Reducing Financial Riskfor New Technologies

Issue 3 and Volume 112.

By David Wagman, Managing Editor

A myriad of technologies exist that could, their eager backers insist, deliver low-cost, sustainable, environmentally neutral and universally applicable solutions to even the most vexing energy questions.

One trouble facing many such technologies is a lack of capital to move from startup to commercial deployment. The financing gap is sometimes known as the “valley of death.” Countless good ideas end up there, never to be heard from again.

Joe Franceschi and Alan Libshutz, both of whom are operating advisors to Pegasus Capital Advisors, recently discussed problems related to financing start-up renewable technologies. They also discussed how a biofuel development project they are involved with seeks to minimize risk and enhance marketability.

Franceschi has expertise in bio gas and bio energy, along with other alternative technologies. Most recently, he was vice president of business development for Changing World Technologies Inc., a bio-fuels production company. Libshutz comes from the investment banking industry, where he was a managing director at Salomon Brothers Inc. in charge of the energy group for 16 years. He also was senior managing director in charge of energy and project finance at Bear Stearns Inc. Pegasus is a private equity fund manager that provides capital to middle market companies across a variety of industries.

Franceschi said a typical start-up green-tech company passes through three basic phases in its financial development. The first is the grant phase. Here the technology makes its way out of a research lab and into the “real world”. This phase is relatively straightforward: work long hours, develop and tell the technology’s “story” and write numerous grant proposals.

The second stage moves the technology to the venture capital world. Success here depends in large part on the mood of the initial public offering (IPO) market. Eighteen months ago, virtually anything with a “g” for “green” in it was favored, Franceschi said. The recent bearish market has cooled the green-tech IPO market somewhat. But it’s during this venture capital phase that a company builds a pilot version of its technology and moves from development to demonstration, albeit on a limited and still largely experimental basis.

The third stage is the big one. Here the technology moves from pilot-scale to commercial deployment. The jump is from the world of venture capital to that of private equity. Not only does the technology need to be “bankable” but its backers need to present a credible financial statement to potential investors. It’s here that many new-tech companies stumble into the valley of death. The primary reason is that companies aren’t well enough established to have a solid financial statement. That risk is compounded by ongoing development risk inherent in new technology.

“That’s nervousness” for potential investors, Franceschi said. “That’s the tough leap.”

A Successful Jump

Many green energy-tech companies do successfully make the leap. Libshutz said that in 2007 venture capital and private equity firms raised around $8.5 billion for alternative and sustainable energy ventures. That was an increase over 2006. “There is a lot of private capital available,” he said.

But still more could be done by government to achieve even greater success, he said. In Germany, government feed-in tariffs have proven attractive for renewable energy technologies. These tariff incentives have led to widespread deployment of bio-fuel digesters to produce renewable fuels including alternative natural gas. In the United States, by contrast, feed-in tariffs are not adoptd as widely, even though they can change market behavior.

Libshutz and Franceschi point to an ethanol venture they are involved with and say that a role for biofuels exists, even though current market structures create some negative consequences.

One current problem is that corn- and sugar beet-derived biofuels compete in the commodities market with food producers. The biofuels venture that Franceschi and Libshutz are pursuing focuses instead on what they call a “closed-loop” ethanol plant that relies on a cattle herd for its biomass source. The facility locates an ethanol plant near the herd. Manure generated by the herd feeds a digester to make biogas. “Syrup” produced by the ethanol plant is recycled. And distiller grain that is produced is fed to the herd.

“We look to combine things,” Franceschi said. The idea is to reduce business risk as much as possible.

A conventional ethanol plant exposes developer and investors to four principal price risks: distiller grain prices, corn prices, natural gas prices and ethanol market prices. A closed-loop approach reduces exposure to two of the four risks: distiller grain prices and natural gas prices.

The approach removes a “significant element of cost,” namely, the energy generation, Libshutz said. This “significantly lowers” the cost of production and helps make the project attractive financially.

In the long-run, Libshutz said he would like to see elected officials in the United States agree on a “sensible, integrated plan” that helps utilities and markets to more widely accept renewable energy technologies.

Some might see that as overly optimistic thinking, but not Libshutz. “I do believe in Santa Claus,” he said. “I do believe in the Easter Bunny.”