The Valley of Death and Other Myths
Regarding Environmental Technology Funding
    Harvard Business School Field Study
      Sponsored by EPA New England
                May 1995

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       Harvard Business School Field Study
        The Valley of Death and
Other Myths Regarding Environmental
          Technology Funding
                 May 1995
 Team Members: Kelly Kennedy, David Levine & Jeff Zindel
        Faculty Advisor: Richard H.K. Victor

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                         Agenda
               Project Purpose
               Industry Overview
               The Funding Gap
               Venture Capital Industry Overview
               Stock Market Performance
               Barriers to Commercialization
               Reducing the Funding Gap
               Review of Current Programs
               Recommendations
               Case Studies
The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 2

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PROJECT PURPOSE

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PROJECT PURPOSE
    The Field Study Will Recommend Ways to
  Bridge the Funding Gap for EnviroTech Firms

 The Project Team Will:
   • Investigate the Valley of Death theory
   • Identify perceived and actual barriers to
     commercializing environmental technology
   • Evaluate government efforts and proposed solutions for
     bridging funding gap
   • Develop ideas to bridge the funding gap and determine
     the  organizations best suited to implement them
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 4

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INDUSTRY OVERVIEW

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INDUSTRY OVERVIEW
     The Environmental Industry is Large But
Dominated By Services and Low-Tech Equipment
         Expected to
          double by
          year 2000
            Low-tech
            Equipment
              20%
                           Worldwide
                      Environmental Industry
                           $320 billion
                                   42%
            U.S. Environmental Industry
                  $134 billion
High-tech
Equipment
   6%
Services
 74%
 SOURCE: ENVIRONMENTAL BUSINESS JOURNAL
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
                              Page 6

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INDUSTRY OVERVIEW
 The EnviroTech Industry Encompasses Diverse
    Approaches to Improving the Environment

 Environmental technologies intend to improve the
 quality of the environment through:
   • Reduces human and ecological risk
   • Enhances cost effectiveness
   • Improves process efficiency
   • Creates products and processes that are environmentally
     beneficial or benign
   • Hardware, software, systems, services
SOURCES; NATIONAL SCIENCE & TECHNOLOGY COUNCIL
 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 7

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INDUSTRY OVERVIEW
     The EnviroTech Industry is an Important
            Industry for the United States
            	    	—	___^^^^^^__^^^^^^^_M^^^^^^^^^^^^^^^^^^^^^^^a^
            •^•HSB^BB^BSBBBSBSgB^^^BB^^^^B^^^^^^^^^^^^^^^^^^
    More than 1 million people are employed in the
    environmental industry
    Environmental Technology offers solutions to improve
    society's air, water, and land quality
    Environmental technology offers excellent export
    potential due to increasingly global issues
    Reduces impact of population growth
    Deserves the attention of regulators
    What forms of attention is most effective?
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 8

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THE FUNDING GAP

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THE FUNDING GAP
 Conventional Wisdom Identifies a Funding Gap
         in EnviroTech Commercialization
                      The "Valley of Death"
          Easy
    Capital
 Availability
       Difficult
Commercialization
Stage of
Development
             Early-Stage
              Late-Stage
The Valley of Death and Other Myths Regarding Environmental Technology Funding
                              Page 10

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THE FUNDING GAP
    EnviroTech Entrepreneurs Claim the Gap
           Results From a Lack of Capital
     Environmental technology developers believe that there is
     a lack of capital
     They coined the phrase "valley of death" to describe the
     natural funding gap
     They think capital allocation is based on technology
     efficacy hot on market potential
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 11

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THE FUNDING GAP

     The Funding Gap Is a Natural Hurdle in
              Efficient Capital Markets


   • The gap is not particular to the environmental technology
     industry but common to all industries
   • Investors require minimum rates of return on their
     investments
   • Companies that meet the appropriate hurdle rate are
     funded
   • Environmental technologies are not funded based on
     their social merit but must show comparable economic
     returns
The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 12

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THE FUNDING GAP
                Efficient Markets Fund
                    Worthy Projects

