Communicating risk to project investors

Project investors are far more risk averse than early stage equity providers, like VCs. To earn their confidence, you’ll need to pinpoint everything that can go wrong with your business, then demonstrate how you plan to eliminate, allocate (to a partner, for example), or mitigate those risks. Not only will this win over investors, but it’ll help you uncover any overlooked vulnerabilities, and build a far stronger business.

This is the third of a series of Insights with Hannah Friedman of Planeteer Capital, about what it takes to incorporate best in class development principles within early-stage technology companies. Here, we look at how you can break down the five pillars of risk that will impact your climate startup and effectively communicate your mitigation strategies in order to secure capital. 

Why project investors care (more) about risk

Project investors are more risk averse because they have very different priorities and tolerances compared to corporate equity investors. First, their money comes from allocator sources like pension funds, who have long-dated, predictable cash flow needs. And, unlike VCs, project investors’ returns on individual transactions are often capped. This means their tolerance for failure is much lower – while VCs can afford to lose 99 out of 100 deals, a project investor can afford less than 1 in 10, if that.

So, while VCs care about scale and speed, project investors need stability and certainty. Your equity providers want to see the upside of scale with massive leaps in orders of magnitude; your project financiers want to see the consistency of repeatability with continuity over time. Graduating to this project audience means you’ll need to meaningfully shift the way you talk about risk. Talking about risk in their language demonstrates an understanding that you’re taking all precautions to prevent anything from going wrong, and that you have the right guardrails in place when it does. In some ways, you now have to think about protecting their money just like the fiduciary that they are - all the more important when these cash flows are insurance policies or someone’s pension. 

How to start thinking about risk

This process won’t feel intuitive or natural – if you’re doing it right, it will feel like you’re trying to pick holes in your business. Think about every aspect of your company and project where things can go wrong, write it down, then consider how you can eliminate, allocate, or mitigate that risk. If you don't have a perfect answer or if something is completely unmitigated for now, it’s not deal-killing, write it down anyway. 

At early stages of diligence, investors primarily want to see you’re thinking deeply about these challenges and aren’t leaving any stone unturned. Many infrastructure and project investors will welcome the chance to be a part of troubleshooting or strategic planning for risk mitigation. But know your audience: This will not be true for all project financiers and investors.

The five pillars of risk in project development

We wrote about the five building blocks of project development, and here, we’ll translate the five foundational blocks into tactical ways you can categorize and describe risk. 

1. Technical risk
When building your first projects - both demonstrations and first-of-a-kind at commercial scale (FOAKs) - you not only need to show what you’ve already validated (with data!), but what will be different in the next version, and then at scale. 

For instance, if you’re a membrane technology and you're going from 5x5cm of membrane material to 10x10cm, that change needs to be reflected in your techno-economic analysis – a tool that shows how adjustments across your system impact your cost and inputs. Often, when talking about technical risk, it’s helpful to draw parallels and analogies to other technologies and industries. For example, you can show your scale-up is just a fraction of the scale-up that similar membranes in reverse osmosis accomplished in water. If you're using comparable materials, you can reasonably demonstrate mitigation to the scale-up risk.

Communicating technical risk also means explaining how you integrate with sites from an engineering perspective – e.g., whether you have a totally stick-built unit versus a skidded unit – will impact your partners like EPCs, and what their reactions have been to these proposed changes. The more that these risks can be documented in formal (and third-party validated) studies and engineering designs, only helps to augment the perception that risk is mitigated or retired for your project. 

Technical risk can be one of the most challenging risks to communicate to investors, often because investors are not technical. Sometimes independent engineering reports can be leveraged to help bridge the gap, but having individuals within your team who can go toe-to-toe with technical reviews in diligence and translate that risk seamlessly to investors with analogies and clear connections to the business case is a superpower of project teams. 

2. Commercial risk
Commercial risk is all about your contracts - most often your feedstock and offtake contracts, but for strategic partners (EPCs, equipment vendors, insurers, etc), too. The clauses in these contracts need to be clear on who’s “holding the bag” if things go wrong. For instance, if the price of your feedstock spikes in the market, what prevents your supplier from selling to someone else when you can’t afford that? If transportation delays increase costs, do you pay, or does your customer? If there are time delays and your customer isn’t able to receive the product, who covers the warehousing or downtime costs?

