Dark Thoughts: Solar is Useless for Ice Cream Lovers

NER’s CSO & CCO, Brentan Alexander, reflects on northern California’s “Public Safety Power Shutoffs” occurring this fire season. Because, you heard that right, California now has a fire season.

 

The most surprising thing about this power outage is how loud it is. As I write this, Pacific Gas and Electric Company (PG&E) has temporarily turned off the power to as many as 3 million people across northern California, and the sound of countless consumer-grade gasoline generators is echoing throughout the valley. You’ve likely heard about PG&E’s actions since it made international headlines (to offer just a sample from The Guardian, The Economist, and Financial Times). The effect is being acutely felt by the NER team; we all live within the PG&E service territory. 

For myself, that means I’m on hour 30 without a utility hookup. My garage door is stuck, laundry is piling up, and I’m reminding myself not to open the freezer by applying tape to the handle with the words ‘DO NOT OPEN’ scribbled in sharpie. It’s a failing strategy: I’ve accidentally peeked inside twice. But I’m not in the dark. Outside, my 15-year old Toyota Prius with 150,000 miles is happily running a small DC-AC inverter, kicking on the engine as needed to keep the battery topped up, and providing the house with lights, a few working outlets, and power for the internet.

It’s an absurd situation, but one I’m reasonably well equipped to understand and handle. Working in the insurance industry where I think often about risk makes me wonder if these shut offs are really helping reduce fire risk, or just reducing PG&E’s exposure. On the one hand, the vast majority of large fires in California over the last few years have been caused by utility equipment (burning over a half-million acres since 2000). De-energizing lines surely reduces the risk of utility-sparked fires dramatically. And yet, there are now a large number of generators in operation, each manually filled from gas canisters. How many of these systems are properly wired to the house and up to code? (My Macgyver Prius generator sure isn’t.) A common solution to a lack of electric lights is also to literally light fires, albeit small controlled ones (ok: candles). Surely the uptick in candle usage increases the risk of an accidental fire. And then there’s the separate issues of deaths caused by offline medical equipment, or the loss of phone power to report other local emergencies. I have yet to see a detailed analysis of this risk tradeoff. Perhaps it’s good to trade the risk of (A) remotely started fires in rugged terrain from large power lines with (B) fires started in populated areas (where they’re more likely, perhaps, to be caught early and extinguished?). I do not know the answers. All that is certain is that this action lowers financial risk for PG&E, on the backs of financial losses (e.g. spoiled food, lost business) of their customers. 

I brought this risk tradeoff question up with a neighbor, and he quickly pivoted to a different but related point: how much reliable electricity is taken for granted and how little the average person knows about how it works and how it’s delivered. He was primarily talking about his frustrations with his solar system. Across my neighborhood, countless homes have gleaming panels on the roofs, some coupled with shiny battery packs mounted on the side of the house. All of these houses currently lack power. My neighbor simply didn’t know that solar is useless without a working electric grid, and for the folks with batteries, I doubt those owners understood that most of their inverters were not designed to island during a blackout. For my neighbor, I could sense his exasperation that this panel on his roof, which can generate electricity, somehow can’t power his home. A discussion on alternating vs. direct current, load matching, and frequency regulation was met with a blank stare and shake of the head. 

My hunch is that this experience will lead more people who currently lack solar to seek to install it (especially with the imminent step-down in the investment tax credit). I wonder how many of those installs will be done with the latest generation hardware (enabling the house-sized nanogrid), and how many installs will instead be the usual setup that only allows for power when PG&E keeps the street energized. 

That leads me to another question: these household systems have been built around a particular financial story; will it hold up? The utility death-spiral, wherein more and more consumers put solar on their roofs and therefore lower utility revenuesall without lower O&M costs to maintain miles and miles of utility lineshas been explained in exhaustive detail for nearly a decade. But the sudden bankruptcy of PG&E raises the distinct possibility that the current rate structure will be reshaped to ensure the financial viability of the utility while funding the repair and replacement of the ageing and failing infrastructure causing this whole mess. The more the utility bill shifts to distribution charges instead of use charges, the less the home-solar array will payoff.

For now, there are just questions and accusations. Should I point my finger at PG&E, climate change, or the inverse condemnation doctrine? (A recent article by Micheal Shellenberger broke this down well.) Does it even matter? None of that blame is going to get someone to replace my lost pint of rocky road.

