BioCycle June 2007, Vol. 48, No. 6, p. 40
U.S. venture capital and private equity investments in clean tech energy were close to $2.5 billion in 2006. Biofuels and other biomass utilization plants received a significant share.
Diane Greer

RISING oil prices, concerns over global warming and commitments by a growing number of companies to change their energy usage are a few of the factors driving venture funding in the biofuels and biomass energy sectors, says Ron Pernick, cofounder of CleanEdge, a research firm with an office in Portland, Oregon. CleanEdge pegs U.S. venture capital investments in clean tech energy at $2.4 billion in 2006. Biofuels investments comprised $813 million of the total, a 78 percent increase over 2005.
Clean tech, as defined by CleanEdge, is “a diverse range of products, services and processes that harness renewable materials and energy sources and substantially reduce the use of all resources and dramatically cut or eliminate emissions and waste.” In addition to venture investments in early-stage clean tech companies, later-stage private equity players also are joining the fray, funding infrastructure and development projects. London-based research firm New Energy Finance (NEF) reports venture capital and private equity funds combined to invest $4.5 billion in U.S. clean energy companies last year. This represents a 167 percent increase from 2005. NEF estimates 627 U.S. based technology incubators, venture capital funds, private equity firms and corporations are targeting the sectors.
Pernick sees the increase in the number of players interested in clean tech as a natural evolution. “Many of these sectors are maturing and becoming more mainstream and proven in the market,” he says.
So what exactly is the difference between venture capital and private equity? Private equity encompasses investments that are not available for public participation. Venture capital is a subset of private equity, typically involving investments in early stage or start-up companies viewed by most investors as too risky. Private equity generally refers to later stage deals, hedge funds and buyouts.
It should be noted that the distinction between venture capital and private equity has become blurred, as each strays into the space occupied by the other. Two venture capital companies and a private equity firm illustrate the diversity of strategies and criteria used when investing in biofuels and biomass energy ventures.
LEADING THE VENTURE CHARGE
Vinod Khosla knows what it takes to transform a great idea for a new technology into a viable business. He cofounded Sun Microsystems in 1982 and, as a partner at venture firm Kleiner Perkins Caufield & Byers (KPCB), guided the commercialization of several high profile Internet and computer technology start-ups. About two years ago, Khosla left KPCB to start his own venture firm, Khosla Ventures (KV) in Menlo Park, California, focusing his expertise on emerging technologies with social and economic impacts. Of specific interest are investments in renewable energy and environmentally friendly technologies – the clean tech sector. KV has invested in over a dozen biofuels start-ups and is looking for more. His latest investment, New Zealand-based LanzaTech, is employing microbes to convert carbon monoxide into ethanol.
Khosla’s passion for clean tech is reflected in his investments, roughly two-thirds of which are in the clean tech “space,” says Doug Cameron, Chief Scientific Officer at KV. But passion is only one element driving investment decisions. “There are tremendous opportunities for new companies and wealth creation within the clean tech sector,” he notes. Pointing to the emerging ethanol industry, Cameron sees a real shift in the way companies are structured and new companies are being formed. “We want to lead the way for that to happen.”
When evaluating potential investments, KV looks for interesting new ideas and assesses the people behind the idea. “The people are probably equally if not more important than the idea,” Cameron explains. “If we are not impressed with the founders, then we do not invest.”
Another important factor is the potential size of the business. “We are interested in ‘B’ type companies and not the ‘M’ type companies, meaning ones with the potential to be in the billions instead of the millions,” he adds. The protection afforded small technology companies by intellectual property is another essential element. Finally, the team prefers very early stage opportunities. “We like to get in early and be the leaders,” Cameron says.
At least 12 of the firm’s known 26 clean tech investments are in the biofuels sector. Biofuels investments are spread across a wide range of technologies, from conventional corn ethanol to so-called next generation biofuels. To date, KV has funded four corn ethanol companies – Altra Biofuels, Cilion, Hawaii Bio and Brenco. Cameron believes investing in this sector still makes sense since corn ethanol is farthest along in terms of technology and commercialization and, while not the ultimate solution, he thinks corn ethanol will be around for the long-term.
“Most of our investments have a slightly different twist than the standard ethanol plant,” he explains. A good example is KV’s investment in Cilion. The company’s California facilities, currently under construction, are located near large population centers and dairy operations, not near the feedstock source. Rather than shipping the ethanol from the Midwest to California, corn grown in the Midwest will be shipped to Cilion’s facilities.
