How to grow: Raising capital
Many small developers lack capital to take their projects through construction. They end up seeding projects for larger developers. The goal is to move the projects as far up the development curve as possible before having to sell. How do some companies get past this stage? What lessons have they taken away from dealing with strategic partners, private equity funds and banks? What is the secret to raising capital to support growth?
A group of CEOs and company founders talked in late September about how they got their own companies off the ground. More than 1,700 people registered to listen. The group was Ryan Creamer, CEO of sPower, Jeffrey Eckel, CEO of Hannon Armstrong Sustainable Infrastructure, Declan Flanagan, CEO of Lincoln Clean Energy, Sandy Reisky, founder and chairman of Apex Clean Energy, and Mikhail Segal, founder and chairman of LS Power. The moderator is Keith Martin with Chadbourne in Washington.
MR. MARTIN: Ryan Creamer, when was sPower started?
MR. CREAMER: We started in 2012.
MR. MARTIN: Describe the company’s focus.
MR. CREAMER: We develop renewable energy projects. We have a current portfolio of about 1,200 megawatts of solar and about 140 megawatts of wind, but we look at all types of power. The “s” stands for sustainable.
MR. MARTIN: If I am not mistaken, in the space of just four years, you have already moved to a place where you build and own your own projects.
MR. CREAMER: Correct. We started as a small family office that serviced the back end of 104 nuclear power plants in the United States and operated all 20 reactors in the United Kingdom. Five years ago, I was called the naysayer of solar. I watched the technology get better and the cost come down. It got exciting. We jumped in.
In 2014, we had the opportunity to merge with a solar development platform, called Silverado Power, that Fir Tree Partners, a private equity fund, had acquired, and over the last 30 months we have placed in service almost 700 megawatts of solar assets and 60 megawatts of wind, and we have another 600 megawatts of projects moving into construction. We are building between six and seven megawatts a day.
MR. MARTIN: So the merger with Silverado provided the spark. What were your first two years like?
MR. CREAMER: During the first two years, we built about 40 megawatts of smaller, commercial- and industrial-scale solar projects. When Fir Tree Partners started provided funding, it let us move to another level. Fir Tree has a number of different funds within it: a hedge fund trading desk, a real estate fund, and a private equity arm, and through it and with its backing, we were able to raise almost $1 billion of equity.
MR. MARTIN: So for roughly the last two years, you have had no trouble finding capital. You can get all the way through construction. But how did you fund the business during the first two years?
MR. CREAMER: I would not say the last two-and-a-half years have been easy. I’ll be honest. I didn’t think I would ever say that a billion dollars is not enough, but to build what we have today, we have had to raise almost $1 billion of tax equity and almost $1 billion of back-levered debt. We have a continuing need for more capital.
When we first got started, I was probably a bit naive in thinking all it would take would be to throw a little money from our family office to get traction. It was funded out of our own pockets. The initial thought was to see how far we could get with $4 or $5 million.
By the end of the first two years, we were into it a lot more than that. We learned we had to make a commitment to the industry and not to one or two projects.
MR. MARTIN: So in your case, your own money carried you to a point where you got backing from a private equity fund.
Let’s move to Jeff Eckel, who is currently CEO of Hannon Armstrong Sustainable Infrastructure, which provides financing for other renewable energy developers, but before that, he ran two development companies, Wärtsilä Power Development and EnergyWorks. Tell us about them and how they were funded.
MR. ECKEL: I feel like a history lesson because Wärtsilä Power Development was 25 years ago. I started as CFO for North America, and we delivered engines to the electric utility in the Dominican Republic, CDE, but the utility pulled its letter of credit securing payment for the engines just before the ship arrived. As CFO, I said, “This is a catastrophe. Turn the ship around.” The Finns — Wärtsilä was a Finnish company — delivered the engines anyway. CDE of course didn’t pay for the engines, so I said, “I think we are in the development business.”
I went down there and turned it into a $15 million power plant. What I figured out was we were also starting in the operations and maintenance business. There was a pretty good margin in the O&M business, so I proposed to our parent company in Helsinki, “You weren’t counting on this O&M margin. We got the problem fixed. Let me run this development business. The only thing I ask is that you never touch my million dollars a year in O&M margin.”
