20171231 Biofuel start-up Case Study · 2018-03-23 · Biofuel Start-up - Strategic choices and decision-making in a novel industry 4 Strategic choices We’re in early 2006, and

Learning.climate-kic.org

Strategic choices and decision-making

in a novel industry

Case Study: Biofuel Start-up

Biofuel Start-up - Strategic choices and decision-making in a novel industry

2

Contents KiOR – A Biofuel Start-up ................................................................................................................................. 4

Strategic choices ........................................................................................................................................ 4

The situation in the biofuel industry ............................................................................................................................ 4

The starting point for Paul O’Connor ........................................................................................................................... 7

Strategy ............................................................................................................................................................................... 10

Exhibits Chapter 1 ............................................................................................................................................................ 11

References .......................................................................................................................................................................... 21

2. Investor negotiations .............................................................................................................................. 22

General instructions for negotiation ......................................................................................................................... 23

Confidential instructions BIOeCON ............................................................................................................................ 25

Confidential instructions Khosla Ventures.............................................................................................................. 31

3. Innovation systems .................................................................................................................................. 38

Biofuel industry ................................................................................................................................................................. 40

Decision ............................................................................................................................................................................... 41


References .......................................................................................................................................................................... 47

4. Underlying Forces..................................................................................................................................... 48

The second half of 2013 ................................................................................................................................................ 49

2013: 3rd Quarter results ............................................................................................................................................... 51

The curtains fall: 2014 .................................................................................................................................................... 52


Imprint................................................................................................................................................................. 59


3

About Climate-KIC

Climate-KIC is the EU’s largest public private partnership addressing climate change

through innovation to build a zero carbon economy. We address climate change across four priority themes: urban areas, land use, production systems, climate metrics and

finance. Education is at the heart of these themes to inspire and empower the next

generation of climate leaders. We run programmes for students, start-ups and innovators

across Europe via centres in major cities, convening a community of the best people and

organisations. Our approach starts with improving the way people live in cities. Our focus

on industry creates the products required for a better living environment, and we look to

optimise land use to produce the food people need. Climate-KIC is supported by the

European Institute of Innovation and Technology (EIT), a body of the European Union.

http://www.climate-kic.org


4

Strategic choices

We’re in early 2006, and Paul O’Connor is pondering all the evidence in front of him. The

board of Albemarle has asked him to consider the options for development of a process

that turns biomass into fuel. Albemarle has been active in the oil and gas industry for a

long time, providing chemicals and processes needed for the production of fuels from

crude oil. A description of the company is included in Exhibit 1.1.

Paul meets with a long-time acquaintance, consultant Dennis Stamires, to discuss the

various options that they see. Both in terms of technology, the business model and

company structure, a lot of combinations are possible. There is a meeting with the board

early next week, and Albemarle is looking for new opportunities. Paul wants to convince

Albemarle to place a significant effort into the development of biofuels since that is his

personal passion. If they are not convinced, they will focus on other things and Paul would

have to continue his project outside of Albemarle…

In the back of the cab driving him from the airport to the office of Stamires in California, he

is rearranging all the documents that he gathered for this meeting. There are so many

things to consider.

The situation in the biofuel industry

Growing international tensions in 2006 had highlighted the economy’s dependence on oil.

In January, US president Bush even claimed the United States was ‘addicted to oil’ and in

his State of the Union he mentioned:

“We must also change how we power our automobiles. (…) We'll also fund additional

research in cutting-edge methods of producing ethanol, not just from corn, but from wood

chips and stalks, or switch grass. Our goal is to make this new kind of ethanol practical

and competitive within six years. Breakthroughs on this and other new technologies will

help us reach another great goal: to replace more than 75 percent of our oil imports from

the Middle East by 2025.” (President G.W. Bush, State of the Union transcript, 2006)

All the while, Brazil was well underway to achieving ‘energy independence’ through the

big bets placed on biofuels by that country. That development had also triggered the ‘food versus fuel’ debate: the Brazilian biofuel economy was using land that could also be used

for food production.

KiOR -- A Biofuel Start-up


5

Subsidies

The ambitious policy targets gave rise to substantial financial support for biofuel

initiatives in the United States. Exhibit 1.4A provides an overview of the various levels to

encourage development of bio-based alternatives.

The subsidies may very well be a mixed blessing for the sector, as industry analyst Igor

Tvaric mentioned: “Whilst these schemes promote the attractiveness of biofuels as an alternative, the presence of subsidies might also keep fundamentally unsustainable

technologies or companies in biofuels alive. Thus, a dependence of these businesses on

the political climate is introduced. Will this setup deter the market entry of small scale

initiatives that could survive on their own in the long run?”

Investments

Venture Capital investment in the sector has been steadily on the rise (Exhibit 1.4b) both

in the number of deals and the total amount of capital committed. Industry specialists

already anticipate that 2006 will be a record breaking year for biofuel investment, largely attributable to the strong policy direction indicated by several governments and the

scaling up of production efforts.

Market Demand

The market uptake for biofuels has been largely secured through policy incentives, such as

the EU directive 2003/30/EC that set an ambitious goal for 2010: 5,75% of all road fuel

energy content should be provided by biofuels.

The primary sales channel for biofuels is blending the biofuel with existing fuels (in the EU this is allowed up to 5%, with the exception of ETBE (an ethanol derivate) which can be

blended up to 15%).

The incentives for fuel companies to blend biofuels with the superior fossil based products

can be one of four:

1. biofuels are a cheaper resource,

2. there are hard policy incentives (i.e. compliance with strict targets),

3. there are soft policy incentives that enhance attractiveness (such as carbon credit

trading for emissions),

4. Consumers prefer greener alternatives (regardless of pricing).

A specific vehicle of interest is the Clean Development Mechanism (CDM), developed

under the Kyoto protocol. The CDM allows industrialized countries to buy Certified

Emission Reduction units, that in turn can be traded in emission trading schemes. This

allows companies to invest in emission reductions where it is cheapest globally.


6

Competition

The biofuel industry in 2006 is dominated by players that have been in ethanol production

for years. These larger players specialize in feedstock growing (ADM, Cargill, DOW) or in

processing technologies (Bunge, DuPont) and have established production outputs,

making use of the recent incentive schemes to increase their biofuel production efforts.

These companies produce first generation biofuels: the feedstock they use could also be

used for food production.

Second generation biofuel production uses feedstock that would be regarded as waste

(such as wood chips, grasses or inedible plant parts). The production of 2nd generation

fuels occurs only at about one fortieth of the volume of first generation biofuel production.

There is a lot of R&D activity going on, but the primary deterrent for building second

generation biofuel production plants is that the technology is insufficiently reliable or

proven to attract investors. See exhibit 1.2 for an overview of existing pilot projects and

their economics.

Incumbent players in the oil industry are showing their interest in diversification and

second generation technologies. Royal Dutch Shell has expressed interest in cooperating

with Hawaii based HR Biopetroleum to commercialize Algae producing biofuels. Petrobras

and ConocoPhillips are meanwhile working on refinery based technologies (such as

catalytic hydrogenation and cracking) because they are compatible with the existing

infrastructure. BP is preparing a major investment into fundamental research with

universities in California and Illinois. It is noteworthy that players located further on in the value chain, such as GM, Volkswagen and DaimlerChrystler are also investing in R&D

approaches for biofuels because of their potential impact on engines.

Availability of skilled personnel in the industry

The average oil company employee is nearly 50 years old; in the next decade, more than

half of the industry’s employee base will retire, leaving behind a massive void of skilled

workers. “There has never been a time when our industry so needs outstanding talent,” said Rex Tillerson, chief executive officer of ExxonMobil.

Industry expert Varya Davidson from Booz&Co explains: “Faced with one of the biggest

periods of expansion in its history, the global oil and gas industry is already being held

back by its failure to attract, recruit and retain highly skilled staff.” Her analysis shows

that 40% of the experienced staff will leave the industry in the next 5 years, and that

efforts to recruit new personnel have been initiated too late and too slow. (Davidson et al,

2007)

As a first addition to his team, Paul had been able to convince Armand Rosheuvel to join.

See the CV of the members involved in Exhibit 1.3.


7

The starting point for Paul O’Connor

Over the past few months, Paul had become more and more convinced of the potential of

the largely unexplored terrain in biomass-to-liquids, and he had various ideas on how to

approach the issue. He had met with several friends inside the industry and together they

had been able to put together a fund of €1 million for the first stages of development.

Whilst this may seem like a lot, the team was still at the earliest stages of development

and the ideas that Paul had at this time were not at all validated.

Technologies

Even more, there were different ideas on how to proceed. The primary expertise of the

team was the use of catalysts in the oil and gas industries to speed up chemical processes

and improve their outputs. The basic options for conversion and their end-results are

shown in figure 1.

Figure 1: biomass to biofuel conversion routes. Source: Adapted from Hamelinck and Faaij, 2006.

Green fields indicate biochemical pathways, FT = FischerTropsch, SNG = Synthetic Natural Gas.

Some processes showed potential for the use of catalysts and used a thermochemical approach. The first where catalysts can add potential is in gasification is rather

straightforward: heating the biomass to 700-1300 degrees with little oxygen, thereby

transforming the solid biomass (wood chips etc.) into synthetic gas, which can be

converted into a number of different fuels.

HTU


8

The routes involving anaerobic digestion were being pioneered by competitors (most

notably Verenium), and the routes requiring fermentation involve biological processes that

are not the expertise of the team. Partnering with other companies would be necessary.

The first generation routes are possible, but involve higher competition. Hydrolysis offers

limited opportunities for catalysts to be of added value, but the feedstocks are more

reliable and technology is less of a risk.

Catalysts can also help with pyrolysis heats the biomass as well, but to a lower

temperature. At this lower temperature, the biomass does not dissipate into a gas but

forms a liquid pyrolysis oil. This bio-oil can be upgraded and refined into biodiesel and bio-

gasoline through a process called hydrotreating. The biomass must be totally dry and is

preferably ground into small particles.

Already in 1986, Shell had patented a process called HydroThermal Upgrading (HTU). This

process turns biomass into a bio-oil through applying high pressure and high

temperatures to the biomass. The biomass is wet or water is added to the biomass. The main difference of this process with pyrolysis is that an extra step of separation is

necessary to extract the components that can be further developed into fuels, but

catalysts can also enhance these processes. There are some doubts about the HTU

process. The combination of high temperatures and high pressure calls for large reactors

and energy-intensive processes, both major cost drivers in the chemical process

engineering.

An overview of investment costs, thermal efficiencies and annual operational costs

related to running a plant with one of these processes are given in exhibit 1.5.

Greenhouse gas estimates

In addition to the argument often made about energy independence (see page 1), the

reduction in greenhouse gasses is one of the most important arguments for political

support of biofuels. A possible proxy for the long term support of an option is therefore

indicated by the greenhouse gas emissions offset by choosing for a particular initiative.

Biofuels have an effect on emissions because the carbon that is burnt into CO2 has recently been captured out of the air (by a plant or tree), instead of captured and stored in

oil millions of years ago. There is however a difference in the efficiency with which the

biomass can be converted into usable fuels, and that (combined with other factors such as

the efficiency of the feedstock) results in different greenhouse gas impacts for the various

technological alternatives.

Exhibit 1.6 provides an overview of the different greenhouse gas emissions coupled for a

couple of the technological alternatives that could be considered.

Involving universities

In the chemical industry there is frequent and well-established interaction between

industry and academia. Through his years at Shell, Akzo Nobel and later Albemarle, Paul


9

had established contacts with the leading experts in the field of biofuels and related

catalysts. Because of these existing relationships, it was very easy for Paul to initiate

contract research with these professors based on the ideas that the team had. Involving

universities meant ensuring access to young talent through their PhD work at the

universities. Universities are expensive however, and a full-time PhD costs about €70.000

per year, almost 50% more than a regular employee.

The different universities had different preferences.