This strategy reduces transportation costs and eliminates the energy required to dry the distillers grain (DG), a by-product of the process used as animal feed. Normally, the DG is dried to prevent spoilage during shipping. Since the dairies are nearby, the DG can be shipped wet.
KV is also bullish on cellulosic ethanol, investing in competing technologies including Celunol, Mascoma, Range Fuels and Coskata. “In a sense it is putting your chips on multiple bets,” Cameron says. “We think more than one company can win.”
Celunol has genetically engineered E. coli bacteria to convert both five and six carbon sugars into ethanol, resulting in a more efficient and economic process. Traditionally, yeasts can only ferment six carbon sugars. Mascoma is focusing on the conversion of wood-based cellulosic feedstocks. Cofounder Lee Lynd also is working on consolidated bioprocessing, a one-step process that employs genetically engineered bacteria to both break down cellulose into fermentable sugars and ferment resulting sugars into ethanol.
KV’s third cellulosic ethanol investment, Range Fuels, uses a thermal process to break down biomass into a syngas composed of carbon monoxide and hydrogen. Chemical catalysts convert the syngas into ethanol and methanol. Coskata is also producing ethanol from syngas, but employs a fermentation technology to convert the gas to fuel. “This is a huge, rapidly growing industry and there will be room for both microbial and thermochemical routes to producing cellulosic ethanol,” Cameron says.
Beyond ethanol, KV is funding companies producing next generation biofuels. For example, Amyris Biotechnology, LS9, Inc. and Gevo are engineering microbes to function as living factories, producing fuels and high value chemicals. Amyris is using synthetic biology and a technology it originally developed to create an antimalarial drug to produce a fuel type molecule by direct fermentation, Cameron explains. LS9 also is employing synthetic biology and bacteria to produce a petroleum-like molecule from renewable feedstocks. Likewise, Gevo is using bacteria to produce butanol and higher alcohols from sugars and cellulose.
Next generation biofuels, butanol and other higher alcohols have advantages over ethanol. “You get more energy density and more compatibility with existing oil infrastructure,” he adds.
A HYBRID APPROACH
Infrastructure build-outs are not the normal realm of venture investments. Yet 2006 saw a significant portion of venture money funding clean energy infrastructure, says CleanEdge’s Pernick: “Of the $2.4 billion that we saw invested last year, about $1 billion went into steel, cable and concrete instead of intellectual property.”
While investing in infrastructure may not be a typical activity for many venture firms, Vantage Point Venture Partners (VP) sees a real opportunity in what it calls “multistage investing” in fast growing companies, regardless of their development stage. This strategy is especially pertinent in the energy industry.
“There is a major transformation going on in the energy industry that will require an enormous amount of new technology and technology development as well as a major rebuilding of the energy infrastructure,” says Scott Brown, Managing Director at VP’s Cleantech Group. “What differentiates our company is that we have a perspective on both the technology and infrastructure build-out side. We can anticipate when and where technologies are needed to support the infrastructure and we can also support infrastructure investing when technologies reach commercialization.”
When investing, VP – with offices in the Silicon Valley, New York City and Montreal – seeks companies with technologies offering a competitive advantage and a strong management team, Brown explains. The company also needs to be in a market of sufficient size and growth potential and experiencing rapid change. Factors making biofuels an attractive investment include oil price volatility, energy security concerns and favorable government legislation targeting the sector, he says. Concurrently, new technologies are under development that could revolutionize the liquid fuels sector – and the oil and gas industry is ripe for innovation.
VP’s investments within the biofuels and biomass energy sector include New Energy Capital (NEC) based in Hanover, New Hampshire, which owns corn ethanol and biodiesel plants. “The ethanol industry is probably half built out in this country,” says Brown. He also sees significant opportunities for upgrading processing performance, pointing to improvements in dehydration and corn fractionation technologies and advances in enzymes that increase yields. VP also is betting on cellulosic ethanol and has invested in Mascoma. “We liked their technical approach [consolidated bioprocessing], which we think offers the potential of reaching a low cost solution,” he notes.
An investment also has been made in Chemrec, a Swedish company, which gasifies black liquor, a by-product of the pulp and paper industry, into renewable fuels such as methanol and synthetic diesel or electricity. The technology has the potential to improve the profitability of the industry while supplying significant quantities of renewable fuel.
Beyond NEC’s investments in biofuels, the firm also owns distributed power generation and a biomass-fired power facility in Maine. Biomass power investments are attractive since the country’s power infrastructure requires build-out and there are renewable power mandates in certain regions of the country without a lot of renewable resources other than biomass, Brown explains.