Comparables that show your clauses are very standard for your particular customer is, again, a huge help – e.g., if you’re a geothermal company, and you use a clause that’s standard in traditional renewable PPAs, you can say with a large degree of certainty that your customer will sign it. Contracts derisk commercial aspects of your project by painting a picture of “what happens when”. These days, clauses that address volatility in the market and tariffs are now business as usual.

Your lawyer also matters: for this work, don’t go with a generalist startup lawyer. Make sure they’re extremely well-versed in contracts in your or a comparable industry, and can tell you what is boilerplate in the space.

3. Siting and regulatory
One often overlooked aspect of siting and regulatory is community engagement and proactive stakeholder involvement. Anyone can build a permitting matrix and a list of siting criteria to demonstrate to financiers that they’re de-risking the process in development. But having the names and numbers of real people on the ground in your target potential sites will go a long way; infrastructure development is an intensely local activity. 

Another risk strategy is to demonstrate that you are keeping multiple plates spinning at the same time, running parallel strategies with clear mile-markers for when you divert from Plan A to B (or D, E & F). Build redundant development strategies and financial models with toggles when it comes to key drivers.

In today’s market, especially with  permits and incentives, you will also ideally show that your project will be economical with or without incentives, or in the face of delays. Where possible, show investors that you have contingencies in play, such as moving to another site or getting the same grant from a different state. Essentially, you’re demonstrating that you’re all in on Plan A, but you’re already building the relationships that will make backup plans possible. If this sounds like a lot of extra work, don't think of it as just checking boxes for your investors – think of it building corporate optionality & resiliency, which in some cases is also simply pipeline development and proactive sales work. 

4. Financing risk
Your financial pro forma is an opportunity to sit in the driver’s seat of your narrative and tie all your business and development pieces together. If you’re leaving your pro forma for investors to put together themselves, you’ll come across as unprepared and lose your opportunity to take control of your story. Plus, if you hand investors a financial model or any kind of projection, they’ll run a sensitivity analysis on it, and many of them will not do a good job. Get ahead of this by including it yourself. And, build your models to be easily audited. You can’t risk coming across as unprepared, but you also have to recognize that investors will seek to understand the model’s drivers and sensitivities themselves, often by rebuilding the model themselves - we’re all human after all, and even experienced investors will best learn your business by (re)doing the model!

The other financing risk that project investors will care about is the parent company’s (“TopCo’s”) financial health, funding needs over time, and your ability to execute on those fundraising goals. TopCo fundraising risk can be one about execution; are your executives experienced, well-networked and ready for the current market conditions? Missing your fundraising targets by three months won’t push your ramp back by three months, it will dramatically shift your timeline, with delayed capital compounding into delayed hiring, construction, and revenue. Investors want to safeguard against these risks, and the often look to team and advanced preparation as part of this mitigation. 

5. Global risk
Global risk is all the other stuff and often how risks interact. Global risk covers black swan events, key persons and other external risks. For instance, if your site changes, how does that affect offtake with different customers? If you can’t access a critical piece of equipment, how could that affect your timelines? What if your CEO gets severely injured accidentally? Are there risk “dependencies” of one on top of another that could compound or cascade?

Communicating it all

Overall, risk is about transparency and documentation with your investors. To cover the five pillars above, your data room will need to include a risk matrix or memo articulating i) the risks you perceive ii) whether they rank as high, medium, or low, iii) the people tasked with managing these risks, and iv) whether these risks are currently eliminated, allocated, or mitigated - and with what strategy.

Communicating project risk to investors is communicating a real-time process, so finding investors who are collaborative and strategic (ideally because they’ve been there, done that) can be immensely helpful. But, ahead of meeting with any investors, putting this down on paper in an organized way for yourself and consistently checking in about how you’re tackling those risks will give you, your team and your investors higher confidence that you will be able to weather all the storms that come.

Hannah Friedman is a climate investor and operator. She's deployed 10s of millions of dollars into early-stage companies and has directly supported more than $100M+ of fresh capital raised to invest in climate specifically. She spends an embarrassing amount of time with CFOs perseverating on capital stack strategies. Most recently, Hannah helped launch Planeteer Capital from scratch, a Pre-Seed climate tech VC fund looking for the next generation of hardware-enabled software. Grateful alum of Closed Loop Partners and Columbia University.