Invest in some sound business advice

What makes a waste company an attractive investment opportunity for investors, particularly growth equity funds? Nicholas De Mestre offers some pointers

The UK waste industry is currently the focus of a great deal of interest from investors and entrepreneurs alike as the economics of excessive waste, increasingly stringent legislation, a historic reliance on landfill and a rash of developing technologies combine to create a booming industry.

This boom has led to a wide variety of opportunities for investors in businesses at different levels of development. Investment funds hoping to invest in the UK waste industry will be looking for different things depending on their strategy - from angel investors and venture capitalists through to the bigger leverage buyout players.

FourWinds Capital Management, an alternative investment manager, operates a waste resources fund (WRF), which is a program dedicated to waste resource and waste infrastructure. The fund is focused on growth equity - that part of the market which requires capital to help accelerate the growth of an existing operating business. These businesses will typically be well beyond the technology development stage favoured by more traditional venture capitalists but at an earlier stage than those businesses which are investment targets for funds focused on leverage buyouts.

So what is a growth equity investor looking for when assessing an investment opportunity? The answer is simple. A potential investee would have high growth and strong margins, proven, commercialised technology, a solid order book, a high percentage of contracted revenue for the coming year and an exciting pipeline. In an ideal world these attributes would also be found in a business looking for a reasonable valuation.

However, a business with all of these is, realistically, less likely to need external capital, and is even less likely to be looking to attract a conservative valuation. The kind of businesses that appeal to funds like WRF will need, to a greater or lesser extent, to possess some of these attractive qualities. Let's consider technology. Growth equity funds are typically not seeking to take a great deal of, if any, technology risk.

Commercial viability
This will mean that the technology being used will have been in operation for some time at a commercially viable scale and also treating the kind of waste stream that the company intends to sell the equipment for. After all, a business plan based on equipment sales to municipal solid waste (MSW) project developers where the equipment is only proven on, say, single source energy crops, carries with it almost as much technology risk as a sub-scale pilot plant which has successfully tested on MSW for six months.

In terms of business plan development, growth equity investors typically like to see positive revenues, stable gross margin and a bottom line that is at or close to being positive. In terms of a waste business, investors will either like to see a strong order book for equipment suppliers or, for developers, either assets in the ground already or a strong pipeline - preferably made up of projects with feedstock locked in, planning and permitting completed or at an advanced stage and a clear route from financial close to positive cashflow.

Another key issue is deliverability of forecasts - unrealistic expectations can cause an investor to lose confidence in management as forecasts are repeatedly adjusted downwards during due diligence. Investors prefer to see conservatism in forecasting because not only does it signal a focused and cautious management team but also a team that has a far clearer idea of how likely it is that the company will need another cash injection, when and in what circumstances.

Controlling costs
The other key forecasting items investors will focus on are gross and operating profit margins and how management control them. While investors do appreciate that bidding low as a new business is often necessary to secure all important references, gross margin weakness leaves the company vulnerable in a downside scenario.

It is key that it has the ability, where possible, to pass on at least some cost increases to its customer. At EBITDA (earnings before interest, taxes, depreciation and amortization) level the issue is often one of central costs - as longer term investors, growth equity providers prefer to see their money being spent on a flexible focused cost base that easily allows the company to react to events.

The final big item which can overlay all the other issues and cause a swing one way or another in an investor's view of a business is the quality of a management team. This is especially important in waste businesses, where their success or failure rests not purely on vision or design skill, on sales ability or operational excellence but on a mixture of all of these things. Investors will typically be seeking a well balanced management team made up of part engineer, part salesman, part entrepreneur and all realist.

Growth equity investors examining the UK waste space will ultimately be looking for opportunities that control their risk but offer enhanced returns. The best way a company can convince investors that it is the best option is to provide as much certainty as is possible in a very fast moving industry.

Nicholas De Mestre is an associate at FourWinds Capital Management

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