Debt Financing for Climate-Tech - Perl Street
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Debt Financing for Climate-Tech
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Debt Financing for Climate-Tech - Perl Street
- 1. STRUCTURED FINANCE FOR HARDWARE STARTUPS climate change is a hardware problem.
- 2. 2 “Investors have a deep-seated bias against hardware companies …” - Paul Graham, Y Combinator The Hardware Problem Capital Intensity
- 3. The Investor’s Perspective Let’s take a hard look at the math … 3
- 4. 4 hardware company vs. software company Example: With everything equal aside from the capital-intensity of the hardware company. Capital Required to Scale
- 5. 5 hardware Here’s the simple seed-stage It is just math: software Exit Valuation $50M $50M Seed Investment $2.5M $1.5M Required Return (50% @ 5 years) $18.6M $11.7M Follow-on Investments (Dilution) $11.9M $4.2M Required Seed-Stage Ownership 68% 28% Exit Ownership 37% 23% yikes okay
- 6. 6 Startup Capital Appreciation (80% of gains) Venture Capital Limited Partners Venture Capital Fund Financial Returns General Partner 99% of Investment Capital Annual 2-3% Management Fees Deal Flow, Management, 1% of Capital Carried Interest (20% of gains) VC Fund Operations “Silicon Valley is built to fund software companies, not hardware.” - Michael Seibel, Y Combinator
- 7. 7 0x 1x 2x 3x 4x 5x 6x 7x 8x 9x 10x Hardware Software Valuation Multiples The unfortunate result of capital intensity for hardware companies: 1. Slow and constrained growth 2. Lower valuation multiples 3. High dilution to reach scale
- 8. Perl Street – Confidential and Proprietary 8 Leverage Non-dilutive Debt Financing For Your Physical Assets While Preserving Your Equity For Higher Value Adding Activities Financing Strategy For Hardware Startups CAPEX & Inventory Overhead Marketing Salaries & Benefits CAPEX & Inventory Overhead Marketing Salaries & Benefits CAPEX & Inventory Overhead Marketing Salaries & Benefits CAPEX & Inventory Overhead Marketing Salaries & Benefits Hardware Financing Vehicle Hardware Startup
- 9. Deploying hardware at scale requires massive amounts of capital. These leading startups are using debt finance. $150M $450M $1.25B Indoor Agriculture Virtual Power Plant Circular Economy DEBT FINANCING DEBT FINANCING DEBT FINANCING
- 10. “The next 1,000 unicorns will be businesses developing green hydrogen, green agriculture, green steel and green cement.” Larry Fink CEO and Chairman, Blackrock Inc.
- 11. Hardware-based startups benefit from a complete capital stack at seed-stage to scale. 11 Product & Materials Marketing Salaries & Benefits Overhead Equity Financing Hardware Startup Uses of Funds Traditional Model for Software Only Blended Model for Hardware Debt Financing Equity Financing 1. Unconstrained growth 2. Higher valuation 3. Higher success rate 4. Less dilution The traditional venture capital model results in higher failure rate due to a suboptimal capital stack.
- 12. Debt Financing Options • Revenue-Based Lending • Venture Debt • Purchase Order Financing • Asset-based Lending • Venture Leasing • Project Finance • Structured Finance
- 13. 13 Hybrid Financing Options Revenue Based Financing • Fills the gap between bank debt and VC • For startups that are growing rapidly and have solid income statement • Loan payments are based on the performance of the startup (revenue, turnover, or earnings). • Investors do not generally receive equity or warrants • Loans do not share losses. In the event of bankruptcy, providers of participating loans share in the results of the liquidation in the same way as other loan creditors. You are growing rapidly and have predictable revenue growth This might be for you if:
- 14. 14 Debt Financing Options Venture Debt – Enterprise Banks • Usually available only to startups with top-tier venture investors with lender relationships • Secured by the probability of raising several more rounds of venture capital • Bank loan designed to be paid off before the hardware startup reaches end of runway • Direct loan to the startup – with a lien on the intellectual property • Generally size-constrained to around 20% of a large successful equity raise • Often a small dilutive equity component as well (warrants) • One-time, doesn’t solve long-term financing issues You have raised massive amounts of venture capital and have strong intellectual property and VC backers This might be for you if:
- 15. 15 Debt Financing Options Purchase Order and Supply Chain Financing • Highly targeted to a particular customer order - literally one at a time • Requires a signed contract or purchase order prior to financing • Allows transfer of credit-risk to the credit-worthiness of the end customer • Advances are used for order production costs including labor, raw materials, etc. • Advances generally go directly to the supplier, not to the company • Financiers receive payments, deduct fees, and distribute profits • Generally higher cost and higher risk with lower advance rates (~50%) • Sometimes requires additional collateral or guarantees • Requires advanced monitoring of projects and company operations You need to finance large orders for high-value and reputable customers This might be for you if:
