Raising Energy Technology Capital
In 2006, over $100 billion1 was invested in renewable energy, almost a 50% increase from 2005 ($71 billion)1. Energy is quickly becoming one of the world’s hottest sectors, now accounting for more than 15% of the world’s total investment2. Through, angel investors, venture capital companies, and even private equity firms, the entrepreneur with a brilliant idea has reaped incredible benefits and values in the marketplace.
Typically, ideas that come out of the family den usually proceed first to friends and family, candidates who are not only most likely to first hear the stroke of genius, but also the first to offer funding and moral support. However, friends and family can only offer so much capital. If the idea is good enough, and, more importantly, if its owner is ambitious enough, funding then proceeds through angel investors. These ‘angels’ consist of ultra-high net worth local individuals who are willing to take the risk in investing in these ideas that are in its infancy. Friends, family, and even fools entrust their ideas into these angel investors, who in turn invest a lump of money out of their own pockets (usually $250,000 to $2 million) in return for part ownership in the newly expanded company. According to the
Naturally, the first step for inventors and engineers who think that they have a great idea that’s about to change the word we live in is to get the ball rolling with their friends and family. Unfortunately, however, the most that our friends and family can offer pales in comparison as to what an idea needs for a business to thrive. Venture Capitalists also usually don’t deal with ideas that are literally in its baby stage- that is, has yet to create a prototype, has not gone through extensive R&D, and, most importantly, has yet to find its aura of appeal. Angel investors have filled the gap between family and friends and venture capitalists, offering anywhere from $250,000 to even $3 million. Last year, angel investors across the States devoted an average of $500,000 to 51,000 startups3. However, angels are definitely aware of the risk that a “brilliant” idea might have, which is why they expect at least a return multiple of 2-10 times their initial investment.
Angel investors lay the claim as the most unique type of investor- different from the average private equity fund, venture capital fund, or even bank. Angels aren’t necessarily looking to make another fortune, even though this can pretty much sum up the other 99.5% of corporate
Before pitching to an angel, entrepreneurs must understand what they’re looking for and why they’re looking for it. Even if an angel is an ultra high net worth, ex-Fortune 500 CEO, money is still money, and he’s going to want to make a sound investment. With angel investing, angels usually take money from their own deep pockets to invest in startup companies. However, angels aren’t necessarily investing in the idea or the company, per se; so much as they are investing in the person sitting across the table. Many of these angels have probably been in the fundraising position, and the guy being pitched to probably has been the one doing the pitching in his past. They know and understand how entrepreneurs feel, what’re they are going through, and they know what it takes. With that being said, angels want somebody that they’ll love to be around, an entrepreneur that exhumes confidence, shouts passion, a personality that parades charisma, craves a challenge. I’d want to invest my money in somebody that charmed my socks off, knew what they were talking about, and had the confidence that their startup could be the next Apple. They’ll also want to see a business model that they can understand, that they can level with. What that means is that these guys are businessmen, not the next Albert Einstein! Most won’t understand the key intricacies of the engineering behind the proposed rocket science- a general overview will more than suffice. Nobody wants to be shoved 5,000 200 page business plans, where pages 40 through 188 will diagram and explain the most crucial technical details of the design. They want to see models, numbers that speak of growth and return on their investment, why a product is better than the next guy’s, what kind of market exists and its potential. Another key feature of successful angel investor ventures lies in the management- who’s running the company? Is it going to be Me, Myself and Irene, or has the entrepreneur already enrolled the Top 1% of
Angel investors can only help bring along a project so far- they simply just don’t have the resources to continue investing in larger and larger amounts, which is where venture capitalists come into play. Venture capital funds tend to consist mostly of a collection of former CEO’s and senior executives in technology companies. What’s more impressive about some VC funds is that they actually hire engineers as consultants, and thus, unlike angel investors, will understand the technical jargon thrown at them. Careful though, just like angel investors, and probably every other business venture out there, venture capitalists don’t want to be bored to death with every key component of engineering that has been invented. Venture capital funds usually invest a larger sum of money into the venture to help get it moving, with the average investment hovering around $7 million4. Where angel investors value quantity over quantity, per se, venture capitalists highly value quality investments over quantity. Simply put, venture capital funds cannot afford to spend $3 million - $20 million for each investment that they have a “hunch” for. Overall, venture capital funds spent about $26 billion in 2006 on investments4, nearly the same amount as angel investors, but only invested in about 1/15 of the amount of startups that angels did. Just like angels, venture capitalists also look to grow early-stage companies, hoping for tremendous potential, and, therefore, tremendous growth. However, VC funds tend to invest in companies and receive a certain amount of equity yearly, and even a voice in the company boardroom. What does that mean? Well, for one, creators and investors will have to be sharing profits, and two, there will be another ear at every important meeting for the company’s future. The voice in company decisions, however, has actually become one of the better benefits of VC, as they can actually help the company grow in very significant ways. After all, many venture capitalists were, at one time, highly successful senior executives and chief executives.
