Jonathan Strimling faced a dilemma. His company has been working for nine years on a chemical process that turns old cardboard boxes into high-quality building insulation. The good news is that the team finally cracked it. CleanFiber technology delivered the insulation. It was a really good insulator. It contained fewer pollutants and produced less dust than other cellulose insulation materials made from old newspapers. Insulation contractors loved it too.
CleanFiber needed to do more with it. A lot more.
Many founders and CEOs may be envious of this problem. However, the transition from a scientific project to a commercial project is one of the most difficult to pull off successfully.
“Starting a first-of-its-kind plant is difficult,” CEO Strimling told TechCrunch. “It cost more than I expected. It took longer than I expected. And that's pretty typical.”
Any startup involves some level of risk. Early-stage companies often don't know if their technology will work or if their product will reach enough customers. But at that point, investors are more willing to accept risk. They know that a new startup is a gamble, but the amount of capital required to get a startup off the ground is relatively small. It's easier to play the numbers game.
But things change when a startup emerges from a young age, and it becomes especially difficult when the company's products are made of atoms rather than ones and zeros.
“There's still a lot of hesitancy around tackling hardware, hard technology, and infrastructure,” Nest and Mill co-founder Matt Rogers told TechCrunch. These messy intermediate steps are especially difficult for climate startups, which are dominated by hardware companies.
“SaaS will not solve the climate problem,” says Rogers.
This issue has come to dominate conversations about finance and climate change. Recent years have seen a surge in the number of startups aiming to electrify homes and buildings, reduce pollution in industrial processes and remove global warming carbon from the atmosphere. But as these companies emerge from the lab, they're finding it difficult to raise the funding needed to build their first commercial-scale projects.
“That transition is really, really difficult,” said Lara Pierpoint, managing director of Trellis Climate at Prime Coalition. “This is not something that VCs are designed to address, and this is not something that institutional infrastructure investors are designed to address from a risk perspective.”
Some people call this the “first time” problem. Some call this the “missing middle” to describe the vast gap between early-stage venture funding and expertise and infrastructure funding. But these terms belie the seriousness of the problem. A better word might be what his Ashwin Shashindranath, a partner at Energy Impact Partners, called the “valley of commercial death.”
Sean Sandbach, president of Spring Lane Capital, is more blunt, calling it “the single biggest threat to climate companies.”
Hardware financing is difficult
While the valley of death is not unique to climate change technology companies, it poses a greater challenge for companies looking to decarbonize their industries and buildings, for example. “When you're building hardware and infrastructure, the capital requirements are completely different,” Rogers said.
To see how, consider two hypothetical climate technology companies. One is a profitable SaaS startup that recently raised a $2 million round, and he's looking for another $5 million. “This is a good story for traditional venture companies,” said Abe Yokell, his partner and co-founder and managing partner at Congruent Ventures.
Compare this to a deep tech company that has no revenue and wants to raise $50 million in Series B to fund its first project. “That's a more difficult story,” he said.
As a result, “a significant portion of our time is consistently spent helping our portfolio companies take their capital to the next level,” Yokel said. “We're looking for people to fill that gap. But we're not going to 20 funds. We're going to 100 or 200.”
It's not just the amount that makes fundraising more difficult. Part of the problem lies in the way startup funding has evolved over the years. Decades ago, venture capitalists were working on hardware challenges, but now the majority tend to avoid them.
“Our economy has accumulated capital built for digital innovation, not hardware advancement,” said Saloni Multani, co-head of ventures and growth at Galvanize Climate Solutions. Masu.
How startups disappear midway through
The commercial valley of death has caused considerable casualties. More than a decade ago, battery maker A123 Systems worked hard to build not only its own factories but also an entire supply chain to supply cells to companies like GM. In the end, it was sold to a Chinese auto parts giant for pennies on the dollar.
More recently, Sunfolding, which made actuators that help solar panels track the sun, faced manufacturing problems and went bankrupt in December. Another startup, electric bus maker Proterra, declared bankruptcy in August, in part because it entered into unprofitable contracts, meaning its buses cost more than expected.
In Proterra's case, the woes of mass-producing buses were compounded by the fact that the company was also developing two other lines of business. One focuses on battery systems for other heavy-duty vehicles, and the other focuses on charging infrastructure for those heavy-duty vehicles.
Adam Sharkawy, co-founder and managing partner of Material Impact, says many startups fall into this trap. “Once they have some early success, they start looking around at themselves and thinking, 'How can I build an ecosystem?' How can I pave the way to true scaling? Scale. “How do we build the infrastructure to prepare for this?” he said. “They lose sight of the core value proposition that they're building and that they need to make sure executes before they can start scaling the rest linearly.”
