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Companies fighting climate change are increasingly looking beyond venture capital to fund their products and services — with green energy installer Enpal and battery manufacturer Northvolt tapping debt or asset-backed securities to finance big projects, as my colleague Freya Pratty has explored in depth.
But debt isn’t just for those big companies. Fledgling climate tech startups should also be thinking about debt, perhaps as early as when they pick their founding team, some investors say.
Lots of climate startups are only focusing on software — catnip for VCs. But for the many that have some physical or hardware component to their business model, figuring out the debt financing piece of the picture early on is key.
“The question is, what are the skill sets you need on the entrepreneurial side, on the management [and] executive side? Because that changes dramatically [depending on the mix of financing you’re going after],” Anja Rath, managing director at VC firm PT1, said onstage at the firm’s portfolio day in Berlin last week.
If it’s venture capital that you’re after, you need to be a sector expert. But if you’re looking for debt financing, “that's a completely different skill set you need.”
To get this type of hybrid financing as a young startup, you need to be able to “speak bank,” said Thomas Antonioli, cofounder and CFO of Terra One, a startup aiming to optimise the grid with battery storage and trading solutions, which just raised a $7.5m seed led by PT1. You need to be able to “understand the covenants, the structures, how you present the project, how you structure everything — and it's very specialised knowledge,” he said.
Securing debt and project financing isn’t the same as raising a venture round, noted Rath. She said VCs are looking at the profile of the founders and “how experienced [are they] in this area [of corporate finance]”. “Do we need another person, another skill set, to add? I think that is very crucial to whatever you do in this sector, where a lot of money is needed to grow fast,” she argued.
The need for quickly scaling decarbonisation solutions — like green energy storage facilities or hydrogen producers — is also prompting entrepreneurs to get more creative with their company structures. “There is a lot of opportunity for new business models,” said Alexander Winkler, senior investment manager at the Liechtenstein Gruppe family office. “With one company, you [could] have three different classes of financing with venture capital, private equity and debt.”
Take another PT1 portfolio company, Ecoworks, which renovates buildings to make them more energy efficient. Winkler said “you could well envision” a private equity investor owning the real estate that Ecoworks is modernising, as well as a debt financier funding the more asset-heavy aspects of the process.
Terra One — which has a software and a hardware component to its business — set up a special purpose vehicle, or SPV, to raise more money from infrastructure investors and lenders for its physical hardware, which is underway. The SPV, which is a separate entity, enables the company to secure debt or funding that wouldn't be on its balance sheet, while also insulating the financiers from the risk of the venture-funded side of the startup.
Getting a good CFO from the start to oversee these less straightforward corporate setups is a good idea — not that it’s easy.
“It's quite a hurdle for startups to bring [in] these people because they earn half a million-plus where they are, and you need to somehow convince them to take a haircut on their salary and get some equity or something to join you,” Antonioli said (a good ‘mission’ can help).
Of course, there is one glaring hitch to this VC-debt marriage: namely, that young companies with little or no collateral will have a very tough time convincing bankers to part with their cash. “One challenge going forward, despite the convergence [of sources of financing], will still be to fund those projects where you have long lead times working towards pilot plans for some kind of production, but you have no assets that can serve as collateral to take the risks,” said Winkler.
Venture debt, which is typically paired with or timed around a venture round and can instead use things like intellectual property (IP) as collateral, is one option — although unlikely to be sufficient for very capital-intensive projects.
This discussion got me thinking: is there such a thing as too soon to be thinking about the types of financing your company might need down the line? Will these hybrid models — having a startup funded by VCs and an SPV or a debt-funded business subsidiary — become even more commonplace in the climate space? Which areas in climate tech are best suited for this type of structure? What are the risks of debt for these types of startups? I’m all ears and for the latest on climate tech follow our dedicated weekly newsletter here.
