Financing Bioeconomy Ventures

By Wayne Lee and Gerald Kutney, Lee Enterprise Consulting

Gerald Kutney

Wayne Lee

Special to The Digest

First of an 11-part series

This article is the introduction to a series of articles[1], reviewing the typical steps that investors consider before providing financial support to biofuels or biochemical projects. There is often disconnect between those seeking funding for new and emerging technologies, and those who can provide funds. Entrepreneurs often approach their requests for funding without providing the proper tools for understanding, evaluating and mitigating the risks of their projects. This series of articles is meant to bridge this gap, encouraging more investment into alternative and renewable fuels and chemicals projects.

From Friends & Family to Investment Rounds

The initial financing for an emerging-biofuel or renewable chemical project typically comes from the founders[2] and “friends and family.”[3] These funds are often used to prepare investor-grade pro forma and business plans,[4] and test the technology to estimate preliminary operating and capital costs.

Developments funded by initial financing prepare the stage for the next round of funding, which begins the seed or pilot-stage phase of the technology development and continues through scale-up stages to a demonstration facility. The patrons of technology, commonly called angel investors and angel syndicates, start this phase, and then VC firms (i.e., “Series A”, the first institutional round of funding) increasingly become the common funding sources as the scale-up of the technology progresses. Another avenue for launching the start-up phase is to find a strategic industrial partner who has a specific interest in the process’s biomass (upstream), technology (midstream), or biofuel/renewable chemical (downstream). Generally, financing options improve with the advancement of the technology, as the accuracy of estimated process economics improve. The best financing options are usually groups and funds that specialize in the sector, such as biofuels/renewable chemicals, green technologies or clean tech.

During the early pursuit of financing, the quality of the entrepreneur’s pitch is the initial major sell of the opportunity to the investors. Most investors cannot judge the best technology, but they are experts at evaluating the best pitch, including the merits of the economic claims (e.g., where do the numbers come from?). The pitch must be passionate and compelling, but still based on facts that can be verified by external pundits (i.e., no hyperboles).

The entrepreneur loves discussing details of the technology, vision and strategy, and altruistic aspects of the project, such as saving the world from climate change; but these subjects are not what the investor usually wants to hear about. A project is evaluated by the investor on the risk-reward scale. Emerging biofuel/renewable chemical projects can be disadvantaged compared to other investment opportunities because of many characteristics: capital intensity, long innovation cycle (cash-burn rates), feedstock variability and reliability of supply, and NIMBY protests. The investor must see that the project’s management team understands all the risks and has the skills and experience to manage them. At the end of the day, the investor must see a far greater ROI (or SROI[5]) than risk, which must exceed their hurdle rate or MARR (minimal acceptable rate of return). This ROI (and its associated risk) is not simply based on the claims of the entrepreneur, but must be verified by independent experts.

After the verification process is completed, and the technology has been thoroughly tested on a demonstration scale,[6] more equity and debt (and mezzanine) project financing options open up; more so for the growth of post-demonstration technologies that have a history of commercial operation.[7] There is a shift towards more independent evaluations of the project, as the financial requirements are now in the tens of millions of dollars. Financing groups in this sector include investment banks, merchant banks, institutional investors, and private equity firms. Again, project developers should focus on financial institutions and funds that specialize in their sector.

Due Diligence Components

In the first quarter of 2017, biofuel/renewable chemical ventures in the U.S. raised more than one billion dollars.[8] The question is how can you become one of them? All levels of financing are extremely difficult for any entrepreneurial venture; so understanding the process and being prepared for the associated trials and tribulations are important. There is no definitive formula for project evaluations, but the following are common steps (or a sequential check list) in financing due diligence. The expectations in each step will vary according to the commercial maturity of the technology and/or level of financing requested:

