Cellulosic Ethanol Collaborations: Matchmaking Isn't Easy

By Carey Jordan and Paul Landen | October 06, 2008
Soaring oil prices, the concentration of hydrocarbon reserves in countries with unfriendly or unstable regimes, the worldwide push to lower greenhouse gases, and the emerging political concerns regarding food-based biofuels have led some to refer to cellulosic ethanol as a "silver bullet" solution to the energy crisis. The U.S. renewable fuels standard mandates that advanced biofuels, which include cellulosic ethanol, constitute 21 billion gallons of the nation's gasoline pool by 2022. However, no commercially available cost-effective cellulosic biofuel technology is yet available.

Start-up ventures, funded largely by venture capitalists, have taken the early lead in developing cellulosic biofuel technology. In the race to develop cost-effective commercialization of cellulosic biofuels, major oil, chemical and automotive companies, acting as strategic partners, have entered into collaborations with these start-ups. These arrangements, likened by some to the tie-ups between big pharmaceutical and biotechnology companies, provide the start-ups with needed cash and potential project development, logistics and infrastructure support, and allow the strategic partner to immediately bolster its green credentials and provide key technologies without the delays, risks and costs inherent with in-house development.

Recent examples of these include the strategic alliance between BP Amoco PLC and Verenium Corp., the joint venture between DuPont and Genencor, and investments by Marathon Oil Corp. and General Motors Corp. in Mascoma Corp.

Left unstated in the glowing press announcements looms the potential for divergent interests between the strategic partner and the start-up. Both parties should choose the other with care and understand the potential areas of misalignment.

Are the Parties Aligned?
The start-up will seek to commit the strategic partner to provide financing sufficient to satisfy its investors, as well as to enable the start-up to weather schedule slippages and problems that arise during the pilot process or commercialization. In addition, the start-up may be looking to the strategic partner for much-needed expertise in project/construction management and plant operation, regulatory compliance, logistics support, marketing to blenders, and/or pursuing and maintaining patent protection on a global basis. The start-up will also want to prevent the strategic partner from foreclosing other options for it to exploit its technology to provide its investors with the quick returns and exit options venture capitalists and hired-in professional management teams seek.

The strategic partner's objectives will in part depend on the nature of the investor. For instance, it's likely that DuPont wants to commercialize and license technology that it believes will be useful in the field. GM wants to secure a green source of ethanol production for its next-generation flexible-fuel vehicles but doesn't want to be an ethanol producer. On the other hand, Weyerhaeuser Co. likely sees opportunities for its wood mills and forest plantations as cellulosic ethanol can be produced from wood chips and wood mill tree waste.

Some objectives will be shared by many strategic partners regardless of their nature, and these objectives often are not aligned with the start-up's objectives. First, the strategic partner won't want to be locked into a single company or single technology as indicated by GM's investments in both Mascoma and Coskata, which have different technologies. Additionally, Shell has invested in Choren Industries GmbH, a German company focused on producing biofuels from biomass (e.g., wood chips), in addition to taking an approximately 50 percent ownership interest in Iogen Energy, a Canadian firm making biofuels from non-food sources (e.g., wheat straw).

Second, a strategic partner will want to control its spending both in the aggregate and year-to-year. Moreover, the strategic partner will seek the flexibility to cut its losses and stop funding if milestones aren't met or test results are unfavorable.

If the technology proves successful, the strategic partner likely has a longer investment horizon than the start-up's investors and will seek an exploitation plan tailored to its strategic objectives, which likely differ from the start-up's investors. The introduction of a strategic partner could potentially accentuate divergence in the interests of the start-up constituencies. While the strategic partner likely will be focused on ensuring that the founders and technology gurus of the start-up are properly incentivized to stay, it may have far less interest in protecting the start-up's professional management and financial backers.

A Range of Collaboration Forms
Just as there is an array of potential types of strategic partners, there is a range of potential collaborative forms to consider. They are not all mutually exclusive. The most straightforward and least entangling arrangement is a technology license from the start-up to the strategic partner.

