Non-dilutive funding (NDF) is financing that startups can leverage to receive money without giving equity in return, making this an attractive tool for risky or hardware-based solutions. For climate tech startups, this usually takes the form of grants or debt (often concessional), but also includes incentives or private contributions.
I connected with Joel Armin-Hoiland, CEO and Founder of Climate Finance Solutions, to dive deeper into NDF, when startups should consider NDF, and what startups should think about when looking at NDF.
When should startups consider NDF?
NDF will be appropriate for most climate tech startups. However, before pursuing NDF sources, startups should create an integrated funding strategy that will enable them to understand how to most effectively leverage both equity and non-dilutive funding.
In order to develop the NDF portion of an integrated funding strategy, startups need to:
Startups may look towards NDF for a variety of reasons:
Who is eligible?
Most climate startups are eligible for non-dilutive funding. Different opportunities and funders have varying eligibility requirements, from the type of entity that can apply, the technology or sector focus, stage of technology development or commercialization, and geographic region. This wide range of requirements one of the reasons that it is so important to take a comprehensive view of the NDF ecosystem before pursuing funding.
Generally speaking, public funding (i.e., government funding) is more accessible to startups and private sector companies. It is also by far the largest source of funding. The biggest trend in NDF for climate in the past few years has been the dramatic increase in the availability of public funding for climate startups and climate solutions. Philanthropic funding has historically been directed more toward nonprofit and academic entities, but is starting to become more available to startups, particularly at early stages.
What are the different types or stages of NDF?
There are different types and sources of NDF that are available at various stages of a company’s or technology’s development. Below is an overview of the different types of grants available at each stage, what they are used for, and some examples of funders that offer those types of grants:
What should startups think about when pursuing NDF?
NDF can be an incredibly valuable source of funding for climate tech startups. However, pursuing NDF, specifically grant funding, can be complex and time consuming. It’s easy to get disqualified and it takes some experience to really understand exactly what the funders are looking for. All of the context that you need to submit the best application not not always be in the RFP or solicitation. It’s also difficult to simply navigate the NDF ecosystem, understand what’s out there, and identify the right opportunities. Post-award management can also be complicated. Carefully budgeting and scoping out the work can make post-award management and reporting easier. With all of this complexity, it can be helpful to secure knowledgeable support in developing strategy, identifying opportunities, and pursuing funding.
If a startup develops a NDF ecosystem map and an integrated funding strategy, ensures that the funding opportunities that it applies to are well-aligned with its technology roadmap and commercialization plan, it can both give itself the best chance of securing funding and ensure that its implementation of the project will be successful.
Revenue Based Financing (RBF) is a corporate finance product (as opposed to project finance) used to assist business growth. RBF provides debt capital to a business in exchange for a share of revenue for either a fixed term or until a cap is met. Borrowers often make monthly payments based on a proportion of gross cash receipts.
When should startups consider RBF?
A startup might look at RBF in 3 scenarios:
Generally, RBF is used to directly impact near-term revenue (sales, marketing, BD, etc.) but can be used by early-stage companies to purchase inventory, invest in new equipment, etc.
What are the benefits of RBF?
RBF, compared to other financing, is:
Who is eligible?
Eligibility varies depending on the lender, but common criteria lenders pay attention to include:
RBF is generally limited to post-revenue companies with healthy gross margins (> 30%).
What is the process for a startup to apply for RBF?
The process varies depending on the lender, but generally lenders will ask for financial documentation and access to banking (and sometimes accounting/commerce platforms as well) before receiving a term sheet, if eligible. If the financier uses automation in their underwriting, the whole process should take a few weeks. Otherwise, it can take up to 2 months – and in this case, businesses should be mindful of how much time this can take compared to the amount of runway they will receive.
When talking to RBF providers, what should a startup pay attention to?
The question every startup should be trying to figure out is: how is the lender projecting future revenue and how does that compare to internal projections? To answer this question, there is nothing to lose, but everything to gain by asking the lender for their model, such that one can understand the lender’s assumptions, business performance expectations, and IRR.
Other than assessing a lender’s model, below are questions businesses should ask of their prospective lender:
Who else is providing RBF?