1. Initial Project Assessment:
   1. Pro formaanalysis – Includes ROI, debt service coverage ratio (DSCR) – an analysis of sources of major inputs and outputs of the financial model, and identification of major risks and other unknowns (considering the stage of commercial development of the technology).
   2. Business plan analysis – Includes management capabilities, biomass supply, off-take agreements, regulations and permitting, CAPEX (cost estimate “class”), process flow diagrams, competitive differentiation, strategic alliances, technology roadmap, cash flow analysis (cash-burn rate), timeline to positive cash flow, milestones (stage gates), gap analysis and critical path review, risk[9] assessment and mitigation.
2. Competitive Technology & Market Assessment:
   1. Considers stage of commercial development, competitive position of the technology evaluations, and analysis of strategy to bring the project to positive cash flow as quickly as possible.
   2. P. strategy and patent threat evaluations
3. Pilot Site Assessment (by independent experts) – facility review and observing pilot/demo operations or other facility using technology; review of data history, analytic and other operational records.
4. Engineering Design Assessment
   1. Front-end engineering design (FEED)/front-end loading (FEL) evaluations, classification of capital cost estimate, P&ID (piping and instrumentation drawing), PFD (detailed process flow diagram).
   2. Start-up, training, operation, maintenance, and quality control plans and procedures.
5. Site Selection Assessment:
   1. Supply and demand logistics analysis; feedstocks and products.
   2. Regulations and permitting, local community consultation, involvement and support.

For the biofuel/renewable chemical projects that survive the process, the data and reports from above will be added to the information in the Due Diligence Data Room for review by prospective investors. Then, if investors show interest, negotiations begin on a term sheet (funding, governance and control, liquidation), which leads to a funding agreement (likely with stage gates or milestones for the release of future funds).

The steps for financing bioeconomy ventures will be developed further in a series of articles by leading experts from Lee Enterprises Consulting. (Next Up: Financing Bioeconomy Ventures: 2- The Pro Forma).

About the Authors

Wayne Lee is the CEO of Lee Enterprises Consulting. He is an internationally recognized alternative fuels and business consultant with over thirty years’ experience. He owns both Lee Enterprises Consulting, Inc. and National Business Brokerage, Inc., a full service business brokerage firm specializing in buying, selling and evaluating alternative fuels plants.  Wayne received his B.A. from the University of Arkansas at Little Rock, has written two copyrighted series on buying and selling businesses, served on Congressional energy panels, and written many industry articles.  In addition to leading our group, Wayne specializes in project consulting & oversight, efficiency and operational review, strategic planning, risk management, and in the buying or selling of plants.

Gerald Kutney is the Executive Vice President of Emerging Technologies, Biomass Power, Biogas/AD, and Investor Services for Lee Enterprises Consulting, and Managing Director of Sixth Element Sustainable Management in Ottawa. He has a Ph.D. in chemistry and over two decades of executive experience with global corporations and entrepreneurial enterprises in the forest bioeconomy.

[1] This is the first in a series of articles to be published by members of the Corporate Finance/Transaction Services Division at Lee Enterprises Consulting. www.lee-enterprises.com

[2] Direct investment by the entrepreneur (skin in the game) will be expected by later outside investors (“sweat equity” does not count).

[3] Depending on the jurisdiction, government grants may be available during any stage of the commercial development of a new technology.

[4] These provide the business case and are living documents throughout the life cycle of the project.

[5] Impact investing: Social Return on Investment (i.e., includes financial and social returns) can also widen the scope of potential financing.

[6] For the detailed report by the U.S. Department of Energy on determining the stage of commercial development of new technology, see Sanchez, R. 2015. Technology Readiness Assessment Guide. The Technology Readiness Level (TRL) scale developed by NASA is discussed on pp. 8-9, 22-30. In the nine-level system, project financing may be considered at TRL 8, but usually not until the last stage TRL 9.

[7] For a categorization of biofuel technologies, see Kutney, G. 2017, The Industrial Status of Biofuel Technologies, Biofuels Digest, January 11, 2017.

[8] Lane, J. 2017. Advance to Go! The Digest’s Multi-Slide Guide to Q1 2017 cap raises in industrial biotechnology, Biofuels Digest, April 17, 2017.

[9] Typical risks include:

1. technology – stage of commercial development, engineering estimates, I.P. and patents, and scale-up
2. financial – scope creep, cash-burn rates, timeline to positive cash flow
3. biomass – supply, quality assurance and price
4. product – yields, quality assurance and price
5. market (offtake) – demand, pricing, customer commitment
6. project costs – developmental, operating, capital, return on investment, growth potential
7. government – regulations, permitting, SH&E, and NIMBY
8. “unknown unknowns.”