They were fine with that approach, and we went on to develop 750 megawatts.
MR. MARTIN: These were barge-mounted diesel generators, right?
MR. ECKEL: Land- and barge-mounted.
MR. MARTIN: Did you have to raise outside capital or did all the money come from the Finnish parent?
MR. ECKEL: We took no money from the Finish parent to cover development spending. We funded development with the million dollars a year and most of our developer fees and then financed construction on a project-finance basis through a combination of debt and equity. The equity was usually about 25% of the total capital cost, and it came from a variety of investors who put capital into Latin American projects. We used a portion of our developer fees to fund about 10% of the equity.
Bechtel recruited me to start EnergyWorks, which was a very different business model. While the goal at Wärtsilä was to find a use for Wärtsilä generators, EnergyWorks was a startup business focused on India, Indonesia and Brazil, and we were supposed to execute on a distributed and renewable generation strategy so that Bechtel could see how smaller projects could get done. We did not have as our goal generating construction projects for Bechtel. That was in 1995. Unfortunately, we were just a little ahead of our time.
The company was owned by Bechtel and PacifiCorp as joint venture partners. They funded the venture. We were not short on capital.
I took away two lessons from the experience. One is that strategic investors change strategies a lot more often than I think is appreciated. After three years, Bechtel and PacifiCorp decided the company was a stupid idea. The other lesson is joint ventures are riskier to the management team than a single strategic investor, because the company is only as stable as its weakest partner. I have looked askance at joint ventures since then.
Hannon Armstrong, where I am now, has also dabbled in the development business. We formed a geothermal development company, EnergySource. If you want to make a lot of money, geothermal is not the place. Although we were very successful with the Hudson Ranch I project, we doubled down on Hudson Ranch II, and it was not quite as successful.
Hannon Armstrong did fine with EnergySource, but as a public company, we no longer invest in development assets or developers. We are a public vehicle that needs current yield.
MR. MARTIN: Where did the capital come from to develop the geothermal projects?
MR. ECKEL: From Hannon Armstrong. I have a view that if you need money from private equity, you are in trouble. If you cannot find a way to bootstrap your way into the development business and have to turn to private equity for funding, then you are put in the position of having to pay the private equity fund return ahead of any return you might earn, and the inevitable delays in development make it very challenging for the developer management team to make any money.
Now, that said, you have on this panel, a group of people who are just awesome developers and who have done fantastic jobs with their companies. I am not nearly as good as those gentlemen. But in my experience, if you need private equity, you are in trouble.
MR. MARTIN: So if private equity is out as a source, what is the right source?
MR. ECKEL: If I were getting into the renewable energy business today, I would focus first on solar, not wind, because wind is so capital intensive, and I would bootstrap my way into the first project, bootstrap my way into the second and generate some operating cash flow. I know it is difficult to do this in solar, but these other fellows have shown it can be done. Their growth trajectories have been just astonishing. I would probably take it more slowly because I do not have the same appetite for risk.
MR. MARTIN: Bootstrap means use your own resources?
MR. ECKEL: Yes.
MR. MARTIN: You have just teed up Declan Flanagan. Declan, you have done a great job of growing Lincoln Clean Energy, and you have followed a more rapid growth strategy than perhaps Jeff was describing. When was Lincoln Clean Energy founded?
MR. FLANAGAN: Toward the end of 2009.
MR. MARTIN: So the company has been in business for seven years. What types of projects are you developing?
MR. FLANAGAN: The current focus is mostly wind, some solar. We have some activity in natural gas, but that will take a number of years to bring to fruition.
MR. MARTIN: Are you at a stage now where you are building and retaining ownership of your own projects?
MR. FLANAGAN: Yes.
MR. MARTIN: Did you go through discrete steps to get to that stage or did you start there?
MR. FLANAGAN: I started in 2009 using my own capital and some founding partners’ capital and focused initially on solar for all the reasons that Jeff articulated. The goal was to develop smaller projects that we can get into operation without institutional capital and take it from there.
