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BIOCYCLE NOVEMBER 2009

DESPITE the extraordinary eco-nomic challenges the U.S. andglobal economies have experi-enced, the organics recycling in-dustry remains an active and at-tractive sector, weathering theeconomic storm comparatively

well. Indeed, if you were at last month’s Bio-Cycle conference, it was hard to miss the op-timism and excitement.

To be sure, our industry faces significantchallenges, including regulation, permit-ting, technology, competition and legisla-tion. However, heading the list in thisvolatile economic climate may be access tocapital. The best business plans and themost capable teams can do little withoutthe capital to turn ideas into realities. Andnot just any form of capital, but capital atacceptable terms and structured in the ap-propriate way to achieve long-term eco-nomic viability. There are many examplesof good businesses that fail because of badcapital structures.

So how does one go about determiningwhat kind of capital is right for a particularset of circumstances, and what terms andconditions should be deemed “acceptable”?One way to address this question is to lookat what others have accomplished. For ex-ample, what deals have been done in our in-dustry over the last couple of years? Howwere they structured and why? What fac-tors were unique both in terms of the par-ticipants as well as the general economy?What lessons can be learned? How mightthese apply to your particular situation?This article provides some basic tools to

Investment banking professionals dissectrecent transactions in the organics recyclingsector. Their findings will guide othercompanies in this industry.

Andrew C. Kessler and Jason A. Seltzer

DEBT AND EQUITYOPTIONS FORORGANICS RECYCLINGINVESTMENTS

Garick Corporation was sold to HendricksHolding Company, Inc. in 2007. Itscomposting operations (facility above)process a variety of source separatedorganics, including food waste (left).

RAISING CAPITAL

help answer those questions, including ex-amples of recent transactions in the organ-ics recycling industry.

CHOOSING THE RIGHT TOOL Some key factors involved in making fi-

nancing and capital structure decisions in-clude whether to raise debt or equity, orsome hybrid, and which types of investorsto target (and how to access them). Under-standing when and how to use certaintools or financial products can materiallyimpact the quality of the end product (i.e.,the capital structure and resulting finan-cial obligations). Knowing how to proceedinvolves consideration of the following:

Strategic rationale. What is the endgame? Decisions you make regarding yourcapital structure can often constrain yourstrategic alternatives.

Use of proceeds. All investors want to knowhow their capital will be deployed. Raisingcapital that is paid out to shareholdersrather than used to build the business maybe problematic to some capital providers.

Collateral. Investors will always run a“worst case” scenario. What if things gobadly, very badly? Are there assets that aninvestor could rely upon to cover some ofthe investment risk? How does pledging orencumbering those assets impact yourbusiness going forward?

Cash flow. How much cash flow does the

company generate? Is there consistency inthe historical cash flows? Is there enoughcash flow to meet anticipated debt serviceand payment over time of the principal?What kinds of risks are imbedded in thecash flow stream (e.g., seasonality, cus-tomer, product or market concentration,technology, etc.)? The profile of the cashflow must match the profile of the debt ser-vice and amortization schedule.

Maturity. Unlike equity capital, debteventually has to be repaid. If you do notanticipate having sufficient cash to repay aloan, you are introducing “refinancing risk”into your business model. To compensatefor perceived refinancing risk, lenders willseek higher interest rates and contractual-ly limit things you can and cannot do with-in documents known as credit agreements(in the case of a bank loan) or indentures (inthe case of a bond financing).

Market conditions. The presumption of ra-tional behavior underlies most economic the-ories. But people make decisions about eco-nomic activities and people are, at best, onlyoccasionally rational. Financial products un-dergo periods of fads, trends, bubbles andcrashes. It is within these periods when,quite often, the market no longer rationallyprices risk. During bull markets, risk is of-ten priced too cheaply — the cost of capital isirrationally low and capital is available tounreasonably risky projects. During bear

Some financialsponsors requirecontrol as acondition of makingtheir investment.Others do not.

BIOCYCLE NOVEMBER 2009

ADVANCING COMPOSTING, ORGANICS RECYCLINGAND RENEWABLE ENERGY

419 State Avenue, Emmaus, PA 18049-3097610-967-4135 • www.biocycle.net

Reprinted From:November, 2009

markets, the converse is true. Market condi-tions must always be taken into account andyour financial tool chest will expand or con-tract accordingly.

ACCESS TO CAPITALDepending on a particular company’s sit-

uation, financial profile and stage of growth,there are a number of different ways to ac-cess capital. These include: Incurring debtby borrowing from banks, institutionallenders or other financial sources; Issuingnew equity to private equity partners; Issu-ing new equity via the public capital markets(e.g., initial public or follow on offerings); andSelling the company itself to a third party.

