Unpacking Private Equity for Growth-Stage Climate Companies

Once your climate business has demonstrated meaningful traction, growth equity can be a powerful tool for scaling your company. Growth-stage financing, like growth equity, can support manufacturing and go-to-market scale-up, product extensions, new market expansion, or growth through acquisition.

We sat down with Katharine Hawthorne to discuss how to know if your business is ready for growth-stage capital and guidance on working with private equity investors. Katharine is Vice President with The Builders Fund, a growth-stage private equity fund focused on sustainable systems and human elevation.

What does “growth-stage” mean?

Growth-stage investors look for established businesses with proven and recurring revenue and limited business model or technology risk. Companies might have at least $10-20M in revenue (i.e. beyond pilots), and be approaching profitability, break-even, or cash flow positive. Investors will evaluate “quality of revenue,” diversification across customers and product/service offerings. Companies should be positioned for continued expansion of 20%+ annualized growth over a sustained period of time. Growth capital typically supports replication of products/services in current and new markets; therefore businesses with clear commercial traction and compelling expansion opportunities will be a strong fit for growth-stage investment.

Deciding to raise growth equity

There are several considerations when deciding to raise growth-stage private equity from a fund like The Builders Fund.

Growth-stage businesses typically work with multiple financing partners, including both equity and debt providers. Cash flow positive companies can often support bank or other commercial debt but may wish to work with an equity investor to finance growth initiatives that would result in net cash burn, or negative EBITDA.

Pre-profitability growth-stage companies can also access debt now that the alternative financing space has expanded dramatically including inventory finance, receivables finance, revenue-based financing, venture debt, factoring, etc. A strong private equity partner can open relationships to other capital providers and advise on balancing the “capital stack” as the business scales (the definitive resource from Climate Tech VC).

Private equity can also create partial liquidity for management and early investors via secondary transactions (i.e. purchasing existing shares as opposed to “primary” or “growth” capital investment that involve issuing new shares). In climate, exits can often take 10+ years, and a secondary transaction can provide a path towards returning capital to early investors without forcing the company to pursue an acquisition or IPO. Secondaries may also align timelines and incentives of all shareholders, and allow management to participate in future value creation instead of selling the business today and potentially leaving money on the table.

Late-stage VC funds and growth-stage PE may differ in intended hold period and loss ratio, with late-stage VC seeking an exit in 2-3 years and expecting a 25-30% loss ratio (i.e. percentage of companies that fail to return capital). Private equity firms typically have a concentrated portfolio approach and focus on investing in businesses with low risk of failure that can provide capital appreciation over 3-5+ years. Builders invests with a 12-year time horizon from fund inception, which supports more exit flexibility than typical in VC/PE. To balance this longer timeline, Builders and other PE firms will seek companies with lower risk of failure (Industry Ventures has a great Risk/Return/Timeline matrix on how these factors interrelate).

Private equity investments can take 6 months or more to finalize due to deal complexity. Builders views investing as a partnership with portfolio companies and works to establish relationships prior to engaging in a transaction, including following emerging growth-stage businesses that may currently be too early for the Fund’s revenue and profitability targets.

How to prepare

When you decide to initiate a growth-stage private equity process, you may wish to consider developing the following before approaching investors:

• Audited financials and credible projections. Be prepared to provide a comprehensive picture of historical and projected financials that supports your growth plan. Growth-stage investors will likely expect audited financial statements and may perform a “Quality of Earnings” as part of accounting diligence. Audited historical financials, the financial model, and the CIM (Confidential Investment Memorandum) are three foundational files in the data room of a growth-stage company.
• Growth strategy and “Use of Funds.” Have a clear understanding of the market opportunity and tangible strategies for how the business will capture demand and generate cash and profits. Identify the amount of capital required to execute this growth strategy and provide detail about intended use of funds. If the business is currently burning cash, communicate the timeline to achieve positive cash flow and profitability with as much clarity as possible.
• Intentional approach to relationship building. Growth-stage companies have often worked with prior and existing investors and have a sense for what type of support may enable the next stage of growth. Research potential financing partners for what they may contribute beyond capital to your company’s growth and success, and with the understanding that this may be a long-term relationship.

Katharine Hawthorne is Vice President of The Builders Fund, a growth-stage private equity fund focused on sustainability. She is a Board Observer at MPOWERD Inc, a Certified B Corporation specializing in designing clean energy technology including solar lighting and mobile charging. Katharine holds a BS in physics from Stanford University and an MBA in finance from UC Berkeley.