 Efficient Capital Markets are Characterized by:
   • Prices adjust rapidly to new information
   • Current prices fully reflect available information about
     the assets traded
   • Capital is allocated to the ultimate user in the most
     efficient manner
   • Investments whose expected returns compensate for
     determined risk will find funding
 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 13

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THE FUNDING GAP
  There is an Efficient Flow of Information in the
                 EnviroTech Industry

 Many Private and Public Investors:
   • Focus solely on the environmental market
   • Have specialized knowledge of technologies and markets
                                       k
   • Are well positioned to evaluate the commercial potential
     of environmental technologies
 The Valley of Death and Other Mytlis Regarding Environmental Technology Funding               Page 14

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THE FUNDING GAP

  The EnviroTech Funding Gap is Increased by
   Regulatory Risk and Limited Profit Potential

  • The effects of regulation on the industry increase the
    systematic risk of investing in these companies
      - Regulatory uncertainty, multi-level permitting, and other risks increase the
       required returns for funding
  • The profit potential for many of these firms is limited
      - Niche markets and specific applications limit the possible returns of many
       of these investments
  • Environmental technology companies that are not funded
    are perceived as unlikely to generate sufficient returns to
    compensate for their risk
The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 15

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 VENTURE CAPITAL
INDUSTRY OVERVIEW

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VC INDUSTRY OVERVIEW
        Different Players Fund Each Stage of
  Development for Environmental Technologies
                  Development Cycle
    Start-up
    R&D
Deihohistratioii
  Proven
Technology
  Sweat equity
  Personal savings
  Family/friends
  Private Investors
Foundations
State
Federal
Government
         Venture capitalists
         Public markets
         Potential customers
         Bank loans
                     Capital Source
 The Valley of Death and Other Mytlis Regarding Environmental Technology Funding
                                         Page 17

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VC INDUSTRY OVERVIEW

      Venture Capitalists Are the Most Active
        Investors in the Demonstration Phase
•••••^••^••••^^•••^••^^••^••••^^•^•^^^^^^^^^^•^^^^•^^•••••^^•••''^^••••^^^^••'^^^^gg^^^^SSS^^g^^^SHB

   • Although individual and private investors constitute the
     largest pool of capital, they focus primarily in the start-up
     phase
   • Government programs funded an estimated $1.8 billion
     for environmental technology (1994) mainly in the R&D
     phase
   • It is in the demonstration phase that EnviroTech
     companies experience the "valley of death"
   • Environmental technology firms look to the $2 billion
     committed to venture capital funds annually to bridge the
     funding gap

 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 18

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VC INDUSTRY OVERVIEW
         Venture Capital Investments in the
   Environmental Industry Are Relatively Small
   • Of the roughly 500 US VC firms in 1993, only 20-30 were
     active in the industry
   • In 1992 the VC industry provided financing for only 15
     environmental technology companies of the 1000-1500
     firms funded
   • In 1994 only $60-80 million went to environmental deals
     of the more than $2 billion invested nationwide
   • In New England in 1994, VC financing totaled $130
     million; only $1 million -1 of 44 deals - funded
     environmental technologies

 SOURCES; EBJ, LIBERTY ENVIRONMENTAL, BOSTON GLOBE SURVEY, TECH. FUNDING CORP.
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 19

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VC INDUSTRY OVERVIEW
    VC Investments in Environmental Projects
              Peaked in the Late 1980s
            History of Environmental Investing
         Year
VC Investments
 IPO Focus
       1987 - 90
       1991 - 92
       1993 - 94
      Peak
Rare & Endangered

  Nearly Extinct
  Services
Technologies
  Neither
 SOURCE: EDISON VENTURE FUND
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
                                    Page 20

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VC INDUSTRY OVERVIEW
        Venture Capitalists Demand Strong
        Performance from their Investments

Venture Capital Funds:
   •  Expect to receive 10 times their capital invested within 5
     years (58% return) and achieve liquidity in 5-10 years
   •  Look for companies with 30% or greater revenue growth
   •  Expect annual revenues in range of $25-200 million
   •  Demand premium exit valuations
   •  Must be able to to liquidate investments, typically
     through IPOs or the sale of companies
 SOURCE: HARVARD BUSINESS SCHOOL CASE
 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 21