In hindsight, we were a little too early into some markets, particularly the mid-Atlantic states and southeast that are really booming now, but they were infertile ground in 2010. We had some success in New Jersey where we still own assets, and we had some success in California where we developed a couple projects that we later sold.
Three years into the company in 2012, we started to get a lot more traction with wind projects. We have developed more than 1,000 megawatts of wind since then, all of which we have sold. At the end of last year, we decided that we needed to raise more capital to build on our success with large wind farms. We specialize in 200- to 300-megawatt wind projects. So in December last year, we sold the company to a private equity fund, I Squared Capital, and with the momentum we have built up with our platform, we now build and own our own projects with a focus mainly on wind, but also some solar.
MR. MARTIN: What was the intermediate step along the way? You used your own resources initially, got some traction, and now you are owned by a private equity fund. Was there an intermediate step?
MR. FLANAGAN: We brought in some capital from a Texas-based venture growth equity fund, Austin Ventures, who are great partners and investors. They came in at the project level. We had a co-investment from Danson Construction in 2011 to 2012 through a joint venture that focused on a couple solar projects.
That was the intermediate capital between the founder capital and where we are now. I think it is really important in any development business that you have quite a bit of founder capital to build momentum. During that intermediate period, we didn’t actually launch any processes to raise capital. We were in a comfortable position of just responding to incoming approaches, from people who were looking to partner. Early-stage development capital, particularly in small increments, is difficult to raise.
Don’t be in too great of a hurry.
MR. MARTIN: Let me make sure I understand the intermediate step. You had one or two partners. Did they take interests solely in particular projects or at the company level?
MR. FLANAGAN: In both instances there was an element of holdco capital.
MR. MARTIN: What was the nature of the relationship then with each partner? Did you give up 30% of the company? Did you give warrants? What was the deal?
MR. FLANAGAN: There are many ways to structure such arrangements. You probably have many different arrangements just on this panel. When issuing equity to build up a development platform, it is more common and easier to achieve alignment of interests if there is some sort of preferred return to the external money.
MR. MARTIN: Let’s go to Sandy Reisky next. Sandy, I think your earliest venture was wind. You amassed a portfolio of sites for wind farms. The sites proved as valuable as beachfront property. You ended up selling them to BP Alternative Energy. Then I think you took a look at solar, but now you are back focused on wind and it seems like every third big wind farm coming to market for financing lately is an Apex project. Are you at the stage currently where you are building and owning your own projects?
MR. REISKY: I would say we are building for the market. We might retain an interest in the projects, but we have really focused on bringing a portfolio of projects to market to be sold to a strategic partner or an infrastructure group or fund.
MR. MARTIN: You build and retain projects until you have a large enough portfolio to sell?
MR. REISKY: The original company I started in 2000 was Greenlight Energy. We completed a 150-megawatt wind farm in Kansas. We developed it and built it together with PPM Energy, and we were at the point of bringing a 300-megawatt wind farm to market together with Babcock & Brown when BP acquired Greenlight.
From a founder’s perspective, the value that BP saw in our company could be recovered quickly because there was a large project ready to go into construction. BP could justify the purchase of the whole company with that late-stage asset and the pipeline of development projects.
MR. MARTIN: Describe the discreet stages you went through to get to where you are today.
MR. REISKY: The story is similar to some others on this panel. After the transaction with BP, there was a non-compete agreement for a number of years, but we had capital and we had a lot of happy investors. All the capital we raised for Greenlight was from friends and family and local family offices.
The theme was we are investing in clean energy resources. We launched a new company, Axio Power, to pursue development of utility-scale solar facilities. We acquired three companies and rolled them up into one. We had assets in California and Canada, in the northeast and in Hawaii.
The Canadian assets were well positioned to benefit from the Ontario feed-in tariff program. We were awarded a number of contracts. The lesson was that a geographically diverse portfolio with critical mass where you are covering a lot of markets gave us a good hit rate. We sold the company to SunEdison.
MR. MARTIN: You have been paid the full purchase price?
