Programs +
Access to venture capital is a wonderful thing, but it is an expensive form of capital–likely the most expensive capital a company will seek in its lifecycle. For capital-intensive climate tech companies, venture capital can be a blessing, especially when founders are navigating the first valley of death in climate tech (technology development). But high-cost VC can also be a curse for founders traversing the second valley of death(commercialization)–especially those building the first few iterations of physical infrastructure. Thus, it is imperative that climate tech startups reduce their cost of capital as they scale, which means supplanting VC with cheaper forms of capital.
One such form of capital: project finance.
How do you unlock this capital for your climate tech startup? The answer, quite simply, is in the name. You need to have a project to finance.
Before you label me a smart ass, let’s discuss exactly what a “project” is and isn’t. If you are building a climate tech company that delivers a software solution or sells a good (for which your manufacturing is outsourced), you don’t have a project which you can finance. You have your company, your product which you sell, and your income statement, and you will need to raise capital based on the projected future cash flows that business will generate. These asset-light business models have their benefits, the most notable of which is you don’t need to raise as much capital to generate cash flow! As you scale, you’ll explore growth equity, venture debt, working capital, and equipment loans, all as means to lower your cost of capital and finance your business.
But, if your company has a physical asset that it will create, then you may be able to open the door to project finance, provided that physical asset has a few unique characteristics. These unique characteristics are critical as they create the unlock to project finance. Specifically, you’ll want that asset to:
One of the backbones of our economy and an OG of project finance, real estate is the best example of project finance in action.
Real estate companies, whether specializing in developmentor asset management, have a plethora of talented individuals that buildpipeline, close deals, manage projects, and run the administrative aspects of their business. These companies aim to build or acquire discrete properties which have the unique characteristics described above:
The proliferation of real estate helped proliferate and perfect project finance, and it opened the doors for talented folks to take the project finance model and apply it to clean energy projects. Hello Solar PPA!
In many instances, solar projects are a natural extension of real estate because they often sit on top of real estate. Literally! In addition to unobstructed rooftops, solar projects can also be found in parking lots, greenfields, brownfields, and even on water. Wherever they are found, solar possess the same unique characteristics as real estate:
Real estate and solar have a lot of similarities, which is one reason why you see a lot of real estate folks doing solar deals! Solar may even be lower risk than real estate because you don’t have to deal with those pesky tenants, but it should be noted that real estate assets have a serious advantage over solar: they appreciate in value while solar projects generally don’t.
Setting aside the discussion of asset appreciation, realestate and solar’s similar characteristics make these types of assets great candidates to unlock project finance. Why, you ask?
The three characteristics outlined above, which real estate and solar projects each have, are so important because those characteristics together unlock the opportunity for investors and financiers to underwrite the asset independent from the business.*
*Public Service Announcement: For climate tech startups, the asset will never be underwritten completely independent from the company and its leadership. On the contrary, project financiers will look hardat the management team and make sure they are the right folks to commercialize the company’s technology, scale operations, and build an enduring business.
The independent underwriting will show a physical asset that could be owned by a subsidiary, have its own income statement, have predictable, long-term, contractually obligated cash flow (hopefully from a credit worthy offtaker) and be highly replicable (so asset management and operations will be predictable and consistent with the asset’s financial model. The underwriting will also spotlight the team managing the project (see the PSA above) and determine whether they are the right folks to build and operate this project and others like it.
Most importantly, this type of underwriting, if successfully completed, will showcase a less risky asset than say, venture capital investment in a Seed or Series A climate tech hardware company. With less risk comes a lower cost of capital, and project level equity and debt that will be much, much cheaper than early-stage VC.
That is why early-stage climate tech companies should be asking themselves right now–what are you selling, how are you selling, and who is going to finance it? If what emerges from these questions is a discrete physical asset that will produce a sellable good or service (i.e., leasable space or electricity), then you’re in a position to explore how project finance can support the growth of your business. Renewable energy projects, energy storage facilities, EV charging stations, energy efficiency projects, green hydrogen facilities, factories that will produce a low carbon product (such as sustainable aviation fuel or green steel for which you can contract offtake), and circular economy projects (such as carbon removal and battery recycling facilities), a real prime candidate for project finance, provided these examples share the three characteristics described above!
Now, project finance will come with much more onerous terms than early-stage equity. That, however, is for the next edition of the Startup Playbook. In the meantime, founders should take a hard look at their climate technology and ask the hard questions outlined in the last post and this one. The answers could lead you right to a lower cost of capital for your climate tech startup!