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VC INDUSTRY OVERVIEW
    Expected Returns Reflect the Level of Risk
          Inherent in the Stage of Financing
The High Rate of Return Can Be Attributed To:
   • The Systematic Risk - environmental technology companies
     are much more volatile than the S&P 500; during recessions,
     regulatory activities slow, further increasing systematic risk
   • Liquidity Premium - investors are unable to convert their
     holdings to full value in cash
   • Value Added - investors expect a premium for their
     management input
   • Cash Flow - only a small percentage of investments meet or
     exceed expected rate of returns

 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 22

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VC INDUSTRY OVERVIEW
     Earlier Financing Requires Much Higher
         Returns to Qualify for Investment
    Stage of
  Financing

       Seed

     Start-up

  First-Stage

Second-Stage

      Bridge
                          Applied Discount Rates
                   10   20  30  40   50   60  70   80   90   100
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
                                                      Page 23

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VC INDUSTRY OVERVIEW

           Venture Capitalists Participate in
                  All Stages of Financing

 • Seed Financing - the earliest stage of funding (typically $25-
   300K) made to explore an entrepreneur's idea
 • Startup Financing - provided to an organization that is prepared
   to commence operations
 • First-Stage Financing - provided to ongoing businesses for
   marketing, sales and support efforts
 • Second-Stage Financing - provided for working capital and
   fixed asset needs to support the growth of a company with active
   production, sustainable sales, and some profits
 • Bridge Financing - provided to carry a firm until its initial
   public offering (IPO) which  occurs within a year after the bridge
 SOURCE; HARVARD BUSINESS SCHOOL CASE  	
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 24

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STOCK MARKET PERFORMANCE

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STOCK MARKET PERFORMANCE
     Recent Environmental Industry Offerings
             Have Performed Poorly...
Follow-on
Year IPOs Offerings Return
1991
1992
1993
1994
4
5
8
2
9
5
8
6
-43.8 %
- 30. 1 %
- 27.9 %
- 3.7 %
 SOURCE: OPPENHEIMER & CO. INC.
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
Page 26

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STOCK MARKET PERFORMANCE
  ... and Many Major Environmental Stocks Are
       Trading Well Below Their IPO Price
                Company
            Molten Metal
            Energy BioSystems
            EnSys Env Products
            Purus, Inc.
Stock
Issue
Price
 $14
 $6
 $10
 $14
Current
 Price
 • $18
 $5.50
 $3.25
 $0.125
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
                     Page 27

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STOCK MARKET PERFORMANCE
  The Stock Market Reflects Little Confidence in
  the Performance of Environmental Companies

            Index of Environmental Stocks
                vs. Dow Jones Average

                                      + 1.7%
                                           Dow Jones
                                           EBJ
                                      - 5.3%
           Jul  Aug  Sep   Oct  Nov  Dec

                      1994
 SOURCE: ENVIRONMENTAL BUSINESS JOURNAL
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
Page 28

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STOCK MARKET PERFORMANCE

 Poor Stock Performance Has Led Mutual Funds
     to Abandon the Environmental Industry

    • In 1993 net assets of environmental mutual funds were
     estimated at $236 million
    • In 1994 only a handful of funds remain with total net
     assets approximately $100 million
    • Most of the remaining assets are invested in highly
     liquid, large market capital stocks, offering little
     capital for emerging companies
SOURCE: ENVIRONMENTAL BUSINESS JOURNAL
The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 29

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STOCK MARKET PERFORMANCE
            Several Major Environmental
              Mutual Funds Have Folded
     In 1993 green mutual funds ranked dead last among the
     28 categories tracked by Lipper Analytical Services, Inc,
     At least three Mutual Funds exited the environmental
     industry in 1994
       - John Hancock Freedom fund was down 12% and folded into a larger
        fund
       - Oppenheimer's fund was down 11% and folded into a larger fund
       - Kemper's fund folded
 SOURCE: BARRON'S
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 30

