Blog Post

The Slippery Definition of Risk in Cleantech

deathvalleyHere’s how many renewable-energy startups envision their road to success: Raise venture-capital financing, prove their technologies in pilot and demonstration projects, secure project financing to build full-scale plants, build them and then enjoy all the profit rolling in. But even well-funded venture-backed startups are running into a roadblock that their investors may not have seen coming.

Project finance has proven much harder to get than expected, and startups have had to turn to equity investors to fund smaller projects or switch to another less-capital-intensive strategy, such as finding a corporate partner (like Synthetic Genomics).

The stimulus package has provided a reprieve for some cleantech companies at that tricky commercialization stage, such as Tesla Motors, but many companies haven’t yet been able to cross the much-lamented “Valley of Death.”

It seems that in cleantech, venture capitalists and project financiers have different definitions of both “risk” and “proven technology,” and the differences go beyond semantics. For example, venture capitalists that have helped a startup build a profitable demonstration project might think that removes the bulk of the technology risk from the equation. However, project finance firms are unlikely to consider the technology to be tried and true until the technology’s established a much longer track record, explained Jim McDermott, managing director of private-equity firm US Renewables Group, at the Renewable Energy Finance Forum West this week.

For most institutional investors, “established, proven technology” really only means conventional wind and solar, with those projects making up a whopping 75 to 80 percent of the clean-energy projects financed in the U.S., he said. Stephen Dolezalek, a managing director at VantagePoint Venture Partners, said that understanding how project finance works has become as essential as understanding how the government and utilities work for venture capitalists investing in large-scale renewable-energy generation. A project financing structure allows much less room for risk than venture capital. “You can’t have anything go wrong,” McDermott said, which means that in project finance, “reliability trumps novelty, and it always will.”

All this has led to what McDermott calls “a dislocation” in the market. What that means is there’s a hole in the pipeline of funding for cleantech startups, where technologies that are too developed for venture capital, but still considered too risky for project finance, are falling through. “Early-stage investors are struggling to bridge the gap,” McDermott said.

That’s a serious problem because it’s not just the weakest technologies or companies that fail to get across, but also some of the most potentially game-changing technologies. If capital-intensive technologies can’t get funding, even when they’ve proven the technology works and makes sense economically on a demonstration scale, many innovative solutions that could potentially help solve the climate-change problem – and make money – could end up being shut out of the market.

To get markets moving, the financial community needs to start thinking in innovative ways itself, McDermott said. Renewable-energy cash grants in lieu of tax credits will certainly help, but they’re set to expire next year and companies can’t count on the government filling the whole gap. “What’s going to happen when the government exits the market?” McDermott said.

McDermott would like to see a new type of bridge financing created to help innovative technology that can deliver “very good project financing returns,” but that no banks will currently back. Solving this problem would allow the industry to move more innovative technologies to a stage where they can get project financing and would allow project financing firms to get involved in “the non-wind part of the market.”

In the meantime, he suggests that venture capitalists talk to their banks to find out what they think before signing on to invest in new technology that will require project finance to succeed. At least until new financial solutions come out, it looks like startups with renewable-energy-generation technologies are in for a continued struggle as they figure out how to fit themselves into the current project-financing structure.

Image courtesy of Flickr creative commons.