This is the second article in a two-part series exploring non-dilutive financing options, the opportunities for alternative financing pathways in climate tech, including an example with Comfort Connect.
In our previous article, we examined the different types and potential benefits of non-dilutive capital. This article will consider when companies should look into non-dilutive capital, particularly in the climate tech sector.
We believe companies well positioned to raise debt or project finance in climate tech tend to be companies with real assets and recurring or contracted cash flows that can reassure investors (the exception is venture debt which usually follows strong equity raises, gathers upside in warrants to compensate for risk, and takes a view on cash from equity raises or IP as collateral).
To highlight how non-dilutive capital may efficiently help scale a business, we’ll use the example of S2G’s portfolio company, Comfort Connect. Comfort Connect is a financial technology, innovation, and training company serving residential home service contractors. Through its Premier Program®, Comfort Connect offers homeowners a service to replace and upgrade their home comfort systems, including high efficiency HVAC systems, electric heat pumps, and water heaters, for example. For a predictable, low monthly payment, homeowners receive the latest energy-efficient equipment, while eliminating the common pain points associated with owning, maintaining, and repairing such systems. The company utilizes a financing model to scale Premier Program originations and fund the growth of its platform.
S2G’s Special Opportunities team invested in Comfort Connect’s Series B corporate round to support the company as an equity partner and financed a Special Purpose Vehicle (SPV) with mezzanine debt to fund the purchase of the home comfort systems.
We believe the capital provided through the SPV reduced Series B fundraising needs, minimizing dilution for founders and financing originations growth to strong credit quality consumers in a capital efficient manner. Comfort Connect is just one example of a company using creative financing to manage company growth efficiently.
As noted in the last article, alternative financing solutions can help enable companies to extend runway, carry equity dollars further, create buffer room for milestones, and wait for the right time to fundraise. In our view, these efficient capital solutions support sustainable company growth, which is particularly important for achieving climate objectives.
We've observed that in the energy sector today, creative structuring often includes project finance - in many cases, debt and equity at the project level are structured as legally and financially separated from the corporate entity via an “SPV” (such as in the Comfort Connect example). Project finance is ubiquitous in renewable energy, which typically feature high levels of contracted cash flow and low levels of technology and engineering risk. Renewable energy project finance may include multiple layers of financing, such as construction debt, tax equity, back leverage, and sponsor equity. With “non-recourse” structuring, lenders and investors typically assume project-level risks and have step-in rights if the project defaults on its debt.
At S2G, we believe project finance structures may be applied to asset-oriented or cash-flowing climate tech companies outside of conventional wind and solar (like Comfort Connect). In our view, many of these companies need to be underwritten differently because the technology might not be as well-understood as wind/solar, and they likely do not have the same long-term contracted revenue structure as the renewable energy industry. Despite this, we view climate tech companies with assets that can provide investors with downside protection and value (often via an SPV structure) as strong candidates for off-balance sheet capital who can benefit from a lower cost of capital than that of their corporate equity.
We have seen that different transaction structures and revenue sharing arrangements between project investors and the company can be utilized to minimize risk while creating flexibility for companies as they scale. Investors like S2G Special Opportunities can look to prove out the technology and revenue models to enable these companies to graduate to even lower cost of capital investors such as traditional infrastructure, banks, pension funds, and insurance companies.
One subset of project finance opportunities that is becoming increasingly relevant in the world of climate tech is the first-of-a-kind ("FOAK") project. Today, we have observed that many asset-oriented climate tech companies are using their corporate equity to develop FOAK assets before bringing in outside project investors. These assets are often capital intensive and it can be expensive for companies to fund them entirely through venture capital, a dynamic that can slow the deployment of important climate technologies. As a result, we have seen that climate project investors and venture capitalists alike are working together to determine alternative financing structures for companies developing FOAK projects. We believe that as these technologies gain sufficient proof points to become “bankable,” project finance models may apply to new segments of the climate tech market, enabling companies to fund capital expenditures off balance sheet and share cash flows and asset downside protection with investors.
S2G's Special Opportunities strategy analyzes risk and capital structure to create solutions that help scale deployment-ready technologies (we're often not taking engineering risk but instead scale up risk). To this end, we see tremendous opportunity in a distributed asset approach. Sometimes, we feel it may make more sense to underwrite a company’s asset pipeline instead of taking on the execution and operational risk of a single asset. These assets can range from equipment such as HVAC systems, as outlined above, to electric vehicles and small-scale industrial plants. S2G may also partner with companies at an earlier stage than typical project finance investors to provide relationships and strategic advice that can bridge companies to a lower cost of capital from traditional infrastructure investors and the like.
We are excited about the possibilities of tailored funding for climate tech companies enabled by flexible investment mandates. Above all, we believe it is critical for management teams to collaborate with trusted partners that can communicate with clarity, find win-win solutions, and provide connections and support. We look forward to finding creative ways to meet the financing needs of more company growth plans and ultimately deploying more climate assets.
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