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    BARRIERS TO
COMMERCIALIZATION

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BARRIERS TO COMMERCIALIZATION
        Different Studies Reveal Numerous
          Barriers To Commercial Success
                                 VCs
RIMTECH
SBA
Lack of seasoned management
Poor or unrealistic business strategy
Lack of compelling economics
Insufficient market size
Uncertain Pathway to Market
Ill-defined performance data
Inconsistent multi-level permitting
Perceived liability exposure
Regulatory uncertainty/inconsistency
Customer Lock-In

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BARRIERS TO COMMERCIALIZATION

We Identified Five Major Barriers That Increase
   the Environmental Technology Funding Gap


     1)  Regulatory Uncertainty
        • delays in enactment
        • free-flowing exemptions
     2)  Inconsistent Enforcement by Regulators
     3)  Poor Management
        • unrealistic business plans
        • unfamiliar with capital markets
        • poor marketing
     4)  Small, Fragmented Markets
     5)  Lack of Certification and Verification Programs

The Valley or Death and Other Myths Regarding Environmental Technology Funding               Page 33

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REDUCING THE FUNDING GAP

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REDUCING THE FUNDING GAP
              Government Agencies Can
               Reduce the Funding Gap
           Easy
    Capital
 Availability
       Difficult
Commercialization
Stage of
Development
              Early-Stage
               Late-Stage
The Valley of Death and Other Myths Regarding Environmental Technology Funding
                                Page 35

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REDUCING THE FUNDING GAP

       Like EnviroTech, BioTech Companies
                  Face a Funding Gap

 • Biotech Industry evolved due to:
    - quantum leaps in scientific discovery
    - perceptions of dwindling innovation
    - increased availability of risk capital to fund start-ups
 • The key concern of all biotech companies surveyed by Ernst &
   Young in 1990 was future ability to raise financing
 • In 1988 VC funds decreased from $4 billion to $2.9 billion
   however investments in biotech companies increased from
   $233 to $343 during this same time span
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 36

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REDUCING THE FUNDING GAP
      The FDA Approval Process Reduces the
                     Funding Gap


  • The FDA approval process is clearly defined and
    understandable
  • Investors can better evaluate the potential for approval
    and the resulting market size
  • Companies and investors could have a grand slam if their
    drugs receive FDA approval
 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 37

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    REVIEW OF
CURRENT PROGRAMS

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REVIEW OF CURRENT PROGRAMS
  The Government Invests $1.8 Billion Annually
           in Environmental Technology ...
    Organization
    ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

  Dept of Commerce
             Focus
Industry access to private labs
Amount
(million)
  $80
  Dept of Defense
Remediation of contaminated sites
  $340
  Dept of Energy
Sustainable energy; remediation
 $1,300
  EPA
Pollution control; remediation;
pollution prevention; monitoring
  $80
 SOURCE: OTA
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
                                   Page 39

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REVIEW OF CURRENT PROGRAMS
    ... But Generates Little Commercial Success
    Government programs act independently with little
    strategic direction and coordination of federal R&D
    funding efforts
    Majority of individual programs do not use commercial
    applications as funding criteria
    Most programs have had limited dialogue with industry
    Only a very small percentage of the funding actually
    reaches environmental technology companies
SOURCE: OTA STUDY
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 40

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REVIEW OF CURRENT PROGRAMS
       OTA Cites Significant Variation in the
      Effectiveness of Government Programs
 EFFECTIVENESS
        Low
               INDUSTRY
               CONSORTIA
                CRADAS
                LOCAL FUNDING
                DIRECT FUNDING
Gov't support of industry
consortia
Federal lab technology
cooperation & transfer
Direct funding based on
local needs
Direct funding by gov't
after federal solicitation
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
                   Page 41

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REVIEW OF CURRENT PROGRAMS
  The Federal Government Is Not Very Effective
             Directly Allocating Money
  STRENGTHS:
 WEAKNESSES:
Approval processes such as the FDA
Leveraging private capital such as SBA
Organizing industry groups such as
SEMATECH