In addition to Enduring Planet, some other RBF lenders include Lighter Capital, Decathlon Capital, and Calm Capital Fund.
One thing to note is that while Pipe looks similar to RBF, Pipe is actually a different product, Factoring. Unlike RBF, which provides debt against revenue, Factoring entails pre-buying contracts. The risk involved in this is that if a contract is cancelled, the borrower is expected to replace it with another contract (or multiple contracts) of equal value.
Launching a first-of-its-kind green loan program to help scale early-stage cleantech firms and speed up equitable climate action, the Los Angeles Cleantech Incubator (LACI) debuted their scaled debt fund earlier in 2022. For startups that require funding to support their first client orders or working capital to scale their operations, the debt fund will offer loans as a non-dilutive substitute for venture capital. The LACI Cleantech Debt Fund will not need founders’ personal collateral or their personal credit scores for underwriting, in contrast to most conventional bank loans.
I connected with Hyder Shuja, Senior Manager of the LACI Cleantech Debt Fund, to dive deeper into eligibility, when this capital should be leveraged, offerings, and considerations to think about.
Who is eligible?
HS: Startups who are alumni (or have completed six months of curriculum) of LACI’s Incubator or Market Access Programs are eligible through LACI. Additionally, portfolio companies of partner incubators (Greentown, Evergreen, and New Energy Nexus), as well as CalSeed or CalTestBed participants will also be eligible. However, anyone coming from a partner incubator must be nominated by their respective incubators first.
What is the use of this capital?
HS: We have two products that we’re offering. 1) Our First Customer Financing loan is designed for startups with an executed pilot or project agreement for which they need bridge financing. This is for startups that are pre-revenue or find themselves in gap periods between grant programs or their first round of customers. 2) Our Working Capital loan is for startups that are a little further along in their development, making $100,000/year or averaging $10K/month revenue, or at least showing strong signs of traction towards those milestones. The Working Capital loan can cover payroll, inventory, supplies, and a wide variety of business expenses.
When should startups come to you, and why?
HS: Startups should come to us if they’re participating (or have participated) in our Incubation or Market access programs; or if they’ve been nominated by one of our incubator partners. We are looking for businesses involved in these programs because they tend to be de-risked through a wide variety of support services and resources.
What is the process like?
HS: Applicants will start by contacting their respective incubator points of contact (Hyder Shuja with LACI, Jackie Firsty with Greentown Labs, Ian Adams with Evergreen Climate Innovations, and Christina Borsum with New Energy Nexus). They will then undergo an initial screening to determine if they align with our impact goals and are financially ready to pay back a loan in the projected time period. If there is a potential fit, they will begin the application process and be introduced to our lending partner. The due diligence process can go as quickly or slowly as the applicant chooses. If there is a well-established data room, we can move much faster to secure the loan. The process takes 4-6 weeks from the beginning to a final decision. Once due diligence is completed, we’ll collect closing documentation and move to fund.
What is the fee structure like? What is the cost of capital? How should startups think about pricing? What are the additional terms that are noteworthy?
HS: The interest rate of both loans is 9%, and there is a 1.5% closing cost for the loan. It’s essential to recognize that debt sits on the balance sheet and is a more concrete payback structure than equity. However, loans are non-dilutive and allow founders to maintain more ownership of their companies. Most startups cannot access cheaper bank capital, so compared to other products out there, this tends to be more affordable.
What are the pros/cons?
Asset Backed Lending (ABL) provides capital backed by revenue-creating assets, such as hardware or receivables. Unlike traditional venture debt, asset-backed lending is differentiated by the nature of its security. Since the assets that back the lending can be sold or transferred should a business be unable to pay its obligations, ABL can provide more capital than traditional venture debt, in some cases. And, of course, like all forms of debt, ABL requires only warrants for equity in most cases – far less than is ever required in traditional equity financing.
When should startups consider ABL, and what can ABL be used for?
MP: ABL is typically used to help solve cash flow problems. That said, ABL can be used for a variety of things:
What are the benefits of ABL?