Discovering human resources to fill the gap
Part of the challenge is staying focused. Knowing what to focus on and when is another. It can be learned from first-hand experience, which is often lacking in early-stage startups.
As a result, many investors are asking startups to hire people with manufacturing, construction and project management experience sooner than usual. “We always advocate early hiring for roles such as project managers, engineering directors and construction directors,” said Breakthrough Energy, which invests in large-scale demonstrations and first-of-its-kind projects. said Mario Fernandez, head of Catalyst.
“The gap between teams is a big problem that we are trying to solve,” said EIP partner Shashindranath. “Most of the companies we invest in have never built a large-scale project before.”
Indeed, there is no point in having the right team in place if the company runs out of money. For that to happen, investors will have to dig deep into their wallets or look for solutions elsewhere.
money is important
Writing more checks is one solution many companies pursue. Many investors set aside opportunity or continuation funding for their most successful portfolio companies to ensure they have the resources they need to get through the valley of death. This not only gives startups a big war chest but also helps them access other capital pools, Shashindranath said. He said companies with larger bank accounts have “more confidence” from debt lenders. “Signaling can help in many ways.”
Tom Chee, founding partner at At One Ventures, said that asset-backed equipment loans are also an option for companies building factories. “In the worst-case scenario, 70% of the capital investment We can sell the equipment back.” For what it's worth, there's only a small amount of debt you'll have to pay back. ”
But for a cutting-edge company like a convergence startup, there are limits to how far that handbook can go. Some projects simply need a lot of money before they can deliver meaningful returns, but not many investors are in a good position to fill that gap.
“Early stage investors struggle to support the intermediate process for a variety of reasons, primarily the size of their funds, the size of the checks they can draw, and frankly the reality of returns. These assets can ultimately be generated,” said Frances O’Sullivan, Managing Director at S2G Ventures. “When you move into this larger, more capital-intensive, more project-oriented world of commodity production, it’s very difficult to achieve venture-like returns.”
While the typical early-stage venture investor aims for a 10x return on investment, O'Sullivan argues that 2x or 3x is probably better for a hardware-focused climate change technology startup. . That would make it easier to attract follow-on investments from growth equity funds seeking similar returns, before handing over to infrastructure investors who tend to aim for 50% returns. The problem is that even within large asset managers, most investors have no incentive to collaborate, he said.
Moreover, there aren't many climate change-focused VC firms with the scale to provide mid-stage funding, Abe Yokel said. “What we're really betting on right now is that there's enough overlap.” [in interests] “This is to encourage traditional venture companies to come in,” he said. “The problem, of course, is that traditional venture companies have been hit hard in recent years.”
bring in more capital
Another reason traditional venture companies aren't stepping up is that they don't truly understand the risks involved in investing in climate-changing technologies.
“Some hardware looks like it has technology risk, but in reality there is no risk. I think this is a huge opportunity,” said Shomik, Overture co-founder and managing partner. Mr Datta said. “And there are some that appear to have technology risks that still exist. So the question is how do we diverge those paths?”
One company, Spring Lane, which recently invested in CleanFiber, has developed a kind of hybrid approach that leverages both venture capital and private equity. The firm conducts extensive due diligence on its investments, “on par with a large infrastructure fund,” Sandbach said. This gives confidence that the startup has overcome scientific and technical challenges.
If they decide to proceed, they often use a combination of equity and debt. Post-closing, Spring Lane has a team of experts to help portfolio companies address scale-up challenges.
Not all companies are inclined to take that approach. That's why Pierpoint's company, Prime Coalition, advocates for more so-called catalytic capital, which includes everything from government grants to philanthropic funding. The latter can absorb risks that other investors are unwilling to accept. It is thought that over time, as investors become more aware of the risks associated with mid-stage climate technology investments, they will be more likely to make bets on their own, without a philanthropic backstop.
“I strongly believe that humans can de-risk things through knowledge,” Multani said. “The reason I love to see generalist firms invest in these companies is because it means they have spent a lot of time understanding the space and recognize there is an opportunity. ”
Even if that happens, creating solutions to climate change through technology is an urgent task. Countries around the world have set goals to eliminate carbon pollution within the next 25 years, which isn't that long considering it takes several years to build a single factory. Keeping temperature rise below 1.5°C will require building many factories, many of which have never been built before. And to make that happen, startups will need far more funding than is currently available.
At CleanFiber, Strimling and his team not only completed the company's first factory, but also expanded it. We currently produce enough insulation for 20,000 homes each year. The next few facilities should take less time to build, but the hurdles to opening the first facility were quite high. “When you start a plant with a first variety, you can run into unexpected situations,” Strimling says. “We have a pandemic.”
It wouldn't be easy or cheap to replicate that success in different industries. Still, many investors remain optimistic. “The future will be different from the past,” Multani said. “I'm sure.”