Choosing projects with commercial
viability
Selecting companies with highest expected
returns
Providing management assistance
 SOURCE: OTA
 The Valley of Death and Other Myths Regarding Environmental Technology Funding
                                 Page 42

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REVIEW OF CURRENT PROGRAMS
     CRADA's Have the Potential To Assist in
  Commercializing Environmental Technologies

 •  Set up to promote the transfer of technology from federal labs
   to industry
 •  Federal labs contribute only in-kind resources
 •  Of the 382 DOE CRADAs signed by April 1993, only 18 were
   for environmental technology
 •  Problems include:
    - Negotiating the distribution of revenues is cumbersome
    - Suspicions of political ties have hurt image
    - Goals of private companies and government labs differ
The Valley or Death and Other Myths Regarding Environmental Technology Funding                Page 43

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REVIEW OF CURRENT PROGRAMS

         SITE Has Received Mixed Reviews

 Strengths:
  • Develops cost and performance data for early stage
    technologies
  • Accelerates cleanup while lessening costs
  • Not a marketing device, although provides participating
    companies with reasons for publicity
 Weaknesses:
  • Long delays waiting to test
  • EPA's wide distribution of details sacrifices a firms
    proprietary knowledge

 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 44

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REVIEW OF CURRENT PROGRAMS
         EnTICE Builds on EPA's Strength
                   As a Coordinator

 EnTICE Provides:
  • Credible data and verified results based on standardized
    protocols
  • Fully-permitted incubation facilities to test environmental
    technologies
  • Readily available information
  Strengths:
  • Private labs will accomplish the task more effectively and
    avoid the appearance of favoritism
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 45

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REVIEW OF CURRENT PROGRAMS
   EPA Should Channel Gov't Research Funds
  Through Industry Consortia and Associations

 Industry Consortia:
   • Are best suited to evaluate commercial promise
   • Can speed deployment of new technologies through
    strong internal communication link
   • Can help avoid duplication in research
   • Avoids government favoring individual firms
   • Will own intellectual property and give all members
    access
SOURCE: OTA
 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 46

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REVIEW OF CURRENT PROGRAMS

     The Government Should Further Support
                  Matching Program

 Matching programs facilitate the information flow between
 technology companies, investors, and customers

  • MIT Enterprise Forum - matches early-stage entrepreneurs
    with potential investors
  • VISITT - promotes the use of innovative clean-up technologies
    by enabling customers to screen technologies for use at specific
    sites
  • NET AC - maintains a database with more than 1500
    technologies

 SBA's commercialization matching system could be expanded

 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 47

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RECOMMENDATIONS

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RECOMMENDATIONS
  EPA Should Focus On Its Role As Coordinator
     Streamline permitting and encourage innovation
     Help establish a private-sector testing infrastructure
     Support partnerships through CRADAs that are more
     company-friendly
     Coordinate federal labs to assist emerging technologies
     Focus on development of small business managers
     through education
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 49

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 RECOMMENDATIONS

 There Is No Substitute for Predictable, Consistent
Enforcement of Strong Environmental Regulations


   • Investors can better evaluate time to market and potential
     market size
   • The risk/reward ratio of environmental companies will
     improve, attracting more capital to bridge the funding
     gap
   * A well-defined market leads to greater investment in R&D
 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 50

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RECOMMENDATIONS

 The EPA Should Facilitate the Creation of State
        or Regional  Certification Programs

  • The results of the certification programs can be used to
    support marketing of technologies and provide information
    for permitting requirements
  • Regional programs typically have more flexibility and are
    more responsive to local needs than national programs
  • States have more incentives to promote their local
    technology companies
      - Successful small firms create jobs and generate tax revenues
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 51

