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Sightline Climate

🌏 Venture to Project Finance Duolingo

FOAK I: A translator from venture to project finance, with David Yeh

CTVC, David Yeh

“Deploy, deploy, deploy” starts with building the first project or factory, or the first-of-a-kind (FOAK). Only after the launch of its first factory plant in Fremont (thanks to the DOE Loan Programs Office) did Tesla grow into the success story of Cleantech 1.0 and drive the shift towards full-electric transportation. But the first of anything is always the hardest, and a true net zero future will depend on a “Tesla” arising in every industry – from new clean ways of flying, generating power, or producing steel. 

Defining FOAK

A FOAK project is the first step on the bridge to bankability, and getting to FOAK is as Darwinian as it is ambitious. Companies ready to cross the bridge will have already traversed several valleys of death, first proving their tech works in a lab, then progressing to pilots to demonstrate their technology can work in the real world. They’ll have raised tens, if not hundreds, of millions of venture, won customers and deals, and hired top talent. But it’s only at FOAK where the rubber really meets the road – where they’ll demonstrate the solution scales effectively and de-risk all of the commercial, operating, technical and even manufacturing risks that make them attractive to project financiers - before moving to second-of-a-kind projects then third, and eventually “Nth” where projects become repeatable and derisked (boring for VCs and entrepreneurs : ) which means bankable for project finance (PF). 

We’ve written about the FOAK challenges companies face when scaling beyond the world of venture:

Today, more climate technologies are maturing, and we’re starting to see FOAKs in a variety of sectors, from sustainable aviation fuel to green steel (e.g. H2Green Steel’s $5B deal, Lanzajet’s Freedom Pines sustainable jet fuel plant, DOE’s DAC and green hydrogen hubs).

The problem is that while venture capital funds the lab and pilot stages, and project finance is available for commercial projects, FOAK falls in between, requiring infrastructure-scale sums of money with risk comparable to venture capital. This leaves these potentially pioneering projects in a finance “no man’s land”, straddling two adjacent asset classes with contrasting risk and return profiles. 

A tale of two investors

Venture investors swing to hit home runs, where a few investments can return multiples of a fund. Project finance investors look for a high batting average –– no strikeouts in investments characterized by long-term stable cash flows from projects with de-risked technology and creditworthy commercial agreements, secured by assets. Financing FOAK is a brave new world, requiring a blend of VC and infra expertise, as well as philanthropic capital, grant funders, customers, and strategics. 

Learning project finance lingo as companies plan the first commercial-scale, $100m+ facility is already too late. Talking the talk and walking the walk to get to FOAK takes years of putting steel in the ground, operating performing projects, and raising capital in a markedly different world than VC. Project financiers have their own distinct pattern recognition for what “good” looks like. Due diligence requires detailed review of long-term commercial agreements, credit quality of off takers, market studies, and EPC contracts to start. Debt-service coverage ratios (DSCRs) are more important than return multiples. VCs’ ears may perk up at “innovative” and “disruptive”, but “off-the-shelf” and “vanilla” are the preferred adjectives for PF.

Fluency in project finance takes years. But we’ve built a VC-to-PF Duolingo to get you started. 

(Note: Both venture and project finance are incredibly nuanced in their own right, and the information below is for illustrative purposes only. For simplicity here we’re only addressing project finance debt, and ignoring project equity. Typically debt-equity ratio for project finance will be around 80% debt and 20% equity. FOAK terms will not be that generous in debt.

Venture to Project Finance Duolingo

You say unicorn, I say repayment 


VC

PF 

What they do

Buy preferred equity in a company, typically a minority ownership stake  and (ideally) mentor the next generation of “Teslas” for ~10x returns

Loan money plus interest to credit worthy projects and manage risk. PF is non-dilutive to founders and VCs

Mindset

Swing for a home run 

Play it safe, don’t strikeout 

Background 

Serial entrepreneurs and tech executives often with a technical background. These polymaths cover a wide range of areas and may invest when relatively new to a space 

Career finance executives who tend to specialize in an area and spend years working on deals in that space 

Their math 

In a portfolio of 15-20 investments, a couple to return the whole fund. Failure is an accepted part of venture. 

Lenders expect the vast majority to repay in full. For the remainder they can recover ~80% if not more of the losses through the sale of project assets and collateral 

Returns

20%+ pa over 10 years. 

~7-9% over ~10-20 years (SOFR+several hundred basis points)

Check size

$1ms to $10ms

~$100ms to $bns

What is in their term sheet?

Relatively simple compared to PF. Valuation and capitalization, board representation, downside protection, voting rights, negative control covenants, and exit provisions

Highly structured including interest rate and term, fees, minimum DSCR, events of default, guarantees, ROFRs, debt reserve accounts, equity contribution obligations, and collateral to start

TRL 

1-7

Does this come in a 10? 

Due diligence 

Relatively light compared to PF with costs in the tens of thousands of dollars  

  • Team, team, team. Is this a cohesive and well-balanced team of all stars? 

  • Tech - Ambitious but plausible roadmap for a superior product 

  • Growth Show me a hockey stick

  • Market! Is there a big addressable market for even more growth? 

  • Product market fit. Is their product being bought, renewed and expanded? 

  • IP. Is it there and is it protected? 

  • Competitive landscape

  • Exit - who will buy them? Can they IPO?


Expensive and extensive if not exhaustive diligence of the project with an army of 3rd party consultants. Transaction costs may reach hundreds of thousands if not millions of dollars.

A short list of DD items below to start

  • Forensic analysis of the project finance model. PF xls dwarf the size and complexity of their venture cousins

  • Offtake agreements. PF lenders check your customers’ credit on top of the contract

  • Construction and tech due diligence including independent engineering report, EPC contract review, and modeling construction contingencies (overruns)

  • Permits and more permits. Is your NEPA ready?

  • Supply agreements. Does your “4 cents a kwh” renewable electricity contract pass muster?

  • Reference checks on you, your developer, your investors, and all of your mutual agreements 

And when you thought you were done:

  • O&M agreements

  • Third party market due diligence report

  • Third party legal and regulatory report

  • Insurance agreements

  • Interconnection study if you are in power generation

Looking for a dynamic project finance model to get you started? Check out Extantia’s FOAK Financing Toolbox here. 

This is Part I in our FOAK playbook series with David Yeh. Here’s a little sneak peak for Part II: pathways to finance FOAK 

David Yeh is a veteran climate investor with 20+ years in infra and VC; and former White House and DOE official. He’s a climate OG focused on catalyzing FOAK financings for gigaton scale climate solutions. 

And special shoutout to Guy Cohen for acting as lead venture to PF translator.

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