Finding the Private Benjamins: Bridging the Dev Cap Gap

By Matt Lucas, PhD. Managing Partner, Tuatara Development Capital
Special to The Daily Digest

We read with interest CJ Evan’s piece about the need for development capital (“Dev Cap”) to expedite the development and deployment of projects in the energy transition space. CJ is completely correct: Dev Cap is both incredibly important to project success and mostly unavailable: it’s simply not a recognized investment class.  We at Tuatara Development Capital (“Tuatara”) are working every day to change that by providing Dev Cap to worthwhile projects, demonstrating attractive returns for capital providers, and building a constituency for this new investment class.

What is Dev Cap?

Dev Cap provides the funding needed to pay for the pre-construction activities including G&A for the project development team, site acquisition or optioning, FEL & FEED engineering, permitting and other technical consultants, legal and professional services to negotiate commercial agreements, and debt- and tax-equity- preparation work needed to bring a commercial-scale industrial or infrastructure project to the point of bankability with lower-cost non-recourse investors. . In short, Dev Cap funds the project development work that comes prior toconstruction financing of debt and equity. At Tuatara, our commercial experience has taught us that projects will spend between 5 to 10% of their eventual total project cost (“TPC”) in the development phase, with smaller projects being on the higher end and larger projects being on the lower end of that range. These can be substantial sums in the millions or tens of millions of dollars that must be raised and spent prior to a commitment from construction capital providers.

Why is Dev Cap hard to find?

The use of non-recourse project finance to fund new technology infrastructure is a relatively new phenomenon. Prior to the late 1990s, most large scale infrastructure was funded through public dollars or on the balance sheet of large corporate players. As a result, Dev Cap was a cost of doing business and covered by the corporate or governmental entity. As a result, Dev Cap sits between several established sources of capital and few players have built up the expertise needed to appropriately underwrite Dev Cap opportunities, particularly in frontier technologies verticals of the advanced bioeconomy. Dev Cap fills the whitespace between VC, PE, and Infra:

• Venture capital (“VC”) typically invests in the generation of intellectual property and the invention of new technology. Project development is a poor match because it generally does not involve the creation of new IP: it is all about execution. VCs have traditionally supported companies that exit through IPOs or M&A and as a result they generally don’t understand project finance or project development.
• Private equity (“PE”) generally seeks passive investments with established cash flows. PE buys EBITDA. Of course, there’s no EBITDA until a project is built and operating.
• Infrastructure equity (“Infra”) typically seeks to deploy hundreds of millions of dollars at a time with a low tolerance for risk. This profile is a mismatch for the 6-, 7-, or low 8-figure capital needs during the development phase and the binary risk associated with Dev Cap investments. Infrastructure funds are typically not tolerant of total losses, but the nature of project development is that some projects just don’t work out and lead to total losses. We’ve seen infrastructure funds try to make Dev Cap investments in order to gain a first right on the eventual project investment, but the lack of a developed project at that stage leads to a wide bid-ask spread between the optimistic developer and the conservative infrastructure investor who really wants the project and not the Dev Cap.

Introducing Tuatara Development Capital

Investing in Dev Cap in the advanced bioeconomy requires a mix of skills–from technical to commercial. Led by PhD engineers with experience in deeptech startups and structured finance, Tuatara has the unique experience that allows us to bring Dev Cap to projects in the advanced bioeconomy: we are tolerant of technology risk (including first-of-a-kind projects) and we walk our talk–each term sheet we’ve issued to date has been for a first-of-a-kind project. Although we don’t seek out first-of-a-kinds, they face a particularly high barrier in the capital landscape. That means that to be attractive for Tuatara Dev Cap financing, these projects need to be squarely focused on their objective of accessing construction financing. With that end goal in mind, I offer two tips to ease your journey through the project development process and maximize your chances of success:

Tip #1: Right-Size Your Project

For technologies that permit it, right-sizing your project can be helpful to attracting both Dev Cap and eventually raising construction financing. Tuatara spends most of our effort on mid-cap projects–projects with an expected total cost of $100-400M. These projects are large enough to attract Tier1 EPCs and have multiple routes to debt, yet are small enough to allow any single infrastructure fund to invest the equity. This is also the range that has historically been most successful for first-of-a-kind and frontier technologies.

Small-cap projects (less than $100M project cost) are too small to attract infrastructure investors on their own. In order to put the hundreds of millions of dollars to work that infra investors need to invest in each transaction, several projects may have to be financed together, creating operational complexity. Some small projects, like anaerobic digesters, are naturally in this range and don’t readily scale larger. However, other projects are down-sized under the mistaken conclusion that VC will be needed to capitalize the project. In these situations, re-scoping a larger project can both improve economies of scale and make the project easier to finance.

Large-cap projects ($750M+ project cost) are the most challenging to finance. As project equity requirements surpass $400M+, the number of infrastructure funds that can write that check dwindles. Options for debt also narrow, especially for projects that are not investment-grade. For projects requiring $500M+ of unrated debt, the government loan guarantee programs are the principal solution. DOE’s Title 17 and USDA 9003 are potential answers, however the lack of optionality in project financing does not provide the depth of market needed to underwrite a Dev Cap investment

Tip #2: Start by planting a Tree, not a Forest

Few business plans stop after the construction of the first project, however focusing too much effort on the development of a large project pipeline can distract from the effort needed to actually see your first (or first two) project through to construction financing. Developers often spread themselves thin developing a large pipeline of projects, then seek funding to “advance the pipeline”. Tuatara invests on a project-by-project basis, which forces a conversation about the portion of the pipeline with the most potential. Tuatara can support a pipeline with several project-specific investments, however our experience, particularly in first-commercial projects, is that one comes before two.

We thank CJ for highlighting the challenges and opportunities with Dev Cap and look forward to continuing to partner with the pioneers of the advanced economy in driving new and innovative projects to financing. Reach out if Dev Cap could be a fit for your project and let’s help drive the energy transition forward!