MR. REISKY: Good question. Yes. We then had another shot on goal that connected with investors, and were able to continue raising capital for our current company, Apex Clean Energy. Apex launched in 2009. The SunEdison transaction for Axio was in 2011.
All of this has given us a lot of momentum. The Apex founding story is that we had some of our own capital and, over the years, we brought in capital from our investor group. I agree with what Declan said that it is best to use founding capital to get to a point where the company has critical mass.
About 18 months ago, we worked with Prudential Capital Group, and that was our first institutional capital. They were great to work with, and it was a good transaction for Apex that gave us resources to invest in more projects and bring them to market.
The inflection point for Apex that truly got us launched was completion of the 300-megawatt Canadian Hills project in Oklahoma. The revenue from that sale really fueled our growth. We have about 220 people now. We originate, develop, finance and build our own projects. We are also operating about
1,000 megawatts of assets from a state-of-the-art remote operations center.
MR. MARTIN: Although the breakpoint was the revenue from the Canadian Hills project, it sounds like the real key was you had a lot of happy investors from your first venture, Greenlight Energy, and the success with Greenlight meant they were willing to continue investing in your follow-on ventures.
MR. REISKY: That’s absolutely correct. What we were telling investors is this is a resource play and people may look at it as project development, but it is really about investing in energy resources that have tremendous option value.
MR. MARTIN: Option value meaning what?
MR. REISKY: The option to produce energy and sell it for a fixed price over a 20-year term delivered to a specific spot on the grid. An option like this can have significant value in an environment where energy prices are higher than the cost to produce the energy.
Delay Outside Capital
MR. MARTIN: Let’s turn to Mike Segal, who is one of the big names in the independent power industry and who built LS Power into a major independent power company. How did LS Power get started and in what year?
MR. SEGAL: I feel a bit like a dinosaur next to these guys, because we started in 1990. We were a very small shop at that time focused on projects with high barriers to entry. The reason to like those deals is there is limited competition for them, and they usually offer the best rewards.
When we started, we tried to advance the first group of our development projects as far as possible using our personal resources. We managed to push them up the development curve to a point where they were significantly de-risked. At that point, we took a small amount of outside funding to support further development of this group of projects. By waiting as long as possible, the dilution was very small and we retained full control.
During the 1990s, we developed approximately $3 billion in enterprise value of projects.
MR. MARTIN: Where did the outside capital come from initially?
MR. SEGAL: The outside capital, which was very small, came from one institution and a family office and their participation was limited to the first group of projects.
MR. MARTIN: Was it equity or debt?
MR. SEGAL: It was a limited partner interest.
We completed about $3 billion of deals in the 1990s and sold them, so that by early 2001 we ended up with a very enviable cash position. That gave us the resources to continue developing our own deals. We never needed any more development capital because we had a pretty strong balance sheet.
MR. MARTIN: Before taking the story further, you had a small amount of institutional capital, it sounds like at the project level, from a limited partner. Surely you had to raise other outside capital to complete the $3 billion in projects?
MR. SEGAL: The initial capital was to support completion of the development efforts on the first few projects and came at a portfolio level. The remaining capital was mostly debt, our own equity and, occasionally, sale of the limited partnership interests in specific deals at construction financing.
MR. MARTIN: So now we are in 2001 and you have raised a lot of cash from selling a portfolio of natural gas-fired power plants at the top of the market before Enron collapsed.
MR. SEGAL: Since 2001, we have completed another $6 billion in development projects. They include transmission lines and substations, some renewables and several large fossil-fuel fired plants. All the funding came from a combination of debt and our own equity.
After 2001, we broadened our platform from the initial focus of building and owning gas-fired power plants. We set up a hedge fund. We formed several private equity funds and took in outside investment in them. Both are focused on the energy sector. The hedge fund trades securities, passive positions in companies in the utility and energy sectors, and the private equity business buys existing operating projects that are undermanaged and then we try to improve their performance and resell the projects at a higher price. We raised about $6.5 billion across the three private equity funds. In 2006, we purchased Duke Energy’s North American portfolio of gas-fired projects. We got a gas portfolio from Mirant, from NextEra, and there were others.