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RECOMMENDATIONS

           Cal EPA's Certification Program
                      Is  a Good Model

  • The efficacy and efficiency of a technology's performance
    are evaluated
  • Regional regulatory requirements associated with using the
    technology are streamlined
     - Obtaining operating permits from local entities should be simplified
  • The program is  financially self-supportive
     - By law, the agency must recover all certification costs, and it does so by
       charging companies fees for actual costs
  • Program currently has limitations:
     - Public resources for program are limited
     - Inability to evaluate all technologies may put some companies at a
       disadvantage

 The Valley of Death and Other Myths Regarding Environmental Technology Funding                  Page 52

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RECOMMENDATIONS
   Cal EPA's Program Could Help Break Down
          Interstate Permitting Differences

  • A committee of 17 western states and the federal
    government is examining whether Cal EPA's approvals can
    be used to certify technologies for use at western federal
    facilities
  • The committee to Develop On-site Innovative Technologies
    (DOIT) is investigating using Cal EPA certified
    technologies at 14 federal sites in western states
  • Massachusetts, New Jersey,  and Illinois have recently
    signed memorandums of agreement with Cal EPA
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 53

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RECOMMENDATIONS

 Management Shortcomings Often Prevent Small
    Businesses From Receiving Gap Financing


   • Many small businesses, while technically skilled, lack the
    marketing and financing skills necessary to
    commercialize their technologies
   • Venture capital firms consistently identify a lack of
    seasoned management and poor business strategy as the
    two biggest reasons they don't invest in companies
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 54

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RECOMMENDATIONS

   The Government Should Continue to Support

    Programs Which Educate Small Businesses


   • EPA sponsors seminars and programs:
      - Golden Opportunities for Environmental Technology Innovation
      - Center for Environmental Industry and Technology (CIET)

   • The SB A sponsors several programs:
      - Small Business Development Centers provide management and technical
        assistance, counseling services and training opportunities
      - The Service Corps of Retired Executives provide free advice and
        consultation

   • State and local pollution prevention programs
      - The programs help firms understand and cope with regulations providing
        information and technical assistance
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 55

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RECOMMENDATIONS

   SBICs Provide A Valuable Source of Funding
                 For Small Businesses

  • SBICs are private investment firms licensed by the SBA
    that provide long-term capital to new ventures
  • They use their private capital plus SBA guaranteed funds
    to provide equity capital and/or debt to small businesses
  • SBICs have invested nearly $10 billion in more than 70,000
    small businesses since the program's inception in 1958
  • SBA regulates the program to assure that public policy
    goals are met and that the interests of small business
    concerns are protected
 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 56

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RECOMMENDATIONS

 "Inexpensive" Gov't Leverage Has the Potential
         to Enhance SBIC Portfolio Returns

  • Assume a VC fund invests $10 million of capital and receives
    a 15% annual return on its investments over 5 years after all
    management fees and other costs are taken out
     - The funds assets would double to $20 million - gain of $10 million
  • Assume the same fund is licensed as an SBIC and is able to
    leverage the $10 million of private capital with $20 million of
    SBA capital; assume fund receives the same annual return
    of 15% over 5 years
     - The $10 million of private capital would nearly triple to $28.6 million after
       the SBA is paid in full - a gain of $18.6 million
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 57

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RECOMMENDATIONS

        Proposed Envirobank Would Provide

   EnviroTech firms Another Source of Funding


SB A and EPA would facilitate the creation of this SBIC:

       Focus: Providing funding and management assistance to firms in the
             EnviroTech industry

 Management: Professional venture capitalists

    Investors: Many sources including foundations, pension funds, trade
             associations, private investors, etc.

     Funding: Initial capitalization of up to $135 million, $45 million in
             private sector funding would leverage $90 million in SBA
             funding

    Schedule: 4 years at $33.75 million per year or longer

 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 58

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RECOMMENDATIONS

      To Succeed the Envirobank Must Fulfill
                 Several Requirements

   • The bank must be managed by private, profit-driven
     professionals
   • The organization must be autonomous, having minimal
     government interference
   • The bank must provide "intelligent-capital" to companies
      - Firms require management assistance as well as funding
      - Thorough industry knowledge is critical for Envirobank managers
   • The bank should accept no substitute for making money
      - Rate of return must reflect riskiness of investments
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 59