MP: ABL, when compared to other debt, is:
Since ABL is tied to assets as much as anything, as assets grow (or are expected to grow) the ABL facility can grow with the startup – thereby increasing the amount of capital available and saving time and trouble of doing a new search for capital.
ABL can often be used to unlock specific types of growth, like Buy Now, Pay Later (BNPL). When it comes to climate action, ABL can help startup customers to avoid technology or cash flow risks by getting access to emerging climate solutions now, while sharing risk with lenders and/or the startup.
Who is eligible?
MP: Eligibility varies depending on the lender, but common criteria lenders pay attention to include:
What has your experience been like working with startups in ABL?
MP: One of the primary advantages of working with Third Sphere is that we are early-stage investors, first and foremost, and that ethos informs us, as lenders. As such, all of us have spent at least a decade (and much more) in venture capital and credit capital. We provide financing for early-stage startups because early access provides the highest probability of catalyzing positive movement for the startup and returns for our investors.
We have seen it all in regards to the startup interface when it comes to lending. Many startups are not sophisticated in capital markets, and many founders are intimidated by lenders. Our job is to do everything we can to reduce anxiety about the process.
When we started, founders and their boards were suspicious of what might happen if things go wrong. It’s quite common for founders to believe that lenders will do everything to take control of their companies while believing that VCs are much better aligned. We find that we’re able to work with founders on initial terms, but also as they encounter surprises which are the only predictable part of early-stage startups.
What is the process for a startup to apply for ABL?
MP: Although there are several steps to finalizing an ABL transaction – including structuring of the transaction, term sheet, due diligence, and documentation – the process is quite deliberate and clear. We start with a conversation and questions, followed by discussing terms and structure for a transaction, if appropriate. This is not to say you won’t need a lawyer before you close a transaction, but our job is to make this easy, not painful.
Because of the potential for financial surprises during a startup’s journey, it is good to build relationships early – so both the lender and the borrower can conduct early due diligence.
When talking to ABL providers, what should a startup pay attention to?
MP: Startups should pay attention to the terms a lender is providing. One of the early mistakes startups make is that they don’t read the fine print and they agree to terms that are strict and inflexible.
A few terms to specifically look for are:
Other than scrutinizing the terms, when looking at different lenders, below are questions businesses should ask about the lender:
The takeaway is to look beyond what the loan amount and the interest is, as lender flexibility is more important, especially when things go badly.
What happens when a startup can’t repay debt?
MP: Ideally, you don’t get to this stage. However, if a payment is missed, this will trigger the cure period, which is the time between when a payment is missed versus when you are actually in default and lose control of your options.
Depending on the lender, at this point, debt can be restructured. Often, this will be in the form of extending the payback time. This is where the rubber meets the road – reputable lenders should not only do all they can to protect their investors but also figure out how they can preserve the startup.
If a business defaults and can’t pay back the loan, lenders can take possession of the collateral to recover their capital. As a result, one thing you will notice is that the borrowing base (the value of the collateral) will always be more than the loan amount. Just like a home mortgage, where the primary mortgage is never more than 80-90% loan-to-value, ABL adheres to a similar ratio, depending on the type of collateral and structure.
About Third Sphere
MP: Third Sphere is, first and foremost, an investor in very early-stage startups providing climate-focused solutions. For first investments, 70% of teams have no revenue and main their interaction with customers is to understand their needs. Third Sphere invests in software and hardware-based companies that can deliver climate impact in the next decade. While VC investments focus on pre-seed and seed, asset-backed lending is for Seed+, Series A, and Series B startups. Third Sphere also serves a community of over 12,000 startup founders, investors, end-users, and influencers, so that great companies can have access to an open and transparent network to solve various problems unique to climate-focused startups. Today, we are going to discuss the less understood world of asset-backed lending for early-stage companies.
There are many more things about ABL to discuss that I would be happy to share should people have questions. firstname.lastname@example.org is the best way to reach me.
