Filling In the Missing Middle: FOAK Financing

Part 1: Challenges and Alternative Sources

Lots of venture capital funds love the risk control, potential lucrative rewards, and strategic influence that come with investing in climate tech companies at the seed and early-stage rounds. Many others dive headfirst into startups that have entered the growth equity stage and have validated and begun market implementation of their technologies.

But how do viable startups navigate from one peak of VC interest to the next and navigate that “valley of death”?

TDK Ventures takes an in-depth exploration of the unique aspects involved in financing first-of-a-kind projects aimed at helping startups scale their operations and demonstrate their technologies’ commercial potential. In Part 2 of our journey, we’ll see how entrepreneurs can structure and operate their startups to mitigate risk and make their endeavors more attractive to venture capital funds and other sources of revenue and support.

Here in Part 1, we examine the often-well-founded reasons that financial and corporate venture capital funds may be reticent to support these risky projects. And we’ll discuss alternate sources startups can tap and VCs can pursue as limited partners to fill out and diversify the required resources.

Climate tech startups need capital to emerge from the lab testing and prototype validation chrysalis and spread their wings into full-scale production and operation in a bona fide plant. Unfortunately, typical CVCs and financial VCs are uncomfortable financing FOAK. projects that provide the infrastructure startups need to move forward. Investing in physical infrastructure presents several challenges that conventional institutional investors try to avoid:

● Elevated CAPEX Costs — Unlike a climate tech software startup, where a VC can secure a significant stake with a 6-figure check, companies standing at the precipice typically need tens or hundreds of millions of dollars to build their FOAK facility.

● Magnified Risk — The landscape here is littered with the bones of startups that failed to meet the challenge of large-scale integration, lacked the expertise to overcome hurdles and optimize, or relied on untested business models.

● Murky Revenue Prospects — Startups need FOAK projects to begin attracting customers. Given that they don’t have any customers yet, they cannot generate revenue which is a red flag for many VCs and CVCs that seek portfolio companies that have gained some indication that the market is ready to accept the startup’s technology.

● Lengthy Exit Horizons — While VCs focusing on climate tech usually accept longer timelines, many even many of these balk at the decade-plus projection for a profitable exit from FOAK investments. These projects typically center on hardware, which is notoriously difficult to evaluate over the long term.

FOAK Financing: Shifting the Mindset

FOAK project funding seeks to fill the “missing middle” between early-stage and proven-solution investments.

Many transformative ideas can take flight only by stimulating investment in FOAK projects that span the chasm between innovation and commercial viability. This funding is critical for accelerating technologies’ market penetration where they can hasten decarbonization solutions. As a multifaceted challenge, climate change requires diverse approaches. FOAK financing provides the means to deploy novel technologies and encourages continuous innovation and competition within the climate tech sector. Confidence that financial support and technological expertise are available for viable high-risk projects incentivizes startups to push the boundaries of what’s possible.

As nothing succeeds like success, profitable FOAK projects can create a positive feedback loop within the climate tech ecosystem. This attracts more investors and stakeholders, leading to increased funding availability, which in turn supports further innovation and deployment. Over time, this virtuous cycle will boost climate tech solutions’ impact and scalability.

Achieving these aims combines three tactics:

1. Tapping less traditional and more unconventional sources of capital
2. Reducing projects’ technology risk
3. Establishing bankable processes within the startup

Capital Source Diversification

All business ventures face the challenge of securing adequate funding throughout their lifecycles. Climate tech startups must tap into a diverse range of capital sources that not only fuel their growth but also support them from innovation through scaling and into commercialization.

Financial venture, corporate venture, and other traditional sources of capital are often sufficient to finance these startups through the early stages. However, as the company matures and its capital requirements grow, it becomes increasingly important to diversify funding sources:

● Government Grants, Loans, and Tax Breaks — Governments around the world have recognized the urgency of addressing climate change and have established programs to support innovative solutions. The United States maintains a suite of loan programs designed to propel climate tech startups forward.