The private equity funds buy existing projects. We never use capital from the private equity funds to fund development of our own projects.
MR. MARTIN: These are some very different approaches among the five panelists.
Now let me ask each you what lessons you learned about raising capital along the way. We are looking for practical advice. Ryan Creamer?
MR. CREAMER: I was a little naïve. I had just come off financing more than $2 billion of nuclear installations. I looked at solar and thought, “It is like my erector set as far as difficulty to build.” But it was not easy to do the financing.
One of the toughest tasks was arranging tax equity. There is only a small number of players investing tax equity. They are serious companies. Getting invited to that club and being able to get their help financing your projects was a challenge. Then later adding debt and trying to tie it together with tax equity was even more challenging.
One of the things we found was you have to have some skin in the game. They want to know that you are in the energy business and that you have a good track record. I had a track record servicing nuclear power plants, but I began to feel like I was pretty inexperienced to go build solar facilities. The financial community wanted to see industry-specific experience with solar.
So we ended up building a couple facilities on balance sheet to get there. We recycled some early capital.
MR. MARTIN: Was the lesson to prove you can walk before you try to run?
MR. CREAMER: You have to walk before you run, but you also have to ensure you are always capitalized appropriately. As Jeff Eckel said, these projects always take longer than expected.
We all hear the term “shovel ready.” You really have to make sure your projects are to the nth degree ready for due diligence as you go in for financing. Make sure you are appropriately capitalized so that you can weather any delays. Be mindful of deadlines in the power purchase agreement.
When we combined with Fir Tree, we looked at the Silverado portfolio and concluded there might be 100 megawatts that we can bring to fruition. Months later, after a lot of hard work, a lot of sweat and tears, and after throwing a lot of capital at projects, we saved almost 370 megawatts out of Silverado’s 500-megawatt development portfolio. We got the projects to a point where they were execution-ready and buildable.
MR. MARTIN: There seem to be two lessons in what you just said. Developers need more money than they think. Make sure everything is neatly tied together before taking a project to market.
MR. CREAMER: Absolutely. There is no tax equity investor or bank that wants to spend the time training you to do your job. Maybe another lesson from our own experience is that half of our portfolio has come from greenfield development and the other half has come from working with other developers to help push their projects across the finish line. The lesson is to understand your core capabilities and where you add the greatest value in the development cycle.
MR. MARTIN: Interestingly, you said as a former nuclear power expert that one of the hardest things about moving to solar energy was the complexity of tax equity.
MR. CREAMER: Yes. It was a lot more difficult than I thought. I thought nuclear was about as tough a game as there is trying to explain to people and get comfortable with risk. But renewable energy financing is at another level. It is a good thing we are building renewable energy facilities because the amount of paperwork these projects take to get financed is destroying whole forests.
MR. MARTIN: Jeff Eckel, you offered some practical advice earlier, but do you have other advice for CEOs of small project developers that want to grow?
MR. ECKEL: Many capital providers think most problems can be solved by money. I do not believe that is the case. It comes down to the management team. It takes experience, wisdom, lessons learned and just plain street smarts actually to develop a project.
The next point is you have to be in a position to say no. Either be willing to fund it yourself or bootstrap with others or work your way into a related business that generates a revenue stream and puts you in a position where you do not have to ask financiers for cold, hard cash. That will give you a lot of leverage.
MR. MARTIN: Mike Segal said he pushed his first project to a point where it was largely de-risked before going out to raise capital. That way he kept more of the project.
MR. ECKEL: LS Power has been just genius at this for decades.
Speaking today as a capital provider, you only want to give money to people who don’t need it. That is a sad fact, but it is the way it works. A developer has to bet the farm a few times to get the value he deserves.
MR. MARTIN: Let me test one other proposition. It sounds like you believe business plans change, so you basically are putting your money behind particular people. They need to be resilient and determined enough to be able to work through the inevitable obstacles that are thrown in the way of developers.