1. Delft – preference for pyrolysis

2. TU Twente – preference for HTU processes

3. Valencia, Spain – preference for gasification

Thanks to European regulation, Paul was able to incorporate into the contract research

agreements that all Intellectual Property of the resulting work was to be owned by

Albemarle. However, involving the universities at arms-length also carried a major risk: it

was likely that a lot of know-how was developed that would not end up in a patent or

report for Albemarle. How would the company learn about all of these tacit experiences?

Feedstock availability

Another issue is the input for the chemical process, you need biomass. That biomass is

called feedstock. Jan Dirks, analyst at Energy Research Agency ECN in The Netherlands

reports: “We see significant barriers in the availability of biomass and the ‘wrong type’ of biomass for ambitious growth.”

This situation can be improved quite drastically when second generation biofuels or even more advanced biofuels are used. To illustrate this, exhibit 1.7a shows how current and

expected performance of biofuels per kilometer relates to the amount of land used for

these purposes. Exhibit 1.7b depicts the potential for production of different types of

biomass for a selection of European countries. It is important to understand that wet

biomass is far more common than dry biomass, and that the cost of drying biomass can

be significant in terms of energy and money.

Compatibility

Treated Pyrolysis Oil is still far from meeting the European norm for fuels (the EN590

specifications) but it has come closer to the norms that have been developed especially

for biofuels (EN14214). This is however before refining, but at this time a lot is uncertain

about the effects of further refining the pyrolysis oil into more fuel-like products.

For HTU diesel, the result of a step of upgrading (HDO: hydrotreated de-oxygenation) has

been compared with the existing standards, and it is expected that a range of 10-20%

blending in with existing fuels would not result in any major problems for the HTU Diesel.


10

Through the gasification route, compliance with standards is generally less of an issue

because the biomass is first broken down into small parts (H2 and CO) that are then

combined into relatively clean end-products. The major issue here, however, is the

efficiency with which certain end products can be developed over the entire process. Of

course, routes considering application of hydrogen as a fuel have significant compatibility

effects, as both the refueling infrastructure and fuel users cars need to be adapted.

Strategy

Reviewing the different documents and supporting files, Paul found himself again

pondering what the best approach would be for Albemarle. What would a logical

development strategy be? Which technology should they focus on, considering the entire

landscape, and in what way should that technology be brought further?


11

Exhibits Chapter 1

Exhibit 1.1: Albemarle company description

(source: adapted from Reuters and the Albemarle Annual Report of 2006)

Albemarle Corporation (Albemarle), incorporated on November 24, 1993, is a developer,

manufacturer and marketer of specialty chemicals across a range of end markets,

including the petroleum refining, consumer electronics, plastics/packaging, construction,

automotive, lubricants, pharmaceuticals, crop protection, food-safety and custom

chemistry services markets. The Company operates through two segments: Performance

Chemicals and Catalyst Solutions.

Catalyst Solutions Segment

The Company’s Catalyst Solutions segment included the Refinery Catalyst Solutions and

polyolefin catalysts product categories. The Company’s two refinery catalysts businesses

are Clean Fuels Technologies, which primarily consists of hydroprocessing catalysts (HPC), and Heavy Oil Upgrading, which is primarily consisted of fluidized catalytic cracking (FCC)

catalysts and additives. HPC products are applied throughout the refining industry. The

Company offers a range of HPC products and approximately 60 different FCC catalysts

and additives products to its customers.

Refinery Catalysts

Our two main catalysts product lines are hydroprocessing, or HPC, catalysts and fluidized

catalytic cracking, or FCC, catalysts and additives. HPC catalysts are primarily used to

reduce the quantity of sulfur and other impurities in petroleum products as well as to

convert heavy feedstock into lighter, more valuable products. FCC catalysts assist in the

cracking of petroleum streams into derivative, higher value products such as fuels and petrochemical feedstock. Our FCC additives can be used to remove sulfur in gasoline and

to reduce Albemarle Corporation and Subsidiaries 5 emissions of sulfur dioxide and

nitrogen oxide in FCC units, to increase LPG olefins yield and to boost octane in gasoline.

We offer more than 90 different HPC catalysts products and more than 70 different FCC

catalysts and additives products to our customers.

Polyolefin Catalysts

We manufacture aluminum- and magnesium-alkyls, which are used as co-catalysts in the

production of polyolefins, such as polypropylene and polyethylene used in plastic

products, elastomers, alpha olefins, such as hexene, octene and decene, and organotin

heat stabilizers and in the preparation of organic intermediates. We are continuing to build

on our organometallics base and to expand the portfolio of products and capabilities we

offer our customers.

Customers

Our Catalysts segment customers include multinational corporations such as ExxonMobil Corporation, Royal Dutch Petroleum Company and ChevronTexaco Corporation;

independent petroleum refining companies such as Valero Energy Corporation and Tesoro

Petroleum Corporation; and national petroleum refining companies such as Saudi Aramco


12

Mobil Refinery Company Ltd., Petróleo Brasileiro S.A. and Petróleos Mexicanos. We

estimate that there are currently approximately 450 FCC units being operated globally, each of which requires a constant supply of FCC catalysts. In addition, we estimate that

there are approximately 2,000 HPC units being operated globally, each of which typically

requires replacement HPC catalysts once every one to three years. We believe that our

existing relationships with global petroleum refiners developed by our other business

segments present opportunities to grow the market share of our new refinery catalysts

business.

Competition

In the Catalysts segment, HPC and FCC catalysts competition is primarily from major

catalysts companies. Our major competitors in the HPC catalysts market are Criterion

Catalysts and Technologies and W.R. Grace & Co./Advanced Refining Technologies, and

our major competitors in the FCC catalysts market are W.R. Grace & Co. and BASF. Some of the major catalysts companies have alliances with global major refiners to facilitate

new product development and introduction. Our major competitors in the polyolefin

market include Akzo Nobel N.V., Axens NV, Basell Service Company B.V., Chemtura

Corporation, Tosoh Corporation, Univation Technologies LLC and W.R. Grace & Co. We

seek to enhance our competitive position by developing product and process

improvements and specialized customer services.

Research and Development

Through our research and development, we strive to develop value-added products and

products based on proprietary technologies.

Catalysts research is focused on the needs of both our refinery catalysts customers and our polyolefin catalysts customers. Refinery catalysts research is focused primarily on the

development of more effective catalysts and related additives to produce clean fuels and

to maximize the production of the highest value refined products. In the polyolefin area,

we are focused primarily on developing catalysts, cocatalysts and finished catalysts

systems to polymer producers to meet the market’s demand for improved polyolefin

polymers and elastomers.


13

Exhibit 1.2: Existing pilot projects and their economics as of 2006

Company Process Capacity Capital cost Comments

VTT Fischer Tropsch 300 MWth biomass feed to plant €210-235 million FB syngas production plus FT, possibly integrated with paper mill

ECN Fischer Tropsch

250 MW biomass feed to plant –

Typical biomass scale: 80,000 t/y FT liquids, production cost

€27/GJ

1,750 MW biomass feed to plant –

Central conversion plant: 0,6 million t/y FT liquids, production

cost €17/GJ

10,000 MW biomass feed to plant –

Very large central conversion plant: 3 million t/y FT liquids,

production cost €15/GJ

TNO HTU and HDO Commercial design for 130,000 t/y biomass €50 million

Production costs €11-12/GJ (including HDO) future plant €6-

7/GJ feedstock cost €1/GJ

HTU 25,000 t/y €17 million -

BTG Fast pyrolysis 50 t/d € 3 million

Installed and running, Current costs are €6-7/GJ because of local

cheap feedstock (Malaysia)

Choren Fischer Tropsch Beta plant 13,000 t/y FT diesel Ready in 2007 Gamma plant target 2009/10

FZK Gasification to

methanol

2 MW demo plant (4,000 t/y capacity) under

construction €22 million -

Source: Adapted from DTI global watch emission report, 2006.


14

Exhibit 1.3: CV of team members at the start of the project

Ir. PAUL O’CONNOR

Academic Education:

Eindhoven University of Technology –Chemical Engineering.

Professional Background:

Shell International Petroleum Company, in the head office in The Hague as

development engineer in the field of distillation, thermal and catalytic cracking. Appointed

as advising technologist in Fluid Catalytic Cracking (FCC) at Shell Refinery in Curacao.

1981-1983 Deputy Division manager of the Cracking & Chemicals section of the Shell

Refinery in Curacao.

Akzo Nobel as technical service representative for FCC in Scandinavia and Italy

1986-1990 Applications Research Manager of FCC Catalysts.

1990-1994Technical Service Manager FCC Catalysts for area World outside North America (WONA).

1994-1997 Research Manager of FCC Catalysts.

1997-2004 World Wide Development Manager FCC+ Project. Leader Advanced Fuels &

Materials.

2005-2006 Divisional Development Manager Catalysts

Ir. ARMAND. E. ROSHEUVEL MBA

Academic Education:

Delft University of Technology –Chemical Engineer

INSEAD Fointainebleau, France. – Business Administration

Professional Background:

Akzo Fibers, Quality Control Management. Expatriated to Medellin, Colombia.

MACInc. (Management Analysis Center), a Harvard based consulting firm with offices in

Barcelona, Spain. Assignments in Spain, France, Norway and Argentina

Amstel NV., Marketing manager of the Amstel Brewery in Willemstad, Curaçao.

SHELL Curacao NV – Economics & Scheduling department.

ROSCIM BV -Turn Around Management assignments as General Manager of different

companies:

DPI BV. -recycling and filmblowing of LD polyethylene products;

VAGIPS BV. Production of gypsum/fibre boards for construction sector from gypsum

from de-sulphurisation of stack gases;

ELAM BV. Production and sales-marketing of high capital equipment of games of chance;

PIN-LOCK BV. Production and sales-marketing of computer directed safety locker

systems.

ROSCIM BV- Consulting assignments in the Netherlands and Spain.


15

Exhibit 1.4a: Different support measures around the globe in 2006

Country Target/mandate Production support Consumption support Special vehicle and other

requirements Government support

Brazil

Ethanol: 1975 PROALCOOL

Programme Mandate of E20 -

E25 Biodiesel 2002

PROBIODIESEL Programme

Mandate of a B2 by 2007

B5 by 2013 and B20 by 2020.

Credit to cover 60% sugar storage costs

Tax exemptions on vehicles using ethanol

or FFV Lower taxes on biofuels

Credit to cover 60% sugar storage

costs

Tax exemptions on vehicles using

ethanol or FFV

Lower taxes on biofuels

Mandate to use on Government

vehicles

Mandate to use on Government

fleet vehicles

US

The 2005 Energy Bill requires

increases in ethanol use from 4

billion gallons in 2006 to 7,5

billion gallons by 2012 (an

increase target of 2,78% for

2006).

Volumetric Ethanol Excise Tax Credit (VEETC): a

US$ 0,51/gallon to gasoline refiners.

Small producers get US $0,10/gallon tax credit for

the first 15,000 gallons

Grant and loan programs

A tax credit of US$1/gallon of biodiesel blended

with petrodiesel

Tax credits

Fuel tax exemptions

Federal and states incentives to acquire FFV

Mandate to use ethanol on Government

vehicles

Loan assistance

All cars built after 1980s will operate

on E10 FFVs on sale The 2005 Energy

Bill will remove the oxygenate

requirement

US$140 million (€117 million) in

federal taxes for the Highway Trust

Fund 1978-2004. Cost of US $375

million (€311 million) of the 2006-

2012 tax incentives set by the 2005

Energy bill for biofuels.

Canada 3,5% of ethanol in transport fuel

by 2010 Some provinces exempt ethanol from road taxes Exemption from €0,07/lt excise tax

All cars built after 1980s will operate

on E10 FFVs on sale

€62,5 million in fuel excise

exemption plus others in capital

grants

Sweden 3% in 2005 (in energy content)

Tax incentives for new plant construction Access

to EU CAP provisions

Capital grants

Quotas

Ethanol: Capped fuel tax exemptions (a

total tax exemption (€520/m3), to be

revised annually.)

