A 2011 Tool Kit for Savvy Cleantech Investors

3/24/11

2010 was a banner year for U.S. cleantech investment and M&A deals. The 371 mergers, acquisitions and capital-raising transactions in 2010 were a record high. The aggregate transaction volume was $14.7 billion—55 percent higher than 2009. Cleantech funding rose 65 percent, to $10.1 billion from $6.1 billion in 2009. Large-scale wind, solar and geothermal projects in the United States seeking project financing are expected to increase three fold in dollar volume over the next two years.

The numerous and powerful drivers for cleantech investment are undeniable, even with the sector’s up and down track record of investment deals. Economic advancement and urbanization are driving explosive increased energy demand, especially in the developing countries. There is pressing need to replace outmoded U.S. generation capacity. Clean energy solutions continue to drive down costs along the curve toward grid parity, while the capital and production costs of discovering, extracting, and refining fossil fuels increase. In his State of the Union speech, President Obama called for cleantech innovation, and challenged the country to get 80 percent of its energy from cleaner sources by 2035. He also called for one million electric cars on the road by 2015. Public awareness of climate change continues to motivate strong action from policy makers. Big business is committed to sustainability programs.

There is a large, robust and maturing cleantech fund universe, with specialty funds and family offices emerging as important players. The cleantech exit markets are strong and are expected to further improve. Projections for private funding of the entire cleantech value chain are off the charts.

Yet, despite all these bullish trends, moving clean technology from demonstration and proof-of-concept through the so-called “valley of death” to commercial maturity is still a challenge. Certain venture capital firms have rotated out of solar, wind, and biofuels after running head on into the capital-intensive task of scaling up a major new manufacturing plant or power-generating project. Private equity funds, while flush with dry powder, are still wary of technology and commercialization of risk when calculating potential returns. Most of the clean technologies are not yet “bankable” by large financial institutions. Government assistance, while crucial, is not available across the board.

In many ways, the drive toward commercially proven clean energy technologies has been slowed by a search for new investment models for cleantech deals.

We believe that 2011 will see the continued emergence of new financing models that combine project finance and venture capital, create innovative approaches for the combined use of debt and equity, craft innovative joint ventures between strategic and private equity players, explore the use of public-private partnerships, de-risk projects by integrating innovative clean energy technologies with existing conventional products, develop innovative insurance products to mitigate risks, and creatively tap utility balance sheets for project support.

I’m encouraging cleantech investors to think in terms of a “cleantech tool kit” that can help them minimize risk and take advantage of these emerging trends and opportunities. Some of those tools include:

—Intellectual property. Many cleantech companies are taking advantage of the U.S. Patent and Trademark Office’s accelerated patent examination program for “green technologies” to build their patent portfolios. This program is taking off with over 1,200 patent applications undergoing accelerated examination and 177 patents issued, creating value and choice for investors. With a steady rise in the number of cleantech patents issued, we will likely see a rise in cleantech patent litigation as companies fight to secure their lead in this technology race. Performing patent due diligence to identify key patents and players in the field will help mitigate these investment risks. Further, identifying the cleantech companies that can leverage their intellectual property assets by entering into cross-licensing partnerships will also be key to cleantech ventures that will successfully cross the valley of death.

In general, a deep understanding of cleantech intellectual property is key to reducing technological risk. Evaluating the strength of a cleantech company’s intellectual property assets involves understanding the scope of coverage of a cleantech company’s patent portfolio, as well as assessing freedom-to-operate in the cleantech patent landscape. Domain specific intellectual property expertise will be essential to investors in picking cleantech winners and losers.

—China. In 2010, China surpassed North America in terms of cleantech dollars invested for the first time. We are facing a “Sputnik moment” in cleantech, and it is China that is our competition. Renewable energy ambitions are central to the current five-year plan of the Chinese government. China’s ability to quickly implement its public policy to transform from a net importer of “old” energy in favor of becoming an exporter of “new” energy creates enormous opportunities for almost all energy companies. China’s importance in cleantech is reflected in the market by the increasing interest among foreign private equity and venture capital funds in setting up RMB-denominated funds to access cleantech investments in the PRC. Renewable energy companies (to date, principally solar and wind) are an important part of the steady stream of Chinese-based companies executing IPOs in the U.S. and Hong Kong. President Hu Jintao and President Obama released a joint statement saying they view climate change and energy security as two of the greatest challenges of our time, and further announced a series of joint energy deals, including a $7.5 billion collaboration between Alcoa and China Power Investment Corp.

In short, it remains vital for investors and their portfolio companies to maintain their global reach, particularly by utilizing the “China price” of manufacturing to drive down cleantech costs.

—A comeback for IPOs. It is a fundamental maxim that a rising IPO tide lifts all investor boats. Though the market remains volatile, the IPO market has been strengthening, and 2011 could be a strong year for cleantech IPOs buoyed by a recovery of equity prices from their Great Recession levels. Some strong companies that are unique, first-of-a-kind plays coming to market, and cleantech startups on pace for IPOs in 2011 include Bloom Energy, Brightsource Energy, Enphase Energy, Opower, Silver Springs Networks, and Solar City.

—Government incentives. Government policy remains critical to the development of the cleantech market, and federal, state, and local policy driving toward energy security and renewable and sustainable energy production will continue. The Department of Energy loan guarantee program has been crucial in the development of innovative energy projects. Most of these loan guarantee recipients have been shining stars on the equity-raising side. We believe that the feds have found their stride with respect to this program and that the dollars will continue to flow for the next several years. The tax incentive and equity market will strengthen in 2011 as financial firms return to profitability. Investors must use the partnership-flip model, the sale-lease back model, and other innovative and creative tax structures to take advantage of investment tax credits, production tax credits, accelerated depreciation and other tax incentives. The extension of the Section 1603 cash grant (in lieu of investment tax credit) at the end of 2010 is a huge plus for cleantech project finance activity in 2011. This cash grant is “bankable” and forms a critical component of project finance structures. Finally, President Obama has recently launched his “Start Up America” program, which is a wide ranging public-private partnership designed to bring transformative innovations to market, with a focus on clean energy.

As you can see, the cleantech funding market will continue to be pushed forward by powerful economic and political drivers, but remains subject to technological, regulatory and market risk. We believe that educated investors with a proper cleantech tool kit will combine multiple solutions to these problems, utilizing unique and innovative structures to separate the wheat from the chaff and generate outsized returns.

Steve Rowles, a partner with the Morrison Foerster law firm, is chairman of the firm’s San Diego corporate group and former co-chairman of the emerging company venture capital group and private equity fund formation group. Follow @

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