MR. ECKEL: Yes. Ryan Creamer talked about the need for industry-specific experience. Bechtel had a great phrase: it wanted to be the first party into a construction project the third time around. You are going to have a few broken plays before a capital provider will be confident you know the six ways you could lose money. Until you stub your toe a few times, you don’t know what you don’t know. Experienced people are extraordinarily valuable.
MR. MARTIN: No mistakes, no experience. No experience, no wisdom. Declan Flanagan, what practical advice would you give people trying to move up the development chain?
MR. FLANAGAN: You do not want to get into a situation where you are in too much of a hurry or too much of a corner that you must do a deal. You will end up having to work through the consequences for a long time.
It is one thing to take a sub-optimal deal for a single project — it is bounded — versus growth capital or holdco capital. Things always take longer than expected. Always make sure you give yourself adequate time.
Another lesson when it comes to growth capital and bringing in partners that is obvious, but that too few people heed, is really get to know them upfront and diligence them. Look into their backgrounds. Spend time with them. Get to know how they think before you are sitting around a board table making decisions.
Again, back to the first point: do not allow yourself to get into a situation where you are in an undue hurry.
MR. MARTIN: Sandy Reisky, what practical advice do you have for CEOs of smaller companies?
MR. REISKY: There has been a lot of really good advice already. I am afraid I might repeat some of it. Start raising capital well before you need it, because you do not want to be in a position where you are desperate for the capital. Allow yourself time and have alternatives, and say no if it is not the right capital.
When I first got in the business, I thought people would see that this is the future. This is green energy. It is clean. It does not use water. Frankly, people also wanted to hear the story about the value proposition, and it seemed the more you talked about the renewable aspect of it, you were not doing yourself any favors, particularly back then.
Really know what your value proposition is and how you are going to manage risk. Be able to express the value proposition simply and to explain the risks your business will face and how you are going to address them.
Be able to explain what the real sizzle is in your business model. You have a business that requires $10 million in risk capital for early-stage development, but a project can deliver multiples on that. What you are really capturing when you sell a project is the net present value of 20 years of earnings above your cost of capital.
If the market moves and there is a carbon tax or natural gas prices go higher, all the projects across the portfolio get more valuable as wind gets deeper in the money, and we all know that there are technology trends that will make wind and solar continue moving down the cost curve, and the rest of the energy market probably will not follow as rapidly. That is a fundamental part of our value proposition.
The emphasis on assembling the right group of people that I have heard already today is absolutely spot on.
We brought in a lot of veterans from a lot of other great companies to join the Apex team. They really brought the expertise, especially on the operations side. Part of our business model that not many others are pursuing is we are ready to sell projects that are completely de-risked and in operation to strategics and financial counterparties. We have a terrific operations center with 25 people that is run 24/7 and is staffed by industry veterans.
Moving away from holdco capital and explaining how to drive a company to the point where it has to focus on how to finance projects through construction, Apex did what I think a lot of the people on this call did. It is like climbing up a ladder. We were capitalized in anticipation of the next few rungs, and once you climb those, then you get to the next stage in the capital cycle.
MR. MARTIN: Mike Segal, many people envy the progression of your company. Explain to someone who has just come to the United States and wants to start up a similar company how to follow in your footsteps.
MR. SEGAL: You are being too kind. I always believed that capital is available for the right idea sponsored by the right, competent and credible team. So if you have that right combination of a good idea, good project, and a team that has credibility, competence, and ability to add value at each stage of the project, plus personal integrity, you should not have a lot of difficulty finding the initial capital to get the business going.
There are two other lessons. Projects that enjoy competitive advantage in raising capital are the ones with some unique, innovative commercial structures or with the first-mover advantage. On the other hand, if your deal is a kind of plain vanilla, low-barrier-to-entry type, you may get funded, especially under current conditions when so much liquidity is sloshing through the system around the world, but you better watch out for the exit because the music can stop and you can end up stranded.
So the quality of the deal that you are presenting to potential investors combined with your competence and credibility determine the outcome. I have seen it many, many times over my entire professional life. We see many developers come through our doors and present deals, ideas, projects, and if there is not the right match of personal capabilities and characteristics wi