Biodiesel: tax exemption (€344/m3)

1996-2006 Fuel tax exceptions =

€2,000 million and expected to go up

to €9,000 million by 2009

France

Directive 2003/30/EC set target

for their consumption in the

transport fuel mix:2% by 2005

5.75% by 2010

In 2003, the French tax exemption will amount to

€ 380/m3.

It was €502,3/m3 in 2002

Biodiesel: a tax break of €330/m3 is

allowed for motor fuel blends in 2004 (with

a quota of 387,500 tons in 2004 and up to

5%. Pure biodiesel not covered

Germany

Biodiesel blends should be

authorised in the very near

future

No production quota

Ethanol: tax break of €54/m3 Biodiesel: tax

incentive of €470/m3, which includes a

carbon tax exemption

UK

Directive 2003/30/EC set target

for their consumption in the

transport fuel mix:2% by 2005

5.75% by 2010

From January 2005 a tax break of 20 p/l

(€138/m3) for either ethanol or biodiesel

Source: Dufey (2006). FFV: Flexible Fuel Vehicle. If no specific type of fuel is mentioned, the incentives apply for all biofuels.


16

Exhibit 1.4b: Investments in the biofuel industry


17

Exhibit 1.5: Selected data for biomass processing processes (inputs and outcomes)

Name Description Thermal Efficiency

Fixed investment costs

(Euro/ thermal kilowatt of

biomass capacity)

Operations +

Management

(annual, % of

investment) Short term Long term Short term Long term

Gassification

(Fischer Tropsch Diesel)

Able to achieve 50-90% conversion of the carbon in

the syngas with recycling of the off-gas back into the

catalyst input stream.

45% (fuel only) 45% (fuel)

10% (power) 720 540 4

Gassification (Methanol)

via biomass gasification and subsequent syngas

processing. Combined fuel and power production

possible


12% (power) 690 530 4

Gassification

(Hydrogen)

via biomass gasification and subsequent syngas

processing. Combined fuel and power production

possible; for production of liquid hydrogen additional

electricity use should be taken into account.


6% (power)

480

(+ 48 for

liquefying)

360

(+ 33 for

liquefying)

4

Anearobic Digestion (into

Synthetic Natural Gas)

Depends on the mass gas-liquid transfer rates,

microorganism growth and activity, and if recycling is

used.


8% (power) 800 450 6

Fermentation (Ethanol

from wood)

production takes place via hydrolysis techniques and

subsequent fermentation and includes integrated

electricity production of unprocessed components.

46% (fuel)

4% (power)

53% (fuel)

8% (power) 350 180 6

Fermentation (Ethanol

from beet sugar)

Production via fermentation; some additional energy

inputs are needed for destillation 43% (fuel only) 45% (fuel only) 290 170 5

Pyrolysis

(Biodiesel from dry

biomass)

Production of pyrolysis oil that is subsequently refined

in refineries. Investment assumes use of existing

refineries.


13% (power) 850 280 3

HTU (Biodiesel from wet

biomass)

Heating a mixture of water and biomass under high

pressure and temperatures, forcing the woody

biomass to break apart into a bio-oil.


6,4% (power) 1000 600 7

Source: adapted from Faaij, 2006.


18

Exhibit 1.6: Comparison of well-to-wheel greenhouse emission


19

Exhibit 1.7a: Distances that could be driven on certain feedstocks divided over land use

Feedstock Fuel Engine Distance (thousands km/ha)

Short term Long term

Lignocellulose

Hydrogen ICEV 26-37 80-97

FCV 44-140 189-321

Methanol ICEV 34-49 75-287

FCV 68-83 113-252

FT ICEV 22-38 56-167

FCV 50-67 97-211

Ethanol ICEV 29-30 82-238

FCV 38-72 129-240

Biodiesel ICEV 27-42 72-184

Sugar beet Ethanol ICEV 15-37 57-88

FCV 19-93 58-138

ICEV: Internal Combustion Engine Vehicle, FCV: Fuel Cell Vehicle. Source: adapted from Faaij, 2007.


20

Exhibit 1.7B: Suitability of land for different feedstocks

*Suitability classes:

VS=very suitable; S=suitable;

MS=moderately suitable; ms=marginally suitable; NS=not suitable

** Herbaceous and woody are second generation feedstocks

source: Fischer et al., 2007.


21

References

Davidson et al, 2007. Labour and Skills Crisis Could Stall Oil and Gas Boom.

DTI Global Watch Mission Report (2006). SECOND GENERATION TRANSPORT

BIOFUELS: – A MISSION TO THE NETHERLANDS, GERMANY AND FINLAND

Dufey, A. (2006). Biofuels production, trade and sustainable development: emerging

issues. Sustainable Markets Discussion Paper Number 2

Faaij, A., 2006. Modern biomass conversion technologies. Mitigation and Adaptation

Strategies for Global Change 11: 335-367.

Fischer, G; Hisznyik, E.; Prieler, S. and van Velthuizen, H. (2007). Assessment of

biomass potentials for biofuel feedstock production in Europe: Methodology and

results.

Hamelinck, C., A. Faaij, H. den Uil and H. Boerrigter, 2004. Production of FT

transportation fuels from biomass; technical options, process analysis and

optimisation and development potential. Energy, the International Journal 29:

1743-1771.

State of the union transcripts, retrieved on 16-12-2015. From: Zwart, R.W.R. (2006) -

Biorefinery: The worldwide status at the beginning of 2006.


22

2. Investor negotiations

We write the year 2007, May 24th, the team has gathered for a meeting about their

second round of financing. And it’s very much needed! In the last couple of months, Paul

has spoken to more than 30 parties for investments and the startup company, BIOeCON, is almost running out of funds. Only one offer came out of all these conversations and no

one in the team is really happy with the deal they’ve been offered. The term sheet was

discussed and everyone feels it is not good enough. After playing with the numbers a bit,

Pauls’ guess is that the investment fund COINS probably valued BIOeCON at around €10-

€12 million seven years from now. Irrespective of the valuation, which is, let’s face it,

always too low for an entrepreneur, the team feels there are many other limitations in

this offer. They only want preferred shares, which seems to be what all investors want to

lower their risk, but everyone in the team feels common stock would be preferable. They also demand many board seats and will only pay once all the patents have been approved.

Especially the latter point is interpreted by everyone as a lack of trust. The first step

therefore was to decline the offer from COINS.

But what to do next? Money is needed, and only a few options are left: StartGreen, Rabo

Private Equity, a few informals and Khosla Ventures. Of these options, Khosla ventures

had the deepest pockets. The firm was founded by Vinod Khosla, the biggest investor in

cleantech in the world! How to reach out to such a man? Paul decides to simply try. A former colleague works in Silicon Valley and might be able to pull some strings. With the

idea that there are some more people Paul wants to speak in the States, he decides to

book a flight.

In the airplane, Paul starts to organize everything he knows about Khosla and everything

he wants. First of all, he wants to safeguard more than the €2 million they asked before,

ideally the investment is €5 million. That will give them some breathing space in the

development. Khosla Ventures invests a lot in sustainable start-ups, but they do lack something in their portfolio. No company in their portfolio focuses on converting biomass

directly into biocrude and this is exactly what BIOeCON wants to do! So in terms of

strategy for Vinod Khosla, the odds might finally be in the favor of BIOeCON. Vinod Khosla

is also known as someone who is willing to invest a lot in his start-ups since he likes to be

involved and not just be the ‘money guy’.

As the plane touches down, the strategy is clear to Paul. When Paul switches on his phone

he receives a message that two days from now, he will be invited by an employee of Vinod

Khosla in the morning. Basically good news, but he had hoped to meet Vinod himself. As was his custom, Paul invited this employee to dinner on the evening before, and during

dinner asked whether it would be possible to also meet Vinod. With some hesitation, the

employee mentions that if Paul would be there before 9AM in the morning, he could have

a few minutes with Vinod himself.


23

On the big day, Paul arrives even before 8AM on the legendary Sand Hill, the street in

Silicon Valley with most venture capital per square foot in the world. Somewhat after 9, Vinod walks by and together with his employee and Paul they enter the meeting room.

Within a few minutes Paul explains the goals of BIOeCON, why it is revolutionary and the

reasons for having Vinod on board. The legendary investor clearly did his homework,

within minutes he agrees to do extensive due diligence with the eventual aim to add

BIOeCON to his portfolio of investments.

After Vinod leaves, the rest of the meeting is much more detailed about BIOeCON, the

people involved and of course the technology. More meetings, Skype calls and due diligence is performed in the weeks after this first meetings and everything looks positive.

Five independent industry experts had been consulted, and they had ruled that the

technology held promise, but it was still in a very early stage of development.

Months later, the negotiation teams were in the final stages of making the deal. Everyone

at Khosla is now convinced that this new technology could be able to revolutionize the oil

industry, but they also reckon that it will take time. In principle, Khosla is willing to take

the risk and to invest €5 million. The plan on what to do with this money is already in

place. Right now, it is time for the real negotiations on the specifics of the deal. Although

everyone is positive, Paul is well aware that the deal could still be blown! Exciting times!

General instructions for negotiation

In this role simulation, you will negotiate the terms of a potential €5 million investment by

Khosla Ventures in the start-up company BIOeCON. The investment world is a small

world, people talk, and the same goes for the start-ups that work on sustainable

technology. It is therefore beneficial for both to keep the future relationship in balance

with substantive stakes at hand right now. Accordingly, both parties in this negotiation will be scored both on the ability to negotiate good terms for themselves, but also on the

quality of the relationship developed with the potential business partner.

Substantive points: Each of you will be given confidential instructions explaining your

interests and preferences regarding the substantive terms of the investment and their

corresponding point values. Point values for each term are unique and you should not

share this information until the end of the exercise, including evaluations, has been

completed!

Process points: In addition to the points described above, each of you will also be scored

by your counterpart in the negotiation on your ability to develop and maintain a positive

relationship. As mentioned, this is important because both of you want to protect your

name in the industry. After you concluded the terms of your deal, but before you debrief

the exercise, each of you will complete a process evaluation in which you will assess your

counterpart on five basic process interests.

Total score: This sum of the substantive points and the process points reflects your

overall success in the negotiation. Your goal is to maximize this score. So keep in mind


24

that in the end the higher total score is more important than just the most favorable deal

for yourself, it might be worthwhile to grant the other party some topics that seem to be important to them in order to maintain a good relationship. However, stay true to

yourself. Negotiations can be hard and tough, but at the same time respectful and fair.


25

Confidential instructions BIOeCON

Scenario

You are Paul O’Connor, the CEO of BIOeCON and inventor of the process that converts

biomass directly into biocrude, the sustainable form of crude oil. You are already working

on this idea for 2 years, of which 1,5 year within your own company BIOeCON. Time is not

on your side and you are more or less desperately in need of cash. At the same time, the

talks with Khosla Ventures so far, were the best you ever had with investors. For the

appearance of BIOeCON, an investment from Khosla Ventures would be great since they

are the biggest investors in sustainable technologies. You are positive, and confident that you will be able to close the deal, although caution is needed, there is no need for

arrogance since there is a lot at stake!

The current deal you are going to negotiate is a €5 million investment. However, there is

still a lot that needs to be discussed. You are now going to discuss the first term sheet,

and if all goes well, you will be able to sign a more detailed term sheet next week.

Background on potential investment

The offer from COINS, a few months ago, included a €2 million deal for 43% of the

company, in other words, the valuation was €4.3 million for BIOeCON. However, you were hoping for a valuation somewhere around the €20 million. With this €5 million deal with

Khosla Ventures, you are therefore aiming at 25% of the shares. However, you are well

aware of the fact that Khosla is probably valuing the company at €10 million. On the

positive side, as far as you know, no one knows about the details of the deal COINS

offered you, with a little bluff, you should be able to convince your counterpart that the

offer of COINS was better than it actually was.

