Community Event: Cost of Capital for Climate Tech

Check out the recording from our recent Enduring Planet and Friends Webinar, together with Planeteer, SVB, Greenbacker, and the Ad Hoc Group. Over the course of 90 minutes, we covered an array of concepts and tactics focused around the changing costs of capital for climate-tech, and the implications for founders.

The next Webinar, Government Funding for Climate Tech, will be on December 17th at 10AM PT. Sign up here.

Speakers: ​

• Hannah Friedman, Venture Partner, Planeteer (moderator)
• ​Dimitry Gershenson, CEO, Enduring Planet
• ​Jordan Kanis, MD, Silicon Valley Bank
• ​James Schulte, Partner, Ad Hoc Group
• ​Trixie Blair, Principal, Greenbacker

Notes:

• Q: How did we get here in terms of the zero interest rate environment over the past 10 years? A: The past 10 years have been unique due to the low to zero interest rate policy (ZIRP) environment. This environment has led to distortions in capital raising and investment decisions, as investors have been seeking higher returns in a low-yield environment. This has resulted in a significant amount of private venture dollars being invested in climate tech, totaling nearly 160 billion over six plus years.
• Q: What have been some of the distortions in capital raising for climate tech as a result of the zero interest rate environment? A: Some of the distortions in capital raising for climate tech as a result of the zero interest rate environment include inflated valuations, increased competition for deals, and a focus on short-term gains rather than long-term sustainability. Additionally, the low interest rates have made it easier for companies to access debt financing, leading to potential over-leveraging and financial instability in the long run.
• Q: Why was the ZIRP environment called "frothy," and what's the equal and opposite reaction happening now? A: A frothy financing environment is one where a lot of transactions are happening at overly optimistic valuations. There is a high risk tolerance and prices reflect that optimism. The opposite would be a more rational, disciplined and "structured" market environment where valuations are based on realistic factors such as unit economics and profitability. Competition in the market, driven by frothiness and lots of money, led to distorted valuations from actual fundamentals. Investors were pushing for higher valuations, even if the company hadn't proven durable unit economics or hit EBITDA targets, creating a competitive environment that contributed to inflated valuations.
• Q: How did investors think about winning deals in a ZIRP environment? A: Winning deals in ZIRP often meant competing on the strategic value an investor could provide to companies. Investors emphasized their understanding of financing markets for subsequent rounds and forms of capital and their ability to shepherd companies through the growth process to achieve durable valuations.
• Q: Can you give us a map that storytelling through the phases of a startup's growth and what are the different types of capital they're going to encounter and those quick snapshots on associated costs? A: There's a whole map of the different types of financing companies can access, including equity, grants, and credit, throughout the lifecycle of the company. Equity is leveraged for uncertain bets, grants have associated costs despite being zero cost, and credit can take various forms with pricing varying depending on the lender. Return expectations for equity at different stages of a company's growth and pricing in equity markets can impact the cost of capital for companies. Debt at 15% for something unsecured is competitive.
• Q: What should equity capital be used for, and what's its cost? A: Equity should be leveraged for uncertain bets, such as investing in product development and hiring a team for companies with high growth potentials and real revenue generation opportunities. Equity is the most expensive capital to raise at any stage, with return expectations varying based on the stage of the company.
• Q: What is the cost of project finance side in terms of equity and debt? ? A: On the project finance side, the cost of equity for large scale utility projects can be in the high single/low double digits, while debt can be fairly cheap. For smaller distributed generation projects, the cost of debt can be around 6-7%, but for less well-known projects, the cost of equity can be in the low double digits to mid teens. Investors consider factors such as proven technologies, long-term contracts, and assured cash flows when determining the cost of capital for project financing. Lots of challenges faced by companies seeking project financing for new technologies, as banks are hesitant to finance first-of-a-kind projects due to the high risk involved.
• Q: What is the cost of capital for senior secured lending in early stage venture debt? A: The cost of capital for senior secured lending in early stage venture debt is quite low, as it provides a non-dilutive runway extension on top of an equity round, with a small warrant component.
• Q: Can you explain the process of project financing at the bank and the requirements for it? A: Project financing at the bank requires experience, a strong management team, and sponsors providing capital. Project finance is the lowest cost of capital, typically around 6-7%, but it requires minimal risk.
• Q: How do you approach financing for smaller assets? A: Banks or alternative lenders can often finance smaller assets based on shorter contractual terms and through alternatives like hardware as a service, but it is challenging to secure funding for these projects without proven scale or volume. Even for proven technologies like EV chargers, capital providers prefer to fund projects with scale. Often, the best path can be to initially fund the project or roll-up with equity and then refinance with bank debt or credit. This allows companies to demonstrate scale and attract larger investments from credit providers.
• Q: How risk is perceived when preparing to inflect from equity and early stage investors into the credit and infrastructure, later stage investors? A: To secure corporate debt and/or project finance, often founders need to set up quality data rooms including thousands of pages of documents, track performance to plan, and come with an informed perspective on what risk their target investor can practically take. It also involves communicating to the investor frequently well ahead of underwriting to build a relationship. Preparing for this inflection requires multi-stakeholder collaboration across customers, service providers and investors. Additionally, the goalposts for milestones and metrics may shift alongside the broader macro market shifts.
