits

Knowldege and cost control of the inputs (feedstock, fuel, process chemicals)

A well-established, proven energy conversion technology

Credit-worthy, long term buyer for the output

Established, deep-pocketed EPC contractor

Experienced project operator and maintenance contractor

I described the rational for business plans in a recent post, but suffice it to say here that investors who are being asked to put in millions of dollars have every right to expect to see a thoughful document that explains what you have in mind, why it costs what it does and how it will make money.

The need to have control of the land is important because once word gets out that a developer has something in mind for the property, the price and availability become much less agreeable to the developer. The investors use this as a gating function, asking about land control early in the process to see if they want to spend any more time looking at it. Land control is a must-have.

Permits are important, not only because the project will have to have them but because they are sometimes not available for hard to fathom reasons. The permitting process can be subject to changes in the political winds and local opposition. If you have them, you have them. That will be comforting to investors.

Having an understanding and ideally some control over your input costs is the greatest hurdle to getting good projects financed. It is also a big reason for the surge in wind and solar power. The fuel is free and relatively predictable over a yearly basis. Consider, by contrast, corn for ethanol production.

The need for a proven conversion technology is another area that trips up would-be renewable energy developers. So often I see or read about inventors who have developed and sometimes patented a new energy conversion technology. Sometimes it's a new type of wind turbine. Sometimes it is wave power. Unfortunately, every time it is unsuitable for being deployed as part of a commercial energy project.

The reason for this is that the most common way that these projects can offer the returns that investors expect is to borrow money from big banks in addition to the private equity that the investors put in. Banks are more risk adverse than project equity investors (who, in turn are more risk adverse than venture capitalists). If the project intends to use new technologies then, in general, the banks won't loan against it.

Consider this; if a windfarm is built with a new type of turbine using a ten year loan. The turbines work great for seven years but then start failing. Soon, the project can't pay its debts. In theory the bank can repossess the wind farm but without reliably functioning turbines, there isn't much to repossess. Hence, banks stay away from first or second commercial use of new technologies. How does a new technology get into commercial use? That is a topic for a whole separate post at a later date.

The next box to check off for project finance is the sale of your energy (power or fuel) to a credit-worthy buyer for a time period that matches the length of bank loan you seek. Here the independent power industry has a big advantage over biofuels as many utilities are readily buying renewable power and most of those are considered "credit worthy" i.e. they have enough financial strength to weather any foreseable economic storms.

Given that for many projects, the biggest risk in the early days is going to be "completion risk." Completion risk is simply the chance that a given project will not be able to enter commercial operation or will not pass some completion test or commissioning. The reasons can be varied but most often come down to blown budgets for manpower and or material. This is why the financiers like to see a big name as the EPC contractor (Engineer, Procure, Construct). If Bechtel underbids a contract that they have promised to fulfill, you can be pretty sure that they can and will make good on it out of their own pockets. One can't say the same about very small firms. It may not seem fair, but again, it's about fairness as much as it's about wringing out risk.

After the project is in service the remaining risk to investors is that it may be operated poorly or poorly maintained. Depending upon the technologies involved the relative importance of these can vary. The "operator" of a windfarm has more of an accounting role than engineering. Maintenance is where the focus will be and often equipment manufacturers can and will be strong contenders for maintenance contracts. In the case of biofuels plants, the operator and maintainer are often one in the same and the combined role is much more technical than administrative.

I close with a reminder to entrepreneur developers not to be discouraged if you don't have all of these factors covered. You should however, have all of these factors considered and to cover as many as possible. I'd like to see all of them well covered, but then again, I'd like to see a ten pound butterfly! It doesn't mean that I can reasonably expect to.

Foundations of Energy Project Finance pt. 1

Anyone who writes a blog has to make some assumptions about their audience. I assume that readers are interested in the cleantech/renewable energy/sustainability arena in general. I also assume that there is a specific interest in the inner workings of the money raising process needed to get new firms financed and projects built.

I encounter some confusion about what types of entities put up money for energy projects. Often people think that all risk capital is venture capital. That is not really true. There are funds of monies that are under the large umbrella of "Private Equity" that do not take on technology risk (like VCs do) but will assume project completion risk (among others) that are associated with building energy producing facilities. They can be wind farms, ethanol plants, anaerobic digesters or even merchant transmission lines.

What these investors are looking for are entrepreneurs, sometimes referred to as developers, who can put together all of he necessary pieces to create an energy (and more importantly) profit producing project.

So what do these Private Equity project finance funds look for when they are evaluating an opportunity? There really aren't many hard and fast rules on this but the more of these the developer has lined up, the better his project looks:

A business plan that describes the opportunity, the need and the prospective financial performance

Control of the land for the project by ownership, right of way or most likely, option

All necessary permits

Knowldege and cost control of the inputs (feedstock, fuel, process chemicals)

A well-established, proven energy conversion technology

Credit-worthy, long term buyer for the output

Established, deep-pocketed EPC contractor

Experienced project operator and maintenance contractor

It's as simple as that! While I can hear my readers groan over the above list let me remind you all that few projects have all of these lined up when first approaching capital sources. They constitute what I have referred to in an earlier post, "the ten pound butterfly." It is something everyone would LIKE to see but no one really expects to. Nonetheless, over the course of putting together the project and lining up the money to build it, developers will have to address all of these issues.

In my next post, I'll drill down on each of the items in the punch list. In the meanwhile, I invite the readers to post comments on any additional factors that they think may have been overlooked or that don't belong.

Lessons From Biofuels

The corn ethanol industry doesn't need another voice to deride it's performance and unexpected consequences of late. In today's blog, I'd like to consider the lessons that we can all learn from it and some related renewable energy industries.