Ramon, the number two of Khosla Ventures, is the counterpart in this negotiations. He proved himself to be a smart guy in the meetings you had earlier. He is experienced with

investments, especially in the sustainability and energy sector. Before he went to Khosla

he was involved in several startups, first as early employee in high tech companies,

especially in the semiconductors industry. Later on, he was co-founder and CEO of a solar

cell company. You consider that to be an advantage, since you are also a technical

engineer by training and now the CEO of your own company.

Alternatives to a negotiated agreement

Considering your time limitations, there are not many options to explore next to this

negotiations. However, not every deal is acceptable with you. On your score sheet there

are a few options that are ranked as NO DEAL. For you, it will be absolutely unacceptable

to make a deal with that specific terms. Overall, you discussed with the rest of your board,

that you are allowed to accept a deal with a minimum of 40 points. This will be the

absolute minimum deal that you should take, otherwise, you prefer to look into a deal

with a different VC. Ideally you are of course looking for an even better deal than the 40

points.


26

Negotiable terms

The following confidential information regards eight terms you will discuss with the investor. The terms may be negotiated in any order, in packages of multiple terms as long

as you rate all the terms individually. A confidential score sheet is also included, which

breaks down the specific point values for each term. Use this sheet to calculate your total

score. You must abide to the scoring restrictions in this exercise.

The following points are the terms that will be negotiated. Please remember to not show

any of your confidential instructions to the investor.

Term #1: Commercialization route

Basically, you aren’t quite sure yet which strategy would be best to follow. Your number

one goal is to develop this process and upscale it to commercial volumes. You prefer a

licensing route, because that enables you to focus on the development and let others

worry about the commercial plans. From earlier conversations you noticed that the

investor really wants to shake up the oil industry by building a sustainable oil company. In

the end, this won’t be the most important term to you, because the ultimate goal is more

important than the route to you.

Term #2: Stock type

You must agree on the nature of the security for the investor for their investment. You are

considering four forms of stock for Khosla: common, common with extra voting rights,

non-participating preferred and participating preferred. This is an important term for you,

because you feel you should be going in this adventure together. In such a situation, you

don’t like too much imbalance.

However, you are aware of the fact, that preferred stock is standard when VC’s invest.

However, you intend to at least try to go for the common stock, even if it will cost you the

extra voting rights.

Common stock is a regular type of share. One common share is one vote, and x% of the

company in common stock gives you credit for x% of the liquidation or acquisition. You will

get dividends if the board decides to grant dividends.

Common stock with extra voting rights is the same kind of stock as common stock with

the difference that one common share equals 2 votes.

Non-participating preferred is often used by investors because it will downgrade their risk in the case of a failure. When the company goes bankrupt, the preferred stock will get

their original investment back whenever possible. In the case of an IPO or acquisition they

can convert their preferred stock into common stock in order to increase their gain.


27

Participating preferred is for VC’s the best option, this way they will get their initial

investment back and on top of that the percentage of the shares they are holding in the

case of a bankruptcy or an IPO (Initial Public Offering).

Term #3: Board seats

Your board currently holds three members and that works fine. You prefer to keep it this

way but at the same time you realize the investor wants influence in some way.

Term #4: Dividends

Because it’s common in the industry you allowed dividends to be part of the negotiation.

Potential dividends will not be paid in cash. Rather, they shall accrue until a liquidation event and be paid in equity, commonly referred to as payment in kind. The dividends are

negotiated as a percentage per annum of the original VC owned equity. Your primary

interest in agreeing to dividends is to increase the commitment of the VC. As far as you

know, the industry average is somewhere between the 5% and 7% but your goal is to keep

the dividends as low as possible.

Term #5: VC equity percentage

You will give equity in return for the investment of €5 million by Khosla Ventures. This

term is one of the key issues in the negotiation. You are aiming for a valuation of BIOeCON for €20 million, which suggest Khosla will receive 25% percent of the company. The equity

percentage and the valuation are related such, that the higher the valuation you attach to

the company, the smaller equity percentage Khosla will receive for the fixed €5 million

investment.

Determining the value of a company in such an early stage is a subjective analysis.

Detailed financial projections are of secondary value to experienced recommendations

from industry contacts and consultants, so you decided to talk to some people in the sector. Consensus in general was that people were pretty confident that it should be

possible to make the technology work which potentially could lead to a valuation of €500

million in 2010. This enormous potential upside for the investor is your justification to

keep the equity percentage as low as possible. Realizing that this upside is far from

certain, you feel the potential upside of 25 times the valuation right now is enough reward

for the risk they are putting in.

Another significant consideration is who will have the majority of shareholder control. A business is run by its board of directors, currently consisting of three persons including

yourself, but a majority stakeholder has the ability to take control of the company. As

founder of the company and inventor of the process you want to have an influence on the

way to proceed. The last thing you want is one stakeholder that could decide the route to

follow. It is therefore important to you that you give away a maximum of 49% of the

company for the €5 million investment.


28

Term #6: Anti-dilution rights

Dilution refers to a reduction of the fractional ownership of the company. For investors it is important to limit the dilution of their equity. Generally, investors therefore like to get

anti-dilution rights to protect their equity share. This term will contain the ‘VC right of first

refusal’ when additional capital is needed. In other words, when additional capital is

needed, Khosla will have the right to buy the additional shares of equity before they are

offered to another party. Your assumption is that you will require more capital in the

future. When the cooperation with Khosla is smooth, you have no incentive of bringing a

new VC at the table, however, without this option you will have your options open to look for other investors when necessary. This term is negotiated as either ‘VC right of first

refusal’ or ‘no anti-dilution rights’.

Term #7: CEO replacement provision

You heard some stories from other entrepreneurs that VC’s fire the CEO and replace him

with someone they know. You will definitely want to stay the CEO of the company, you

build it from scratch! You can imagine a scenario in the future where you do want to step

down, because you are not that experienced in leading larger and fast growing

organizations. As long as you feel that you contribute to the success of the firm as a CEO you want to stay the CEO, but when it starts to get to a bit over your head, your definitely

willing to step aside and focus more on the R&D or a board function. You agreed to

negotiate this issue based on the projections you made earlier about the growth of the

company. Ideally, you don’t want this provision in the deal because you feel you can be

trusted to step aside when you are clearly not longer the right man for the job anymore.

Second best choice is to be judged on the conservative projections, and maybe on the

moderate projections. You are pretty confident you can make both projections work, but it’s better to be safe. The aggressive projections are way too aggressive in your opinion

and are impossible to reach, no matter who would be in charge.

Term #8: No shop provision

A ‘no shop’ provision would prevent you, as the founder, to shop around with the deal

with other VC’s in an attempt to negotiate better terms before you sign the agreement.

With the no shop provision, you are not allowed to shop around for sixty days and will give

Khosla the exclusive rights in this period to negotiate with you.

You know this will be very important for Khosla, because it will give them a save feeling

for the rest of the process. Downside for you is that you cannot go check if there are other

VC’s that might have a higher valuation for your company. On the other hand, because you

are in such an early stage, not many VC’s are interested. At least that’s your experience

from the last couple of months.


29

Confidential score sheet for BIOeCON

Terms Options Point allocation Points awarded

Commercialization

route

Sell off IP 5 pts

____________ JV with process licensor 8 pts

License IP + continue development 10 pts

Full scale business 5 pts

Stock type

Common stock 15 pts

____________ Common stock + extra voting rights 12 pts

Non-participating preferred stock 5 pts

Participating preferred stock 0 pts

Board seats

0 9 pts

____________ 1 7 pts

2 3 pts

3 0 pts

Dividends

No dividends 12 pts

____________ 1% - 6% 10 pts

7% - 9% 8 pts

10% or more 0 pts

VC equity percentage

25% or less 20 pts

____________

26% - 32% 15 pts

33% - 39% 12 pts

40% - 46% 10 pts

47% - 53% 3 pts

54% or more No deal

Anti-dilution rights No anti-dilution rights 5 pts

____________ VC right of first refusal 3 pts

CEO replacement

provision

No provision 16 pts

____________ Conservative projections 12 pts

Moderate projections 10 pts

Agressive projections 2 pts

No shop provision Provision NOT included 8 pts

____________

Provision included 6 pts

Minimum substantive points required: 40

Total substantive points awarded: ____________

Total process points awarded: ____________

Grand total points awarded: ____________


30

Founder’s process evaluation of the Venture Capitalist

Instructions: After an agreement has been reached, but before the exercise is debriefed in class, you will evaluate the process following the score card you

find below. Based on your experiences, you will score the questions (associated with 0, 2, 4, 6, 8 or 10 points). The resulting process points should be added

into the total process points. Include comments that might help explain your evaluation.

Attributes Questions 0 2 4 6 8 10 Score Comments

Trust How much do you

trust the VC?

I do not trust

the VC

I do not really

trust the VC

I have no

reason to

distrust the VC

I think the VC is

trustworthy

The VC is very

trustworthy

I completely

trust the VC

Respect

How much respect

were you given for

the value you bring

to the deal?

No respect at all Very little

respect

Sufficient

respect

Considerable

respect Much respect

Very much

respect

Equitability

How equitable do

you believe the

process was?

I was fully taken

advantage of

The process was

not fair

The process

seemed fair

sometimes

The process

seemed fair

most of the

times

I think the

process was fair

I am convinced

the process was

very fair

Regard to

other’s interests

How much did the

VC attempt to

understand your

interests?

VC didn’t

attempt to

understand my

interests

The VC acted to

understand my

interests

The VC

considered by

interests when

convenient

VC was

interested in

understanding

my interests

The VC often

attempted to

understand my

interests

The VC was

greatly

concerned with

understanding

my interests

Interest for

future

collaboration

How interested are

you in working with

the VC in the future

again?

Never again! I would prefer

someone else

Doesn’t really

matter

I am open to

working with

the VC again

I would enjoy

working with

this VC again

I would prefer

to work again

with this VC



31

Confidential instructions Khosla Ventures

Scenario

You are Ramon, the number two of Khosla Ventures, the largest venture capital (VC) firm

that focuses on sustainable technologies. Especially early stage, high-growth companies.

Your founder, Vinod Khosla, has the dream to revolutionize the energy sector with

sustainable start-ups. Khosla Ventures is known to be very active in its role as investor

and advisor for the companies in their portfolio. You feel that is the case because you

share the dream with all these founders to build their companies into successful industry

leaders in the energy sector.

Your own background is in electric engineering where you hold a cum laude master’s

degree and a PhD degree. As a graduate, you were involved in a company which is now

the number one laser technology company in the world and recently acquired by a big

corporate. You also worked for other early stage companies in the semiconductor industry

before you started your own revolutionary solar panel company. You designed and

manufactured high-efficiency solar cells which led to two impressive world records on

solar cell efficiency. Since five years you are working for Khosla Ventures and you are

really enjoying it.

Background on potential investment

BIOeCON was founded a few years ago, in the Netherlands, with the goal to revolutionize

the oil industry. The founder, with whom you are negotiating, is an experienced R&D and

business development manager with over 20 years’ experience in the catalyst and

chemical industry (Shell, Akzo Nobel and Albemarle). He is also the current CEO of the

company.

The mission of BIOeCON is to make biocrude commercially available for a competitive price. Eventually, it should be possible to make the necessity for crude oil obsolete. The

company is on its way to deliver on this promise. The work they have done so far in

Europe is impressive. Although it is still on a small scale, they proved that it is possible to

create a high quality oil out of wood chips. It makes perfect sense that they are looking for

ways to scale up the process to prove that it could also work outside the laboratory.

You are very optimistic for the potential of this investment, but you realize the challenge

ahead of the team and yourself. The positive side is that BIOeCON has the characteristics of a great investment. It is still in a really early stage phase, but the potential is huge and

the process seems to work. Based on your experience and instinct, you are confident that

they can dominate the industry in a couple of years. The market also seems to be ready

for a sustainable alternative for oil.

