Venture Capital Due Diligence in Algae Deals
Interest in algae remains very high among venture and strategic investors. Being prepared for dealing with them is critical to your success in getting an investment. After you have made the initial contact with a potential investor and they expressed interest, you will need to be ready to respond to due diligence where you tell them all about yourself. It is a key part of the investment analysis decision making process. The outcome is often the deciding factor on whether to invest.
First, think like a Boy Scout and be prepared. Don’t wait to get the due diligence checklist from the investor. Google “due diligence checklist” or ask your advisors for one before you start contacting investors. Gather the material, so you are ready to respond immediately once asked. More important than anything, do not lie, exaggerate or withhold important information. Not only will that likely be revealed, but the final investment agreement will require you to make a legally binding statement that you provided all material information to the investor. Failure to do so or misleading them is not only a breach of the agreement but also could be grounds for fraud.
There are elements of due diligence that are typical of any startup such as financial projection, business plan, intellectual property portfolio and qualification of the team. Besides those, algae companies should expect to also be investigated in four major techno-economic areas that underline both the complexity and the potential impact of algal biomass. We identify those as business and society, engineering, systems integration, and biology, in ascending order of technical difficulty. Each is important in its own right, and the lower difficulty areas often serve as a stage gate to be passed before the next area is addressed.
Business and society questions include coproducts marketability and value. That requires a realistic analysis of the entry barriers that an upstart may have to penetrate conservative markets with large, entrenched players. Some literature searches showing like products selling for high prices will not be enough. Most importantly, in this part of the due diligence, one needs to consider the interaction between one’s own business and society at large. Do you know what the permitting requirements of your business may be? Have you engaged the relevant stakeholders? Did you have a discussion with local, state and federal government officers and agency about permits? If you plan to use genetically modified organisms, have you thought about possible public opinion or criticism of nongovernmental organizations? How do you plan to handle them? Do you have a biosecurity plan? What is your worst case scenario and its contingency? You do not want to scare your investors needlessly, but when it comes to perception associated to safety and environmental impact risks, remember Andy Grove’s motto: “Only the paranoid survives.” If you perceive a risk, so will your investor. Do not hope it will go away, but work a clear mitigation plan and communicate accordingly.
Systems integration addresses issues such as nutrients, land and water availability and suitability, temperature and solar irradiation. We all know that to grow algae we need water, nutrients, sunlight and carbon dioxide. Do you have enough of them at the same time and place? For how long? At what cost? What is your actual consumption? Have you thought about these issues in terms of long-term life-cycle analysis? How scalable is your business model? Are these factors constraining your ability to deploy outside of certain geographical areas? If so, where are they and are they consistent with your proposed business model?
Engineering addresses mainly process engineering choices, which, all too often, are taken for granted or left for later. How complex is your process for harvesting the algae or their products or, if applicable, fractionate them and extract added value coproducts of suitable purity? How energy intensive is your process? How reliant are you on known-to-the-world processes and unit operation and how much improvement, if any, you may be required to achieve desired performance. Some operations like drying, dewatering, pumping, etc., are well known outside this field and many similar process engineering technologies are in the area of diminishing returns when it comes to further optimization. Do not assume that some technology will be developed to, say, cut in half the cost of drying biomass when compared to the existing state of the art. Do not forget the mundane parts of engineering design such as pumping costs while getting enthralled in a revolutionary photobioreactor system.
Biology questions relate to biomass and oil yields, cultivation method, productivity, and control of ecosystems. Here is where many algae companies use most of their resources. These are the most exciting—and often most difficult—issues that relate to an algae business, and the typical startup has plenty to present. Nonetheless, even here critical questions are often left unanswered. How different will the situation be when we leave the lab or a relatively controlled environment to move into industrial production? Can you ensure consistent yields over a long time? How do you control contaminations from native strains or infestation from parasites and predators? In a reprisal of previous issues, how do you handle biosecurity and containment of genetically modified strains, if any, as you scale up?
Obviously, business plans and technologies for algae companies can vary, and not all of the above questions will be relevant for every algae company, but whether your company is developing an end-to-end solution or a part of a system, a venture investor will examine your company in light of the entire business need of the industry and always ask “What problem does this solve? At what cost? What new risks are encountered?” Being able to address the four areas above in due diligence will be key to obtaining financing.
Authors: Todd Taylor, Luca Zullo
Attorney, Fredrikson & Byron; Founder, VerdeNero LLC