Feature

Corporates' venture


Felicia Jackson

Corporate venture capital could prove the vital lifeline for renewable energy developers facing an exodus of private equity investors from the market.

The renewable energy sector faces a series of complex challenges as it is scaled up around the globe. Critical to success are innovation, the ability to raise finance and access to markets. What makes success so challenging is that renewable energy is a replacement technology. It's not creating new markets; rather it's targeting an existing industry.

The renewable energy market is largely shaped by regulations and legislation: environmental laws; utility regulations; tax incentives; permitting rules; and so on. These dramatically affect the economics, market potential and even the applicability of clean technologies. This makes funding new energy technologies a challenge, while energy generation is capital intensive – meaning it can take a long time before returns are achieved.

Equity investor exodus

Equity investors are nervous of the risks posed by new technologies. Early stage companies, with unproven technologies, lack a track record, making it hard for investors to assess the risks. So, in an economic environment where most forms of capital have retreated from risky investments, how is clean energy innovation to be financed? One obvious answer is by corporations, as they can look at the long-term perspective of a shift in mainstream energy and economic frameworks.

The private equity market has been challenging for renewable energy in the last 18 months. There has been a shift away from pure renewables towards resource efficiency and the wider clean tech market. Indeed, resource efficiency as a percentage of clean tech venture deals rose from 17% in 2006 to 45% in 2010, according to US research company Cleantech Group.

Meanwhile, venture investment in energy generation fell from 70% in 2008 to 30% by the second quarter of 2011.

The problem is that demand for investment, especially in energy and infrastructure, has never been higher. “The potential amount of new investment needed is unprecedented – up to £250 billion in the next fifteen years or so – equivalent to an average of £15-£16 billion per annum,” adds Tomas Freyman, assistant director renewable energy, Ernst & Young. According to analysis from E3G, the sum may be higher. It says infrastructure and climate change-related investment of £750 billion will be required in the UK economy alone to 2025.

“The reality is that limited partners and venture capitalists have to accept that in the current risk-averse environment, traditional limited partners are simply not making the allocations to venture capital today that they were before 2008,” says Tom Whitehouse, chairman of the London Environmental Investment Forum (LEIF):

“This leaves a dearth of capital for clean tech businesses.” With public sector funding under stress, finding new sources of capital is even more paramount and the signs are positive. There has been a steady increase in the number of corporates involved in clean tech deals from 49 in 2007 to 84 in 2010.

But why would utilities, or other corporates, invest in high risk technology or projects?

The answer lies in the strategic goals of the corporate in question. Are they looking for market growth, financial return or access to innovation? “Utilities need innovation to hit clean energy targets but it's not happening fast enough,” according to Albert Fischer, Director of Yellow & Blue, an independent venture capital fund backed by utility Nuon.

Corporate venture, or the deployment of risk capital by corporate investors rather than venture/financial investors, has been around for some time. Traditionally, the large energy incumbents have been responsible for energy innovation activity but, as Per Ragnarsson, director, Clean World Capital points out, the jury's out on whether corporate venturing really works.

Corporate demand

Corporate venturing is moving away from the oil and energy majors, and into other industrial and engineering groups. This is happening for a number of reasons. Industrial and energy efficiency is becoming a business critical issue for many corporates, as a means of securing power supply and of managing power price risk, which is driving interest in energy generation.

For those large corporations with high electricity bills and carbon footprints, such as facilities management companies or info tech companies like Google with massive server farms and associated power demand, investment in onsite renewables can provide a cost-effective way to address price volatility.

Internet giant Google has taken a range of approaches to renewables investment. It invests primarily through its philanthropic arm, Google.org, and in June 2011 CEO Larry Page said the company was set to increase its own renewable energy R&D spend. The company also has a venture fund, Google Ventures, which also provides engineering scale consulting, user experience and interface design, design research and help with recruitment – all critical issues for a growing technology business.

Earlier this spring for example, Google signed a Power Purchase Agreement (PPA) to buy the output of a 100.8 MW wind farm in Oklahoma when it becomes operational in late 2011. NextEra Energy Resources' Minco II wind farm will supply power to Google's Mayes County data centre through Google Energy LLC – Google's entity allowing the internet giant to participate in the wholesale energy market.

The fact that Google has entered a PPA directly with the wind farm instead of buying the power via a utility, ensures the money goes to the wind farm, enabling its construction.

Adjusting the model

A critical aspect of successful corporate venture capital (CVC) seems to lie in aligning investment with the overall vision of the company, rather than simply being opportunistic.

There is a growing interest in exploring potential new markets for traditional industry, as awareness of the coming resource crunch becomes ever more apparent in the economic and energy environments.

According to Ragnarsson, the key issue is that clean tech and clean energy are about the transition to new economic models. That means that corporate investors are perhaps best placed to invest in external innovation in traditional industry sectors.

Historically, an important factor in traditional corporate venturing has been ensuring there is a synergy between corporate strategy and new technology investment. GE, Alstom, ABB and Siemens are all involved in the wind industry, so it makes sense they would invest in innovation in the sector.