Private equity firms, commonly referred toas financial sponsors, play various roles assources of capital and acquirers of compa-nies. Private equity sponsorship may be acompelling way to finance a company, partic-ularly for early stage ventures when raisingdebt capital is not viable due to insufficientcash flow and operating history. In additionto equity capital, financial sponsors can pro-vide many important capabilities, which canbe particularly valuable to early stage com-panies. These include strategic advice; accessto other sources of capital; network of rela-tionships; financial analysis and modeling;corporate planning and structuring; and ad-ministrative and legal support.

But equity financing can be quite dilutiveto existing equity holders. Issuing equity isgranting another party the right to partici-pate in the upside (or downside) of your com-pany. A variety of private equity strategiescater to different deal sizes and stages ofcompany maturity. Some financial sponsorsrequire control as a condition of makingtheir investment. Others do not, but eventhose that do not will want some degree of in-fluence in the form of Board representation.

Some common categories of financial spon-sors include: Angel investors — includingprofessional investors as well as friends andfamily — are often the first source of thirdparty equity; Venture capital investors investin early stage companies; Growth capital in-vestors fund more mature companies seekingexpansion capital; and Leveraged buyout in-vestors acquire control of companies and usedebt financing from the target company topartially fund the acquisition price.

All of the financing and monetization op-tions just described have been pursued byvarious companies within our industry.Within the set of transactions highlighted inthis article, there are examples of: Borrow-ing to finance a large-scale facility (Peninsu-la Compost Company, LLC); Selling to a cor-porate acquirer (Garick Corporation); andPartnering or selling to a private equity firm(Harvest, Inc., Living Earth TechnologyCompany and StormFisher Biogas).

SALE TO CORPORATE BUYER In October 1980, Gary Trinetti and

Patrick Mahoney founded Garick Corpora-tion. Over the years, Garick has become a

leading manufacturer and distributor of nat-ural resource products servicing the land-scape, recreation, lawn, garden and con-struction industries. In January 2007,Trinetti and Mahoney sold Garick to Hen-dricks Holding Company, Inc.

Although any financing that may havebeen used has not been disclosed publicly,Hendricks Holdings appears to have hadthe wherewithal and access to credit tomake the purchase from existing cash flowand/or lines of credit. Hendricks Holdings isone of the largest private companies in theU.S., with a diverse portfolio of operatingcompanies. ABC Supply (one of the princi-pal assets in the portfolio) is currentlyranked the 155th largest private companyin the U.S. by Forbes, achieving sales of$2.9 billion with 5,005 employees. Accord-ing to Forbes, Ken Hendricks himself had anet worth of more than $2.6 billion in 2007and was ranked 91st in its list of 400 rich-est Americans.

Like most private transactions, this was a“friendly” deal. Trinetti met Hendricks 23years ago at a conference in Houston. Overthe years, the relationship grew. Discussionsbetween the companies started informallyas early as 2002 when Hendricks became in-creasingly intrigued with monetizing whatothers considered “waste” into valuable andmarketable new products. By 2006, a com-mon vision formed that led Garick’s control-ling shareholders to sell the company toHendricks Holdings and agree to stay on andcarry out this common vision, a testament tothe close relationship forged between theparties over many years.

Although Trinetti and Mahoney stayed onto manage the company, strictly speaking thetransaction represents a clear example of asuccessful financial exit within the organicsrecycling sector. These are very importantdata points for investors, particularly finan-cial investors who want to fully understandwhat exit strategies are viable before makinginvestments in a given industry. In additionto the sale of a company, other exit strategiesinclude taking a company public (commonlyreferred to as an Initial Public Offering orIPO) as well as “cashing out” over timethrough the receipt of dividends.

VENTURE CAPITAL SPONSORSHIP/INCUBATIONThe story of Harvest, Inc. is less about a

transaction than it is about the birth of aplatform, i.e., the creation of a new company(versus an early stage company shopping it-self to investors). Conceived on a white boardin the Menlo Park, California offices ofKleiner Perkins Caufield & Byers, Harvestis an example of a company incubated by anentrepreneurial firm to take advantage ofcompelling opportunities they see in the or-ganics recycling and biogas sectors.

Kleiner Perkins specializes in investing inemerging industries. Although it is moretypical for a venture capital firm to invest inan existing early stage company, in the caseof Harvest, Kleiner Perkins formed a view of

BIOCYCLE NOVEMBER 2009

Living Earth wasacquired for about$37 million in aclassic middlemarket leveragedbuyout.

the emerging biomass sector and assembleda team to execute its business plan. Thatteam is led by Paul Sellew, who has been inthe organics industry for more than 25years. Harvest is an organics managementcompany that integrates composting and en-ergy production.