- 16. 16 Debt Financing Options Asset-Based Lending • Loan is secured by business assets. Typically, those assets are • Accounts receivable • Inventory • Equipment • Real-estate • Generally fixed assets are term loans • Accounts receivable and inventories are subject to revolving loan borrowing potential • Debt sizing depends on asset value as opposed to credit rating • Depreciation of asset value and liquidity are the primary risks • Requires ongoing asset-monitoring to control credit risk • Uniform Commercial Code (UCC) and electronic registration systems defines lien filings (USA) You are purchasing inventory, equipment, some sort of valuable asset, or have a large amount of accounts receivable This might be for you if:
- 17. 17 Example Asset-Based Lending • Receivable Financing • You have a Hardware-as-a-Service contract with good credit customers for 48 months and $10,000 monthly payment • You can use accounts receivable as collateral and obtain a revolving line of credit for 80% x $480,000 = $384,000 • Inventory • You generally carry $600,000 worth of inventory on your balance sheet • You can use inventory as collateral and obtain a line of credit for: 50% x $600,000 = $300,000 • Equipment • You own a CNC machine worth about $200,000 in the secondhand market • You can use the equipment as collateral and get a term loan for 75% x $200,000 = $150,000 • Real-estate • You own a small commercial building for $2,000,000 • You can use the real-estate as collateral and obtain a term loan for: 80% x $2,000,000 = $1,600,000
- 18. 18 Debt Financing Options Venture Leasing • Generally for use and purchase of equipment, motor vehicles, and real-estate • Underwriting depends on underlying asset value and projected firm cashflows • The lessor continues to own the asset and the venture leases it. • Owner provides the right to use the asset for a series of payments • Ownership may or may not be transferred at the end of the contract • Lessee must maintain the asset during the life of the lease You need to utilize but not necessarily own expensive and financeable equipment This might be for you if:
- 19. 19 Example Leasing You select equipment Lessor purchases it You pay the lease monthly $600,000 $600,000 • Commitment fee: $12,000 • Monthly fee: $20,000 (x36) • Restocking fee: $45,000 • Security deposit: $100,000 $670,000 (~20% interest) • Lack or preserve working capital needed for outright purchase of asset • Do not qualify for conventional bank lending • Credit decision is based on your ability to generate cash flow • Lease payments generally have priority over loan payments • Flexibility and optionality for changing your capital assets frequently
- 20. 20 Debt Financing Options Project Financing • Usually requires a long-term (10+ years), high-value off-taker • Extremely competitive interest rates • Requires extensive underwriting and due diligence of counterparties • Requires extensive financial modeling of project cashflows • First-loss loan reserves or project equity may be required • Generally non-recourse, shields the assets of project sponsor in the event of failure • Secured based on project assets and paid through cashflows • Lenders can assume control of the project through a lien on the project assets • Usually financed through an SPV entity for each project, and sometimes a series of SPVs Your projects are very large and long-term, with reputable customers This might be for you if:
- 22. We help hardware startups use debt financing to unlock over 25x more leverage * * Our structures reach up to 800% leverage as compared to venture debt averages of 20%
- 23. 2 3 Current Customer Smart City IoT-as-a-Service (IaaS) Up-front sales only to customers Before Perl Street Difficulty launching IaaS No interested lenders or investors $50M debt financing term sheet Scales to $500M+ in IaaS projects Launched with only $6M in equity 01 02 03 04
- 24. Hardware Startup Project Company Project Financiers Equity Investors The key to high leverage is building high credit structures
- 25. How our customers use our platform Transforming into an asset-light company and getting a higher valuation Raise Equity Deploying projects at large scale and becoming a major infrastructure provider Finance Growth Building a stickier and more profitable revenue model Sell Hardware-as-a-Service (HaaS) 25
- 26. Customer Case Studies Let’s take a look at someof the financing facilities 26
- 27. 27 Hardware Assets Hardware Startup Hardware Financing Vehicle (Borrower) Customer Product Sales Seller Purchase Orders Suppliers Project Capital Example Inventory Financing Structure Residential Homes Profit Sweep Project Financiers Investors & Lenders Returns & Debt Service Manufacturers Factory Payments Product Delivery
- 28. 28 Example – Inventory Financing Smart HVAC Device Startup • Collateralized against liquidation value of inventory • Loan advancements used for production costs • Customer payments collected through SPV • Inventory levels and SPV cashflows monitored • Profit sweep back to the startup • Reduced backlog, increased revenue, less out-of-stock incidents