Venture leasing is a sale-and-leaseback (SALB) investment structure that Kineo has created for novel hardware. In a SALB contract, an asset (e.g., a mobile pyrolysis plant, a rapid charge battery system, a novel water purification system, an indoor farming robot, etc.) is sold by its creator (the “seller” here) to Kineo (the “buyer”) and leased back to the original owner. With this approach, the company receives capital for its assets upfront and ‘rents’ out to its customers regularly. This enables the company to more widely and rapidly deploy. Because of the company risk profiles in these deals, venture leasing is a simple, flexible SALB structure that includes warrant coverage.
I connected with Chuck Sellman, U.S. President at Kineo, to dive deeper into venture leasing, when startups should consider venture leasing, and what startups should think about when looking at venture leasing.
What type of company is Kineo?
Kineo is a Swiss and SF-based investment firm that has built its thesis on providing targeted capital to finance the building and placement of hardware through “Venture Leasing.” Kineo believes that enabling HaaS (Hardware-as-a-Service) will help hardware startups compete alongside SaaS businesses in the venture model and overcome the working capital challenges associated with scaling hardware. By combining the principles of traditional equity investment, venture debt, and equipment leasing, Kineo can minimize dilution, narrow collateral, and provide access to working capital.
When should startups consider venture leasing?
Startups should consider venture leasing in the early commercialization stage of their business. The hardware is ready for deployment with customers, and ideally, the company is establishing a track record of early wins in its market.
Businesses with high-cost hardware and other fixed assets are the most frequent users of sale-and-leaseback agreements. Traditionally, businesses use leasebacks when they need to use the money they invested in an asset for other parts of the business but still need the asset in question to run their operations. Kineo has modified this SALB structure to suit novel assets and the startups creating them broadly for markets in climatetech, healthcare, and robotics.
Sale-and-leasebacks may be a desirable alternative to traditional capital raising strategies, especially when entering commercialization with a novel hardware solution. This is because when a business wants to borrow money, it usually obtains a loan or completes equity financing; however, the implied cost of equity capital* can be high and often difficult to obtain for hardware companies, many debt structures have strict covenants, and other SALB structures generally require a ‘run-of-the-mill’ asset with a predictable resale value. Kineo’s venture leasing is built to fit these novel assets and the risk profile associated with these startups to fund the acceleration of their commercialization.
*Although equity is not “repaid,” shareholders are entitled to a percentage of a company’s value based on the number of shares they own. At the exit, this dilution has substantial value (hopefully), and this is where the cost of equity can be calculated.
Who is eligible?
Venture leasing has a niche target. Eligible startups should:
If a business is significantly more mature (e.g., raising a Series D+, public, etc.), it is likely to have a lower cost of capital financing options for working capital. As a result, venture leasing is most suitable at the beginning of a startup’s commercialization journey, where there is higher risk. On the other hand, since the model requires the ‘sale-and-leaseback’ of an asset, the company does need assets ready for the market – at least when they are ready to begin drawing capital.
What is the process to receive venture leasing?
Obtaining venture leasing is like raising venture equity or venture debt. The diligence process includes, but is not limited to, multiple calls with leadership, a review of financial plans (with an emphasis on unit economics), a discussion of the customer relationship, and, ideally, a site visit to check out the assets. At the end of the process, a framework agreement is agreed upon, which is the contract that defines the partnership, the leases, and the steps for drawing down capital. After that, the company can actively utilize Kineo’s facility.
What should a startup pay attention to when considering venture leasing?
Businesses should keep in mind a few terms when looking at venture leasing, especially relative to other financing options:
Kineo has a unique model when it comes to the terms of their contracts:
What are the pros and cons of Kineo’s Venture Leasing?
Project Expansion Capital, Catalytic Equity for First-of-A-Kind Commercial Projects
FullCycle Climate Partners (FullCycle) provides a unique flavor of “expansion capital” needed for financing first-of-a-kind (“FOAK”) infrastructure-scale deployments of new climate technologies. FullCycle provides equity capital to businesses and business projects. When financing developments with project equity, each development is treated as a distinct project financeable entity (separate P&L/off-balance-sheet and non-dilutive). As a result, investors in the independent subsidiary generate returns principally via the project cashflows.
I connected with Kyle Adkins, Partner at FullCycle, to dive deeper into project expansion capital, when startups should consider project expansion capital, and what startups should consider when their potential options for financing expansion.
