DECEMBER 8, 2009, 6:30 P.M. ET

By MARA LEMOS STEIN

A handful of venture-capital-backed advanced biofuel companies cheered the receipt of nearly $600 million in federal funding last week, but they still need more money to bring their technology up to commercial scale.

Venture capitalists that have taken the greatest risk by funding these companies to this stage of development are looking to private equity, hedge funds, investment bankers and strategic partners to step up and help fill the funding gap.

“The grant is an important step for these companies but not the only step [they need to reach commercialization],” said Eric Straser, a general partner at Mohr Davidow Ventures, Menlo Park, Calif. Companies must be able to supplement government grants with further financial support from strategic partners, he said.

The Department of Energy selected 19 companies from a pool of approximately 200 applications for a total of $564 million in cost-sharing grants funded by the American Recovery and Reinvestment Act, or ARRA, with $483 million going to 18 projects to scale up production of renewable fuels using nonfood biomass such as cellulosic materials and algae.

Although the grant award brings some assurance to potential investors, lenders in general have been cautious about providing financing for advanced biofuels producers because the technologies have yet to prove their economic and technical viability. The conundrum is that the technologies cannot be proved at scale until a refinery is up and running.

“As you move from a technology that is really from demonstration stage to getting it to commercial stage there’s a void, it’s not bankable,” said Bill Lese, a managing partner at New York-based Braemar Energy Ventures, in an interview.

Given the growing focus on energy security and independence, if the facilities getting DOE grants show good results and their business plans are executed well, some in the financial community may warm up to the idea of funding an advanced fuels refinery, he said. “The grants pave the way for more interest from the capital markets and lending community,” said Lese.

In addition, investors might be encouraged by the implied endorsement that comes with having a DOE grant, venture capitalists said. The grant implies the government is comfortable with the technology and the company, which could open doors to future awards or low-cost loans.

“These awards have been a signal to the fund raising community that the company has passed some technical review and may be at an advantage in securing a future low-cost funding,” said Mr. Straser.

As in previous DOE grant awards from the ARRA funding, the government cast its net wide, selecting a variety of technologies developed to process a multitude of feedstock. Five companies funded by venture capitalists were among those picked: Amyris Biotechnologies Inc., Enerkem Inc.; Sapphire Energy Inc.; Solazyme Inc. and ZeaChem Inc. They will enter into a period of contract negotiation with the DOE to finalize the terms of the grants.

ZeaChem will negotiate a $25 million grant with the DOE for a $73.4 million project in Boardman, Ore., to produce ethanol using a refining technology that uses a combined biochemical and thermal process. The feedstock for the project is hybrid poplar trees that are grown in the area especially for ZeaChem. The company is backed by Firelake Capital, Globespan Capital Partners, Mohr Davidow Ventures, PrairieGold Venture Partners and Valero Energy Corp.

ZeaChem recently began construction of what it calls the “core,” or the part that converts sugars into ethyl acetate, of the DOE-supported facility. The DOE funding will help it put the front end that converts cellulose to sugar, and the back end, which converts ethyl acetate into ethanol. Like all recipients of DOE grants, ZeaChem is grateful for the supporting hand but not leaning on it too heavily.

“We already have cash,” said Jim Imbler, ZeaChem’s chief executive. Besides a $34 million Series B round raised in January, Mr. Imbler said the company has secured preliminary incentives from the state of Oregon. and other federal tax credits because the project is in a “depressed rural area,” he said.

“We got a hand up, not really a hand out,” Imbler said.