Still, there are also some serious concerns. As any emergent technology, the risk

associated with it is huge. History proves that mechanisms on laboratory scale can take

decades to scale up or even fail. You realize that the positive story of Paul O’Connor might

be a bit too optimistic which means they will need a few more rounds of financing before


32

they can actually build a pilot plant. Accordingly, you hope to set up the terms of the

investment in such a way that it protects Khosla Ventures from as much risk as possible and generously compensate yourself and the firm in the event that the investment proves

to be successful.

Alternatives to a negotiated agreement

Considering the amount of risk you are taking, you have decided that the minimum

amount of substantive points you want for this deal is 40 points. If you cannot agree upon

terms that meets this minimum, you would prefer to pass on the deal and consider other

investment opportunities.

Negotiable terms

The following confidential information regards eight terms you will discuss with BIOeCON.

The terms may be negotiated in any order, in packages of multiple terms as long as you

rate all the terms individually. A confidential score sheet is also included, which breaks

down the specific point values for each term. Use this sheet to calculate your total score.

You must abide to the scoring restrictions in this exercise.

The following points are the terms that will be negotiated. Please remember to not show

any of your confidential instructions to your counterpart in the negotiation.

Term #1: Commercialization route

You realize that BIOeCON has the first priority to make their process work. Your major

goal however is to invest in a company that focuses on everything in-house in order to

become ‘the new Exxon Mobile’, a major player in the oil industry. Although you are a

polite person that will listen to Paul’s arguments for a different route, there is basically

only one route you feel makes sense.

Term #2: Stock type

You must also agree on the type of stock you are getting for your investment. Under consideration are four types of stock; Common stock, common stock with extra voting

rights, non-participating preferred and participating preferred stock.

As an investor, you try to protect your investment and you try to lower your risk as much

as possible. Participating preferred stock is therefore the type of stock to go for. Common

stock would place you on the same level as any other kind of shareholders without any

preferences. To be honest, that is laughable for you as a respected investor. Especially

considering the amount of risk you are taking with this investment. Industry standard is

also preferred stock, most often non-participating, but it does happen quite often that

VC’s get participating preferred stock.

Common stock is a regular type of share. One common share is one vote, and x% of the

company in common stock gives you credit for x% of the liquidation or acquisition. You will

get dividends if the board decides to grant dividends.


33

Common stock with extra voting rights is the same kind of stock as common stock with

the difference that one common share equals 2 votes.

Non-participating preferred is often used by investors because it will downgrade their risk

in the case of a failure. When the company goes bankrupt, the preferred stock will get you

your original investment back whenever possible. In the case of an IPO or acquisition you

can convert the preferred stock into common stock in order to increase your gain.

Participating preferred is the best option for you, this way you will get your initial

investment back and on top of that the percentage of the shares you are holding in the

situation of a liquidation or an IPO.

Term #3: Board seats

Achieving adequate representation on the board of BIOeCON is really important to protect

your investment. Cynics will feel you want to control the company, but you really feel this

is also the way to add value to the company. The board of directors has many

responsibilities that effect the future of the company, like setting the strategic goals,

reviewing performance of management and approving major financial transactions.

You will negotiate the number of board seats that you’ll get. Currently, the board exists of

three members, of which Paul O’Connor, the founder and CEO is one. At least, you want one board member that you can appoint, but ideally you would like to appoint as much as

possible. With more board members you will have more influence in the company, and it

will also be in the best interest of the company to have more expertise on board. Not to

mention the network people you appoint will bring into the company.

Term #4: Dividends

You may also negotiate the right to receive dividends on your equity share. Potential

dividends will not be paid in cash. Rather, they shall accrue until a liquidation event and be paid in equity, commonly referred to as payment in kind. The dividends are negotiated as a

percentage per annum of the original VC owned equity. Your primary interest in agreeing

to dividends is to increase your equity share and thus, your upside potential. From your

experience, the industry average, when dividends are issued, is 7% per annum. You value

receiving dividends rather highly because you realize the substantial increase in your final

equity stake a moderate compounding dividend can produce over a number of years. You

would like to receive as high a dividend as possible without damaging the relationship.

Term #5: VC equity percentage

You will receive equity for your €5 million investment in BIOeCON. One of the biggest

issues for you is to negotiate an as big equity percentage as possible. Before, you agreed

with Paul that €5 million would be enough to get BIOeCON to the next stage. In order to

determine the percentage of equity you will get for your investment, the valuation of the

company is important. The equity percentage and valuation are related as such that the


34

higher the company is valued, the less equity you will get for your €5 million. It is

therefore in your best interest to give the company a low valuation, within realistic terms

of course.

Determining the value of a company is very subjective, as you know from all the deals you

closed in the past. The detailed financial projections of a company almost always proves

to be useless in the end, but expert opinions from people in the industry are very valuable.

From trusted people in the field you got the impressions that the consensus was that

BIOeCON is focusing on risky business that will take some time to flourish. Most people

valued the company somewhere between the €10 and €15 million right now, which would correspond with an equity percentage between the 33% and 50%, but you are eager to get

even more. You justify this higher percentage by considering the amount of risk you are

taking and the desired reward/risk ratio you have in mind. Right now, the management

team is not that experienced and hasn’t proven itself, the technology is still unproven and

the market is heavily influenced by the global oil price, of which you have no control of.

Your second reason to get as much equity as possible is the to get the majority

shareholder control. If you would control at least 51% of the shares you will have the

possibility to take over control of the company if things turn out ugly. You want to make clear to the founder that you have no desire at all to take over the company and to control

the future of BIOeCON via your shareholder control. However, it will give you as an

investor significantly more security if the company will start to fail.

Term #6: Anti-dilution rights

Dilution refers to a reduction of the fractional ownership of the company. For you it is

important to limit the dilution of your equity to protect your equity share. This term will

contain the ‘VC right of first refusal’ when additional capital is needed. In other words, when additional capital is needed, Khosla will have the right to buy the additional shares

of equity before they are offered to another party. You definitely prefer to have this option

in order to protect your equity position from dilution by future investors. This provision

could therefore prove to be extremely important in the future when BIOeCON needs

additional funding. And they probably will need an extra round of funding. You are hopeful

the founder will agree that this provision is beneficial for you both because it underlines

the trust you have in each other. This term is negotiated as either ‘VC right of first refusal’

or ‘no anti-dilution rights’.

Term #7: CEO replacement provision

It is more than clear that the founder is critical to the success of the company, especially

in this phase of the business. You feel however that the company is better off when the

founder only served the board once the company starts to grow. The board could then

appoint a professional CEO to lead the firm through the growth phase. The attributes

needed for a CEO in the starting up phase and in a maturing company are drastically

different. When it was up to you, you decided to replace the CEO immediately, to begin implementing the next major stage of the company. Paul, the CEO right now, could then


35

serve the board, and maybe even as Chief Technology Officer (CTO), or R&D manager. For

you that feels as the best situation, but you know Paul is determined to stay CEO.

To protect your investment, you will give him the chance to stay CEO, but he must need to

be evaluated against a performance benchmark. If the CEO doesn’t meet this benchmark,

Khosla Ventures would have the immediate right to replace the CEO without further

negotiations. Vesting of the founder’s stock would not be affected by such a replacement

in the situation that the founder continues to work for the company, which you hope

would be the result.

Your suggestion was to use the projections presented earlier in meetings as a benchmark. Paul presented conservative, moderate and aggressive projections, and your goal is to use

the aggressive projections as the benchmark. If Paul manages to meet this expectations,

the company will do great, even better than you expect. And if he doesn’t meet the

expectations, you are allowed to hire an professional CEO. The moderate projections

would also be acceptable, but you are really hesitant to accept the conservative

projections as benchmark. With only the conservative projections met, you probably won’t

achieve your required return on the investment.

Term #8: No shop provision

A ‘no shop provision’ is a straightforward term. With such a provision, the founder is not

allowed to shop around with the deal in an attempt to negotiate better terms before the

agreement is signed for a specific timeframe. If this provision is included in the

negotiation, Khosla will have sixty days of exclusive negotiation right with BIOeCON.

You aren’t sure if other VC’s are interested in the company right now, but you don’t want

to gamble with this investment. You realize what kind of catastrophic effect a too

generous offer from a misinformed VC might have on your negotiations. Hopefully, you will be able to convince the founder that this no shop provision is beneficial to you both,

since it gives both parties peace of mind and time to negotiate the best deal. You are

absolutely convinced that Khosla Ventures can add most value to BIOeCON even if a

different VC might offer a higher valuation. Your portfolio and network is unique, and the

relationships between the companies in your portfolio are good. Since everybody is

working in the sustainability area, the portfolio and relationships are valuable to everyone.

You will negotiate this term simply as ‘included’ or ‘not included’.


36

Confidential score sheet for Khosla Ventures

Terms Options Point allocation Points awarded

Commercialization

route

Sell off IP No deal

____________ JV with process licensor No deal

License IP + continue development 1 pts

Full scale business 10 pts

Stock type

Common stock 0 pts

____________ Common stock + extra voting rights 5 pts

Non-participating preferred stock 10 pts

Participating preferred stock 15 pts

Board seats

0 0 pts

____________ 1 3 pts

2 6 pts

3 9 pts

Dividends

No dividends 0 pts

____________ 1% - 6% 3 pts

7% - 9% 9 pts

10% or more 12 pts

VC equity percentage

25% or less No deal

____________

26% - 32% 3 pts

33% - 39% 5 pts

40% - 46% 10 pts

47% - 53% 15 pts

54% or more 20 pts

Anti-dilution rights No anti-dilution rights 0 pts

____________ VC right of first refusal 6 pts

CEO replacement

provision

No provision No deal

____________ Conservative projections 6 pts

Moderate projections 10 pts

Agressive projections 14 pts

No shop provision Provision NOT included 2 pts

____________

Provision included 8 pts

Minimum substantive points required: 40

Total substantive points awarded: ____________


Grand total points awarded: ____________

Breaking new ground - Strategic choices and decision-making in a start-up industry

37

VC’s process evaluation of the Founder

Instructions: After an agreement has been reached, but before the exercise is debriefed in class, you will evaluate the process following the score card you find below. Based on your experiences, you will score the questions (associated with 0, 2, 4, 6, 8 or 10 points. The

resulting process points should be added into the total process points. Include comments that might help explain your evaluation.

Attributes Questions 0 2 4 6 8 10 Score Comments

Trust How much do you

trust the founder?

I do not trust

the founder

I do not really

trust the

founder

I have no

reason to

distrust the

founder

I think the

founder is

trustworthy

The founder is

very

trustworthy

I completely

trust the

founder

Respect

How much respect

were you given for

the value you bring

to the deal?

No respect at all Very little

respect

Sufficient

respect

Considerable

respect Much respect

Very much

respect

Equitability

How equitable do

you believe the

process was?

I was fully taken

advantage of

The process was

not fair

The process

seemed fair

sometimes

The process

seemed fair

most of the

times

I think the

process was fair

I am convinced

the process was

very fair

Regard to

other’s interests

How much did the

founder attempt to

understand your

interests?

The founder

didn’t attempt

to understand

my interests

The founder

acted to

understand my

interests

The founder

considered by

interests when

convenient

The founder

was interested

in

understanding

my interests

The founder

often

attempted to

understand my

interests

The founder

was greatly

concerned with

understanding

my interests

Interest for

future

collaboration

How interested are

you in working with

the founder in the

future again?

Never again! I would prefer

someone else

Doesn’t really

matter

I am open to

working with

the founder

again

I would enjoy

working with

this founder

again

I would prefer

to work again

with this

founder

Total process points awarded:


38

3. Innovation systems

Khosla Ventures decided to invest in BIOeCON, and thereby a new venture was formed

named KiOR. After this deal, the next issue pops up, where to locate the first pilot plant?