- 29. 29 Hardware Assets Leasing Startup Hardware Financing Vehicle Customer Lease Payments Sponsor Lease Purchases Suppliers Project Capital EV Drivers Profit Sweep Project Financiers Investors & Lenders Returns & Debt Service Second-Hand Vehicle Owners Vehicle Purchase Vehicle Delivery Example Hardware-as-a-Service Structure Vehicle Lease
- 30. 30 Example – Asset-Based Lending Electric Vehicle Leasing Startup • Collateralized against the electric vehicles • Vehicles purchased through the SPV • Lease payments collected through the SPV • Vehicle locations and status monitored • Revenue share with the lender • Profit sweep back to the startup • Allowed for fleet expansion and a successful equity raise
- 31. 31 Hardware Assets Storage Developer Hardware Financing Vehicle Customer Shared Savings Sponsor Service Agreement Suppliers Project Capital Example Project Financing Structure Commercial Real Estate Profit Sweep Energy Savings Project Financiers Investors & Lenders Returns & Debt Service Energy Service Companies Performance Payments Installation & Maintenance
- 32. 32 Example – Project Financing New Energy Storage Developer • Collateralized against project cash flows, inventory and contracts • Loan advancements used for project costs • Customer payments collected through SPV • Project performance and cashflows monitored • Profit sweep back to the holding company • Allows development of massive new projects despite tiny headcount
Editor's Notes
- Hi everyone. I am Tooraj. From Perl Street. Perl Street is a structured financing platform for emerging physical infrastructure assets like batteries, thermostats, IOTs, robots, food/ag projects, and drones. Our customers are businesses that need lots of capital for these assets in order to scale. And we exactly solve for that. We help our customers create high credit structures for their assets and make them commercially accessible for the capital market. A bit about myself and cofounder, Arvind: I am a 3x founder and a mechanical engineer and have dedicated my entire 20-year professional life to engineering and financing hardware-based products, projects and startups. I experienced firsthand how hard fundraising is for hardware startups. So this is why we started Perl Street, To solve the fundraising challenges for game changing companies such as your companies that are addressing real problems. Arvind: We put together series of short presentations to share our expertise and learning in hardware financing and hopefully they are informative for defining your capital raising journey.
- Building any type of startup into a success is challenging. But when it comes to cleantech and hardware, in particular; is brutal. Why is hardware so hard? One of the main sources of capital for startups is generally venture capital. However, most venture capital investors shy away from hardware. Paul Graham, Founder of Y Combinator, which had invested in >2,000 companies admits that Investors have a deep-seated bias against hardware companies. This is because hardware companies are capital intensive. They need lots of capital for lots of different things. In addition to hiring a team, they also need capital to pay for physical assets such as equipment, sensors, real estate, raw materials. Their intensity of capital makes hardware startups a poor match for most venture capital investors.
- To better understand why capital intensity is an issue, let’s look at investing in hardware from the investors’ perspective.
- Consider two identical companies – one hardware and the other one software. Everything equal except the capital-intensity of the hardware company in order to scale over time – in here five years.
- As an early stage seed vc investor, when you look at these two companies with identical exit valuation of let’s say $50mm in this example, the required seed investment for software is $1.5 mm whereas for the hardware the seed investment requirement is higher is about $2.5 mm. As a seed investor, in order to make successful investments, you need to make 50% return annually. So assuming these companies exit in 5 years when founders and all the investors are able to harvest their investment, the seed investor needs to make $11.7mm from the software company vs $18.6mm from the hardware deal. This means the seed investor needs to maintain 23% exit ownership in the software company vs 37% ownership in the hardware one in order to harvest his or her return. The seed investor also knows that these companies need to raise additional follow-on investment such as series A and B in order to reach the exit success scenario. And these follow on investments result in the ownership dilution for the seed investor. If the additional follow on investments are $4.2mm and $11.9. for software and hardware respectively, this means at the time of investment the seed investor requires 28% ownership from the software vs 68% from the hardware. Obviously 68% does not make sense for hardware just simply because hardware requires more capital in order to reach full commercialization.
