Monday, November 21, 2011

Solyandra was a Loan Not a Venture Capital Investment

Thursday, Energy Secretary Steven Chu sat through more than five hours of questioning by the oversight panel of the House Energy and Commerce Committee about the failure of Solyndra. He deftly danced around charges of incompetence discussing Solyndra using such phrases such as “cash burn rate”, “start up” and “build up sales,” and said the White House has not lost faith in him. The committee and Secretary Chu seemed to have missed the point. This was a loan guarantee program. This was not a venture capital fund. This was not supposed to be a government investment in Solyndra or any other company (Beacon Power for example), but a loan guarantee program to aid viable projects in obtaining loans to build commercial scale projects.

The federal stimulus bill signed by President Obama expanded Title XVII of the Energy Policy Act of 2005 by adding Section 1705. DOE describes Title XVII Section 1705 as “ Provides loan guarantees to commercial-scale renewable energy projects, that begin construction prior to September 30, 2011 in Biomass, Hydrogen, Solar, Wind/Hydropower, Geothermal, Transmission, or any other renewable energy systems.” This was clearly a loan guarantee.

All loans typically have a primary and secondary source of repayment. The primary source of repayment is demonstrated or reliably projected cash flow. This is cash generated from the business or project. The secondary source of repayment is “conversion of the collateral,” that would be selling the assets of the company. Loan guarantees are necessary when either the primary or secondary source of repayment is impaired. Loans are made with borrowed funds, banks or other lenders borrow money in the financial markets and lend it to businesses at between 0.5% and 2.5% above their cost of funds.

The less risky the loan the less the lender’s spread. A government guarantee would essentially make a loan almost riskless and provide the secondary source of repayment, the U.S. taxpayer. A loan guarantee program provides a guarantee to reduce the interest rate charged and thus the borrowing costs. In order to protect the U.S. taxpayer from excessive losses in the DOE Title XVII Section 1705 loan program, it was essential to make sure the projects had a primary source of repayment, a sound source of cash flow.

The DOE program provided the loan guarantees for free. However, Secretary Chu, the entire administration, the House Energy and Commerce Committee and the press seem to have forgotten that the DOE Title XVII Section 1705 was a loan guarantee program not a venture capital fund. The Solyndra loan appears to have not primary source of repayment, was subject to regulatory and incentive risk and had limited secondary source or repayment. This was not a loan, yet $535 million of taxpayer money was at risk.

Venture capital is equity provided to early-stage, high-potential, high risk, start-up companies. The target return on Venture capital funds is typically 20%-35% and the venture capital investor is buying portions of companies. Venture capital is used to grow and develop companies with limited operating history that have not yet reached the point where they are able to obtain a bank or other type of loan by demonstrating the ability to make a profit. In exchange for the high risks that venture capitalists assume by investing in riskier companies, venture capitalists usually get significant control over company decisions, and a significant portion of the company's ownership (and consequently value). A venture capital fund makes money by selling the equity in the successful companies it invests in.

A Title XVII Section 1705 loan guarantee for $535 million loan guarantee given to Solyndra was not a venture capital investment by the DOE. The DOE took no ownership of the Solyndra, they simply guaranteed the company’s debt. Solyndra had no cash flow from their existing facility and were not profitable. Building a bigger and highly automated manufacturing facility was a wildly speculative attempt to build a market for a more expensive product. Title XVII Section 1705 was clearly a loan guarantee program being misused, not venture capital fund.

1 comment:

  1. That was an excellent explanation of the situation, Elizabeth. Sometimes this financial stuff goes right over my head, but you made it very clear. I knew it smelled fishy, but now I know why. Thanks.