What type of company is FullCycle?
FullCycle is purpose-built to provide critically needed expansion capital to accelerate the deployment of the next gigaton-scale climate technology solutions. They are targeting opportunities with proven technical and economic viability that are ready for large-scale commercialization but need a better-tailored solution for crossing the deployment gap between venture capital and infrastructure private equity. FullCycle’s model uniquely combines project capital for building out the pipelines of emerging sustainable infrastructure assets with the necessary minority growth capital to support the companies driving the development and deployment of these solutions towards widespread market adoption across the circular economy, industrial decarbonization, agriculture, and the energy transition.
When should startups consider expansion capital?
At a certain point, venture capital is no longer the best option for scaling capital-intensive businesses.
Project equity is used for facility construction and commissioning. For projects to be funded off-balance sheet, the technologies being built typically have to have been proven and validated at a smaller sub-commercial scale.
What are the benefits of project expansion capital?
Project expansion capital, when compared to other approaches for financing FOAK projects, is:
Who is eligible?
Eligibility varies depending on the capital provider, but standard criteria lenders pay attention to include:
What should a startup pay attention to when talking to project capital providers?
The universe of project finance is large. There are many capital providers. However, finding sources that will finance first-of-a-kind projects will vary widely, where each provider has a different structure/model. As such, it is always helpful to clarify the terms and conditions of the contract.
A few terms startups should specifically look for are:
Some questions the contract should address include:
Other than scrutinizing the terms, when looking at different sources of capital, below are questions businesses should ask about the lender:
Crowdfunding is a way to raise capital from an audience of people. By leveraging Regulation Crowdfunding (Reg CF), organizations can use platforms like Wefunder, to raise equity, debt, or other types of capital backed by multiple non-accredited investors.
I connected with Adam Roberts, Founder In Residence and Head of Scout Program as Wefunder, to dive deeper into crowdfunding, when startups should consider crowdfunding, and what startups should think about when looking at crowdfunding.
When should startups consider crowdfunding?
Startups can and should be thinking about crowdfunding from day one. The idea behind crowdfunding is to raise capital from a community of followers. Crowdfunding essentially enables potential customers to become investors, which means they also care about the success of the company. This also means that startups can lean on supporters for anything, whether advice or hiring.
Who is eligible?
For crowdfunding platforms based in the US, startups must be incorporated in the US (as an LLC or C Corporation). The one exception is that Wefunder will not do initial coin offerings (ICOs). Because Wefunder does not take equity, anyone can access crowdfunding through their platform.
What should a startup pay attention to when talking to crowdfunding platforms?
A big overall misconception is that crowdfunding platforms bring in 90% of your round, but the truth is that the startup will bring in a lot of the investment. That said, average participation from investors on the platform is 40% of the raise, so it’s essential to look at audience size, average check size, and overall platform activity.
Some other pieces to consider include:
Wefunder only takes a 7.5% commission (there are no other fees).
What are the pros and cons of crowdfunding?
Setting expectations is essential when pursuing crowdfunding, as some types of business models will work better than others (B2C vs.B2B).
What is the key to success when using crowdfunding?
It is all about building and maintaining momentum. This means collecting investments before a startup’s page is live so that when the page goes live, others see that there is already a significant enough investment. Ideally, a startup raises $50K or 25% of its target investment before going live, which triggers Wefunder’s marketing promotions and algorithms.
Wefunder is a crowdfunding platform built by former founders. Wefunder’s goal as a Public Benefit Corporation is to revive capitalism and preserve the American ideal. By providing funding to more eligible companies across the entire country, not just Silicon Valley tech startups, Wefunder is reversing these trends.
I live and breathe the “give first” mentality in the climate sector. This started by volunteering, as a way to explore the climate sector. Over time, this turned into a mission that has taken over my life – helping startups succeed and create climate impact.
Over the years, I realized the importance of capital for a startup’s survival. This was the beginning of my fascination with how to help startups access more capital, especially because fundraising is challenging.
Many startups pursue equity funding (venture capital) relentlessly, but there are more sources of capital available now than ever. The intent behind this series is to uncover these other sources of capital.