In the past two years, it has become increasingly difficult to secure investments from venture capital funds, with about one in every three to five hundred business plans actually making it to the boardroom for discussion. However, this doesn’t mean that VC funds are risk averse: actually, I’ve found it to be true that they actually like some technological risk and some financial risk. Of course, the bigger risk they take, the bigger return they’ll charge, but that’s definitely better than nothing. In the past decade or so, venture capital funds have absolutely fallen in love with technology- well, not all technology; just technology that works. What’s even more important is technology in a market that’s hot (meaning state of the art technology for a e-commerce, one of the coldest sectors for VC funding, is likely to not even get a second glance). One market that has been booming of late is that of renewable energy5. With various laws that have been passed in light of global warming, natural resource concerns, etc., VC funds are finding it increasingly important to invest in this upcoming technology. VC firms are also looking for business plans that work, very high growth potential, a passionate founder, as well as a charismatic one, and even a strong, well drawn out and well thought out exit plan (public offering is much more preferable than any other exit strategy for VC). Two things seem to stick out most when VC firms make their decisions regarding investments. One is a strong, proven management team. And I’m not talking about even the top 1% of
Even ideas that are labeled “half-brilliant, half-ludicrous” can receive funding from venture capitalists. Take Google for example. Amazingly, nobody really wanted to invest in a couple of Stanford kids with a ludicrous idea, which was to create “World’s best search engine”. The Google funding came in 1999, when Yahoo was absolutely on fire in the industry, and so were WebCrawler, MSN, and about what seemed to be a half million other search engines out there. Google had one thing that its competitors did not: a patent pending technology called Page Rank, which was a measure of how important a web page was, in relevance to a particular search. Of course, the technological risk was absolutely astounding, and the financial risk ($25 mil) was even greater! How could a group of Stanford students with an unproven idea compete against the mogul-monster Yahoo, among other search engines? In the end, Sequoia Capital and Kleiner Perkins invested $25 million6, and two of its brightest members into Google’s board of directors, in what might be one of the best investments ever. Of course, we all know how the story ends. Google was taken public five years later in 2004, filing for an astounding $2.7 billion IPO. What might’ve sold Sequoia and Kleiner on Google was that exit strategy. Would the investment be as promising if the plan was to accept a buy-out from Yahoo? Surely, I don’t think in my wildest imaginations, Yahoo wouldn’t have offered $2.7 billion for Google.
Don’t be discouraged when funding requests are rejected once, or even multiple times. Google, the mega-monster itself, was rejected by Bessemer Venture Partners, who also rejected EBAY, Apple, INTEL, and even dinged the packaging king FedEx an astounding seven times. Amazingly, BVP has been in the business for longer than many of us have been alive, so they definitely know a great investment when they see one.
Many companies that receive funding from angel investors, and subsequently find success do not fare as well in the venture capital stage. Even many of those companies that do luckily receive funding from venture capitalists tend to fail. For those lucky few that are standing after the monsoon has passed, there is private equity. What private equity firms are looking to do is purchase a thriving business, usually not in the early stage, but there are no real timetables, or undervalued, put management in place, cut costs and drive up the value, and then, eventually, resell it through an IPO or to a major competitor in the field. Of course, entrepreneurs are the beneficiary of this, as they get to take money off the table (through the buy-out). Moreover, most people tend to stay in the company with a central role. Last year, nearly $415 billion was invested through private equity7. For the most part, private equity firms are looking to spend at least $20 million, with several investments reaching the billion dollar mark.
Private equity firms pride themselves on their diversity, in that they may boast ex-Fortune 500 CEO’s, veteran senior executives, fresh business school grads, finance gurus, and even newly minted college graduates. By operating on a sky-high compensation, private equity firms are able to attract the world’s best and brightest. It is only fitting for the world’s best and brightest to accept companies that have proven to be the best, or have potential to do so. The “best companies”, in the minds of these gurus, are companies that have a steady growth rate and a high cash-on-cash return. Many private equity firms simply do not want to take a billion dollar risk, so companies with unproven technology need not apply. However, private equity firms tend to salivate over companies that clearly have a defined competitive advantage over its competitors, with proven technology, of course. Private equity firms love seeing companies with the possibility of high value, but with a weak management system in place, in that they tend to buy out the company, and then replace its management with an even sharper team of their own. Lastly, and quite possibly one of the more important deciding factors for PE firms, a clearly defined exit strategy, or even a clear path towards an exit must exist. Again, the echo of Buy low, sell high continues to live on.
