Community Event: Corporate Debt in Climate Tech

This is now Enduring Planet, Planeteer, & Friends’ fourth of our monthly “Financing Your Climate Startup” Digital Series. If you missed our first three, we highly encourage you to go back and read the teardowns on the Enduring Planet Insights page.

This month, we sat down to discuss the strategic use of corporate debt across stages and use cases for climate businesses. This discussion is particularly important for climate tech entrepreneurs looking to leverage debt as a tool to fuel growth while navigating the unique challenges of the sector. By understanding the types of debt, managing risk, and building strong financial systems early on, founders can optimize their access to capital and reduce equity dilution as they scale their businesses.

Speakers: ​

• Hannah Friedman, Venture Partner at Planeteer and Head of Partnerships at Mark1 (moderator)
• ​Dimitry Gershenson, CEO, Enduring Planet
• Shuo Yang, Partner, Lowercarbon Capital
• Luc Gerdes, Territory Manager, Camber Road
• Austin Badger, Managing Director, HSBC Innovation Banking

Q: What types of debt should climate tech companies consider when scaling?

A: Climate tech companies have several debt options to consider depending on their needs and stage of growth. These include corporate balance sheet debt, off-balance-sheet debt, and equipment financing. Each type serves a different purpose:

• Corporate balance sheet debt: Tied to the company's overall financial health and assets. This could be in the form of term loans, receivable financing for contracts or grants, factoring, revolving lines of credit, etc.
• Off-balance-sheet debt: Capital provided to a special purpose vehicle (SPV) that finances specific assets that are then held in the SPV, not on the company’s balance sheet. Revenues from those assets are then housed in the SPV and are used to service the loan prior to any distributions made to the parent entity. Generally this debt has limited or no recourse to the parent entity, unless specifically guaranteed.
• Equipment financing: Specifically for purchasing or leasing equipment, where the equipment itself serves as collateral. While this kind of financing can often be balance sheet debt, it can also be structured as a lease or rental agreement.

Understanding the type of debt that aligns with your company's growth strategy and financial structure is critical to making informed decisions. 

Q: What is the difference between secured and unsecured debt?

A: Secured debt is backed by an asset or other forms of collateral (all corporate assets, cash on the balance sheet, IP, contracted receivables, etc). For example, in equipment financing, the equipment or hardware itself serves as collateral for the loan. Unsecured debt doesn’t involve collateral. Instead, lenders primarily evaluate the business’s financial health and/or the risk associated with a specific receivable. Secured debt often comes with lower interest rates due to its lower risk for lenders, while unsecured debt can offer greater flexibility but typically carries higher costs.

Q: What are the risks and incentives associated with equipment financing?

A: Equipment financing varies broadly across providers, so it’s important to understand the nuances:

• Risks: One of the primary risks in equipment financing is the possibility of needing to reclaim the equipment if the borrower defaults. However, lenders aim to avoid this scenario, focusing instead on ensuring that the equipment remains in use and supports business operations.
• Benefits: Equipment financing is appealing because (a) it allows companies to acquire the necessary tools and infrastructure without depleting cash reserves and (b) is often secured solely against the equipment, rather than all corporate assets. Also, when things go wrong, equipment finance providers are incentivized to be flexible, aiming to support the company through challenges rather than repossess equipment, which is costly and disruptive.

Q: When should climate companies seek debt financing?

A: Debt financing should be leveraged to support the working capital needs associated with relatively predictable outcomes, such as funding the work under a large contract with a credit-worthy customer (i.e. government, big corporate, etc), purchasing equipment that generates a predictable revenue stream, etc. 

One important element that was discussed is the timing of when companies should seek debt. A lot of founders mistakenly seek debt as a financing option of last resort, and that is generally not a good idea. If you’re already out of money, the lenders that will work with you will either have very high costs associated with bridge lending, or will have other predatory terms. You should consider debt, with its low cost of capital, as your first resort, and leave your equity for times of uncertainty.