In the September 2009 issue of BioCycle,Amol Deshpande, a partner at KleinerPerkins, wrote an article titled “Investing InThe Biomass Industry.” Elements discussedin the article, which are relevant to this ar-ticle, include: Monetize biomass on the basisof highest and best use; Distributed modelsthat fit into existing organic feedstock sup-ply chains will lead to more value thanmegascale centralized approaches which re-quire creating enormous supplies of feed-stock; Leveraging existing supplies of organ-ic feedstock as opposed to growing organicsto use as biomass feedstock; and Businessmodel must be viable without the need forgovernment subsidies.

MIDDLE MARKET LEVERAGED BUYOUT Living Earth Technology Company is the

largest recycler of organic material andcommercial manufacturer of mulch, com-post and soils in Texas, diverting and pro-cessing over 600,000 tons of material an-nually. Recognizing an opportunity toacquire an attractive platform in the or-ganics recycling sector, the principals ofTerra Verde Partners LLC acquired LivingEarth from Republic Services, Inc. inNovember 2007. At that time, the princi-pals of Terra Verde were part of the privateequity division of Hunt Consolidated, Inc.,a diversified holding company directed byRay L. Hunt. Although Hunt’s principalshave been active in the organics recyclingindustry for some time, Terra Verde wasformed to focus exclusively on the environ-mental sector. One of its primary invest-ment initiatives is to more aggressivelypursue new investments in the NorthAmerican organics recycling sector.

Living Earth was acquired for approxi-mately $37 million in a classic middle mar-ket leveraged buyout by a financial sponsor.Republic had determined that Living Earthwas a noncore asset (often referred to as a“corporate orphan”) and chose to divest theasset. Such transactions are commonly re-ferred to as “carve outs”. According to Re-public’s press release announcing the trans-action, Living Earth had average annualrevenue of approximately $50 million andgenerated low double-digit operating incomemargins. The investment appears success-ful. According to Terra Verde, within ap-proximately one year following the transac-tion, revenue and operating cash flow grewby 7 percent and 35 percent, respectively,and the number of facilities increased from13 to 16.

Consistent with traditional leveraged buy-outs, the transaction was financed with equi-ty from the financial sponsor as well as bankdebt and mezzanine capital. Traditional

bank lenders will typically only lend up to acertain amount; however, some investors willagree to lend more to a company in exchangefor higher yield. In this case, Living Earthwas able to access incremental debt from themezzanine market. Mezzanine capital refersto deeply subordinated debt that often repre-sents the most junior position within the cap-ital structure aside from common equity.

Although mezzanine capital can be signif-icantly more expensive than traditional bankdebt, raising incremental debt enables theacquirer to reduce the amount of equity need-ed to fully fund the acquisition price. Gener-ally, the less equity needed to acquire an as-set, the higher the potential equity returnson that investment are likely to be. Of course,with the potential for higher return comeshigher risk as one is now operating a compa-ny with more debt (commonly referred to as“leverage”) in the capital structure.

FINANCING A LARGE-SCALE FACILITY Next month, Peninsula Compost Compa-

ny, LLC will complete construction of its in-augural commercial composting facility inWilmington, Delaware. The $20 million, 28-acre facility will be capable of processing160,000 tons/year of organics and will be thelargest food waste and yard trimmings com-posting facility on the East Coast. Peninsu-la has partnered with the W. L. Gore & As-sociates Company for use of Gore’s in-vesselcomposting system that will be used at theWilmington facility.

The Delaware facility was financed with acombination of equity from the senior man-agement team and local equity partners aswell as bank debt. The bank deal was led byWSFS Financial Corporation. Peninsulawas able to secure funding even as some ofthe most well known commercial and in-vestment banks were undergoing unprece-dented trauma. It found a local lender whounderstood the local market sufficiently tocommit capital to this project.

Peninsula’s experience is a lesson in per-sistence and flexibility. During the springand summer of 2008, Peninsula was pursu-ing a debt private placement and had beenmaking good progress. When the capitalmarkets began to severely deteriorate, com-mitments they thought they had were nolonger reliable. By September 2008, they ef-fectively had to start from scratch, but byMay 2009, they had secured committed cap-

BIOCYCLE NOVEMBER 2009

Peninsula Compost Companywas financed with equity fromthe senior management team,local equity partners and bankdebt. Startup of the $20million, 28-acre facility isexpected in December. Thereceiving/preprocessingbuilding is shown above.

The emergingorganics recyclingand biogas sectorsseem to haveelements thatappeal to differentcategories of equityinvestors.

ital from the local lender and broke groundthat month. Construction is expected to becompleted ahead of schedule.

During times of economic uncertainly, theprice of risk can rise dramatically. It is like-ly that Peninsula’s cost of capital and theamount of equity required in the deal wassignificantly higher than what they wouldhave been had the deal been structured theprior year. Nevertheless, Peninsula was ableto secure the necessary funding.

