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Renewables and Finance
Submitted by Dan Sweeney on Sun, 2009-10-04 19:28.
Few have made the transition from alternative energy trade journalist to alternative energy equipment manufacturer. I may not be unique but I represent a rare species.
Obviously, one can't present oneself as an unbiased reporter when one has a clear personal stake in one segment of the industry, but still a real insider's view must count for something, especially if expressed with something resembling a journalist's flair.
So an insider's view it is—topic, obtaining first round financing during an economic collapse.
A Greatly Altered Landscape
When I started this publication, the funding situation for alternative energy entrepreneurs was rather sanguine. The venture capital groups were pouring ever increasing amounts of money into the renewable space, and, while the new energy technology sector lagged behind the so-called tech sector (which is essentially network computing in its many guises and embraces no other areas of technology) its growth rate encouraged one to believe that it might soon draw abreast of Web 2.0.
Despite the perturbations in global financial markets, investment in new energy technologies held fairly steady through most of 2008, but began to plummet with the coming of the new year and the new Administration. Very little money is to be had from private sources at present, and most of that little is emanating from what are known as angel investors, the source that we ultimately tapped for our startup.
Here perhaps a few words of explanation are in order for those who are more involved in technology developments themselves than in the means of financing them.
For most entrepreneurs, especially in technology startups, financial concerns are paramount. First raising investment and then placating investors once it is obtained consume much of one's energies and often hinder one's efforts to develop the technology in question and bring the innovation to market. Money is the constant preoccupation, that and the investors who provide it. So who are these investors? They tend to fall within a few more or less well defined categories, enumerated immediately below.
The first of these is oneself, or, alternately friends and family, and this, logically enough, is called self financing. If one has abundant discretionary resources of one's own, then proceeding is only a matter of personal tolerance for financial risk. And if one must lean upon family members, the task of convincing them will usually be much easier than persuading institutional investors or professional individual investors to fund a project. Most startups of any sort begin with self financing.
Angels come next. These can be wealthy individuals of any stripe—I myself sought investment from an auto dealer at one point—but those who figure most prominently in the financing of startups tend to be persons with considerable business acumen and often specialized knowledge of the field in which they are investing. These are the ones who draw up detailed legal contracts, secure rights to intellectual property and protect it subsequently, and perform extensive due diligence on the individuals they are funding and the technologies those individuals are promoting. In short, they're the pros, the individuals with the skill, contacts, and insight to midwife the launch of a company successfully and take it to the next stage if it ultimately shows real promise. I am very fortunate in being funded by such an individual.
Such seasoned backers, who often prefer the term seed investors over angels, are seldom silent partners, and are apt to exercise strict oversight, and, in some cases, to assume de facto or formal management roles with the new company. They have relatively few investments and they tend to be intimately involved in them.
Angels may be individuals or representatives of family trusts, or they may be relatively small investment pools. There's no hard and fast distinction between angels consisting of investment pools and venture capital firms, the next clearly defined group, but as a rule angel organizations command less money, and decisions are made by the vote of the investors and not by professional investment managers as in the case of venture firms. Indeed, few angel organizations have much in the way of staff.
Angels normally invest anywhere from the low six figures to the low seven figures—seldom more and seldom less. Most entrepreneurs requiring only small amounts of money have no choice but to draw on their own resources. No professional money manager wants to deal with a firm with small financial requirements, particularly if it has relatively small sales potential. I was involved in one previous startup where we sought a mere thirty thousand dollars to launch an initial production run and at the same time where we were unlikely to net more than a few million dollars a year best case. This was some fifteen years ago, but 30K was still not a lot of money. We almost persuaded one angel group but for various reasons they demurred, and we were lucky to find even angel investor who would consider backing us.
Angel organizations almost never take a company public or even position it for a stock offering. They are normally what are known as early stage investors or founders. If the firm they are funding appears highly promising, they will often invite larger financial groups to invest in it, most commonly, venture finance groups, who occupy the next stratum of the financial landscape.
So how do you find angel investors? It ain't easy. There are angel umbrella organizations and directories but none is all inclusive by any means because many angels don't want to be found. Very often pre-existing personal relationships are a prerequisite for gaining access. That's what got us a hearing and ultimately funding. Incidentally, we approached two angel firms and elicited serious interest from both, but only one made an offer.
Venture capital firms came into prominence in the nineteen eighties and figured in a great way in the development of the tech sector in Northern California, Boston, and south east Texas, the loci of innovation in this area within the U.S. Venture firms underwrote much of the Internet and telecommunication booms and also invested heavily in biotech. Venture firms have also been extraordinarily active in funding new energy technology but recently the pace of new venture investment in this area has slowed dramatically.
Venture firms are inevitably equity investors. They don't loan money, instead they obtain a percentage of the startup in return for providing the funds for it to develop its product or service. Percentages vary—each deal is different—but they often take a minority position initially. But with each additional round of funding the entrepreneur's share is usually diluted while the venture firm's share is enhanced, so the venture investors end up owning most of the company. They often obtain veto power over corporate decisions as well, and sometimes end up dismissing the very persons who founded the firm and developed the core technology.