Don’t be afraid to sell a start up company to a private equity firm in fear that loss of control or stature and position in the firm will be diminished. Many companies seek out private equity not for financial reasons, but because of the management team that they can bring, and the exposure and opportunities that come with it. Most entrepreneurs who want to have a substantial interest in the company after it is sold to private equity retain that interest. Remember, these firms don’t make money unless the value of the company appreciates, so they have no reason at all to sink a healthy ship.
Private equity firms are always looked for the next market to crack open and make an investment in. In a summary of over 300 private equity fund managers, renewable energy is the sector that shows greatest promise, and is drawing an incredible amount of attention from these firms, as it has become the sector with the “most expected activity increase” 2. Renewable energy has often shown that it offers the highest rate of financial return, has a long-term approach, and is much less riskier To date, renewable energy accounts for more than 18% of the world investment in energy, and is rapidly increasing2.
The last alternative method, and possibly the most expensive, is project finance. Project finance generally has been saved for “infrastructure investments”, more commonly in the energy, transportation, mining, and telecommunication industries. Project finance involves a number of key entities, ranging from a supplier to a financier and even a “product off taker”. To finance an expensive piece of infrastructure, the benefit of project finance is that the “financee” could repay the loan through future revenues and future cash flow, as opposed to basic credit. Generally, private equity firms lend anywhere from 80-100% of the necessary cash, and in return, PE firms typically receive a certain percentage of future cash flow generated. Of course, every project comes with risks, and infrastructure investments are no different. Collateral takes the form of assets used in the project. What’s so important and advantageous of project finance is that one person or one group does not bear the burden of the risk- multiple parties make guarantees, and are thus equally at risk. Each party must make contributions and guarantees, whether it be through future sales, purchases, etc. However, project finance is very expensive, even more so than most of the above mentioned funding.
Project finance looks for guarantees of business in order to ensure that they will be repaid. PE firms understand that they can’t be repaid unless the project has existing customers, which is why many companies offer guarantee of sales at lower costs to others who guarantee to purchase. A strong cash flow and worthwhile collateral are also considered in project finance. To close the deal, financiers are also looking for many of the other attributes that make for winning investments in venture capital and private equity. Nonetheless, project finance is notoriously abundant in risks. The greatest risk seems to be the time frame, as a number of things can go wrong here. The project may not complete construction in time, in which such an action could violate a number of contracts. Because of a late completion, the project may not generate enough revenue, the capital costs for construction may increase, and eventually delaying loan repayments. The project, upon completion, may also suffer from insufficient cash-flow generation, even with several guaranteed clients. The project also is susceptible to inefficiency, in that the project does not operate at its full capacity, or the capacity that it was once expected to operate at. Like most other investments, there are also market risks and technological risks. Of course, financiers are able to mitigate these risks to the best of their abilities using a number of tactics.
Even though there are a myriad of opportunities in raising capital for a startup, entrepreneurs always must be conscious about where to raise money and who to approach. If the venture proceeds through debt financing, be prepared for considerable complications. However, the best investment, regarding these funds, might not actually be the capital investment received from these people. In fact, many companies hire private equity firms just for their representation, just for their knowledge and experience. Why would any entrepreneur pay, even borrow money that they don’t need, for the service of an outsider who seemingly has no real passion or interest for the business, other than the fact that it might make the financier a couple of extra dollars? By definition, all investments have risk, regardless of whether the company being invested in has been proven over time. Take Microsoft into account. Microsoft, in its baby stages, carried numerous risks with it, including technological risks, developmental risks, litigation risks, a lack of a market, and many barriers to entry. Apple had many of the same risks, but the competitive risk to compete against Microsoft was a huge determining factor in many decisions to invest in the firm. Could a small company like Apple really compete with Microsoft? The beauty of venture capitalists, angel investors, and private equity firms lies in the fact that these investors are gifted at recognizing these risks, and them mitigating those risks. If there isn’t a market for a Microsoft, or if Apple has a competitor that is too strong and too big, the above mentioned investors will simply fin d a way to mitigate those risks to yield a sound investment. Not only are entrepreneurs not receiving funding when “signing up” with these investors, they are also receiving expertise and years of invaluable experience to help move the company along and fight any risks that might stand in its way. Simply put, these investors find a way to make a start up company work.
All in all, financiers, whether it be PE firms, venture capitalists, or even angel investors, are making it that much easier to build a company from the ground up and become a master in the respective industry, whether it be through funding or the advice of seasoned professionals.
1The UNEP Annual Report 2007; 2Simmons and Simmons International Survey of 300 fund managers; 3Center of Venture Research; 4National Venture Capital Association; 5Cleantech Capital Report; 6Google Press Release Center (July7, 1999); 7Thomson Financial and Papal Research