At the ongoing first-ever VCCircle Cleantech Investment Summit 2011, IDFC Private Equity managing director Raja Parthasarathy made a keynote address on The New Paradigms In Cleantech Investing. Excerpts from his address:
Ladies and gentlemen – I’ve been asked to speak today about a new paradigm in cleantech investing.
I don’t believe that there really is a new paradigm. The new paradigm is the old paradigm, which seems to get lost periodically in moments of market excitement. But the old paradigm that I just referred to – what I call the ABC of cleantech investing – remains as relevant as ever for those of us here who are either consumers or providers of capital.
The A in the ABC stands for adequate access to equity capital. This is the foundation of the financing plan for any business.
The B stands for bankability, the next layer of financing provided by lenders. That is typically more than twice the equity capital provided either by the promoters or by external investors and therefore essential for any project to get off the ground.
The C stands for cash flow. Without being dramatic, cash flow really is king.
Let me now share my perspective on this holy grail of cleantech investing – having adequate access to equity capital in a bankable project or business with high line of sight on cash flow generation.
I’ll begin with access to equity capital, the A in the ABC I will speak about. There are between 250 and 400 active private equity firms in India today. Despite its relative youth, ours is an exceptionally well diversified market with suppliers of equity capital that address investment sizes all the way from under one million dollars to over 300 million dollars. It’s fair to say that virtually every cleantech business in India today falls within this range. And private equity firms’ appetites for risk, and consequently their risk adjusted return expectations, also vary within this spectrum. In my view, there is no shortage of equity capital that is available to fund quality businesses.
But the same combination of factors that private equity investors look for in any other sector also apply to cleantech – that combination of strong entrepreneur with a track record in a growing and well managed business with a high likelihood of scale-up and exit within a 3-5 year timeframe. There is also a growing recognition within the investment community that businesses need to be commercially viable on their own two feet, without excessive dependence on subsidy or grant-led regimes for survival.
This combination is not always available in emerging cleantech businesses, yet the valuation metrics remain the same as conventional businesses – which are largely cash flow based multiples. The last time new metrics were developed to justify valuations – eyeballs, page views and so on during the days of the internet bubble – we all know how that story unfolded.
There is an additional catch. Especially for cleantech businesses in the early stage of development – take grid connected solar farms as an example – these same suppliers of equity capital require that the projects be bankable and therefore that there are lenders who are willing to extend term loans at reasonable rates in order to make projects viable.
In the last one month, banks have begun sanctioning loans for solar power projects. Lenders in general have approached solar very cautiously. While some were not comfortable earlier with the payment security mechanism, those concerns appear to be getting addressed.
The bankability criteria for lenders in this particular example – grid connected solar – are simple. Track record to minimise execution risk, choice of proven equipment from a well recognised manufacturer and finally, for state level projects, choice of state and its financials in order to lend credibility to the offtake arrangement.
There is a growing recognition within the lending community that early successes in India’s solar push could become a template for the success of other emerging cleantech sectors. And lenders are encouraged by the progress on Government- led initiatives – whether in solar or even in wind with the introduction of the GBI.
The last of the three – the C in the ABC I spoke about earlier – is cash flow. Unless investors have high line of sight on cash flows, they won’t be as willing to offer financing support. They are, in general, a lot more discerning today than they would have been a few years ago. Raising large amounts of financing on the back of just a business plan is getting more difficult – and chasing valuations instead of real cash flows usually ends up in disappointment for at least one and often both sides.
For many companies that don’t have the internal wherewithal to contribute their own equity, that frequently presents a chicken and egg problem. How do you raise capital for project development when you don’t have a long established track record?
There’s no silver bullet. The obvious solution seems to be to start small, be ambitious yet pragmatic and show small successes that require minimal amounts of capital before expanding vision and scale. That has been the old-fashioned way of building businesses, the old paradigm.
So as we enter 2011 with the promise of a dawn for cleantech in India, many of the old fashioned rules still hold true. There hasn’t been a better time for the sector where the confluence of supportive Government policy, adequate access to financing and a widening demand supply gap that cleantech can effectively bridge have all come together.