In 2009, as the financial crisis raged and General Motors and Chrysler plunged toward bankruptcy, Tesla Motors faced a seemingly impossible task: raising half a billion dollars to build an electric-car factory. Tesla had just staggered through a year of layoffs, canceled orders, and record losses. Then suddenly, salvation. The U.S. Department of Energy offered to lend the company $465 million at rock-bottom interest rates.
Four years later, Tesla Motors offers a remarkable example of how a well-timed government investment in the right company can pay off. Every week, 400 all-electric Model S sedans roll out of Tesla’s factory in Fremont, Calif., which the government’s loan financed. Motor Trend named the Model S its 2013 Car of the Year. Tesla’s stock is the toast of Wall Street, giving the company a market value topping $12 billion. And in sharp contrast to Solyndra, the solar panel maker that defaulted on its $528 million loan from the Energy Departtment, Tesla last week paid the government back early, with interest.
Yet despite all the public celebration, both Solyndra and Tesla stand as warnings of the dangers in deputizing bureaucrats to play bankers and venture capitalists. In both loans, the government walked away laughably undercompensated for the risk it accepted in the startup companies. In fact, the Tesla deal was arguably far more costly for America than the Solyndra fiasco.
Solyndra exposed the first way the taxpayer could lose out. The traditional advantage of making a loan (as opposed to buying stock in a company) is that lenders often get paid something even when the borrowing company fails, because they hold collateral. Solyndra’s bankruptcy revealed the ephemeral value of the government’s collateral. Taxpayers have yet to recover a penny from the company.
Tesla’s runaway success, by contrast, is demonstrating how making venture capital–style investments in risky companies—without demanding venture capital–style compensation in return—can end up costing taxpayers even more. In Silicon Valley, one Google pays for a dozen Pets.com. The government made the key mistake of loaning money to Tesla without insisting on receiving stock options, options that could have allowed the Department of Energy to pay for the Solyndra losses several times over.
When the government’s negotiators started hammering out the details of the Tesla investment in mid-2009, it was obvious to both sides that the feds were in a position to name their terms. Tesla’s management knew that if they couldn’t get the government’s money at 3 or 4 percent interest, their next cheapest source of capital would cost 10 times more, a whopping 30 to 40 percent annually. (That’s according to estimates Tesla made in a regulatory filing, which based its numbers on “venture capital rates of return for companies at a similar stage of development as us.”)
Today, the Energy Department defends the massive discount it offered as perfectly appropriate. “The loan program wasn’t intended to generate profit; the goal of the program is to provide affordable financing so that America’s entrepreneurs and innovators can build a strong, thriving and growing clean energy industry in the United States,” says a department spokeswoman.
Yet isn't affordability the exact reason stock options are standard in normal venture capital deals? When a company is struggling, the options can’t be exercised and thus are perfectly affordable, not draining a dollar of cash from a startup company. Unlike a loan, stock options only cost the company money if it goes on to success—at which point it can afford to share that success with its early investors.
Personal loans made in 2008 by Elon Musk, Tesla’s co-founder and CEO, provide a telling contrast. Musk received a much higher interest rate (10 percent) from Tesla and, more importantly, the option to convert his $38 million of debt into shares of Tesla stock. That’s exactly what he ended up doing, and the resulting shares are now worth a whopping $1.4 billion—a 3,500 percent return on his investment. By contrast, the Department of Energy earned only $12 million in interest on its $465 million loan—a 2.6 percent return.
The government had huge leeway to demand similar terms as part of its loan, given the yawning gap between its interest rate and the cost of Tesla’s next-best source of capital. The government was ponying up more capital than all of Tesla’s previous investors combined. At a bare minimum, the Department of Energy could have demanded a share of the company equal to the 11 percent Musk received for his $38 million loan the year before. Such an 11 percent share would be worth $1.4 billion to taxpayers today.