 

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Your Project Finance Should Be a Fat Bear

Your Project Finance Should Be a Fat Bear: Loan Life Coverage Ratio and Why It Matters

By Matt Lucas, PhD; NER's Managing Director, Business Development

 

I’m a huge fan of the US Park Service’s Fat Bear Week, which features some huge bears. The bears have been fattening up all summer and fall for their long winter hibernation. This is the opposite of fat shaming—fatter is better. But truth be told, if they get too fat it’s harder for them to do, well, bear things.

You may not have jumped to the same analog as me, but hear me out: Debt is to project finance as fat is to bears. When you’re building a new facility, as many of New Energy Risk’s clients are, you’ll want some debt. Quite a lot in fact. But too much debt makes the project unwieldy. An over-leveraged project won’t be nearly as healthy looking to your cap table as the fattest of the fat bears.

We know that raising money is hard. Raising equity is especially challenging: equity is in the most junior position to receive cash flows, and equity fundraising is a more linear, incremental process than raising debt. In contrast, raising debt via a public bond offering can raise vastly more capital with similar effort.  And maybe most importantly, debt has a lower cost of capital! It’s no wonder that project developers try to minimize the equity they have to raise in order to accelerate their execution timeline and improve financial returns for their existing equity investors. However, this approach can lead to projects that have too much debt instead. So how do you know what’s the right amount of debt? (You want a fat bear, not a fat bear that can’t climb!) The answer is in your loan life coverage ratio.

 

What’s a Loan Life Coverage Ratio (LLCR)?

An LLCR is a metric that relates available cash to debt service to the cost of the debt service. A higher number is more favorable and means your project can get fatter on debt without drawbacks, reducing the amount of equity otherwise required. A handy equation:

LLCR = [ (net present value of cash available for debt services over the life of the debt) + reserves] divided by (present value of debt)

  • Cash available for debt service (CFADS) is your revenue minus operating expenses (including taxes but not including depreciation).
  • The denominator of the LLCR is the present value of your debt.
  • The interest rate of your debt is the discount rate used for calculating the net present value in the numerator.

A project with a LLCR equal to 1.0 is break-even: all its free cash pays its debt service. A ratio higher than 1.0 means there’s more than enough free cash flow to meet debt service.

You might have heard about a related metric, the debt service coverage ratio (DSCR). The DSCR is similar to the LLCR but is calculated on a quarterly or annual basis, so it’s a snapshot in time. In contrast, the LLCR is an average over the lifetime of the debt. For projects with lumpy free cash flows due to seasonality or infrequent-but-expensive maintenance costs, the LLCR is a more generous metric because it smooths out the cash flows.

 

Why the LLCR Matters

Debt lenders will use the LLCR to gauge the riskiness of your project. Of course, merely breaking even is not a compelling financial result, so the LLCR needs to significantly exceed 1.0.  Below are some typical minimum LLCRs used by lenders for different projects in various industries:

Example of Debt Lending Situation Typical Minimum LLCR
Infrastructure backed by investment-grade rated government entity 1.25
Power plant whose offtake buyer is creditworthy 1.4
Oil & gas industry 1.4
Metal & mining industry 1.4
Infrastructure with merchant risk 1.75
Power plant selling on merchant market 2.0
New Energy Risk’s experience of projects that get funded and reach financial close 1.7

The table makes it clear that projects with merchant risk—those that lack contracts to sell their production to a creditworthy entity—require significantly higher LLCRs.

At New Energy Risk, our experience is that deals with LLCRs of at least 1.7 are those that get investment. That higher ratio gives the debt lender confidence that even if the project technologically under-performs, or the value of the production decreases, the project will still be able to pay its debt service and make it through the long winter (whether hibernating or not).

 

What Can I Do If My Project’s LLCR Is Too Low?

Uh oh, your bear of a project got too fat on debt! What can you do to restore your photogenic and investment-worthy proportions?

