The Valley of Death and Other Myths Regarding Environmental Technology Funding Harvard Business School Field Study Sponsored by EPA New England May 1995 ------- 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 ------- 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 ------- PROJECT PURPOSE ------- 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 ------- INDUSTRY OVERVIEW ------- 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 ------- 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 ------- 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 ------- THE FUNDING GAP ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- VENTURE CAPITAL INDUSTRY OVERVIEW ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- STOCK MARKET PERFORMANCE ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- BARRIERS TO COMMERCIALIZATION ------- 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 j s s */ s The Valley of Death and Other Myths Regarding Environmental Technology Funding Page 32 ------- 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 ------- REDUCING THE FUNDING GAP ------- 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 ------- 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 ------- 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 ------- REVIEW OF CURRENT PROGRAMS ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- RECOMMENDATIONS ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- 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 ------- CASE STUDIES ------- 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 ------- 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 ------- 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 ------- 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 ------- 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. ------- |