EQUITY INVESTMENTS IN BIOMASS
While emerging technologies are fueling venture investments in clean tech sectors such as solar and biofuels, the biomass power sector, for the most part, uses established technologies that exhibit steady efficiency improvements as opposed to dramatic breakthroughs, explains Irmgard Herold, Senior Analyst at New Energy Finance, which has its head office in London. “What little investment the sector has attracted has tended not to be early stage investment, so it is more likely to come from private equity than venture capital investors.”
One private equity fund with a specific interest in biomass energy investments is Energy Investors Funds (EIF). The company has created a series of funds to invest in the independent power and electric utility industry. Each fund seeks investments in a diversity of technologies including those fueled by biomass. “We have always had a sector allocation for biomass facilities,” says Rick Carlson, Vice President of Investments at EIF. “It is just a matter of the right biomass opportunity coming along at the right time.”
A typical fund goes through a cycle – raising capital, acquiring and managing assets and eventually liquidating the fund and returning capital back to the investors, Carlson explains. Within a fund, allocations are earmarked for development projects and the rest are for acquisitions, adds Michele Brauner, Vice President of Investments at EIF. For example, US Power Fund II (USPFII) closed in October 2005 with $750 million committed by 31 investors. As of December 2006, 75 percent of the fund was invested in 16 power projects, including two wood-fired biomass facilities.
One of the fund’s investments is the 50 MW Russell Biomass facility in Massachusetts, slated for completion in the third quarter of 2009. A developer of a previously funded biomass project presented the opportunity to EIF. The Russell project was attractive because it fit EIF’s criteria for a development opportunity. The project was in an advanced state, having progressed to terms of a power purchase agreement with a group of municipal and cooperative electric companies. It had good fundamentals and experienced developers, including one developer that supplies fuel to other biomass projects, Brauner explains. Progress securing the fuel supply was certainly a plus, she adds.
The project also benefited from its location. Massachusetts has an established market for renewable energy certificates (RECs) that permitted forecasting of future REC prices. RECs subscribe a value to the renewable energy attributes, permitting project developers to earn an additional revenue stream from the sale of the RECs. “RECs are something we consider in the economics of the project,” Brauner says. “But because of some uncertainty, we have to qualify that.”
The fund’s other biomass project, Burney Forestry Products, is a 30 MW wood-fired facility located in California and operating since 1990. EIF acquired a 100 percent interest in the facility. This opportunity was of particular interest due to favorable financials resulting, in part, from a long-term power purchase agreement with Pacific Gas and Electric Company (PG&E) through 2020. A piece of the deal was syndicated to a tax partner who could take advantage of the tax benefits afforded by the project’s production tax credits (see sidebar), Carlson explains. “We are normally interested in pretax cash flows.” (A syndicate is a group of bankers, insurers and others who work together on a large project on a temporary basis.)
Going forward, Carlson sees a lot more biomass investment opportunities, pointing specifically to biomass-to-ethanol conversions. “We are not the most aggressive people in terms of technology plays,” Carlson says. “More time is needed before we feel it is safe to go in wholeheartedly, but there may be opportunities for us to invest a minimal amount of capital.”
Diane Greer is a freelance writer and researcher based in New York, specializing in sustainable business, green building and alternative energy. She can be reached at dgreer@greerresearch.com.
Sidebar
PRODUCTION TAX CREDIT AND TAX EQUITY PARTNERS
UNDER federal law, closed-loop biomass power projects qualify for a 1.9 cents/kWh production tax credit (PTC) for the first 10 years of operation. As a tax credit, PTCs only can be used to reduce the amount of taxes a firm owes. For example, if a firm produces 1,000,000 kWh of energy, then the amount of taxes owed to the federal government could be reduced by $19,000 ($0.019 x 1,000,000). Any credits in excess of the firm’s tax liability are lost.
Many renewable energy projects qualifying for PTCs do not face sufficient federal tax liabilities to fully utilize the PTC and other benefits, such as like depreciation. In many cases, the developers will include an equity investor(s) in the deal with sufficient federal income tax liability from other sources to use the tax benefits.
There are various ways these types of deals can be structured. One is for the investor(s) to initially receive a larger percentage of the tax benefits and cash distributions (based on the revenues generated by the project). Once the investor(s) receives an agreed upon after-tax return, the sharing of the tax benefits and cash distributions can be changed, giving the investors a small portion and the developer a larger portion. Many other structures are possible.