  1. Consider New Energy Risk: We can help! New Energy Risk’s insurance products can enable debt funding where it was not previously possible or reduce the cost of debt. In both cases, NER’s help with coverage reduces your cost of debt and increases your LLCR.
  2. Reduce your cost of debt by financing in a major currency: Debt is typically cheaper when it’s denominated in major currencies, so if your project is capitalized in a minor currency, you could try denominating your project’s feedstock and production in a major currency instead.
  3. Reduce your cost of debt with government assistance: In the US, the federal government will provide loan guarantees for certain types of innovative capital projects. At New Energy Risk, we have worked with projects pursuing such guarantees from the US Department of Energy and US Department of Agriculture.
  4. Adjust your cap table to increase the relative percentage of equity: If the total project cost remains fixed, then reducing the portion of the cost capitalized as debt will reduce your debt service and increase your LLCR.
  5. Reduce project capital costs: If you can simplify your project to reduce its capital cost without reducing revenue, that will raise your LLCR. For example, you might find that a captive, on-site system for over-the-fence procurement can shift costs from capital to operating expenses and save money on a levelized basis.
  6. Reduce operating expenses: If you can reduce operating expenses while holding revenues constant, that will increase free cash flow and increase your LLCR. Maybe the project can be situated in a lower-cost location. Maybe automation can reduce on-site labor costs. You might also try to contract your feedstock costs for a fixed or capped price to reduce the risk of escalating operating expenses.
  7. Contract your revenues: Lenders will discount your revenue if they feel it’s uncertain. Selling your production to an investment-grade entity for a fixed price or on a take-or-pay basis will help assure you get more fully credited for all your revenues.

 

So fatten your bear of a project with debt, but not too much; keep the LLCR in mind! Have questions about your own LLCR or project finance? Reach out to us at contact@newenergyrisk.com. We’re here and happy to help. (Although we don’t accept salmon for payment, sorry.)

 

 


Interview: Jay Schabel, President of Brightmark Energy Plastics Division

We are inspired by people who are passionate about technology that solves pressing global challenges. Scaling and commercializing those solutions requires serious knowledge, courage, support, and perseverance. In this interview series, our chief actuary, Sherry Huang, talks with friends of NER who demonstrate these qualities professionally and personally, and whose journeys will inspire you, too.

 

A Conversation with Jay Schabel, president of Brightmark Energy Plastics Division, formerly CEO of RES Polyflow

NER worked closely with RES Polyflow to ensure the cost-effective capitalization of its plastics waste-to-value facility in Ashland, IN, USA. Brightmark Energy acquired a majority stake in RES Polyflow in November 2018. This interview has been lightly edited for length and clarity.

 

By Sherry Huang, Chief Actuary

Jay is a calm, wise, and thoughtful business leader and technology entrepreneur. Before we first met, I joined a conference call for which I hadn’t yet received background information. Although he was leading the discussion and I had not initially been invited, unprompted, Jay sent me the files that I needed to get up to speed. It was a small act of kindness, which made an everlasting impression, and I knew then that RES Polyflow was in good hands.

Jay Schabel
Jay Schabel [Photo credit: Brightmark Energy]

Jay, let’s start with how you got to where you are today. You have vast engineering and construction management experience. Tell us about how you started your own businesses and how that took you to Brightmark Energy today?

I always knew I would start my own business. My father owned a successful trucking company, and I wanted the same experience of creating something. I launched my first start-up on January 1, 2000: a technology company that makes metal injection molding machines. That company is still operating and profitable today! I sold it when I bought another company in the automobile industry with some friends. In the next eight years, I bought and sold various companies, building up to an organization with $300M in revenue before selling my interest to my partners in 2008. This process of buying, building, and selling businesses provided great training for my work with RES Polyflow. I started on the plastic conversion technology in 2008. It was originally known as Polyflow until we added ‘Renewable Energy Solutions.’ Since our acquisition, we are Brightmark Energy Plastics Division, and we are still thinking of a name for the core technology.

Brightmark Energy Plastics Division is providing an important technology solution that turns post-use plastic into valuable products, and this reduces the amount of waste that would otherwise end up in a landfill or the ocean. Looking forward five to 10 years, what is your vision for this technology?

We want to divert 8M tons of plastic waste from landfill and waterways by 2025 and are already working on initiatives to support this goal. (Editor’s note: The Ocean Conservancy estimates that 275M tons of plastic waste is produced every year, of which 8M tons enter the oceans annually.)

What are some trends you are seeing in your industry? How do you see your industry changing and evolving?

