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Financing Expensive Cleantech Projects In Today’s Climate

Kudos to my colleagues at Venture Capital Journal for an illuminating breakfast discussion this morning on how big cleantech projects might get financed in this abysmal economic environment. (Big props especially to Alex Haislip, who organized and moderated the event.)

Held at Quadrus, a glass-lined conference center that sits amid a sea of venture capital firms on Sand Hill Road, the breakfast featured three speakers: John Buehler, the managing director of Energy Investors Fund, a project finance company that invests in a range of power-related projects; Ben Kortlang, a partner at Kleiner Perkins Caufield & Byers who focuses on growth-stage green-tech investing; and Rohan Singh, a senior VP at the commercial bank HSH Nordbank. Singh structures debt and equity transactions for renewable energy projects.

Herewith, to the best of my note-taking, is some of the conversation that took place:

AH: [To Ben Kortlang], What’s the Green Growth Fund’s association with the rest of Kleiner’s funds?

BK: Historically, Kleiner has only done venture-stage investing across IT and life sciences. It began actively investing in green tech three years ago. Now its venture fund does IT, life sciences and green tech. But the Green Growth Fund [a $500 million fund vehicle announced last May] is focused exclusively on later-stage, green tech. Whether a company gets backed by us versus the other funds hinges on whether it still has significant technology risk. If so, it’s an early-stage investment. If it’s an expansion-stage company with less business risk, then it’s a Growth fund investment.

AH: Rohan, how much technology risk on you willing to take on?

RS: We don’t take on technology risk. We work with companies that are proven and just looking to ramp up and that lend themselves well to a project finance structure. To get on our radar, technology risk has to be addressed. If it’s very far from being commercialized or certified or if there are no contracts in sight, it’s probably too early for us. Folks like us get involved when the consultants and the Department of Energy says, “this is something that works.”

AH: John, same question; how much technology  risk are you willing to take?

JB: We’ve taken technology risk in the sense that we’re working on a clean-coal project, converting coal to gas. It’s an example of a risk that was proved around a prototype project that Texaco had built. They’d been working on the project over five or six years, figuring out how to fix everything that could fail and getting it ready to sell to the marketplace.

So effectively in a project finance scenario, we’re akin to a second or third round of financing. The key for us are power purchase agreements. We’re very fond of revenue streams, and of arrangements with industrials or utilities that extent 10 to 30 years. That offtake agreement is critical to us and helps us diversify our risk. [For the uninitiated, I believe an offtake agreement is a contract between a company and the buyer of its products or co-products and is generally negotiated well before the construction of a required facility gets underway, since securing a market for the output is necessary to secure the facility’s financing.]

RS: I completely agree. The best proof of concept is a strategic partner, often a utility, saying, “I will develop this project and buy from you for years.”

AH: How can an entrepreneur or VC best pitch you?

JB: I’m not sure if the concept of pitching enters into what we do. I might call up Ben [Kortlang] after today’s meeting and see if we could talk about his clients and contacts, with that constant cycle of capital in mind.

We started doing what we do in 1987 and we’ve seen 6,000 opportunities, 105 of which we’ve invested in, and they’ve produced return capital in every case but 2. So [we have a pretty effective] BS screen. [Additionally,] we love to have a big-name VC involved.

AH: Ben, how do I put my hands in your pockets? [Crowd laughs.] Okay, maybe I should rephrase that.

BK: A lot of companies that pitch to us, it’s clear they aren’t a good fit. The best way to access Kleiner is to present your investment opportunity as clearly and crisply as you can. We’re looking for a sustainable competitive advantage — a company that has proven commercial proof points, very attractive economics, customers saying, “I will buy this,” and that can be a winner in big marketplace. Bring us those businesses, lay out their value proposition and risks clearly, and let’s cut straight to the chase.

I’d also say KP is very hands on in the way that it invests. If it’s a purely passive investment, it’s not best use of our resources and network.

AH: Rohan, how does an entrepreneur win your money?

RS: It helps if there’s a brand VC firm attached but that’s not the only thing we’re looking for. Proof of concept and economics are very important. There also has to be  a very good rationale for why it will be more competitive than its peers

AH: Is there anything in clean tech that you wouldn’t invest in?

RS: I wouldn’t invest in offshore wind.

BK: [I’d be reluctant to back] first-generation photovoltaic, first-generation biofuel companies. A lot of early opportunities in the clean tech space.

JB: We’ll invest  in offshore wind. We’d sympathize with Ben about some of his concerns, though.

AH: Each of you have different return hurdles. How long will you hold onto an investment, and what sort of return are you expecting?

JB: We look at a five-year investment cycle. But it’s never been more than a year-and-a-half for us [before we start returning some capital] because of the liquidity available on [power purchase agreements] and distributions from operations on a regular basis. That’s the nice part. Our average yield on an investment is 10 to 12 percent in the first year and a half. We achieve long-term capital upside by selling into a favorable marketplace.

BK: We [expect returns] within two to five years. We don’t target yields or IRRs but multiples of money, depending on the stage of the deal and the risk involved. For businesses that are closer to exiting, the multiple is typically lower. If there’s more risk involved and KP can have a larger impact, we’ll look for double-digit multiples.

RS: We can go as long as five years but we like a monetization event in two years or less. We’re basically on the cusp between late-stage VC and commercial banking.

AH: how much harder is it to do business today than in September and who can fill the capital gap?

RS: These days, no one, but I think it’s a very temporary phase. I think a lot of people are changing the hats that they wear. For example, I think hedge funds will reemerge [under the guise of something else]; I think pension funds are dedicating certain amounts of funds to this space. The Chinese government is also looking to put billions of dollars into the space. Everyone is just waiting for the other shoe to drop at the moment.

BK: The environment we were living in [pre-September] was falsely optimistic. Hedge funds had been investing in things they shouldn’t have been and taking on technology risk they didn’t understand. Investment banks obviously did a lot of things they shouldn’t have done as well. A lot of investing was happening in the late-stage clean tech space that wasn’t well understood.

I don’t think we’ll return to that environment. I don’t think sovereign funds are going to step into the shoes of hedge funds and make investments in things they don’t understand. They’re gong to be very careful about the way they invest in this space.

What I think you’ll see is a replacement for loose money. You’ll see smart, more patient, company-building-type investors who understand what they are investing in and are willing to invest for a five year period — rather than invest to flip their holdings. I think the clean tech space needs to reset its expectations.