Wind giant Gamesa is a prime example of a company expanding outside of its core business too, but using its expertise to access external innovation. The company recently announced a fund that will invest €50 million within the next five years. The venture arm will be internally managed and has 6 team members focused on its key areas of interest: wave; next generation photovoltaics; energy storage; green mobility; energy efficiency; and off-grid power.

The traditional corporate venture model is evolving, with a number of new approaches being explored: “A new model of corporate partnering is emerging with larger companies offering smaller companies not investment, but testing and commercialisation support,” says Whitehouse. “This means the company won't necessarily have to raise tens of millions to fund a merchant plant or commercial prototype, which may then need further millions to iron out the glitches. This is the rationale behind the Veolia Innovation Accelerator, for example.”

Independent VC funds

One of the most interesting developments is the growth in deployment of independent venture capital funds backed by industry. Aster Capital is one, formerly Schneider Electric Ventures, now an independent fund backed by Schneider Electric, Alstom and Rhodia.

Managing direct Jean-Marc Bally says that while one key benefit of CVC is to get a view on emerging technologies and markets, it is important to recognise that to the portfolio company the potential partnerships are a key differentiator. “We try to blend the best elements of venture and corporate capital,” he says, which means a focus on being selective (choosing a company because of its attractive business case rather than strategic role) while adding value to the portfolio through partnerships and market access.

Fischer adds that the real benefit of this approach is “we represent the customers view”. The utility does not want to take control of the technology but they are beneficial users. From a venture perspective it provides a degree of validation and portfolio companies see the fund as an important partner in the route to the customer.

Another critical aspect, Fischer points out, is access to seasoned management. Three of Yellow & Blue's portfolio companies are run by former senior executives from Nuon, and the importance of being able to access experienced management from investors should never be underplayed, he says.

The key reason Fischer believes in the independent fund model is the need for innovation, and the potential support from industry, he continues. Innovation is more likely to occur outside a major corporation, but start-ups in the energy industry require scale and robust operations. If a start-up takes a great piece of technology to an interested party that wants 200,000 units within six months, a corporate partner can help with scale-up. Similarly, a corporate can help put in place supporting technology (such as billing systems) ensuring it meets industry standards.

Challenges

There are of course challenges in working with corporate investors. The time frames under which they make decisions can be slow; there is a danger that a change of ceo can lead to a change of strategy; there is frequently little connection between the intention of the investor and the experience on the ground; they are poorly positioned to create new markets (as this could undercut their existing market); and it can be difficult to find the right person to make and follow through on a decision.

“Some traditional limited partners such as pension funds and foundations have reservations about investing in venture capital funds alongside large corporations,” says Whitehouse. “There is the fear that the corporation could have too much influence over the companies the VC invests in, perhaps treating the companies as if they were mere subsidiaries.” CVC gets around these challenges by modelling a private equity fund, with the added benefit of a potential route to market.

Rob Wylie, partner with private equity firm WHEB Partners, suggests that corporates can really help with the more capital-intensive aspects of financing of project construction for new technologies through their balance sheet. CVC is also a useful diversion of R&D funds from large entities into startups which have proven to be more capital efficient in the development of technologies, he adds.

With the growth of such independent funds, the question arises as to where the best opportunity lies, for startups and for other investors. With financial VCs there is a focus on the business case and getting to market, while corporate venture can help with access to partnerships and market growth. Much depends on the stage of the business – a company needs to be able to meet the needs of a corporate client if it wants to take advantage of partnership opportunities.

The relationship between purely financial venture capital and corporate investors has shifted in the last 18 months, and there is a growing recognition that all sources of funding are necessary in current market conditions. For corporate partners, venture investment offers access to companies further down the value chain, giving them access to innovation in traditional markets. For financial funds, working with corporates can provide technology and market validation as investee company partners, or provide distribution/licensing possibilities. It also means co-investment partners or even an exit route via a trade sale.

There is no question that corporate investment can play a big role in the coming paradigm shift in the utility world, but overall success will require different investors at different levels. As Fischer says: “in the end our business is venture capital and our job is to maximise return.” There shouldn't really be a question of whether finance should come from institutional funds or corporate investors. As Toby Peters, co-founder of Highview Power Storage adds: “It's not either/or. It's both.”

As he points out, one of the greatest challenges the sector faces is how to develop something that is high risk, but of overall societal benefit. For a new technology to successfully come to market, we need market demand so that investors can see a return, a Government that is willing to be supportive, and commercial partners. “Energy is about decisions with a 25-30 year impact, while investment decisions are often made on a five or even three year basis,” he says.

Renewable energy technologies must integrate with existing infrastructure and broader systems, and often need to be developed with alternative materials to keep costs down. Bringing new products to market is a complex, lengthy process. In a relatively new and highly competitive arena, market timing for new products is often a key determinant not just of long-term success but of short-term business survival too.

This means the right corporate partnerships can be critical to success, and corporate venture is going to become increasingly important to the sector.

About: Felicia Jackson is an editor and freelance journalist specialising in issues surrounding industry and environment, on topics ranging from technology, policy, investment and sustainability. Author of ‘Conquering Carbon', she writes for a number of specialist business magazines on issues surrounding the transition to a low carbon economy.

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