The goal of our industry is to figure out how we can help divert as much plastic waste as possible from landfill and waterways. Recyclers are struggling to figure out what to do since China and southeast Asian countries stopped accepting used plastic from foreign countries. We want to use our disruptive technology to help manage this change and solve this plastic waste pollution problem.

Others have been working on this issue for a while, too. For example, Dow Chemical along with its partners have tested two “Hefty Energy Bag” programs in Omaha, Nebraska and Citrus Heights, California. They collected previously non-recycled plastics and converted them into valuable products, demonstrating that recovery of non-recycled plastics is a viable municipal process.

What advice do you have for technology entrepreneurs who are trying to start or scale their business?

Be honest with yourself. At RES Polyflow, we determined that we needed a significant level of scale in order to be economically viable, but that created a difficult financing task. The insurance solution from NER and AXA XL was critical in completing the debt financing. The required level of financing was a big pill to swallow, but at the end it was beneficial. Make the tough decision early and stick with it.

Lastly, I understand you used to own and operate a winery, which is almost as exciting as reducing waste and pollution for planet Earth! Outside of Brightmark Energy, what are you up to now?

Yes, my wife and I used to own three acres of grapes. We made our own wine and operated a winery, but it became too much while I traveled a lot for RES Polyflow so we sold it a while ago. Now we are building our dream home. We are having the time of our lives!

Thank you, Jay! 

 

About the Plastics Renewal Facility in Ashley, Indiana

Brightmark Energy’s plastics-to-fuel pyrolysis process sustainably recycles plastic waste directly into useful products like fuels and wax. The plastics renewal facility, now under construction, will convert 100K tons of plastic into 18M gallons of fuel and 6M gallons of wax annually. To finance this deployment, RES Polyflow and Brightmark Energy raised an aggregate $260M including $185M in Indiana green bonds, underwritten by Goldman Sachs & Co.


A Plan B for Air Quality

By Brentan Alexander, Chief Science Officer & Chief Commercial Officer

 

News broke recently that the U.S. Environmental Protection Agency and Department of Transportation would jointly be moving to revoke the waiver that California has used to set stricter auto emissions than the U.S. government. The only shock was that the action had taken so long to materialize. Long a leader in environmental protection, California put rules and procedures in place to manage air pollution before the Feds caught up with the Clean Air Act of 1970. California was awarded for its foresight: the bill enshrined a pathway for California to maintain continued dominion over its air through a waiver process. The Trump administration's decision to rescind that special position was the least surprising development in the long running feud between Trump and the Golden State. As the news exploded across the newswire and prompted to-be-expected reactions from both sides in the twitterverse, I felt a smirk come across my face... Trump may be claiming victory (possibly prematurely!), but California has the upper hand in this war.

The stricter auto emissions standards currently under attack are just one quiver in use by California and its allies in the fight to reduce carbon emissions. Another tool in the arsenal, the Low Carbon Fuel Standard (LCFS), is proving to be equally powerful and, more importantly, durable. But for all the attention that our national media is heaping on the auto-emissions waiver, few are aware of the LCFS program or the work it is doing to enable a cleaner future.

LCFS is a state-run program enacted in 2006 under Governor Schwarzenegger through AB32 that is administered by the California Air Resources Board. Adopted in 2009 and implemented in 2011, the regulations underpinning LCFS require the producers of refined road-ready fuels to reduce the “carbon intensity” of their fuels, with ratcheting targets that continually require further reductions year-over-year. Using a scientifically-derived and technology-neutral process, the LCFS program awards credits to fuel producers who make liquid fuels that produce less CO2 (or CO2-equivalents) over their lifecycle, as compared to conventional methods. These fuels, which are less carbon intensive, lower the total CO2 emitted by the transportation sector when blended into the fuel stock. Fuel producers can reach their mandated carbon-intensity through new technologies and processes, or by buying LCFS credits from third-parties with more efficient processes in place.

The beauty of the LCFS regime is that it does not pick winners or losers. Unlike the investment and production tax credits that have helped wind and solar run down the cost curve and compete without subsidy, the LCFS program is not technology specific. Any method that produces a cleaner gallon of fuel (so long as it’s sold in California) or that sequesters CO2 is eligible for credits under the program. May the best technological solution win!