A variety of commercial arrangements short of a full joint venture are possible. The BP/Verenium strategic alliance is one example. During an initial 18-month "strategic alliance" that is intended to last through development of a pilot plant, the parties license their respective technologies to a newly formed special-purpose entity owned by them 50/50, with the parties retaining ownership of their respective technologies. Jointly developed intellectual property during such a period is owned by the special-purpose entity. Following the strategic alliance, the parties are expecting to negotiate a joint venture for commercial production of cellulosic biofuels.

Dupont Danisco Cellulosic Ethanol LLC is illustrative of a robust joint venture. Dupont and Genencor (a division of Danisco AS) announced that they have formed a 50/50 joint venture to which each partner contributed certain technology. The partners have committed to spend a total of $140 million over three years to develop the technology and construct pilot plants with a view to licensing the technology once it is proven successful.

In connection with a strategic alliance or a technology license, the strategic partner may make an equity investment in the start-up. The equity investment creates alignment by providing economic reward to the strategic partner for the start-up's future success. Often the investment will be accompanied by board representation or other governance, access or intellectual property rights. Recent examples include the GM and Marathon investments in Mascoma, GM's investment in Coskata, and Shell's investment in Iogen and Choren Industries.

The ultimate collaboration is a full acquisition of the start-up by a strategic partner. Once companies develop technologies that are proven to be commercially viable, acquisitions of start-ups by strategic players are expected.

Technology Ownership, Licensing Issues
A host of issues, including governance and exit strategies, valuation of relative contributions and other matters are presented by these various collaborative arrangements. Because technology is the core asset of the start-up and the key to unlocking the success of cellulosic ethanol as an industry, the following focuses on a few key technology licensing issues.

By virtue of a collaboration with a start-up, the strategic partner is risking not only its cash outlay for unproven technology, but also exposing itself to potential liability for patent infringement if commercializing the start-up's technology infringes the intellectual property rights of others. In an infringement suit, the strategic partner will be the "deep pocket," and therefore a target of any potential patent action, which is definitely undesirable as treble damages are possible. Moreover, such risks are real and looming, not only because of the buzz surrounding cellulosic ethanol, but also the sheer number of companies developing technology.

Because of these potential risks, it is critical that the strategic partner do the necessary due diligence before entering into a collaboration with the start-up. The diligence should not only evaluate the start-up's technology and patent portfolio, it should also involve a clearance analysis to identify any other patents that may prove to be blocking patents to the strategic partner's commercialization of the start-up's technology. By performing the due diligence, however, the strategic partner should be aware that if the negotiations fail, it could subject itself to potential claims by the start-up, especially if the strategic partner makes a different investment with another company using similar technology.

A key concern for the start-up in any technology licensing arrangement with a strategic partner is how much control the start-up retains over the technology to be able to continue to monetize this primary asset. Ownership of improvements and the start-up's ability to license those will also be a concern. To protect the start-up's interests, the agreement could carve out "fields-of-use" (i.e., restricting permitted use to a particular industry or product) to create future licensing paths for development with other players. The strategic partner may insist that these be limited to industries or products outside of its primary field or to companies that are not its key competitors.

Another key negotiating area for both the strategic partner and the start-up will concern what happens to the technology and licensing rights should the collaboration fail. These must be considered.

Choose Carefully, Do Homework
Both the constituent members of the start-up and the strategic partner must choose their partners carefully in any collaboration, structure arrangements that meet their specific needs, do their diligence and other homework, go into negotiations with eyes open and develop a negotiation strategy that addresses both the possibilities of future success and potential failures of the collaboration.

Paul Landen is a partner in the global projects group of Baker Botts LLP. Reach him at paul.landen@bakerbotts.com or (713) 229-1173. Carey Jordan is a partner in the intellectual property group of the law firm Baker Botts LLP. Reach her at carey.jordan@bakerbotts.com or (713) 229-1233.