The Bipartisan Infrastructure Law (BIL) allocates an impressive $90 billion for clean energy and climate investments, including grants and rebates for clean energy projects. The CHIPS and Science Act bolsters American competitiveness in technology and manufacturing, including areas critical for climate solutions. This act promises further support for R&D in clean energy technologies. The Inflation Reduction Act (IRA) may be the most impactful federal legislation for climate tech startups. With an unprecedented $400 billion dedicated to climate initiatives, the IRA dwarfs previous investments. A substantial portion of this funding will be channeled through loan programs and loan guarantees, offering much-needed financial tools for climate tech ventures.

Government loans offer favorable repayment terms and interest rates, while loan guarantees relieve traditional lenders of the risk inherent in funding FOAK projects. Many state and local governments have launched loan programs, mirroring or coordinating with federal resources. This collaborative approach creates a robust and accessible funding ecosystem for climate tech startups across the nation.

Federal, state, and local loan programs are often designed to “stack” with tax credits offered by federal or state governments. This allows startups to maximize their financial resources and accelerate their growth. It’s important to note that these programs typically deal with larger loan sizes, often $100 million or more, catering especially to ventures seeking FOAK project funding.

Unlike grant programs with limited funding cycles, loan programs function on a rolling basis, meaning they are always open to applications from qualified startups. This continuous stream of support ensures a steady pipeline of innovation.

Global governments acknowledge the urgency of addressing climate change and have established various programs to support innovative solutions in this space. Grants and subsidies can provide critical financial support not only for R&D and pilot projects but also for the commercialization of new technologies. Climate tech startups should actively pursue these opportunities by identifying local, regional, and national programs that specifically target climate tech and sustainable innovations. Examples include the U.S. Department of Energy grants, the European Union’s Horizon Europe program, and various green funds in Asia and Latin America.

Applications for these assistance programs should clearly articulate the FOAK project’s environmental impact and innovation potential. Potential funding sources include:

● Endowments and Philanthropy — Climate tech startups can access endowments and philanthropic funding by strategically identifying aligned organizations, building relationships, crafting compelling narratives, and preparing strong proposals. By leveraging partnerships and tapping into various sources of funding, startups can secure the necessary resources to bring their FOAK projects to fruition and drive significant impact in the fight against climate change.

Startups seeking funding from these sources should first identify the endowments and philanthropic organizations whose missions and values align with their goals and solutions. This alignment is crucial, as it increases the likelihood of securing support and building long-term partnerships with key decision-makers within these organizations. Attend networking events, solicit introductions from mutual connections, and leverage existing relationships with board members or advisors. Building trust and demonstrating a genuine commitment to addressing climate change is essential.

Climate tech startups must craft compelling narratives that resonate with these organizations. These narratives should highlight the potential impact of their FOAK projects, the innovative nature of their solutions, and the broader societal and environmental benefits they aim to achieve. Startups should be prepared to articulate their unique value proposition, competitive advantages, and a clear path to scalability and sustainability. Strong outlines of their project goals, timelines, budgets, and measurable outcomes should be tailored to each endowment or philanthropic organization’s specific requirements and evaluation criteria, demonstrating a deep understanding of their priorities and funding mechanisms.

● Strategic — Support from corporate venture capital and other strategic sources manifests not only in cash infusions but also from their industry expertise, specialized knowledge, and access to distribution channels, technology, or markets. As global sector leaders, the corporates behind CVCs can profoundly impact a startup’s trajectory.

Typical CVCs are often bound by approval processes and rigid metrics that ensure their successful investments are likely to contribute to their motherships’ operational future. TDK Ventures also seeks these strategic returns but also demands venture-type financial results. To accomplish these dual aims, TDK Ventures employs a nimble vetting, business unit coordination, and portfolio company relations system. While first-generation CVCs may plod along and get mired down by legacy processes and paralysis by analysis, TDK Ventures is not bound by these processes.

Strategics may take an equity or debt position as they seek both financial gains and in-kind services such as technical support or access to proprietary technologies. These may include the right of first refusal on future projects, ensuring they have the first opportunity to invest in subsequent ventures.