Considering such a choice, there is much more than just the costs of a specific location involved in the decision. A system perspective is helpful in this respect, because it helps to

understand the forces at work. Especially in a situation when people work on a new

technology that potentially can change ‘the way things are done’, it is important to look at

the entire system, because minor things can define the difference between success and

failure. The ‘system’ that explains how things work, is referred to as ‘the regime’. Every

sector has its own dominant regime that defines the sector. In the case of Paul O’Connor

and KiOR this is the oil regime, which is quite a conservative and powerful sector. The technology of KiOR is a new technology that potentially threatens this existing oil regime.

It is therefore important to understand how such a regime, conceptually, works.

Figure 3.1: Alignment of ongoing processes in a socio-technical regime (Geels, 2011; adapted from Geels

(2004:912)).

As can be seen in figure 3.1, a regime consists of several components that in itself could

be described as specific regimes. In the framework presented here we distinguish five

components: Socio-cultural, policy, science, technological and the user/market regime.

Together they can describe a regime in a specific sector as a whole. The little arrows show

the dynamic stability of a regime. Things do change, but often not that radical, unless an

innovation is introduced at the right time (often during a period when minor changes are

already taking place), and thereby overthrows the entire regime. An example hereof is the introduction of cars and thereby the fading out of the dominant regime of horse carriages,

whereby not only the source of transportation changed, but also the entire industry

around it (Geels, 2005).

39


The oil regime will be shortly described with a reference to the general situation in Europe

and the USA because those were the two continents were KiOR considered to build a pilot

plant.

Socio-cultural regime

This component of the framework refers to the cultural and sociological attitude within

the existing regime. Generally, for the oil regime, the USA has a strong dependency to oil

within its cultural DNA. The oil usage per capita is about as twice as high in the USA as in

Western Europe, which can also be seen in the overall energy use per capita in figure 3.2.

Figure 3.2: Energy use per capita (Ritholtz, 2015)

Policy regime

Policy wise, there seems to be more focus on sustainability goals in Europe than in the

USA, reflected for instance by the USA not signing the Kyoto protocol in 1997 as one of

the few countries in the world. However, both in the EU and in the US, we see a rise in

biofuel consumption between the 90’s and 2006. Where the US chose to set policy targets on volume, the EU chose to set policy targets on the percentage of ethanol and

biodiesel blend in fuels. Interesting is that only Germany and Sweden managed to exceed

the target of 2005 (Ziolkowska et al., 2010). Within the United States, there are many

differences between the states. California is known for its innovative character and policy

stimulations, while the state of Colorado specifically focuses on attracting alternative

40


energy companies. Texas also started a major program in 2006 to stimulate biofuels, but

there is some hesitance in that state to compete with their major industry, oil.

Science regime

In both parts of the world there is a lot of knowledge in this field. In general, the research

field of biofuels is growing, although the US has Houston, the ‘oil capital’ of the world.

Subsequently, a lot of scientific knowledge in this field is available in that area of the

world. Scientifically it is possible to produce fuels from cellulosic material, however,

scientists agree that there is a long way to go before it is possible to produce this in a

commercial viable way.

Technological regime

Technologically speaking, things are a bit different. Although strongly related with the

scientific body of knowledge, technology is more practice focused. There are a bit more

biofuel startups in the US than in the EU, but the specific technology KiOR is working on

has been developed by Paul O’Connor, located in the Netherlands, together with

researchers from universities in the Netherlands and Spain.

User and market regime

The market seems to be ready for more biofuels. Policies are more and more focusing on blending, so the industry must adopt new technologies. Positive for KiOR is their

competitive edge over all the other biofuel start-up companies. Because KiOR develops

bio crude, a raw material for the refinery process instead of ethanol that is blended with

gasoline in the end of the refinery process, they are not reducing the market of the

refinery industry. KiOR is providing them with more options and is therefore much more

compatible with the current market than any other start-up in the market.

Biofuel industry

As mentioned in Chapter 1, there is a growing awareness that the world, and the US

specifically, is too depended on oil. Therefore, the tendency is to focus more on the

current day biomass feedstock like corn, grasses and wood to decrease the dependency

on oil from the Middle-East. Extra benefit is the 15% - 20% less greenhouse gas emission

for ethanol in comparison with gasoline, so the fuel is ‘cleaner’.

KiOR is focusing on the third generation biofuels, by directly converting cellulosic material

into bio crude that can be refined. Many others focus on first and second generation biofuels. Where the first generation is the most mature technology, it is directly

competing with food because it converts the sugars in corn and other food crops into

ethanol. The second generation still converts crops into ethanol, but is not directly

competing with food anymore. Since 70% of crops consist of cellulosic material, the

second and third generation are much more efficient, because they allow to use much

more of the plant to convert into useful fuel. That’s however still in theory, because right

now, in 2007, almost no one believes the third generation can be produced commercially

viable within 5 years.

41


Economics

For the first generation biofuels, the cost of production is $0,75 a gallon, excluding the feedstock prices and right now, consensus is that this is close to what will become the

price for a gallon first generation biofuel in the future. Because building a factory to

produce the fuels for second generation fuels is much higher, the price per gallon for this

second generation is $1,85 excluding the feedstock. Consensus here is that this price will

dramatically drop in the next decade due to technological development and upscaling.

Estimates ranges between $0,60 and $0,85 a gallon.

For third generation, there is no price yet, since no one is producing this fuel right now. Paul O’Connor is quite certain that BCC (the KiOR technology) will be less costly than

second generation conversion processes. Other advantages are that the catalyst they use

is non-toxic, less energy is needed to do the conversion, and the fuel has a higher energy

content and becauce a bio crude is produced, it can still be refined into jet fuel, gasoline

and other fuels. Most importantly, it can blend into the existing refinery infrastructure

already in place.

Decision

These almost utopic prophecies must first be demonstrated on a larger scale than the laboratory, and therefore a location for the pilot plant is needed. This choice of location is

very important, because if the results are positive a much larger demo plant will be built

next to it. A few topics are important for the choice: Cost of transportation of the raw

material (wood chips), cost of land, infrastructure, proximity of knowledge, attractiveness

for employees to live in the surroundings and costs of land. In the previous board meeting,

the board announced that a pilot plant in Europe is not an option, since all the investors

and board members are located in the USA (California, Colorado and Texas). The only decision that needs to be made is the choice for one of these states to build first a pilot

plant, and later on the demonstration plant. You are asked to give an advice to the board,

of course, this advice needs to be well substantiated.

Cost of transportation

Although the pilot plant is only built to demonstrate the catalyst process will work on a

larger scale, it will need 500 bone dry ton per day. After it is demonstrated the process

works, the goal of the demo plant is to produce between the 60 and 75 gallons of bio crude per bone dry ton. In this pilot plant the goal is to produce between the 610 and 710

gallons per day. Because there will still be a lot of experiments, Paul estimated that the

plant will approximately needs 5 times more than the intended yield per bone dry ton,

which is still considerably less than the 500 bone dry ton needed in the pilot phase. The

biomass resource availability and the costs per ton per kilometer travelled can be found in

Exhibit 1.1a and 1.1b.

42


Cost of land

When building a plant, a lot of space is needed. On the website of KiOR, you can find a virtual plant tour that will give an idea on what happens in such a facility. Building such a

plant is costly, but doesn’t differ that much between the three states. However, what

does differ, is the cost of land. Because of the booming start-up community in Silicon

Valley, the prices per acre are sky high. Texas and Colorado are both a lot cheaper. Please

remember, that right now, the only goal is to build the pilot plant, KiOR will do another

round of financing to build the demonstration plant at the same location. Prices of land

can be found in Exhibit 3.2.

Infrastructure

Regarding the infrastructure, Texas is the absolute favorite which is underlined by Exhibit

3.3. The US headquarters of most major oil and chemical companies that, just like KiOR,

use catalysts is Houston, Texas. Texas is also the number one oil producing state in the

United States. Although California is the third and Colorado sixth producing state, they

respectively produce 7 times and 11 times less barrels a day. Questions is whether it is a

good thing to position yourself in such an oil state if the goal of the company is to make

the oil sector more sustainable. Some people say we must be close to the oil industry,

while others feel we must distinguish the company from the oil industry…

Proximity of knowledge

Only looking at the filed patents between 2001 and 2007, California is the number one

performing state in the USA, with 6 times more patent applications than Texas and 9

times more patent applications than Colorado. However, most of these patents are not at

all related to the oil business KiOR is in. When focusing on a relevant patent class for KiOR,

IPC C10G, Texas is the number one state, before California and Colorado. Details can be found in exhibit 3.4. It must be said, that from the companies located in Texas from exhibit

3.3, two of them just announced to move their sustainability offices and laboratories

towards Denver, Colorado.

Attractiveness for employees

KiOR needs to start attracting employees for their business once the pilot plant is build,

and as can be seen in exhibit 3.3, most chemical engineers and others with relevant skills

already live in Texas. Questions is if they want to switch from their save job in the oil industry towards the insecurity of this starting challenger of the established order. When

it becomes necessary to attract people from outside the state, most people probably

prefer a city like Denver in Colorado over Houston in Texas. Exhibit 3.4 gives an impression

on the happiness of states in the USA.

43


Exhibits Chapter 3

Exhibit 3.1a

Exhibit 3.1a shows the availability of biomass resources in the USA per county. It includes agricultural

residues like crops and animal manure, wood residues, municipal discards and dedicated energy crops. The

black dots are the potential locations in California, Colorado and Texas.

Source: http://www.nrel.gov/gis/biomass.html

44


Exhibit 3.1b

Exhibit 3.1b shows the availability of biomass resources in the USA per square kilometer. It includes

agricultural residues like crops and animal manure, wood residues, municipal discards and dedicated energy

crops. The black dots are the potential locations in California, Colorado and Texas.

Source: http://www.nrel.gov/gis/biomass.html

Exhibit 3.1c

Exhibit 3.1c shows the average grain transportation cost by truck in the United States.

45


Exhibit 3.2

State Price per acre

California $ 39.092

Texas $ 7.542

Colorado $ 6.462

Exhibit 3.2 shows land prices in three US states.

Exhibit 3.3

Company Global Headquarters US Headquarters

Exxon Mobil Irving, TX Irving, TX

Royal Dutch Shell The Hague, Netherlands Houston, TX

BP London, UK Houston, TX

Chevron Corporation San Ramon, CA San Ramon, CA

Conoco Philips Houston, TX Houston, TX

Total SA Paris, France Houston, TX

Albemarle Baton Rouge, LA Baton Rouge, LA

Exhibit 3.3 shows the global and US headquarters of some relevant oil and chemical companies that use

catalysts in their processes. Although Chevron Corporation is located in California, the US headquarters of all

the other companies are located in Texas. Only Albemarle is located one state next to Texas, in Louisiana.

The information is based on the company websites.

Exhibit 3.4

Patents in class C10G since 1976

Texas 2176

California 1697

Colorado 119

Exhibit 3.4 shows the number of patents granted per state in the relevant patent class for KiOR. The

information is derived from the USPTO database.

46


Exhibit 3.5

Exhibit 3.5 shows the happiness level of people in the USA per state. This map is based on the Gallup

Healthways Well-being index. (more information: http://www.well-beingindex.com/)

47


References

Daniela Gonzales, Erin M. Searcy, Sandra D. Eksioglu (2013). Cost analysis for high-

volume and long-haul transportation of densified biomass feedstock.

Transportation Research Part A 49 (2013) 48–61

Geels, F.W. (2011). The multi-level perspective on sustainability transitions:

Responses to seven criticisms. Environmental Innovation and Societal Transitions, 1, 2011; pp. 24 – 40

Geels, F.W. (2005) The dynamics of transitions in socio-technical systems: a multi-

level analysis of the transition pathway from horse-drawn carriages to

automobiles (1860–1930). Technology Analysis & Strategic Management, 17 4,

pp. 445–476

Ritholtz (2015). Available on the World Wide Web:

http://www.ritholtz.com/blog/2010/06/oil-consumption-around-the-world/

Ziolkowska, J., Meyers, W.H., Meyer, S., & Binfield, J. (2010). Targets and mandates:

Lessons learned from EU and US biofuels policy mechanisms. AgBioForum,13(4),

398-412. Available on the World Wide

Web: http://www.agbioforum.org/v13n4/v13n4a13-ziolkowska.htm.