Q: How does loan pricing change based on business milestones or progress?

A: Loan pricing is influenced by several factors:

• The Federal Borrowing Rate is one the primary determinants of pricing, as most lenders start their math there
• The collateral/security of the loan is a big factor. The more secure, the lower the pricing
• The Term of the loan is another. Typically, the longer the term, the higher the pricing
• The type of lender providing the financing will also affect pricing. Non-bank lenders will typically have higher rates than bank lenders
• All of the covenants, warrants/equity participation, and other terms will also affect pricing.
• Your Milestones or Progress also matters. The more mature the company, the lower the risk, the better the pricing

It's important to consider the broader financial market and your company’s milestones when negotiating loan terms.

Q: How can founders better prepare for debt financing in their businesses?

A: Preparation for debt financing needs to be holistic:

• Professionalize early: As soon as you take outside investment, establish sound accounting practices and financial planning to give your company credibility with potential lenders.
• Financial tools/software: Invest in appropriate financial management tools and software to track cash flow and financial health, especially as the company scales.
• Hire financial professionals: Consider hiring a VP of Finance or CFO, even on a fractional basis, to ensure your company’s finances are well-managed and to improve access to capital.
• Understand loan terms: Before agreeing to any debt, scrutinize the loan terms, including fees, covenants, and personal guarantees. This will help avoid unexpected liabilities.
• Maintain open communication: Always keep an open line of communication with lenders, especially when facing challenges. Transparency can often lead to more flexibility and support during tough times.

Q: What strategies can founders use to negotiate better loan terms?

A: Founders can primarily navigate getting the best terms for a corporate loan by:

• Conducting thorough research and being generally prepared: Understand the market rates for similar loans and be clear about your company’s financial health and milestones to prospective lenders.
• Leverage relationships: Building strong relationships with lenders early can help improve loan terms, reduce fees, and increase flexibility in the event of challenges.  Start these conversations before you actually need the capital.
• Avoid predatory terms: Be cautious of lenders offering high fees, short cure periods, and overly complex covenants, as these can become very problematic quickly when things don’t go as planned

Q: How can venture debt support early-stage companies in climate tech?

A: Venture debt can be an essential tool for early-stage companies, especially when bridging the gap between funding rounds or achieving specific business milestones. The key elements include:

• Warrants: Most venture debt agreements include warrants, which allow the lender to convert the debt into equity under certain conditions. This gives the lender a stake in the company’s success.
• Flexible terms: Venture debt can provide more flexible terms compared to traditional bank financing, making it a good option for companies that don’t have the typical 2-3 years of profitability that most banks require
• Reduced dilution: Using debt to fund operations or development costs can reduce the need for equity funding, thus preserving ownership for founders.

Q: How important are strong financial foundations in the early stages of a climate startup?

A: Professionalizing your financial organization early on is crucial for a variety of reasons:

• Improves capital access: Strong financial practices improve your company’s credibility and help you attract better terms when seeking funding or loans.
• Increases efficiency: Proper financial planning and analysis allow you to make informed decisions and avoid costly mistakes.
• De-risks the business: Well-managed finances can help mitigate risks, making your company more attractive to investors and lenders.
• Potentially lower capital costs: A well-organized financial structure can lower the cost of debt, as lenders are more likely to offer better terms to companies that demonstrate financial responsibility.

Having the right financial support team in place—whether through fractional roles or full-time hires—can be a game-changer for a startup’s growth.

Q: What should founders do when things go wrong?

A: The first thing that founders should do when things don’t go to plan is to notify their lenders, unless they think the issue can be resolved without affecting the servicing of their loan. The last thing you want as a founder is to have your lender call your loan because you breached your agreement, triggered a covenant, etc. Most lenders are not interested in moving into some kind of workout situation; they’d rather modify the loan and support your solvency so that they can (a) make the most return and (b) work with you again in the future. Be transparent and move quickly, and the outcomes to your business will be much better.