Climate tech startups can most effectively court strategic investment when their products align with CVCs’ parent companies’ business strategies, horizontal integration efforts, or operational aspirations. For instance, a disruptive technology that could transform an industry can be highly appealing to a strategic investor who wishes to monitor or capitalize on emerging trends.

Because they often have deep pockets and diverse resources, strategics can fill several critical roles, providing a panacea for startups’ FOAK projects:

o Investor and Lender: Providing the capital necessary to get the project off the ground.

o Project Development Partner: Offering technical expertise and resources to ensure successful execution.

o Offtake Customer: Committing to purchase the startup’s output, thus guaranteeing a market for the startup’s technology.

Onboarding a well-known strategic investor can significantly enhance a startup’s credibility. Because these incumbents are often trusted in their industries, their endorsement can unlock additional offtake agreements and attract investment from more risk-averse blue-chip companies.

Climate tech startups should note that despite the numerous advantages, engaging with strategic investors also presents some potential drawbacks. Because they offer far more than just money, they may exert power that limits the startup’s autonomy. TDK Ventures takes pains to collaborate and counsel its portfolio companies and not overwhelm them with heavy-handed advice or demands that stifle their creativity. TDK Ventures takes care that it does not unduly influence startups’ decisions. It does not require the right of first refusal, giving founders the benefit of full valuation in funding future opportunities.

● Project Debt and/or Equity — Project debt, such as loans or bonds, provides climate tech startups with access to capital without diluting ownership or control. This form of financing can be advantageous for startups that have clearly defined future revenue streams or own tangible assets they can use as collateral. However, securing project debt can be challenging, especially for FOAK projects with inherent risks and underdeveloped revenue pathways. Climate tech startups may need to demonstrate a strong business plan, proven technology, and a viable market to convince lenders or bond investors.

Given the higher risks associated with FOAK climate tech projects, project equity is likely to play a more prominent role in the capital structure. FOAK climate tech startups may need to attract investors with a higher risk appetite and a longer-term investment horizon. These investors should have a deep understanding of the climate tech industry, the potential impact of the technology, and the patience to allow for the extended development and commercialization timelines that are often associated with FOAK projects. Climate tech startups can leverage project equity to their advantage by attracting investors who share their vision and values for combating climate change. These investors may not only provide funding but also offer valuable industry expertise, connections, and guidance, which can be invaluable for navigating the complexities of the climate tech landscape.

These startups can strategically combine project debt and project equity to optimize their capital structure. For instance, they may use project equity to fund the initial research and development phases, and then leverage project debt for scaling up operations or commercialization once the technology has been validated and revenue streams are more predictable.

Ultimately, the optimal balance between project debt and project equity will depend on the specific needs, stage, and risk profile of each climate tech startup.

● Crowdfunding — This method allows startups to raise funds from a large number of people, typically via online platforms, in exchange for early access to products, equity, or other rewards. Crowdfunding enables startups to engage passionate individuals who want to do their part to combat climate issues. It builds a shared purpose. By bypassing the high minimum investment required in other fundraising schemes, crowdfunding opens investing to a multitude of micro-investors.

Successful FOAK project crowdfunding campaigns engage in proven techniques and best practices such as running on a platform specializing in environmental or sustainable projects to leverage established communities of climate-conscious investors and resources tailored to green tech startups. They draft engaging stories that capture the essence of your FOAK project and its potential impact. They highlight the problems the technology addresses, the innovative solutions they have developed, and paint a picture of the positive environmental benefits they will enable. These initiatives set realistic, finite, time-bound goals and ensure their accomplishment through constant promotion and engagement. And they plan for the logistics of delivering rewards to backers by amassing the resources and infrastructure to fulfill promises made during the campaign.

As the climate crisis intensifies, public interest in sustainable solutions continues to grow crowdfunding platforms and regulations will evolve, creating an increasingly favorable environment for climate tech startups to leverage this innovative financing tool.

Continue to Part 2 to learn how startups can structure their internal operations to mitigate the risks that may hold investors back from providing financial support and management resources.