48


4. Underlying Forces

Ashley walked back to the coffee machine to reconsider what she’d just read. She was

struggling to find out what the logic was in the string of news messages about biofuel

production company KiOR. With a mug of fresh coffee in hand, she returned and reviewed

them again, chronologically.

It is November 2012 and Fred Cannon, KiOR CEO, proclaimed: “I am pleased to announce that we have commenced operations at the Columbus facility and have produced a high quality oil that is in line with our specifications for upgrading into cellulosic gasoline and diesel”. This was, all things considering, a breakthrough at the time. The ability to be able

to make gasoline and diesel out of the residues of plants and wood chips could be a

game-changer for renewable fuels. There were other initiatives and technologies trying to achieve the same, but none of these had reached the phase that KiOR was now in:

commercial scale production.

It was now a full year after the Initial Public Offering (IPO) of the company, and the

company was looking forward to show its investors progress. The company was now

operating four facilities:

• Pilot facility (2008) in Pasadena, Texas.

R&D activities and Test reactor, no production.

• Demonstration facility (2010), in Pasadena, Texas.

Capacity 630 gallons per day based on 10 tons of dry feedstock per day.

• First commercial scale plant (2012) in Columbus, Mississippi.

Production capacity of 13 million gallons per year out of 500 tons of dry feedstock

per day.

• Follow-up plant (planned) in Natchez, Mississippi.

Production capacity of 40 million gallons per year out of 1500 tons of dry

feedstock per day.

But whilst Fred Cannon was on stage, local journalists were reporting that the plant was

running behind schedule. Fred Cannon explained that the plant was experiencing “Normal start-up issues”.

KiOR CEO Fred Cannon claimed that the Columbus facility had “not only met expectations, but also gives me confidence that we remain on track to upgrade our oil in order to ship America’s first truly sustainable cellulosic gasoline and diesel for American vehicles.” These first commercial shipments were expected to start a month later. Fred Cannon

even upped the ante on the R&D outcomes, now claiming that the company’s catalyst technology would be able to reach a 72 gallon per Bone Dry Ton of feedstock. Previously,

there had been a 67 gallon target announced at the IPO. For the Natchez facility, the

49


company was even more ambitious and claimed that it had ‘Cleared a path’ to yields

higher than 72 gallons per ton, moving towards the target of 92 gallons per BDT.

The company was investing heavily into the new technology and as a result, the cash

balance was declining. A war chest of 74 million remained, down 33 million in the last

quarter. A follow-up round of equity investment in the beginning of 2013 was anticipated,

which was according to the original schedule.

In the rest of 2012, the company’s achievements were applauded and heralded in the

press. KiOR won the Biofuels Digest best project (thermochemical) and got a second place

in the Ardent Rankings of the same newspaper. KiOR was rocking the biofuel community, and critics were revisiting their harsh opinions and comments of the exciting technological

company.

In early 2013, the quarterly earnings report was combined with the exciting message that

the company had shipped its first commercial biofuel. CEO Fred Cannon commented: “I do recognize however that many of you were expecting us to commence commercial shipments late last year, consistent with our guidance from our last conference call. Did we set an aggressive target for ourselves? Yes. Am I disappointed that we missed our target? Absolutely yes. Did we encounter unexpected startup issues unrelated to our technology? Yes we did. However, we have overcome these normal startup issues and we have proven that KiOR’s proprietary biomass to fuels technology works at commercial scale at Columbus. In fact, we know now that our technology performs better in terms of quality as it is scaled. From very good oil at the very small pilot plant to even improved quality oil at the demo and now to our best ever quality oil made at Columbus. So high in quality we’re converting over 90% of our oil from Columbus into transportation fuel.”1

Because KiOR was publicly traded, the disappointing news was expected to have a major effect on the price at which the stock was traded. An overview of the development of the

stock is given in exhibit 1.1. Shares were already down very significantly from initial price

of $15. To counter the expected hit in the stock, Condoleezza Rice, on the board since the

IPO in 2011, announced the following: “KiOR is changing the American energy equation by innovating and commercializing an entirely new generation of hydrocarbon-based diesel and gasoline fuel. By making the promise of cellulosic fuels a reality, KiOR demonstrates that these fuels are an attractive option for lessening America's dependence on foreign sources of energy.

Rice’s supporting comment was not enough to keep the company’s stock from tumbling

down to the $4 - $5 range.

The second half of 2013

At the beginning of July, 2013, the company shipped its first cellulosic gasoline (in addition

to the bio-diesel produced earlier). Publication of the number on actual production was 1 http://seekingalpha.com/article/1283971-kiors-ceo-discusses-q4-2012-results-earnings-call-

transcript?page=2

50


delayed until the analysists day. More significantly however, KiOR showed that the

company was able to complete a full 30-day run cycle, without turning off the facility. This was a significant milestone for the company, that was aiming towards improving yields

and cost effectiveness through increased efficiency.

Ashley shifts in her seat. It is at this point that things start to become confusing. In

August, the volume of production reported was below what it should have been if the

plant had run with 30 days of uptime. This means that the plant must have run at lower

capacity, or that not all of the bio-crude produced in the first production step had been

upgraded in the second production step – for whatever reason. The follow-up plant (located at Natchez) was postponed in favor of a ‘Columbus II’ facility, an extension at the

existing site. The company said this was an ‘opportunity’ discovered by the R&D team

based on the availability of local feedstock, and that they were still considering the timing

of the expansion at Columbus and the Natchez facility.

To cover the operational losses (KiOR was in the red for about 30-40 million dollars every

quarter) they had drawn a new loan of €30 million and after the second quarter, they

could still draw the last €10 million of that, leaving about €11 million in cash reserves.

A major milestone at this point in time for the company was the approval of a blend-in of KiOR fuel up to 25% in the Renewable Fuel Standard by the EPA agency– this ensured that

market uptake was feasible.

In the conference call where the earnings of the second quarter of 2013 were discussed,

Fred Cannon tried to calm down the concerns of investors and followers that the

technology was flawed: “Again, the issues that the Columbus plant has been working through are not at all related to our technology.”

But investors were not buying what Fred Cannon was offering. The company’s stock took a massive hit and lost 43% of its’ value within one week. The company had now lost

almost 90% of its’ value since it was first publicly traded.

In August 2013, Analysts summarize the situation in the following way: “Reaching continuous production was an important milestone — moving from commissioning in late 2012 to continuous production in Q2 is monumentally faster than some of its peers in cellulosic and/or advanced biofuels. Confusion over production of intermediates and shipment of fuels notwithstanding. But it all sets up for a hugely important Q3 — that’s when KiOR will need to show that it can raise production — in order that it can raise money for Natchez.”2

On September 18th, KiOR published a new update of operations because of their EPA

registration. As of August 2013, about 200.000 gallons of fuel were shipped, of which

almost half in the last two months.

2 http://www.biofuelsdigest.com/bdigest/2013/08/12/kior-mulls-columbus-ii-facility-to-accelerate-path-to-

profits-as-2013-production-forecast-is-cut/

51


Industry expert Jim Lane comments: “KiOR had expectations of producing 300,000-500,000 gallons in Q2 and 3-5 million gallons in Q3. This week’s announcement is consistent with a 300,000 – 500,000 gallon production in Q3 — so, a full quarter behind.” Being behind a couple of months for such an industry was not a major cause for concern,

said Molchanov, in the grand scheme of things the company was achieving.

Jim Lane continues: “We don’t know why the company is behind. We see three options: 1)

KiOR is behind in terms of technology, and this would strike at the heart of the company.

2) the company is not running the plant full-time for technical reasons not related to the

core technology. These startup problems could possibly be solved. 3) the company is not running the plant full time due to financial reasons. Why operate a facility at full speed and

ship more gallons that cost money per gallon?”

September 26th: Khosla Ventures commits €50 million in a loan for the extension of the

Columbus facility, that will help the company to bring up the yields. On 21 October, this

amount is raised to a total of €85 million to be invested by Khosla Ventures III and

associates, complemented with €15 million from the investment fund of Bill Gates. Both

parties also committed to an additional €50 million to follow later on. All of these funds

were meant for the construction of the second facility at the Columbus plant, dubbed

Columbus II.

2013: 3rd Quarter results

In November 2013, KiOR was able to report a tripling in the revenues and production that

increased to 324.000 per quarter, with October announced as the best production month

yet at 167,000 gallons produced. Industry analysts rejoice and the stock finally sees some

good news, climbing again to $2,54 on November 20th from the previous all-time low of

$1.47.

But there seems to be a caveat in the reaction of analysts. There had been a significant

increase in the cost of goods sold, and there does not seem to be another cause for this

outside of catalyst. And this is worrying: catalysts are not supposed to be lost in chemical

reaction, and catalysts form the foundation of the company’s technology. See exhibit 4.2

for the full article.

Troubles for KiOR mount as the Chief Financial Officer of KiOR, John Karnes, abruptly

leaves KiOR on December 1. He was gone two days later, leaving the company in the middle of trying to complete the funding for the extension at Columbus 1. In his last

conference call, John Karnes cautioned: “[we are] not in a position to provide any forward-looking information at all for 2014 at this point.”3

No reason for his departure was publicly stated, and there was none of the usual language

indicating that there were no conflicts or disagreements between the CFO and the board.

What had happened? 3 http://seekingalpha.com/article/1820212-kior-management-discusses-q3-2013-results-earnings-call-

transcript

52


On December 23rd, the company reports a record production the fourth quarter, expecting

to produce 420.000 gallons of fuel. A day later, Condoleeza Rice announces to leave the board of KiOR due to ‘the demands of other business commitments and personal time

constraints”.

The curtains fall: 2014

In January, 2014, Raymond James Energy Analyst harshly downgraded its outlook of KiOR.

The company’s production in the last quarter of 2013 fell short and the company had

announced to close the Columbus facility for Q1 of 2014 for process improvements. A

result of this was that securing additional funding for Columbus-II would not be feasible in that same first quarter, since financiers wanted to see steady-state operations. A best

case scenario for securing this funding was Q4 in 2014.

In march 2014, KiOR issues a warning with the quarterly results in which it claims that

KiOR has “substantial doubts about our ability to continue as a going concern”. Vinod Khosla again commits up to $25 million in monthly installments of $5 million, but

additional funding is needed to cover the commitments made (especially the promises

made to the state of Mississippi regarding investments in the local economy).

In May 2014, the last nail seems to hit the coffin as the company announces that they “have not demonstrated any additional research and development progress or any demonstrable progress towards achieving our financing performance milestones (…)” .

The company now descends into bankruptcy chaos, as it starts to lay off workers in June

and the SEC starts to investigate the company. The state of Mississippi initiates litigation

in order to recoup some of the 69 million US dollars that the company still owes them. The

plant at Columbus is sold off in parts at a fraction of their original price, the intellectual

property reverts to other subsidiaries of Koshla Ventures.

As the company fights to be able to restart once litigation clears, a troubling question

lingers: how could things have gone so wrong?

53


Exhibits Chapter 4

Exhibit 4.1: Stock price of KiOR Inc.

Exhibit 4.2: Green Explorer article on KiOR quarterly results

Kior announced their quarterly results. They had bigger losses and lower revenues than expected. The stock analysts asked their questions during the earnings call. Then they found “green” linings in the BS that was spoken.

I simply picked up that Kior is still struggling to keep the plant running and has not done any run at full throughput of the pine chips. They operated for 41% of the available time in the quarter and at 50% to 60% of capacity. This is a little less uptime than last quarter that was 43%. The 55% capacity is above the 40% of the previous quarter.