Can you make a biofuel from plants or plant wastes? You qualify for credits since a portion of the carbon is non-fossil. Can you pull CO2 out of the air and bury it underground? That process is carbon negative and you qualify for LCFS credits, as well. Did you build a solar farm that will be used to power EVs? Congrats, have some credits. As the carbon-intensity target under LCFS rules gets stricter over time, producers must create even more climate-friendly fuels or buy still more credits to compensate for their conventional fossil products, which increases the demand for cleaner solutions and supports the price of the credit.

So, how is this program working? LCFS is the major driver of revenue for several innovative, first-of-a-kind facilities being built around the United States right now. Without this subsidy, these projects would not be economically viable; as with wind and solar, the LCFS program is helping these technologies get to market, and their success at scale will help reduce prices and further enhance the economics of alternative fuel sources. Meanwhile, investors are stepping up to support these projects, assuming the risk that future LCFS prices will remain stable and attractive. Their confidence is well-founded: generators of LCFS credits today are banking a portion of their credits for future years, betting that future prices will be higher than today and justifying a ‘hold’ approach on the asset. Billions of dollars of credits now sit unused in savings, waiting for a future where their value is even greater. Other regions have taken notice of this success, and proposals to replicate California’s system are gaining traction in the Pacific Northwest and Canada. The demand for credits is expected to grow substantially over the next decade as more states come online with their own programs.

The great irony for the Trump administration, and all those fighting against California’s clean-air waiver, is that if they “succeed” and auto fuel-economy stagnates, the resulting increased demand for liquid fuels will further enhance the value of the LCFS credit. This provides more financial incentive for new technologies and developers to enter the space and reduce the carbon footprint of transportation fuels. Perhaps this is not the shortest route to decarbonizing the transportation sector, but it’s not a bad Plan B. When it comes to the future of carbon, California is playing for keeps.

 

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No, we’re not running out of Helium

By Brentan Alexander, CSO & COO

I’m often frustrated when reading science coverage in the national press. There are often a number of inaccuracies and misleading narratives that are routinely embedded in the stories that seem to get picked up by a wide variety of outlets. Seeking a catchy headline or narrative, the articles often distort the science and draw erroneous conclusions (which makes me wonder, are all the articles in these papers where I have less insight and background as poorly researched?). The latest piece to draw my ire?

From Forbes: Humanity Is Thoughtlessly Wasting An Essential, Non-Renewable Resource: Helium

Reading the article, you are led to believe a few things: We waste a huge amount of helium every year, that party balloons and other extravagances are the primary culprit, that once lost to the atmosphere the helium is gone forever because *SPACE*, and that we are running out of helium which will shutdown portions of medicine and science.

WELL….NO.

Let’s start from the top. Do we waste helium? This really depends on what one means by ‘wasting’, but in a simple sense, yes…nearly all the helium we use is done in a one-time fashion that is then released to the atmosphere. Balloons are obvious, but use of helium in MRIs and superconducting magnets also allows for the escape of the helium. The article fails to explain WHY we do this though….and to me it’s pretty obvious. Helium is cheap! Capturing and recycling that helium from MRI machines and other uses just doesn’t make financial sense (or hasn’t in the past)…its cheaper to just let it go and go buy more. That balance may be changing, which is, quite simply, economics at work. We waste because we can.

OK you say, but we are still losing vast quantities of helium from balloons! We can’t possibly recycle that. The article notes that filling party balloons is the single most common use of helium, and quickly works to ruin our fun. What the article fails to note is that by volume party balloons are basically a rounding error in overall helium use. No less of an authority then the National Research Council makes this point. Right there in chapter 6 of this report is an investigation of helium uses. Party balloons? They are less than 40 MMscf a year, or less than 2% of usage in the U.S. Balloons aren’t our problem, so keep on partying .

But even that is a bad idea, you say, because that helium, once released, will just escape our earth and end up…in SPACE! This is my favorite part of this story, and why I think it keeps popping up in the popular press (seriously, just google ‘helium shortage’ and you’ll find dozens of articles over the last decade like this Forbes article). It’s just such a good visual, all that wasted helium drifting up, up, and away, never to be heard from again.

