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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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• 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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