FINANCIAL SPONSORSHIP OF EARLY STAGE COMPANY

StormFisher Biogas is developing biogasfacilities across North America utilizinganaerobic digestion technology. In February2008, StormFisher announced that it hadformed a strategic partnership with Den-ham Capital Management, a global energyfocused private equity firm based in Boston,Massachusetts, to develop a $350 million(Cdn) portfolio of biogas projects.

According to StormFisher, Denham recog-nized that StormFisher had many charac-teristics that fit well with Denham’s invest-ment criteria, including: High upfrontinvestment needs followed by annuity cashflow; Replicable model; Low technology riskgiven well established anaerobic digestionmarkets in Europe/Asia.

We spoke to StormFisher about their re-cent experience in accessing debt to comple-ment the equity investment commitmentfrom Denham. The significant disruptions tothe capital markets over the past year havehad a negative impact on the project financemarket. There is a greater appetite for larg-er ($100 million plus) deals with lower re-turn profiles than smaller ($10 to $30 mil-lion) projects with higher return profiles.However, opportunities for debt financingfrom equipment finance groups, agricultur-al banks (“AG Banks”) and governmentsponsored funding for renewable energy pro-jects remain viable sources of capital.

However, given the more capital con-strained environment, lenders are evenmore focused on risk mitigation through con-tractual arrangements, including: Feed-stock contracts to provide both volume andprice certainty; Purchase power agreements;Engineer Procurement Contract remediesassociated with biogas yield guarantees; andEnd product sales contracts for the compost,bedding, etc.

TAKEAWAY LESSONSThe emerging organics recycling and bio-

gas sectors seem to have elements that ap-peal to different categories of equity in-vestors, blurring the lines between angel,venture capital and later stage investors. Weknow examples of development stage compa-nies within our sector that have attracted an-gel investors. Kleiner Perkins is an exampleof interest from the venture capital commu-nity. Terra Verde represents interest frommiddle market, leveraged buyout investors.And StormFisher’s experience demonstrates

interest from large/global energy focused fi-nancial sponsors. This expanse of interestprovides operators and entrepreneurs with awide set of equity investor alternatives. Itshould be noted, however, that each ap-proach can lead to very distinct outcomes forexisting investors. As previously mentioned,some categories of financial sponsors typical-ly require control as a condition of makingtheir investment; others do not.

It is clear that the due diligence bar for ac-cessing capital is higher than ever, whichunderscores the need for operators and en-trepreneurs to do the work necessary to mit-igate the risk profile of their business andjustify all key assumptions that materiallyimpact their financial projections. Ask your-self the hard questions and have answers tothem before meeting with investors. There isnot a “one size fits all” solution. Identifyingand assessing some of the factors we dis-cussed will help you hone in on what form offinancing and structure is most appropriatefor a given situation.

KEEPING THE PHOENIX FLYINGAlthough the prevailing economic envi-

ronment can widen or narrow your financialtool chest, good projects with good manage-ment teams can be financed even in theworst of economic times. There are lots of ex-amples of successful companies thatlaunched during extraordinarily difficulteconomic environments, including: Procter& Gamble, The Panic of 1837; IBM and Gen-eral Electric, The Long Depression, 1873-1896; General Motors, The Panic of 1907;United Technologies Corp., The Great De-pression; and FedEx, The Oil Crisis of 1973.

We chose these examples out of dozens ofbrand name success stories to make anotherpoint. While good deals can get financed evenin the worst markets, success over the longterm and under changing competitive andeconomic conditions is much more difficult.The above list proves that “out of the ashescan arise a phoenix;” the real trick is keepingthe phoenix flying over the long run. �

Andrew C. Kessler (andrew.kessler@turningearthllc.com) is a Managing Director andFounding Member of Turning Earth, LLC, anorganics recycling company focused on produc-ing biogas, compost and sustainable agricul-ture. Prior to launching Turning Earth, hespent 15 years as an investment banker. JasonA. Seltzer, CFA (jason.seltzer@lovellpartnersllc.com), is a Partner with Lovell Partners LLC,which provides financial advisory, capital rais-ing and general consultancy services for select-ed domestic and international clients. He has aparticular focus on alternative energy. The au-thors thank the individuals at the companiesprofiled, including Phil Arra, Terra Verde Part-ners LLC; Amol Deshpande, Kleiner PerkinsCaufield & Byers; Ryan Little, StormFisherBiogas; Gary Trinetti, Garick Corporation; andScott Woods, Peninsula Compost Company,LLC. They also thank Deven Bhatt for his con-tributions to this article.

BIOCYCLE NOVEMBER 2009

The due diligencebar for accessingcapital is higherthan ever, whichunderscores theneed for operatorsand entrepreneursto do the worknecessary tomitigate the riskprofile.