Playbook: How pre-order agreements help you avoid the “Funding Valley of Death”
For early-stage climate tech startups, building an impressive order book to demonstrate market pull to potential investors is a key exercise. Not sure how to get started in sales? Read on for guidance and a free pre-order model contract.
As a climate tech founder, you have a vision for a much-needed solution that can move the needle on climate change. Turning that vision into a reality takes more than just passion. It takes funding and great execution, particularly in sales. There will be no measurable impact without hardcore sales performance.
The first step to getting on track is to raise a seed round. Entrepreneurs typically have between 18 and 24 months of runway after a seed round. This means that the capital raised should be sufficient to cover the expenses for the next year and a half to two years, giving the company time to advance its technology to a minimum Technology Readiness Level (TRL) of 6–7, if not higher. TRL levels from 6 to 9 mean that the technology is mature enough to be commercially deployed.
With the time and capital of a seed round, entrepreneurs need to focus on de-risking the company for the next round of funding. Later-stage investors will want to see certain levels of de-risking before writing checks. Apart from building a strong team and hitting key milestones in the development of the technology, de-risking the company involves demonstrating commercial traction. An extraordinary performance on the sales side is essential to achieve a substantial impact on climate change and continuing your startup’s journey.
Traction or sales is measurable, and can mean booked revenues, contracted revenues, pre-order agreements, advance market commitments (AMC), and/or letters of intent (LOIs). Demonstrating significant traction through signed customers via these types of agreements to prospective Series A investors is generally a very good idea.
Commercial traction can come in many shapes and forms, but not all of them are created equal. While LOIs show a comparably low level of commitment from potential customers, pre-order agreements are worth a deeper look. Jointly with the founders of Extantia’s portfolio company Reverion, we have successfully adapted a go-to-market strategy from Tesla to result in more than €60M in pre-orders for the Bavarian climate tech startup in only 6 months. Personally, I experienced this strategy firsthand as a customer (when waiting for my Tesla for two years).
This type of agreement tends to work very well for startups that have not fully advanced to serial production of their plants/products but are already experiencing a solid amount of inbound customer interest.
So, let’s take a look at pre-order agreements, how they work, and how founders can use them to build an impressive order book as an early-stage company.
The ins and outs of pre-order agreements
Pre-order agreements are a lightweight legal document between two parties, where the purchaser: 1) secures the option to purchase one (or more) of the startup’s units/plants in the future and 2) agrees to make a fractional down payment of e.g 1% of the expected price today. Either party can back out at any point in time and the down payment is fully refundable. Simple as that.
These potential customers are essentially reserving their place in line for manufacturing. Especially for manufacturing-heavy, deep tech companies, this is an excellent way to demonstrate a very real market pull and demand for their technology. It is important to highlight that pre-order customers are taking significant risks in wiring five-digit amounts to a party they know to be a pre-revenue startup, thereby signalling strong demand for the product.
There are four notable aspects of this type of agreement:
1. There is no binding commitment to deliver the product after the contract is signed. The true value of this type of agreement is the customer giving a reinforced commitment to buy the product once it is available — a proof point of traction from the market.
2. There is no purchase price in the pre-order contract. This is done intentionally as there might be unforeseeable changes in production or on the supply-chain side. However, the basic technical parameters of the unit/plant should be mentioned in a fact sheet, which is often attached as an annex.
3. This is not a financial instrument for startups. Meaning, the down payments are not to be seen as comparable to proceeds from an equity round or grants that could be deployed in product development. The best practice is to put the down payments aside in a separate bank account and not use them.
4. Startups need to consider their realistic mid-term manufacturing capacities. While both parties are aware that delivery might take a while, you and your team should already have a solid plan to enter small series production and work towards actually delivering the signed pre-orders.
Pre-order agreements can be seen as an instrument to mitigate the “chicken-or-egg” dilemma of showing sales traction before a substantial ramp-up of manufacturing capacity has taken place. Investors acknowledge and value an order book of several (dozen) signed and wired pre-orders. It is an entirely different story to show a stack of signed agreements with money in the bank to diligencing investors — compared to just talking your way through a theoretical sales pipeline that is unconverted.
Reverion case study: more than €60M in orders in 6 months
Reverion, one of Extantia’s portfolio companies, is on a mission to make carbon-negative power generation possible at scale. Their technology extracts 2x as much energy from biogas compared to current state-of-the-art combustion-based processes. This groundbreaking advancement is enabled by Reverion’s drop-in solution that replaces the standard combustion engines with a special fuel cell in a novel system design.
Every biogas plant operator in the world is a potential customer for Reverion. This includes local farmers, utilities and industrial customers. Geographically, it was easy for Reverion to know where to start. The company’s home country, Germany, is the world’s leading biogas/RNG market. After defining a target audience, the next step is to develop a sales strategy and a clear process to close an opportunity. This is where pre-order agreements come into play.
“When we first started building our sales pipeline, we put potential customers on a waiting list to be notified when our plants became available. It didn’t work for us. With this approach, we had a poor understanding of the individual level of interest and no idea if or when they would become paying customers,” said Felix Fischer, Co-Founder & COO at Reverion. “As we discussed this issue with our advisory board, the pre-order agreement idea emerged as a promising tool to better reflect actual demand for our technology. So that’s what we did. We started to close customer after customer. Most of these initial pre-order customers are very experienced biogas operators, who understand our value proposition right away. Fast forward to today, we are proud to have built a substantial order book and a well-oiled sales organisation. We are currently preparing to enter serial production with the recent investment round’s proceeds to rapidly scale up the number of units delivered per quarter.”
Final considerations and a free downloadable pre-order model contract
While commercial traction is undoubtedly a key indicator for prospecting investors, it is important to acknowledge that even proper success in closing pre-orders alone will not automatically close your next round. Without parallel progress in product maturity, VCs are unlikely to put up a term sheet. You need to clock in as many operational hours of the plant, that is for pre-order, prior to raising your next round as well. Look at commercial traction as a catalyst to help you achieve your funding targets.
In addition to that, keep in mind that institutional investors are investing in a company. Most VCs are not investing in an idea alone and neither are they looking to invest in a company that is essentially a sales department and not much else. Conviction in the market is key, but so is the market readiness of the product and the team in charge of delivering it.
Also, do not underestimate a certain continuous effort to work with your signed pre-order customers. An established order book already requires some Customer Success Management skills from you and your team to retain interest until the day of actual delivery of the unit to the customer. A regular update newsletter from the factory or engineering department is a good idea. Merchandise for championing customers will also be highly appreciated.
We hope this article helps you understand how pre-order contracts work and how you can potentially use them to demonstrate commercial traction to Series A investors.
We want to take this a step further and provide you with a downloadable pre-order contract template. You can download it here so you can understand what kind of clauses this type of agreement contains and what this document usually looks like. Feel free to use it for inspiration.
Note that this is not legal advice. This document is an example of a pre-order agreement in a business-to-business context and is intended to provide indications of typical provisions; it does not claim to be complete or correct. Prior to any use of this exemplary pre-order agreement (or individual provisions thereof), the provisions must be reviewed from a legal perspective and adapted with regard to the specific circumstances of the use case. We therefore cannot take on any responsibility for the use of this document and disclaim any and all liability — regardless of the grounds — in this regard.