Much of the corn ethanol business proposition could be summed up by these facts:

1. Farmers know how to grow corn.
2. Lots of people know how to ferment and distill corn to make ethanol.
3. Ethanol can be blended into gasoline.
4. The Federal Government will pay people to make such ethanol.
5. The cost of gasoline is high and looks to be headed higher.
6. A big chunk of the cost to make ethanol is in the corn itself.
7. The cost to grow corn is well understood and more stable than the cost of gasoline.

In looking back, everyone was right except for #7. The cost of corn has risen faster than the cost of gasoline. As a result there are a lot of ethanol plants that facing hard times.

I could write the same list of "facts" for biodiesel, substituting soy or canola for corn. While it doesn't get the same degree of negative press, there are many well-intentioned biodiesel plant owners who are faced with buying palm oil from Southeast Asia that has a lot of environmentally negative baggage with it.

Growing palm for the oil is amongst the most productive source of agricultural oils on a land use basis. It also grows best in areas that have extensive biodiversity. The end result often being that the biodiesel plant owners are faced with the prospects of choosing between closing their plant or supporting the bulldozing of tropical rain forests to get cheaper feedstock.

Where with this surge in demand show up next? I'm already hearing about rapid changes in the cost of woody biomass - sawdust, waste wood, etc. It is clear to me that this is a trend. In fact, while NDA's prevent me from saying what the "waste" feedstock is, I'm seeing or hearing simultaneous proposals to convert the same nusiance feedstock in the same geographic region, a feedstock that people now pay to have hauled away. The end products are energy and more valuable recovered co-products.

If your project economics are predicated on getting paid to take the raw materials you use, suddenly having the shoe on the other foot is going to be a huge setback. While everyone strives to have some kind of protected intellectual property, there often isn't much technical advantage to the individual patents and knowhow around mass and energy conversion.

What then is a developer to do? How do you carve out a business that is sustainable?

The best (and most difficult) way is to enter into long term contracts for your feedstock and your off-take (products, co-products, etc.) that covers the length of any loan against the project. Then at least, you can weather periods of low profit or no profit without the fear of foreclosure.

The problem is that long term forward contracts (as their called in the commodity business) are hard to come by. Even in the commodity exchanges, the most mature forward markets in existence, contract terms are usually measured in months not years.

One competitive advantage that impacts most of these opportunities however, is shipping cost. Smaller plants that are using locally available feedstocks to produce locally consumed energy or other products will have a natural advantage. The trick will be in finding the right balance between economies of production scale versus the cost of input and output transportation.

Does this then limit the developers' prospects for building a big business? Not necessarily. As McDonalds has proven so well, you can build a very big business with repeatable, profitable, smaller businesses. If the economic model for local waste to energy works in one community, it often can work in others. Developers who demonstrate their ability to create those smaller, profitable businesses will find many organizations who are interested in helping to bankroll the next 5 or 10 of them.

The long term advantage will belong to the first movers. The bold, smart developers will get their chance at financial success based on their savvy and execution in the roll out of these smaller plants. As it should be.

Borrowing Money for Your Project

I realize that I've been tardy in posting new thoughts this last week but things have been heating up in all aspects of my business. Let me ease back into regular communications by making a short entry today that refers to a lengthy but very valuable article by another.

Stefan Schmitz of the UK law firm Squire, Sanders & Dempsey has written a fine article for the Renewable Energy World website dealing with the issues of debt and lending analyses for wind power. Here link

While the article only discusses wind power, I would hasten to add that the methodology is common across all forms of project debt financing. The main factor to remember that the "debt service ratio" discussed is arrived at by both technical analyses and qualitative experience. The more familiar a lender is with your project and technology the more they may feel free to lend.

Finally, while we are all reading about the big institutions who are taking a bath (and another bath, and another) in the debt markets from the subprime lending fiasco, there is still A LOT of money out there looking for good cleantech projects to fund. Carpe deum.

Time and Money

One of the more subtle ways that an entrepreneur’s optimism can get the better of him is in underestimating the timing of the fundraising process. It takes time to fund even the best deals.

While I am also an angel investor in energy technology companies, my “day job” is in raising funds for cleantech projects. Often these deals make use of provisions in state and/or federal tax code to improve the return to the investors. They are likely to use a “flip structure” to maximize the benefits to the parties involved. The linked article describes how the flip structure deal can work. link The net effect is that it allows investors who value tax credits to take the lion’s share of the tax credits while allowing the developer to take most of his cut of the pie as cash with an ownership interest “flip” in the out years.

The developer in such a deal is a bit like a juggler, keeping many plates spinning atop so many slender sticks in the air. Find the resource. Strike a deal for access to the land. Get someone lined up to operate and maintain the project. Pick the best technology. Get a delivery schedule. Identify a constructor. Find a way to market for your power and often then and only then, look for a suitable investor.

As you would expect, the more complete your preparations are, the easier it will be to get favorable terms from an investor. Where the optimism may trip up the developer is in the sense that when they finally have all of the pieces of the puzzle together, surely the investment community will quickly appreciate the opportunity that has been created. Finding the right investor and getting through the decision-making process takes time.

There is added difficulty when there are other time constraints that might impinge on the investor and therefore weigh on his decisions. Can you get it all built and operational by the (current) production tax credit deadline of 12/31/08? How long can you keep your place in line for production equipment? Is the option on the land due to expire?

It bodes ill for the project when I have to tell a prospective investor that there is a investment decision deadline after which the project could die, even a deadline many weeks away. No one likes to be rushed into a decision to commit capital be it to buy a car or a windfarm.

Even the best of projects take time to be evaluated, modeled by the in-house Excel gurus and brought before the investment committee for a favorable decision. It is never too early to get on the radar screens of prospective investors. If you or your financial advisors are not talking to prospective investors at least 6 months in advance of needing a commitment, you are falling behind.