- And in case you are wondering why 50% annual return, well, Venture capital may seem simple but is actually a complex financial product. Unfortunately, sometimes we see some negative sentiments towards venture capital industry in general. We disagree. This is why I wanted to show you this backend operation of a VC fund. It involves a number of parties from LPs to GPs. It takes years to build a fund and takes eve more years for these investors prove track record and show to their own investors that their investment thesis works. This does not mean that venture capital is broken—rather, it is a highly optimized asset class that proved to work well to fund software and has proved to be a poor match for meeting all the capital requirements of specific types of hardware and cleantech solutions - at least, without any other source of supporting capital.
- So The unfortunate result of capital intensity for hardware companies and relying on venture capital as the only source of funding is Slow and constrained growth, Lower valuation multiples and High dilution to reach scale
- So given the capital intensity problem of hardware startups for equity investors, what is the right financing strategy? what you can do is to raise non-dilutive debt financing for physical assets such as expensive inventory. This way so you can preserve your equity capital for higher value adding activities such as R&D, hiring, business development.
- These are some of the key findings in a new report from Wood Mackenzie Power & Renewables that pulls together disparate technologies into a broad-ranging forecast. By 2025, the combined capacity of these distributed energy resources (DERs) will reach 387 gigawatts, driven by $110.3 billion in cumulative investment between 2020 and 2025.
- And this is why we started Perl Street. We believe that Hardware-based startups benefit from a complete capital stack at seed-stage to scale. Unconstrained growth Higher valuation Higher success rate Less dilution we cover here in this presentation the types of debt financing that can potentially work for you.
- What kind of debt financing are there in the market? we listed some of the most common debt financing options here. You may have heard of revenue-based lending, venture debt, factoring and project finance. Unlike equity financing, debt financing landscape has quite a few choices. So it is important to know the type and amount of debt financing is available and appropriate for your business at a given time. In the following presentations, we will provide an overview of some of these debt financing. them in more detail in the following presentations. ? The answers rely on a number of factors such as The Stage of your company The amount of capital you need? When do you need the capital? (urgency of cash needs) Is the capital need permanent and ongoing or is it temporary? Permanent need: equity (more expensive) and long-term debt (recurring loan service and limit flexibility) Transitory need: short term loans
- RBF loans are loans whose payment is contingent upon the results of the borrower rather than being fixed. The remuneration is linked to the firm’s sales or turnover On the other hand, these loans do not share losses. In the event of bankruptcy, providers of the loans share in the results of the liquidation in the same way as other loan creditors. Sales or turnover participation rights provide the investor receives with a payment based upon the performance of the firm, in terms of revenue, turnover, or earnings. Both the interest rate and the capital repayment are linked to this performance
- There are four categories of venture debt: private debt funds. Direct lenders. Business development companies (BDCs) and enterprise banks like SVB. The most common one that you may have heard of is Venture debt through banks like SVB. For high-growth startups that have received investments from a reputable financial institution such as a VC/PE firm. It is a LONG-TERM commercial finance option that is available to creditworthy businesses to use for working capital requirements and / or runway expansion of business. High-growth businesses have milestones to complete before they can raise next rounds of equity investments. Sometimes, they need additional capital between two rounds of funding to complete milestones. Venture debt provides that additional financing and reduces further dilution of equity.
- Purchase Order Finance allows you to fill a particular customer order and to buy inputs and deliver the output. POF usually funds the production stage of an SME’s activities, as it consist in a working capital advance to cover part of the production of a good or service demanded by one or more specified customers. Through POF, the startup obtains a verified purchase order from a customer and estimates the direct costs required to produce and to deliver the product, which may include labor, raw materials, packaging, shipping, and insurance. The purchase order is submitted to a financier, which bases the credit decision on whether the order is from a creditworthy customer and on whether the startup can produce and deliver the product according to the terms of the contract. If the loan is approved, the financier advances a share of the total order value, typically paying the approved costs directly to the suppliers. Once production and delivery are completed, the payment is directed into an escrow account or SPV under the financier’s control.