At 100% capacity Kior will feed 500 tons a day of wood chips. In the quarter they fed 10,373 tons of wood chips. In the previous quarter they fed 7,826 tons of wood chips using the above capacity and uptime figures. Therefore they fed an extra 2,547 tons of pine chips quarter to quarter. Pine chips cost about $73 a ton so the added feedstock cost was approximately $185,000.

The CFO stated the following in the earnings call: “While baseline fixed cost at Columbus remained relatively constant for Q3, with the increase of production in Q3, we saw a $2.3 million net increase in cost of goods sold relating primarily to feedstock and catalyst costs, along, to a lesser extent, with utilities, maintenance and other costs related to the ramp-up.”

We know the added feedstock was only $185,000 and the utilities, maintenance and other costs were a lesser extent in the added $2.3 million. Therefore the big added cost is catalysts. Based on the above the added catalyst cost probably $1.5 to $2.0 million. This is very disheartening as catalysts should be able to reused over and over but it looks like Kior goes through catalysts in a rapid fashion. The definition of a catalyst is that it is an ingredient that is not consumed in a reaction.

54


Kior did not provide the data on the actual increase in raw bio-oil out of their FCC unit but this probably was in the range of 75,000 additional gallons quarter on quarter (30 gallons per ton times 2,500 tons). This implies that catalyst costs alone are $20 to $25 per gallon of raw bio-oil. This is a fundamental question the analysts should ask. If the process after a year of lining out still needs $20 to $25 per gallon of catalysts to produce a gallon of bio-oil, then the process itself is flawed.

Exhibit 4.3: Paul O’Connors March 22nd Technology Assessment

On March 8th at the invitation of Fred Cannon (CEO) I visited KiOR to discuss my concerns

about the in my mind the limited improvements in the overall process yields obtained over

the last 2 years.

My concerns were based on the scarce and conflicting information on product yields I

received during the board of director meetings (BOD) in the period of 2009 up to 2011.

These concerns are further amplified given the fierce, rapidly evolving and well-funded

competitive technologies in this space. One example is the joint venture between Ensyn

and UOP.

The following assessment is based on limited additional information I received during the

meeting and presentations at KiOR on March 8th, and is constrained by the following

limitations:

1) I requested, but did not receive the “raw” actual pilot plant and demo plant yields

to be able to check the validity of the data presented to me.

2) I asked, but was not given the opportunity for private one-to-one interviews with

key technical personnel, who actually perform the work.

3) I did not receive answers to several critical questions asked during and after my

visit to KiOR

4) I asked, but was not allowed assistance from the in-house expert consultant, Prof

Vasalos, to analyze and validate yield performance.

5) I was not given access to detailed information regarding the properties, handling,

and the suitability of the raw bio-oil to be hydro-treated for upgrading.

Observations Notwithstanding the foregoing it is still possible for me to make the following

observations:

1) The KiOR management team has made excellent progress in building the

organization and scaling up the BCC process from the Pilot to the Demo phase and

now also the commercial phase (Columbus plant) in a record time of less than 5

years, considered impossible in the process industry.

55


2) The KiOR management and technical personnel feel confident that they can start

up the Columbus plant in 2012 and produce good quality saleable products

(Gasoline, Diesel, Low S Heavy Fuel Oil).

3) As can be expected, the major effort of R&D has been and still is in the scaling-up

of the process and the catalyst and hence only limited effort has been spent on

searching for the next breakthroughs. In fact the catalyst and reactor concepts

presently being developed were already conceived in 2009.

4) The way in which product yields are being reported (e.g. to the BOD) by R&D

management is incomplete and misleading and does not correspond with the

actual goal of improving overall yield of saleable liquid products.

5) The present overall yield of saleable liquid products, estimated from the

information received falls short of the targets set for 2012 (= 67 gallons per ton

bone dry wood, GPBD) and has not improved considerably over the last two years.

6) In my opinion it is still possible to reach the target of 67 GPBD and possibly even

also the long term target of 90 GPBD, but this will require a drastically different

approach, than presently being pursued by R&D.

Recommendations To achieve these very challenging goals, KiOR needs two separate and individual teams as

follows:

Team 1: Technology Optimization KiOR-1G

Implementation and optimization of the present demo-phase ideas/concepts being an

improved KC-2 catalyst and an improved 3/4G reactor, technical plant support, in

combination with significant improvements in the oil recovery (amongst others in the

water-oil separation) in order to ensure overall yield in 60-70 GPBD bracket by late 2012 or early 2013. This includes further hydro-treating technology development and

interfacing/screening catalysts supplied by the different vendors for use in the

commercial plants.

Team 2: Technology Breakthrough KiOR-2G, next-Gen

Develop the next generation catalysts and/or reactor design necessary to move the

overall yield up to the 90-100 GPBD bracket. Includes development of new more

effective, less costly, catalysts as well as development of new concepts in the production

of bio-crude and its upgrading to fuels.

It is of essence that the two teams are separately managed, with separate resources and

facilities, and that the teams will report separately and directly to the CEO and BOD.

Team 1 will in a certain sense be a continuation of the present R&D activities, albeit

significant improvements still need to be achieved in unifying the team and in

communications with all other departments

56


Team 2 will be a completely new effort and should involve a very creative Discovery Team

(DT) with dedicated resources, staffed with scientists and engineers with experience in

the “field” and managed by an established, well respected expert

My estimate would be that of the present 60 FTE’s R&D about 90% will be in Team 1 and

about 10% in Team 2 not including new hires with the above mentioned expertise

Furthermore to assist, advise and monitor the two teams, my recommendation is to form

a Technical Advisory Board (TAB) consisting of world recognized specialists. Monthly

separate progress meetings of the TAB with both teams will be required. The TAB will

report directly to the CEO and BOD.

Exhibit 4.4: Paul O’Connors April 30 2012 memo

MEMO: Towards a prosperous future for KiOR

By Paul O’Connor - April 30th 2012

I would like to repeat myself by starting to congratulate Fred Cannon and the KiOR team,

in particular Ed Smith for the timely and on budget completion of the first cellulosic

biomass conversion plant in Columbus.

During my time at Akzo Nobel Fred and Ed delivered similar achievements in construction

and commissioning of chemical plants, amongst other in Houston with the completion of the “CRUSADE” (Cost Reduction USA Damn Exciting) project, which saved Akzo’s FCC

catalyst business in the USA. So once again: Congratulations!

Up to the completion of Columbus, KiOR has been on time and budget with the delivery of

her milestones, however unfortunately since then the success ratio has not been so

dramatic, resulting in the following delays and shifts in performance targets:

A. The Columbus plant is not yet on-stream, and the suggestion is that it may take up

to nine-months before the plant is completely on-stream and ramped up to its

capacity at 85% utilization and product yields ( = x? Gallons Per Bone Dry Ton).

B. The product yields are not at the 72 Gallons per bone dry wood as estimated at the

IPO, and in fact the suggestion is that the 72 GPBD will only be reached in the

larger (and modified?) Natchez plant.

C. The catalyst being used at Columbus is based on large quantities of an expensive

zeolite (apparently public knowledge!) and the rumor is that no substantial costs

reductions are to be expected.

D. Based on A, B and C the overall economics and cash flow of KiOR will be

substantially less positive than estimated at the IPO etc. While KiOR management

is holding the info on A, B and C confidential, the overall financial result is and will

become more clearly visible.

57


E. Because of A, financing of Natchez plant has been delayed and so also start-up of

Natchez has been shifted at least one quarter from 4Q 2014 to 1Q 2015.

The result of the foregoing has been a dramatic drop in the KiOR share value, hurting the

interests of all its shareholders.

While I still fully believe in the benefits and the potentials of further development of

KiOR’s technology, I am very concerned about the way the technology is being

implemented. My strong impression is that KiOR’s management although very competent

and successful in the construction and commissioning phase, lacks the people with

experience, vision and leadership to move forward with necessary improvements of the technology (yield improvement and catalyst cost reduction) and operations (capacity,

ramp-up and time on stream). This is hurting KiOR now and could in worst case even turn

a potential success into a failure if no appropriate corrective action is taken.

This concern of mine is not new, and I have expressed it already for a while, also during

my tenure as director on the KiOR board and an official memo to the board and

management: “KiOR Technology R&D: Assessment & Recommendations” of March 22nd

2012 (exhibit 4.3), one year ago. As far as I know these recommendations have not been

followed up, while they remain at least just as relevant today as they were a year ago.

While I already for some time, no longer have any official function at KiOR and I do not

have any non-public information of KiOR, I am regularly being approached by shareholders

from BIOeCON heritage, but also by other institutional investors and the press, asking me

critical questions, amongst others why I am not actively helping the KiOR team to solve

their problems?

Keep in mind that the success or failure of KiOR is for me not only a financial issue, but

also as main inventor one of honor. Although KiOR never properly acknowledges the origin and heritage of the technology: BIOeCON and myself as primary inventor, most informed

outsiders are smart enough to figure that out.

I cannot just stand back and watch; As I see it now, the only thing I can really do is to ask

critical questions at the annual shareholder meeting on the 30th of May next in Houston

with the hope to get the ball moving in the direction of the corrective actions needed to

speed up the transition towards a profitable and prosperous business.

I understand that US securities laws requires that any answers must be released to the public via press release, so I am sending the questions for KiOR management and/or

board of directors before the quarterly report of May 9th, so that management and/or the

board of directors has the option to include answers in the press release(s) of

May 9th and/or in a second press release before or on the 30th of May.

Attached the questions, which I intend to raise at the shareholders meeting.

58


Separate to that, I would like the opportunity to present and discuss my thoughts on how

to tackle the issues raised by these questions with CEO Fred Cannon and Samir Kaul as key representative of Khosla Ventures (the controlling shareholder) in the board of

directors.

Questions for KiOR management at the shareholders meeting:

1) KiOR has disclosed that the expected yield of 72 GPBD, mentioned at the IPO will be

achieved in the Natchez plant. How sure is KiOR about that? What are the overall product

yields achieved at present in the R&D pilot plant(s) the demo plant and at Columbus? and

how and when does KiOR expect to reach the more ambitious target of 90 GPBD?

2) Two of KiOR’s previous operations managers (Coates ad Lyle) have stepped down,

leaving KiOR without a COO or VP Operations. The delay in starting up and getting

Columbus on stream could be related to this lack of operational leadership. Does KiOR

have sufficient high-level staff with sufficient operational hands-on experience in the FCC

and HPC processes to start up and run Columbus and a second plant in Natchez.

3) Does KiOR have a Scientific and/or Technological Advisory Board in place? How does

KiOR ensure an independent technical audit of their R&D and Operations to ensure quality

and progress in development?

4) When does KiOR expect to have the financing of the Natchez plant finalized?

59


Imprint

Published by: Climate-KIC European Headquarters

21 Great Winchester Street

London EC2N 2JA

United Kingdom

Authors: Tijmen Altena and Paul Tuinenborg

Edited by: Gunnar Glänzel

December 2017

Author info:

Tijmen Altena has a master degree in Innovation Sciences

with an emphasis on financial modelling and business

cases. Tijmen is co-founder of IDfuse and Impacter.

Tijmen is broadly oriented, involved both in product

development (for Impacter) and commercially oriented

consultancy (for IDfuse). [email protected]

Paul Tuinenburg has a background in innovation sciences

with a focus on sustainability. In 2012 he wrote a book

about innovation and currently he is impact specialist and

founder of IDfuse and founder of Impacter. With both

companies, focus is on helping researchers to make an

impact on the world and not just on academia. For

Climate-KIC, Paul is involved in several programs as a

coach, trainer and facilitator. paul @idfuse.nl

Documents

20171231 Biofuel start-up Case Study · 2018-03-23 · Biofuel Start-up - Strategic choices and decision-making in a novel industry 4 Strategic choices We’re in early 2006, and