• Q: How should founders think about traversing across the capital stack? A: It's important to retire specific risks at each step in order to attract different flavors of capital. It's necessary to consider the deployment of capital and access to it, rather than just focusing on the lowest cost. Sometimes paying slightly more for commercial terms can be more beneficial in the long run for scaling a company. Capital efficiency is not just about the price or interest you pay, but also about factors such as dilution, speed of transaction, complexity, seniority, and security associated with the capital. Founders should weigh these factors together when evaluating different capital options. Having partners who understand the challenges and are willing to navigate them together, even if it costs a little more, can lead to a better long-term outcome. Partners who are patient and supportive during hiccups along the way bring a ton of value beyond capital.
• Q: What are the non-linearities of the cost of capital? A: Sometimes, if you can access sustainability-specific capital such as credit provided by Green Banks, you might have an arbitrarily or catalytic cost of capital. Founders should ensure that customer contracts for future projects and growth can support commercial terms such as a higher interest rate from a non-sustainability oriented bank or lender.
• Q: How are companies managing for inflation as interest rates come down? A: Companies are managing for inflation as interest rates come down by focusing on revenue models, go-to market strategies, and maintaining discipline in their financial decisions. They are also looking at policy changes that could impact their revenue streams and are preparing for a more stable revenue environment rather than relying on hope or hype.
• Q: What changes are anticipated with the next Presidential administration, and how are companies navigating potential tariff-led global trade policies and their impact on inflation? A: In the renewable energy sector, solar is still the cheapest form of energy for new builds. However, costs have increased relative to what they used to be. Companies are ensuring their financing is in place and that their unit economics work even with a higher cost of capital. They are also mindful of managing their margins as costs increase and are looking at natural hedges such as retail rates increasing to offset rising costs. Companies are also weighing how much of the resulting costs from tariffs will be passed on to consumers or purchasers of raw materials for projects, and they are preparing for potential increased inflation.
• Q: Is there a possibility of current incentives under the IRA and ITC going away? A: Most current incentives under the IRA and ITC are unlikely to go away, as they are related to domestic manufacturing, which is a bipartisan priority. Some movement is expected but not a wholesale shut off of incentives for technologies and companies they work with.
• Q: How will the fundraising market, particularly equity, for entrepreneurs in the climate space change in the next few years? How are VC investors adjusting their expectations for startups? A: The fundraising market will continue to be challenging in the next few years. Equity markets take time to recover from slumps, and expectations from investors are becoming more difficult to meet. Series A investors are adjusting their expectations by looking for companies with 2 to 3 million in recurring revenue, a clear path to profitability, and 3x year-over-year growth. Also, keep in mind all rounds are taking longer to close; for example, it used to take six months to raise a seed round, but it now takes longer (up to 18 months) unless the founder is a repeat entrepreneur or has a deep venture network.
• Q: What adjustments do founders need to make in their capitalization strategy? A: Founders should cast a wider net: expect to talk to a larger number of investors when raising a round of funding. For example, plan on talking to 300 investors instead of 150 to increase the chances of securing funding. Founders also need to be prepared for a longer fundraising cycle, higher prices (aka cost of capital or dilution), and to make trade-offs between accepting less than ideal structures and choosing the right, values-aligned investors.
• Q: How can founders be better prepared for a longer fundraising cycle and higher prices in certain contexts? A: To be better prepared for a longer fundraising cycle and higher prices, founders should build these factors into their process. Founders should talk to more investors, be patient with decision-making timelines, and be willing to make adjustments in their fundraising strategy.
• Q: How do you think some of the other alternative forms of philanthropic, family office, high net worth, individual capital, step in here? A: Historically, family offices, donor advised funds, private foundations, and corporate foundations have tried to fill gaps in funding. However, many of these entities claim to be catalytic but are not actually providing the necessary capital. It's really important to build personal relationships and create conviction in a champion who will fight for the funding. It's a good idea to go through collectives like Toniic or CREO, where investment teams make decisions on behalf of family offices and foundations.
• Q: If you hadn't taken a single equity dollar onto your cap table today, how would you think about getting through early product market fit and the initial stages of scaling? A: It's really important of focus on early revenue and commercial traction. It's key to identify the strongest signals of demand and unit economics, as well as being creative in driving commercial traction as soon as possible. It's also important to understand the consequences of taking outside financing and from which types of investors. Founders might have to consider taking what they can get when they can get it, whether it be from grants, angels, or other forms of capital. Founders have and will continue to find the right balance of making concessions in order to build the business they want. The primary character traits of successful founders who continue to capitalize efficiently in market downturns or corrections are perseverance and resiliency.