In recent Cleantech Insights columns, we reflected on the nature and characteristics of the enterprises comprising the broader cleantech sector and on some of the drivers and trends that will underpin the sector’s growth over the medium to longer term.

This week, I would like to deal with funding, a fundamental prerequisite for the expansion of clean-technology enterprises in South Africa and elsewhere, both regionally and globally. In particular, I would like to discuss the sources and types of funding that, we believe, will become available to promoters of businesses in the cleantech sector.

There is a general tendency to compare the emergence and growth of the cleantech sector with the emergence and growth of the information and communication technology (ICT) sector during the early to mid-1990s. Both sectors are technology driven and their outcomes have the potential to change the way the world functions. Just as the ICT sector attracted massive capital inflows from the venture-capital (VC), private-equity (PE) and institutional markets, so too is cleantech attracting unprecedented levels of funding support. It is worth noting that the ICT sector was able to absorb and invest this capital funding into enterprises that operate off infinitely scaleable platforms, both vertically and horizontally.

Cleantech enterprises differ in that they are characterised by both technology and capital-intensive, project-type investment opportunities, the latter requiring investors to embed equity into hard assets rather than intellectual property like software. Illustratively, during the dotcom boom, an abundance of capital existed for investment into start-up and early-stage ventures; on the back of simple proof of concept, ICT promoters could tap capital funding from a broad spectrum of angel investors, VC funds and investors, PE funds and institutions. This is not necessarily going to be the case with cleantech.

Since late 2008, VC markets have all but evaporated, and projects seeking debt finance are now subject to unprecedented scrutiny in the wake of the financial sector meltdown.Yet, despite this downturn in confidence, the Cleantech Group, in San Francisco, US, recently reported a record high value in new cleantech investments totalling $2,6-billion in the third quarter of 2008 alone, a 37% increase on figures for the corresponding period in 2007. This data was drawn from markets in North America, Europe, China and India and across 158 companies. Highlights for the quarter include new record investments into smart grid technologies, algae (to fuel) companies and thin-film solar start-ups, which recorded $620-million in new capital for the quarter.

Notwithstanding these global trends, it is increasingly clear that the prevailing approach to capital investments into cleantech enterprises in South Africa will track a consistent trajectory: cleantech businesses – and particularly energy generation enterprises – are characterised by large infrastructure and are, by their nature, capital intensive. The financial returns deriving from these investments will, therefore, depend, to a large extent, on the debt-to-equity ratio and, whereas, previously, international norms for debt-to-equity ratios were greater than 85%, following the credit crunch, these ratios have slipped back to about 65%. This is a double blow for project promoters – on the one hand, this means having to secure 35% of the project finance from equity investors; and, on the other hand, the equity internal rate of return (IRR) of a deleveraged investment is typically lower than a highly geared opportunity.

The upshot is that, in seeking places to deploy their capital, the markets will look hard to identify higher-return opportunities that are already well beyond early stage and where proof of technology and guarantees of inputs (feedstock) and offtakes (long-term revenue contracts) are securely in place. The market is likely to take a sceptical approach to start-ups and early-stage ventures, and will almost certainly avoid the VC approach to backing untested technologies at the prepilot stage.

To capital providers, the ideal ‘sweet spot’ in terms of cleantech enterprises is likely to be one that offers technology returns with an infrastructure-type risk profile. Illustratively, wind farms have known technology and global-standard operating procedures – they are underpinned by clearly discernible wind mapping data supporting the energy conversion model, and the project is usually tied into long-term power purchase agreements (around 20 years) with reliable, credible consumers. In this illustration, the capital provider can model its returns using a range of known assumptions and flex this with any manageable variables, such as changes to the feed-in tariffs. By doing this, the promoter can determine with confidence the likely IRR that the equity contribution will derive.

The smart money is going to be just that – smart about where it goes. Cleantech offers some very compelling new investment opportunities, but promoters must recognise that investors are likely to be both prudent and highly selective in their choices.

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