To meet the urgency of climate change, we need to develop and implement nascent and transformational solutions developed by startup companies that don’t have the budgets or balance sheets to deploy capital-intensive infrastructure.
Scaling early-stage solutions to widespread commercial adoption has historically taken decades (e.g., solar photovoltaics), but our planet no longer has time to wait. We need to find our way to decarbonization faster than ever, and with solutions at all stages of technological development.
Prime Coalition was founded in 2014 with the mission of bringing catalytic capital to climate solutions. We started by focusing on the acute capital gap founders face during early-stage company formation. We started there not only because of the severity of the gap in 2014, when the tide was all the way out on traditional venture capital to climate tech, but also because we could address it with a small but mighty (and now rapidly growing) community of philanthropic partners.
Eight years later, the world has changed. Venture capital has swung back around toward climate innovation and reshaped our view of the capital gaps facing early-stage innovators. In our own portfolio and in those of many other climate venture investors, there are now many hatchling companies that could dramatically reduce emissions if they can achieve commercial scale.
But financing transformative infrastructure is as much of a challenge today as it was eight years ago. Venture capital can’t, and shouldn’t, cover those capital needs alone. Meanwhile, traditional project finance tends to focus on widely adopted projects.
In many climate innovation stories, the commercialization of promising solutions has ultimately gone unfunded in a second “valley of death.”
Deployment, deployment, deployment
To understand what exactly is needed to help climate tech companies move beyond their hatchling stages into large-scale deployment, Prime conducted a year-long research study in 2021. We asked: what is missing in our existing finance sector to enable deployment of the most meaningful, almost-commercially viable climate solutions? And does catalytic capital have a role to play in bridging those gaps?
Our findings reveal multiple gaps related to the distinct stages of development for an asset-heavy climate solution. Most of these gaps center around what we call “early deployments” of a solution. Early deployments include demonstrations or first-of-a-kind (FOAK) projects for new climate innovations; the first few (small) deployments for a new business venture; and projects in the pre-construction phase.
Gaps 1 and 2: Late-stage demonstration and FOAK (1-to-n) projects
In its early stages, a climate tech company builds lab-scale prototypes, pilots, and incremental scales of demonstration projects. Once the commercial-scale demonstration project gives visibility into the expected costs and performance of such a project, the company can then build a FOAK project and additional projects (FOAK 2-to-n) as appropriate to demonstrate profitability.
Mapping and defining the stages helped to reveal why these early projects have a hard time attracting capital: the available capital doesn’t always match the needs of solutions where they are. Venture/growth capital does invest in lab-scale, pilot projects and early demonstration projects. And Project financiers do make infrastructure investments, but only after they are comfortable that it is a technology/solution with little risk of failure during both construction and operation of the asset, and predictable cash flows.
Neither are the right fit for nascent technology solutions scaling from demonstration to commercialization.
Gap 3: Small standalone projects
Project finance requires extensive diligence and structuring costs. A small project often becomes uneconomical once these transaction costs are taken into account. As a result, in the current status quo, project financiers favor supporting multiple small similar projects by the same company at once, because it brings the overall transaction costs down.
But a new small business often doesn’t have the capital or resources to deploy several projects simultaneously. It will typically start by deploying projects one at a time, progressively scaling up operations and financial resources until it is able to deploy several projects in parallel. As a result, project financiers are more likely to pass on these early projects.
Gap 4: Funding early development costs for deployment
Before a project is built, it must go through several steps of project development, including securing real estate rights and permits, designing the project, and budgeting and contracting to build and operate the project. If any of these steps fail, the project won’t get built.
Through this “go/no-go” period, a project might reach the end of its development budget and fail to show viability. As a result, investors prefer to fund construction of the project rather than these development activities — a gap that is even more acute for nascent technologies.
Catalytic capital deployed by the philanthropic sector is a precious resource that can absorb disproportionate risk, accept lower or no returns and/or tackle longer time horizons in order to enable activities that wouldn’t otherwise attract capital from mainstream investors. As a catalytic capital intermediary, Prime aggregates impact-first capital in order to enable or accelerate climate solutions and ultimately crowd in mainstream investors into the highest-impact solutions possible.
In considering potential solutions to fill the capital gaps for early deployments, we first explored how other initiatives have approached similar barriers. We then drew upon our own lessons learned mobilizing impact-first capital over many years in early-stage innovation to consider how catalytic capital could similarly be structured and deployed to match the varied project finance scenarios.
The possibilities for catalytic capital to support early deployments are only as limited as our own imaginations. For example, we could imagine catalytic capital funding 100% of a FOAK project’s third-party costs until the risks are retired, and selling the stake to mainstream investors once the project is stable; or providing the minimum amount needed to reduce risk and enable mainstream investors to co-invest contemporaneously; or serving as first loss reserve to help absorb some of the construction cost overrun or performance risks.
Our world is on fire, and it demands creativity from catalytic capital to help fill the missing middle. Our research report offers the field a better understanding of how climate innovations grow and where we can work together to build finance solutions to meet those needs.
Karine Khatcherian is managing director at Closed Loop Partners, and former senior advisor to Prime Coalition. Sarah Kearney is founder & executive director at Prime Coalition.