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RECOMMENDATIONS

       The Envirobank Must Be Managed By
            Top-Flight Venture Capitalists   	

Several options are available to attract the best managers:
  • An existing venture capital firm could be found to co-invest
    in and manage the fund
     - The Envirobank would be an add-on environmental fund for the VC firm
  • An Advisory Board comprised of the best senior venture
    capitalists and industry leaders could be created to guide the
    Envirobank
     - Younger venture capitalists would be hired to manage the fund full-time
     - Opportunity to work with "giants of the industry" would attract top talent
  • First-rate, experienced VCs could be found to manage the
    Envirobank
     - Due diligence should be performed to verify their competence and intentions
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 60

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RECOMMENDATIONS

 The Compensation Package for Managers Must
     Be Commensurate to Industry Standards


   Guaranteed management fee - The SBIC's restriction
     limiting fees to 2.5% of total capital, private plus SB A
     leverage, is comparable to fees earned by venture capitalists
   Carried interest - The percentage of profits retained by
     venture capitalists after returning investors capital is
     typically 20%

   If the Envirobank doesn't provide its managers with similar
   performance-based pay attracting quality managers will be
   difficult and the fund will suffer
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 61

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RECOMMENDATIONS
    Operational Restrictions May Hamper the
             Envirobank's Performance

 The Envirobank, as an SBIC, must operate within
 several regulatory requirements:
 •  The size of companies in which it can invest is limited
 •  The amount of capital it may invest in a single company is
   limited
 •  The Envirobank is precluded from controlling the companies in
   its portfolio
 •  The Envirobank must have the right to demand immediate
   repayment from its companies if proceeds are improperly used
    - Problems may arise when acting as a minority participant in syndicated deals
 •  It must fulfill SBA record-keeping and reporting requirements

 The Valley of Death and Other Myths Regarding Environmental Technology Funding               Page 62

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RECOMMENDATIONS

      The Number of High Quality Investment

   Opportunities For the Envirobank Is Limited


   •  Only small firms are eligible for SBIC financing
      - As defined by the SBA, small firms have a net worth of not more than $18
       million and an average net income of not more than $6 million
      - 20% of investments must be in companies 1/3 this size

   •  Existing venture capital funds and SBICs are already
     competing for good environmental technology investments
      - Advent, Technology Funding, Robertson Stephens and First Analysis
       Corp. are a few of the VC funds active in the industry
      - 40 new SBICs were formed in 1994 with a total capitalization over $1
       billion
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 63

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RECOMMENDATIONS

    The Ability of the Envirobank to Provide its
  Investors Competitive Returns Is Questionable

• A required takedown schedule of capital may push the bank into
  making poor investment decisions
    - A $135 million fund with a 4 year takedown schedule should invest nearly $34
     million per year
    - Assuming an average investment of $1 million, 34 deals per year would need to be
     made equalling 134 companies over 4 years
• Investing in multiple small companies will not allow the fund
  managers to provide adequate assistance to its portfolio
    - One of the biggest needs of small companies is management assistance
• Liquidity of startup and early-stage investments is lacking
• There will likely be no return from many investments
    - SBIC bankruptcies have been common
    - In 1991, 31 out of about 350 (9%) declared bankruptcy
The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 64

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CASE STUDIES

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CASE STUDY: RAY CALDWELL

   Regulatory Uncertainty Created Disincentive
   For Commercializing Innovative Technology

  • A small manufacturer of efficient natural gas combustion
    technology
  • The company developed a new innovative technology to
    meet an newly-enacted environmental standard
  • The opportunity was lost when the regulatory deadline was
    pushed back two years
  • Ray Caldwell, President of Prosys, believes:
      - The private sector is efficient
      - VC firms stay out of industry because of uncertainty of regulation and
       poor enforcement
 The Valley of Death and Other Myths Regarding Environmental Tecluiology Funding                Page 66

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CASE STUDY: LOWRY ENGINEERING

   Company Fails to Draw Investors Because of
            Inadequate Management Skills