I call BS. Let’s run some numbers. First, helium loss from the upper reaches of our atmosphere is a real phenomenon, with the solar wind blowing the stuff away (we lose hydrogen that way too). How much do we lose? About 50g per second. That is less than 3% of our consumption rate (see my math here). So we are adding helium to our atmosphere far faster than it is being lost to space. It’s not being lost forever, it’s just being mixed in to our air. And what to the argument that the increase in helium in our atmosphere will increase the loss to space? Not much to that really…our annual consumption is just 0.00001% of the volume of He in the atmosphere today!

Which gets to the last argument this article makes: we’re running out of Helium. Nope. Take the number above and invert it….in our atmosphere alone we have something like 6–8 million years of supply at current consumption rates. And that ignores all the helium still in the ground.

SO YOU’RE SAYING THERE ISN’T A PROBLEM?

Not quite…we do have periodic helium shortages (there have been 3 in the last 15 years). But this is fundamentally a supply/demand issue (and public policy too…the sale of the U.S. Helium Reserve, which previously was a government program to maintain helium supply, is also messing with the market) that comes back to price. There is plenty of helium in the world: whether you want to build more infrastructure to grab it from more natural gas wells (our current helium source) where it is otherwise released, or whether you want to build a plant to separate it from the air (unlikely to be very competitive against natural gas separation for a very long time) is simply a question of how much you’re willing to pay to get at it.

This indeed has profound impacts on science and medicine. That MRI test may get more expensive, and those superconducting magnets will cost a lot more to cool. And that collection of colorful paw patrol adverts floating over the picnic table at your next family BBQ may cost you a few more bucks as well. But they will all still be filled with helium.

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Advice for Innovators: Keep it Real

By Brentan Alexander, CSO & COO, New Energy Risk

The latest entry in my series on resolutions for technology innovators: test your tech in the real-world! Having spent a number of years in academic and early-stage R&D, I understand the desire to use highly controlled conditions and parameters when putting together testing programs. When you are working to understand fundamental aspects of your technology to allow for refinements and improvements, it is necessary to inject as few variables as possible in your testing program so that you can reliably link changes in performance to control parameters of interest.

However when moving out of the development stage and in to the commercialization of your new technology, this controlled approach to testing is insufficient. At New Energy Risk, I regularly review testing data from companies and innovators who misunderstand what types of data that I, and by extension the broader debt and growth capital investment market, want to see. You are trying to sell your equipment or build a project; having an understanding of the science underpinning your process is table-stakes. You better have that understanding, or you aren’t even making it through the door. What I (and other capital providers) want to see is that you can demonstrate the engineered system works as advertised.

SHOW ME THAT IT WORKS, NOT HOW IT WORKS

When we first meet, I will assume that the science that underpins your technology is well understood. Showing me the controlled experiments that elucidate the interplay between operating conditions and performance are necessary so I can validate that assumption, but they miss the point of what I’m really after: I want test data that demonstrates the ability of the technology to reliably operate over the full operational window for the expected life of the technology.

Using super-refined, ultra-pure feedstock for a new kind of biomass facility does not demonstrate that a technology will work on the dirtier and less consistent biomass available for a commercial plant. Validating a predictive algorithm on the very data that was used to train the system, even if only a subset of the validation dataset was used in training, provides little guidance on whether the algorithm will perform on the wide variety of datasets likely to be encountered in the field. Running controlled charge/discharge tests on a battery in a specially conditioned laboratory does not validate that the battery will perform under variable loading conditions in the desert sun.

TAKE OFF THE KID-GLOVES

If you’re working to shield your device or equipment from real-world conditions that could significantly undercut performance of the technology, then you probably aren’t ready for commercialization. Take the kid gloves off, because no customer wants to be a guinea pig, and nearly all of them will see a lack of real-world testing data as a lack of readiness and seriousness.

So how do you operate a demonstration test useful to the finance community? Stop trying to control things and let go of the handlebars. Send devices outside, give them to potential clients or partners, and let them control the asset. Is your technology sensitive to feedstock quality? Buy the low quality stuff for an extended test. Does temperature impact efficacy? Send one to the desert and another to Alaska. Vary loads, feedstock parameters, or any other controlling conditions throughout the test, or let nature randomize it for you.

Anything short of this, and you’ll find yourself with customers, partners, or capital providers asking for more validation before starting a relationship.

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