Sunday, March 1, 2009

A Hybrid Business Model for Renewable Energy Companies in Hawaii

In my Feb. 8 blog article, “An ‘Unfair Advantage’ for Hawaii R&D Companies in Renewable Energy Technology”, I proposed that a hybrid business model for R&D companies in renewable energy technology partnering with a developer of an on-site RE power producing facility can provide significant advantages over the typical venture business model. This blog article explains in more detail how the hybrid business model for Hawaii RE companies would work.

The typical venture financing model for startup technology companies in Hawaii has been structured around lowering risk by taking advantage of the State’s 100% investment tax credits (Act 221/215). With a Hawaii average of $5 million funding for a promising deal, the company will staff up with a senior management team, rent office and lab space, and employ an engineering team, product development team, and marketing and sales teams. It typically has a burn rate of $100,000 per month, expending its funds in 4 to 5 years. But Hawaii tech companies seldom can attain market visibility or anywhere near their projected sales targets due to the previously mentioned “perfect storm” of disadvantages they labor under. Making a case for further venture funding then becomes extremely difficult. If the company has not gained enough traction to ramp up product sales to at least break-even levels, it goes into “life-support” mode until the 5-year tax credit recovery period is completed. The Hawaii investors are deemed adequately compensated by the tax credits, and the Mainland investors can try to recover value from the company’s remaining assets, typically its intellectual property and patents.

In contrast to the venture financing model, Hawaii companies developing a new renewable energy technology can use a hybrid business model that provides significantly better results for the company and its investors. Instead of a business plan based on ramping up to unreachable product sales, the Hawaii company in the hybrid business model is formed as an R&D company that will conduct a validation stage of research on a new RE technology with a dedicated customer such as a developer of an on-site photovoltaic (PV) power producing facility. The PV facility is set up to pay for its installation costs separately through federal and state RE tax credits and low-interest-rate debt financing which is more than covered by the expected energy savings.

The R&D company acts as operating manager of the PV facility and researches a “smart” energy management system that can maximize efficient energy usage of the PV facility. Raw PV arrays and windfarms produce power that fluctuates intermittently with changing cloud or wind patterns. Due to hysteresis effects, the fluctuations result in usable energy output less than the facility's real-time generating capacity. The customer/developer would need to make up for power fluctuations by buying electricity from the grid at full retail price plus utility-imposed standby-power charges. If a “smart” energy management system can be devised to squeeze out a 30% increase in energy usage of the facility and minimize the need for backup grid electricity, the R&D company can both validate the technology and justify the installed cost of the “smart” energy management system.

Since the R&D company has access to a full test bed facility, and since its business plan is not based on product sales, there is no need to staff up a senior management team, product development team, or marketing or sales team, or pay for office or lab space or product manufacturing. All investor funds can be used primarily for hiring an engineering team and performing the R&D work. Therefore, the R&D company needs to raise perhaps only in the range of $500K in the validation stage of their new energy management technology. This level of funding is within range for a Hawaii angel investor, and should fully qualify for the 100% Hawaii investment tax credits, and the State's 20% refundable business tax credit on qualifying R&D expenses ($100K on $500K research expenses). Since the test system is to be used for energy efficiency purposes at the developer’s site, the installation costs should also qualify for immediate 65% federal and state RE credits on installed costs.

If the test system proves effective in providing energy cost savings to more than justify its installation costs, the R&D company can then sell the proven system at cost to the customer/developer after the 5-year tax recovery period and distribute the proceeds to its investor(s). Counting Hawaii investment tax credits, federal and state RE credits, and recovery of facility costs, the cumulative payback to the Hawaii angel investor(s) would total at least 165%+ return (net present value) on investment (assuming half the funds are spent on installed equipment and the other half on engineering salaries). The Hawaii angel investor would also retain a larger, undiluted equity share for full upside participation if the R&D firm can now profitably commercialize the now-proven technology.

The R&D company would own intellectual property rights in the developed energy management technology in the form of copyright-protected software, patented invention rights, and/or licensable engineering know-how. It can monetize these intellectual property rights by seeking to license the technology to established RE facilities installation companies in the Mainland U.S. and globally. Alternatively, it can now credibly seek the next stage of venture capital funding for expansion of the company to commercialize the now-proven technology for sale in Mainland U.S. and global markets.

The hybrid RE business model can greatly reduce investor risk in the technology validation stage, and lessen the burdens on the company for early fund raising. It also allows the constrained venture funding pool that exists in the State to fund more companies to develop more innovative approaches to RE technology that would make achievement of the State’s ambitious goal of 70% renewable energy use by 2030 more likely. Last, but not least, the hybrid RE model would slow down the rate of saturation of wealthy investors for and defer usage of the State's investment tax credits until the RE technologies have proven their commercialization potential.