 • Lowry Engineering is a manufacturer of water treatment and
   radon testing technology
 • The company received funding from state and local sources to
   fund early R&D efforts
 • Although the company feels its products have market
   potential, it does not have a distribution network in place
 • The President, Sylvia Lowry felt that:
    - Once research is complete, there is a void of funding for development
    - Financial institutions don't understand the potential of her products
    - Venture capital was an "expensive" funding option
    - The company needed to establish a partnership with "smart capital" to gain the
      necessary expertise and access to the market
 The Valley of Death and Other Myths Regarding Environmental Technology Funding                 Page 67

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CASE STUDY: FIBERDYNE, INC.
    Company Succeeds By Knowing the Market
              Potential of New Technology
                  	          	^__^_^^^^^^^^^^^^.^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^a^^^^^^^^^a^^^^^^^^^MMMi
^^••^••^••^^^••^••^•••••^^••^•••^••^^^^^^•^^•••^^i^g^^^g^^^^^^^^^^^^^    ^^^^=
 • Fiberdyne, Inc. is a manufacturer of carbon cartridge
   filtration systems
 • The company has a long standing relationship with a local
   financial institution which meets its capital needs
 • The President, Bob Long, believes that:
     - Technology with sufficient market sales potential is able to raise capital
     - EnviroTech Entrepreneurs typically:
        >> Are unable to develop a good business plan
        » Don't spend enough time researching the market
        » Don't educate the customer properly
        » Have unrealistic expectations for potential of their technology and
          therefore significantly overestimate demand

 The Valley of Death and Other Myths Regarding Environmental Technology Funding                  Page 68

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CASE STUDY:  MANCHESTER CORP.

  Technology Market Reluctant to Purchase
	Innovative Technologies	

  • Manchester is a manufacturer of industrial wastewater
    treatment and air pollution control systems
  • Its customer, Copley Pharmaceuticals, chose a $1 million
    thermal oxidation system over a coupled system of 2 proven
    technologies at half the cost
  • The company installed two proven technologies for a new
    application at a Mitsubishi plant; after two years of successful
    operation the process is still  not accepted by the market
  • The President, Irving Morrow, cites customers' concerns:
     - Risk of fines or shutdown if new technology or process is ineffective
     - Difficulties in gaining approval from local dept. of environmental  protection

 The Valley of Death and Other Myths Regarding Environmental Technology Funding                Page 69

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                          The Valley of Death and Other Myths
                                 Selected Bibliography


The Boston Globe.  '"94 Investments Signal Shift." Ronald Rosenberg. February 26, 1995. p. 77.

Bridge To A Sustainable Future: National Environmental Technology Strategy. The National
Science and Technology Council.  April, 1995.

Bridging The Valley Of Death: Financing Technology For A Sustainable Future. December,
1994. Prepared by the U.S. Small Business Administration for the U.S. Environmental Protection
Agency. Interagency Agreement #DW7393687701.

Environmental Business Journal.  Numerous issues, mainly January, 1993; May, 1994; July,
1994; November/December,  1994. Environmental Business International.

Environmental Technology Initiative: FY1994 Program Plan. U.S. Environmental Protection
Agency. January, 1994.

Industry, Technology, and the Environment: Competitive  Challenges and Business
Opportunities. U.S. Congress: Office of Technology Assessment. OTA-1TE-586.  Washington,
D.C: U.S. Government Printing Office, January, 1994).

Note on Financial Contracting: Deals.  President and Fellows of Harvard University, 1987.
Harvard Business School Case 9-288-014.

Oppenheimer & Company. Presentation to the Environmental Business Conference, April, 1995.

Small Business Forum. Volumel2, Number 1. Spring 1994.
The authors wish to thank the numerous industry experts who participated in the many hours of
interviews that comprised the majority of this report.  We would like to extend special thanks to
Ray Caldwell, Richard Golob, Paul Hardiman and Terry Rothermel for their help. This report
could never have been produced without the guidance and humor provided by Professor Richard
H.K. Vietor of the Harvard Business School, and Jim Cabot of the EPA, who always came through
in the clutch.

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