Friday, November 18, 2011

Key Features of Funds Providing Equity (Part 5)

- Venture Capital Funds
Money raised from a wide range of sources with high risk appetite to include insurance companies, pension funds, mutual funds, high net worth individuals
• Target new technology, new markets
• Interested in early-stage companies
• High risk of failure in every venture
• Investment horizon around 4-7 years
• Return requirement, many multiples of original investment (50 – 500% IRR)

- Private Equity Funds
• Money raised from a wide range of sources with medium risk appetite to include institutional investors and high net worth individuals
• Target opportunities with possibility for enhanced returns (or ‘upside’)
• Interested in companies and projects with more mature technology, including those preparing to raise capital on public stock exchanges (‘pre IPO’), demonstrator companies, or under-performing public companies.
• Shorter investment horizon, 3-5 years
• Higher return requirement, 25% IRR

- Infrastructure Funds
• Funds drawn from a range of institutional investors and pension funds
• Target ‘infrastructure’ i.e. an essential asset, long duration, steady low risk cash flow
• Interested in roads, railways, power generating facilities
• Medium term investment 7-10 years
• Low risk and return, 15 % IRR
-Pension Funds
• Typical investments include:
- Public equity (via stock markets)
- Corporate and government bonds
- Real estate
- Inflation-linked assets (such as commodities, inflation linked bonds, infrastructure
and energy, forest land)
- Private equity
- Cash and cash equivalents
• Investing directly they seek ‘cash yielding’ investments, i.e. those that generate a stream of cash year on year, as opposed to an investment in which all cash is realised at the end of the investment period through an ‘exit’ (by either sale or IPO). These investments are required to support their long term liabilities;

• For these investments they display a low risk appetite, reflected in expectations of stable returns at around the 15% level;
• In RE they make very low risk investments e.g. a portfolio of operational onshore wind assets;
• As they have very large funds to invest, they do not commonly get involved in individual projects. They may allocate monies to specialised Private Equity or Venture Capital funds (including infrastructure or renewable energy funds) that manage the investments and provide the pension funds with a return;
• A handful of specialised RE bonds have been issued which have been of interest to pension funds. Risks are described in the project bond issue documents.
Project risks will be extensively mitigated (such as reserve facilities, for example for maintenance problems, distribution restrictions, cash sweeps) in order for the project to attract “an investment grade rating”3 making it attractive to investors (a higher rating suggests less risk that the project will default on its bond obligations leaving bond investors at risk of not being repaid).
Note that there is some overlap between the categories, for example, infrastructure units within some Banks, Pension Funds, and Infrastructure Funds.

The box below illustrates the types of financing likely to be involved at different stages of new technology development – from the point at which it comes out of the laboratory (or equivalent) to readiness for commercial roll out as proven technology, after which banks, private equity and other funds will become interested.

Box 1. Building the Supply Chain : Finance for Early Stage Technology Investment e.g. Wave Power

This example demonstrates the phases of investment from public grants, VC funding and production subsidies required to develop a new RE technology through to the point it can begin to demonstrate a track record and attract second stage funding. This might be through an Initial Public Offering (IPO) on a stock exchange to raise equity from external investors, as well as project finance debt from banks, to enable further project build out. The term, the ‘valley of death’ is often used during the phase illustrated above which describes the difficulties of accessing commercial finance between the initial VC investment and demonstration; or from demonstration to commercial roll-out with secondary VC investment.

The diagram shows where public grants or specific subsidies can be essential. In its final stages of development where a technology steps into ‘Proven Technology’, it is then assumed to be fully commercial and to compete with other forms of RE, when standard grants, support or incentive mechanisms or other subsidies will become available. Investors such as private equity firms are likely to be attracted at this point, although there are overlaps between stages and financial institutions.

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