Venture Capital for Financing Hydropower

Definition

Venture capital is a type of private equity that refers to equity investments made, typically in less mature companies, for the launch, early development, or expansion of a business. Venture investment is most often found in the application of new technology, new marketing concepts and new products that have yet to be proven.

Venture capital is a very important source of funding for startups that do not have access to capital markets. It typically entails high risk for the investor, but it has the potential for above-average returns.

Definition by Investopedia

Venture Capital for Financing Micro-Hydro in Rwanda (GTZ Case Study)

In the project, “PSP Hydro” 6 Rwandan companies are being awarded a 50% subsidy to build and operate 6 micro-hydro plants and mini-grids supplying rural areas with electricity. So far 5 projects are in process of preparation and implementation. In preparation of the PSP Hydro II, possible future finance instruments and mechanisms have to be identified. Many instruments are already available to project developers and it is recommended to include venture capitalists early in the selection procedure of new project developers.

Financial institutes and available instruments for micro hydro

The traditional financial sector in Rwanda is composed of:

• a national bank (Banque National de Rwanda, BNR),
• a development bank (Banque Rwandaise de Developpement, BRD),
• a housing bank (Rwanda Housing Bank, RHB) and
• six commercial banks (BCR, BCDI, BANCOR, FINA BANK, COGEBANQUE, BK).

Two years ago three parties started within the banking sector to offer leasing products (BRD, BRC and BK) and they formed the leasing association of Rwanda. Also guarantee mechanisms are in place: the African Solidarity Fund (ASF) operates from Niger and the African Guarantee Fund and Economic Cooperation (FAGACE) operates from Benin.

Further, two venture capital funds to support the private sector have been recently opened their doors: Rwanda Enterprise Investment Company (REIC) and GROFIN. They both had contacts with project developers.

It can be summarized that the PSP Hydro contributed to the situation that micro hydro is now considered by the majority of the financial institutions as a finance possibility. All agreements to the project developers are still at an early stage, some disbursements have been made, and therefore it is too early to indicate whether in future it will be considered a good finance opportunity. At this stage, conditions offered to project developers in micro hydro are in line with long term finance conditions in other segments of the economy.

Perspectives on finance and bottlenecks in micro hydro

The bottlenecks are presented from different perspectives: banks, venture capitalists, developers, ministry and donors. It is interesting to note that these bottlenecks differ with the perspectives of those parties. A classical example is the difference between bankers and venture capitalists.

A banker’s main focus is risk mitigation whereas a venture capitalist main focus is to build on an opportunity. A venture capitalist (VC) will focus on the management and its capability to generate future cash flows. When a bank focuses on risk mitigation the contribution of the sponsor is important, therefore the debt/equity ratio. It is all about the ability of the sponsor to bring in cash or collateral if the project goes wrong. Of course a good banker will also evaluate the management and the project but if sufficient subsidy is involved the debt/equity ratio will give too much comfort. Therefore the subsidy is perceived by the bankers as an instrument to fulfill the equity requirement of the project developer. For the project developer the subsidy is an instrument to get access to a loan. It will add to the project’s equity and therefore reduces the debt equity ratio. However the venture capitalist will perceive this subsidy as a possible weakness: it might reduce the commitment of the sponsors, it might transfer ownership from the sponsors to the donor. The sponsors might get a free ride and in case of problems ask the donor to solve it. However the donor will most likely build on its own regulations to limit itself to a certain maximum contribution. The donor can offer financial and technical support without too much risk.

The Table below presents the above perspectives and also how the parties have put instruments in place to overcome the challenges or mitigate the risks involved (this is written under the heading Actual Instruments). A potential alternative instrument is presented in the last column in line with a future possibly more market oriented approach to help to overcome the bottleneck.

Perspectives on bottlenecks related to finance

It seems that venture capital can contribute to solve problems for many parties. From the perspective of the banks it is real equity and gives direct comfort (lower gearing). Therefore the requirement for loans might be lower. The venture capitalist will make sure that the developers will put in sufficient money themselves. Moreover their VC contribution and the PSP Hydro II contribution will generate extra capital. The developers will have business development support for financial planning on board from the venture capitalist. This is better compared to an external advisor. The ministry and donors can leverage their money each investment cycle. The subsidy can be used more efficiently and more often.

Bottlenecks related to project developers capacity and skills

Different bottlenecks on the implementation capacity and the skills of the project developers were identified by a selection of interviewed stakeholders. These bottlenecks are presented in the next table.

Perspectives on bottlenecks related to project developers capacity and skills