Asset-Backed Lending as a Capital Alternative for Climate Startups
Debt can be a very powerful tool for climate tech startups. This is particularly true for companies that receive recurring revenues from hard assets (EV loans, heat-pump financing, etc). In these cases, founders can raise debt secured against those revenue-generating assets, and free up equity capital for growth, R&D, and other investments. This kind of debt can be transformative for startups, but requires a deep understanding of the terms and dynamics which shape each deal.
We sat down with Mark Paris to understand key areas of nuance when it comes to asset-backed facilities, and help founders navigate this often murky subject. Mark is a seasoned lender and is currently Managing Partner at Urban Us Capital, an asset-backed lender for climate-focused startups.
Cost of capital is just one of many terms
One of the biggest mistakes that founders make is over-rotating on the cost of capital. While the interest rate on a prospective loan is important, it is easy to get caught up and ignore the rest of the agreement. Keep in mind that, while VCs are more focused on exit and hypothetical upside scenarios during the underwriting process, lenders are primarily focused on risk.
Lenders will manage this risk through a complex set of interrelated elements of a transaction: cost, covenants, rights, etc. As a result, a lower cost of capital will typically come with more security for the lender, in the form of corporate and/or personal guarantees, collateral, liens, and the amount of capital provided relative to the asset value (aka, advance rate). For this reason, examining the whole basket of terms within a deal is imperative.
Don’t underestimate how long it will take
Structuring this type of financing may take more time than you expect, as asset-backed debt requires much more diligence than there tends to be in VC. Think of it like a Russian doll – the startup may be in a 1x1 relationship with a lender, but that lender has the same kind of relationship with their investors, and so on. Therefore, the terms that the lender provides to the startup (and the diligence process they must undertake) are interdependent on the relationship between the lender and their own investors.
To cut down on the wait, do your homework and anticipate the risk areas that will draw the most scrutiny. Prepare any documentation your lenders may need in advance of being asked for it. For example, if you are financing electric vehicles, have all the titles scanned and ready for review. You may still get asked for physical ones, but taking an extra step will put you ahead of the game.
For this reason, a great data room goes a long way. If you don’t feel that your bookkeeping and pro forma are top-notch, invest in them now; consider going an extra step and get audited financials done. They are worth their weight in gold as they lend legitimacy to your Company.
Understand Step-in Rights
In case anything goes wrong with your company, lenders will often have provisions to manage downside risk. One key mechanic with asset/receivables loans is step in rights, where the lender can take possession of a contract with a customer and become the new counterparty (i.e. the revenues flow directly to them). For example, if you finance heat pumps to residential consumers, your lender will want the right to step in and take over those contracts in case you go bankrupt or default in other ways. As a result, lenders will want to make sure your contracts with your customers permit this type of assignment already; if not, they may not think it’s worth it to do a deal, given the difficulty of redoing all of your customer agreements.
Remember that the lender is rooting for you
Most lenders who originate are truly looking to be a long-term partner to your business. Often this will mean starting with a small facility, and building up from there. If you don’t already have an existing relationship with a lender, keep this in mind and moderate your ask to maximize your chance of success.
For example, instead of asking for a $5M dollar loan out the gate to support your work for the next 3 years, you may be able to take out $500,000 initially, and go up to $5,000,000 as you scale. This presents less risk over time to the lender, even if you perform the same across both scenarios. Be clear about when and how much capital you’ll be coming back for– this enables lenders to effectively plan their deployment of capital and will make for a better partnership overall.
Everything is negotiable
As with most commercial arrangements, almost every element of a debt agreement is negotiable; this includes the cost of capital, any covenants or conditions, security, etc. As noted above, these terms are interrelated, so addressing one will require adjustment on another. Be prepared for this game by understanding where you can give and where you can’t.
Last minute changes are normal with debt
Sometimes, as diligence moves along after your term sheet is issued, the lender may restructure their terms due to new information coming to light. Don’t freak out: they’re simply trying to find the best way to navigate newly identified risk. It can certainly be frustrating to have a change in documentation when the deal is close to fruition, but patience and flexibility will pay off here.
Mark Paris has spent his career in finance since 1988. He is currently Managing Partner at Third Sphere and CEO of Urban Us Capital,, a company that invests in early-stage start-ups focused on solutions that address the needs of cities and sustainability. He is also a Director on the Board of Swell Energy. Mark was previously Managing Director at the urban technology accelerator, URBAN-X, and was the co-head of Debt Capital Markets and Global Innovation Officer at Citi. He was the CEO and Co-Founder of Perl Street. He holds a Masters from Harvard University as well as undergraduate degrees from Johns Hopkins University and Muhlenberg College.