This is part of a series of articles about building and funding first-of-a-kind climate tech. Read about how to secure off-take agreements here.
Building first-of-a-kind (FOAK) climate tech — be it a carbon removal facility or a next generation e-fuel plant — is hugely capital intensive. That means startups building them can’t count on the traditional financial playbook used by software companies time and again.
VC dollars are helpful at the start, but soon become dilutive and expensive if you’re using them to finance physical infrastructure.
“If you want to finance these assets, you increasingly have to resort to debt or project finance, because it's not the right asset class for VC or classic private equity, and the companies don’t generate enough cash flow to finance it themselves,” says Maximilian Zoller, investor at HV Capital.
So what should a FOAK cap table look like, and how can companies secure much needed debt financing?
The ideal cap table
Irene Gálvez, head of cleantech equity and growth capital at the European Investment Bank (EIB), says the ideal cap table includes “a balanced mix” of equity, debt financing or quasi-equity and non-dilutive grants. ‘Quasi-equity’ is a loan that’s paid back based on the performance of a company, usually its profits, rather than a set figure every month.
Combining early equity with debt or quasi-equity and non-dilutive grants helps to minimise dilution in the way only raising equity wouldn't, while also providing enough capital to grow, Gálvez says.
Yair Reem, VC at Extantia, agrees: “At the FOAK stage, the best-case scenario is having a third debt, a third from grants and a third in equity,” he says.
Where does that debt come from?
Industrial incumbents can turn to banks for debt financing when they need to finance a new facility. Early-stage climate techs can’t, but they can turn to venture debt providers: they offer debt financing but with a higher, venture-like risk appetite.
Venture debt providers take a company’s equity into account when they assess its ability to repay a loan, unlike a traditional debt provider, which predominantly considers cash flow.
FOAK companies that have secured venture debt include Sunfire, a German hydrogen electrolyser startup. It secured multiple equity rounds from VCs before taking a €100m venture debt round from the EIB. Dutch company Battolyser, a spinout from TU Delft, has also recently raised a €40m debt round to build its hydrogen electrolysers.
Learning to talk about risk
Securing debt requires a mindset shift from founders, says Sebastian Peck, investor at climate-focused VC Kompas.
“You have to switch gears from selling mode and talking about all the wonderful things you're going to do, to talking about all the possible things that could go wrong,” Peck says. “That's a not insignificant challenge.”
William Godfrey, who runs Twist, which helps companies to report on metrics to their debt providers, agrees: “The debt market has a million opportunities, it’s 10 times the size of the equities market and they’re looking for a nice and easy deal,” says Godfrey. FOAKs, because they’re by nature not known-entities, break all those rules, he says.
Debt providers need to know how they are going to get repaid in every possible circumstance that could befall the FOAK.
To do that, startups can break down the value of the components in a FOAK and work out how much they could be sold for in a worst case scenario. For example: if a factory needs a battery to run, that battery has a value on the secondary market, and the debt provider could price the sale of it into their modelling.
“It can be a really helpful way of saying, in the worst-case scenario, these 10 things have value,” says Godfrey.
Get ready for project finance
If things go to plan, once a startup has built its FOAK it can then gradually move to nth-of-a-kind (NOAK) — when you start rolling out copies of the FOAK, once the tech has been derisked.
That’s when they can start looking at project finance vehicles. Project finance is where a single large-scale asset is financed through a special purpose vehicle (SPV), rather than through the topco (the parent company). Each SPV tends to include a slice of equity, plus debt and grants specific to the asset. Investors will sometimes put debt or equity into a project level SPV, and then make a small investment from that into the topco.
It’s at this stage that banks are likely to be interested. “By the NOAK stage, projects are de-risked at scale and can access deep pools of comparatively cheap capital from institutional infrastructure investors and more conservative project finance banks,” says Gálvez.
Banks are increasingly dipping their toes in climate tech financing. Europe’s best funded climate tech, Northvolt, has secured funding from the likes of Goldman Sachs, Baillie Gifford and BlackRock.
That said, don’t expect the conversation to be a simple one, says Kompas’s Peck. “I don't think they've completely productised this as a financial service. A lot of the discussions still feel quite bespoke,” he says.
Ultimately, says HV Capital’s Maxi Pethö-Schramm, the goal of a FOAK should be to secure all the metrics that a deep-pocketed financial institution will need to see once you get to NOAK stage.
“What are the goals of a FOAK plant? It's not necessarily revenue maximisation, but getting to know all the metrics — like operating costs and proving how processes run — that investors need to see,” she says.