In many cases venture firms collaborate on investments, particularly when large amounts of funding are indicated. Such collaborative investments are most likely to occur in later funding rounds.
Venture firms vary in size. I knew one firm manager who had trouble raising a few hundred thousand dollars but the biggest firms command war chests brimming with tens of billions of dollars, with billions more spread across scores of investments. So where's all this money coming from? While there have been a handful of venture firms who have sold stock, they usually tap the mega rich for private investments, often members of the hereditary plutocracy with huge family fortunes. Venture firms differ in their minimum investment requirements, but many insist on at least a million dollars. Everyone involved is placing very big bets.
Venture embraced new energy technology in a big way in the middle years of this decade and continued to fund certain projects lavishly through 2008, though the pace of seed investment began to drop off as the world financial crisis deepened. Even this spring there was money on the street. Now there's almost nothing. Everyone has suddenly become highly risk aversive. You can knock on venture's door but they're unlikely to answer.
In fact such doors were never very likely to open for most entrepreneurs. Fewer than one percent of startups presenting business plans ever got money out of the west coast ventures firms with which I was familiar, and most failed to get their business plans read let alone seriously considered. There is such a tremendous number of applicants that most venture groups are more concerned with filtering than soliciting.
Given the small number of successful applicants one would think that only the crème de la crème are receiving funding and that venture firms must enjoy a very high success rate, but such is not the case at all. Venture firms, like publishers and record companies, depend on a few hits and lose money on most investments. They have a well deserved reputation for recklessness, a trait which can serve them admirably during booms and bubbles, but puts them at tremendous risk in down times.
Venture capital firms collectively have scored very few solid successes in alternative energy to date, a fact that is contributing to their hesitancy to fund any more. We never actually approached a single venture firm in our quest for financing this year. We somehow knew it was hopeless.
Anyone who pays the slightest attention to financial news knows that investment banks have been brutally hammered for more than a year, and that some of the very largest have closed their doors. Those that have survived are more concerned with funding executive compensation packages with tax payer bailouts than investing in new businesses that might revitalize the failing economy.
It wasn't always so. The investment banks played a key role in stoking the tech boom of a decade ago, but by the time alternative energy boomlet rolled around they'd changed their business model, focusing on securitized debt instruments and other derivatives which promised consistently high returns, appeared to pose little risk, and which required little or no due diligence. Boy, were they wrong, but an analysis of precisely why they were wrong could go on for several volumes. I'll leave that to economic historians who I'm sure will be studying the matter for the next century.
Investment banks are characteristically late stage investors, providing final infusions of cash before the company is taken public, a process that they execute. This is where the really big payoffs occur or used to occur. If the new company is deemed hot, a buzz is created by the investment bank within the larger financial community and an initial stock offering (IPO) is prepared and is limited to a small group of preferred investors. These will acquire stock at a predetermined price and then the bank will offer a public issue. At this point, if the ploy works, the stock price may quickly be bid up to giddy heights and the investment bank and the early investors will profit enormously. So will the venture capital firm and presumably the founders if they have succeeded in negotiating favorable terms for themselves.
During the dotcom and telecom booms numbers of startups reached the IPO stage and saw their stock prices ascend as high as hundred dollars per share. In such instances the founders would normally be provided with a certain number of stock options which would allow them to buy a given number of shares at the initial price. If the price took off they found themselves enjoying ten thousand percent profits and in some cases they were allowed to borrow money from the firm to purchase the stock which they might immediately sell to repay the loan.
I can't recall a really major IPO involving a recent startup during this decade. Most of the big ones like Google's featured ex-startups with solid histories of business success. The overnight successes of the nineties may be a thing of the past. Incidentally, there have been no truly successful IPOs involving new energy technology companies, not one. When I started studying the energy industry back in 2001 I assumed that experience of the dotcoms would be replicated by the energy innovators. It didn't happen. Tech booms, it appears, are relative rarities. They don't drive investment ordinarily.
The Lender of Last Resort
So where is the money coming from for new energy companies? From the government, particularly the Federal Government. The Obama Administration has an expressed commitment to reducing greenhouse gases and to fostering renewables and energy conservation measures. Billions have been made available to private developers. Because this area of finance is so complex, it is properly the subject of a whole separate posting.
Unfortunately, the Federal funding process does not favor the small entrepreneur. Whereas private investors are answerable only to themselves, government functionaries charged with dispersing funds have to conform to sets of rules emphasizing conventional qualifications and histories of prior accomplishment, rules that favor larger corporations rather than lone innovators. I can understand the caution of government agencies in this regard, but I can also see that it results in resources directed to groups who are opposed to fundamental change.
I am attempting to pursue government funds on a number of fronts, so far without success. And much as I loathe the process, I can't afford not to do it.