- One of the common debt financing options is asset-based lending which refers to any form of lending secured by an asset. Typically, four types of asset classes are secured under ABL: • accounts receivable, • inventory, • equipment and • real estate. They often have different advance rate which is the percentage of the value of the collateral that a lender is willing to extend as a loan. We will go over some examples on this shortly. Fixed assets such as equipment and real estate are term loans. On the other hand, Accounts receivable and inventories are subject to revolving loan borrowing potential The amount the startup can borrow depends on the value of these assets, rather than on the credit history of the startup. This is relevant given early-stage startups have no credit so debt sizing depends on asset value as opposed to credit rating The amount of credit extended is linked to the liquidation value of the assets, (which is estimated and monitored on the basis of hard data, often relying on industry-specific knowledge). Depreciation of asset value and liquidity are the primary risks. This is why it requires ongoing asset-monitoring to control credit risk Enabling factors In the United States, the ABL is enabled by “Secured Transactions” of the Uniform Commercial Code (UCC), which includes blanket filings on account receivables and inventory, and a well-developed electronic registration systems, which temporally defines lien filings. ----------------------------------------------------- Generally, a revolving arrangement So if the borrower needs other advances, these can be secured by more assets, such as more receivables, as others are collected and paid off. Hence, as the borrower generates receivables from new sales or builds more inventories, these assets are generally eligible for inclusion in the ‘borrowing base’. This arrangement requires constant monitoring of collateral by the lender to control and manage the credit risk. Typically, the lender audits the borrower’s assets daily, to monitor and secure the performance of the loan. This is because asset-based loans expose the lender to the generic credit risk, that is, to the risk related to debt-paying habits and ability of the proposed borrower. In addition, the asset-based lender is exposed to risks that are specifically related to the securing mechanisms underlying ABL, such as • Collateral risk, i.e. the risk that the collateral securing the loan will decline in value after loan inception and be insufficient to liquidate the loan. • Collateral illiquidity, i.e. the risk that the process to liquidate the collateral will be time-consuming and costly, detracting from the ultimate returns. Accounts receivable are considered to be highly liquid assets, whereas inventory may be more difficult to value, monitor and liquidate; • Legal risk; i.e. the risk of incurring costly legal mistakes, due to inadequate legal documentation or mismanagement of the loan facility. ----------------------------------------------------------------------------------- Usually financed through an Special purpose vehicle (SPV) entity. A special-purpose entity is a legal entity created to fulfill narrow, specific or temporary financing objectives. SPEs are typically to isolate the firm and lenders from financial risk. This is different than venture debt which is linked to the balance sheet of startups and how cash they have raised. ---------------------------------------------------------------------
- Asset-based lending is a loan that is secured by business assets. Typically, those assets are accounts receivables, inventory, machinery and equipment and occasionally real-estate. In addition, other corporate assets have occasionally been used as the basis for ABL loans, such as trademarks, patents and certain intangible assets. Businesses both large and small, use the services of asset-based lenders. Unlike factoring, which has traditionally served more selective industrial markets, ABL can be utilized by manufacturers, distributors, service firms and even some retailers. As long as the receivable base is deemed credit-worthy and aged within certain defined parameters, ABL is adaptable to most any circumstance. One major advantage that ABL offers is its flexibility and non-notification aspects. Businesses without receivables or tangible inventory, such as restaurants, hotels and certain contractors, generally will not use ABL. The fixed assets are term loans and, as such, are not subject to revolving loan borrowing potential unless those assets are re-appraised at a later date and/or the loans are paid down somewhat On the other hand, the revolving assets namely, accounts receivable and inventories, are a “snapshot in time.” As the balances change (up or down), borrowing capacity will improve or decline based on those movements. The “availability” calculation, under formula, will vary as well as it takes into consideration changes in the ineligibles. Those changes can occur as a result of collecting over-aged receivables, disposing of obsolete inventories or other changes that affect the classification of those collateral items as eligible or ineligible. While it may appear that Sample Company has potential to draw down an additional $310K, consider that elimination of ineligible collateral has already been considered in the calculations. If there were no “ineligibles” to deal with, that would certainly be the case. Consider, as well that improvements in asset quality, increased sales, profitability, etc., are all criteria that would potentially generate and augment increases in the revolving lines of credit for Sample Company. It is also likely that profitability and net worth improvements could result in a higher advance formula being considered by the asset-based lender.
- Leasing is an alternative to asset-based lending. In asset-based lending, the startup or venture owns the asset and the asset serves as collateral on the loan. In venture leasing, the lessor continues to own the asset and the venture leases it. The periodic lease payment is a substitute for debt service. --------------------------------------------------------------------------- In comparison with conventional bank financing, in a lease contract no or limited up-front cash down-payment or security deposit is required. In this way, leasing can finance a higher percentage of the capital cost of equipment thereby allowing the business entity to preserve its cash resources or existing bank facilities to meet working capital needs. On the other hand, over the economic life of the asset, the overall cost of accessing it may be higher than in the case of outright purchase, and the firm does not build equity in capital assets. Another relevant difference with respect to conventional debt financing may concern the impact of the leasing contract on the firm’s a balance sheet. A finance lease is generally capitalised on the balance sheet, thus adding to the leverage of the firms, although the firm can decompose the lease payment into interest and principal repayment and expense the interest paid on the lease each year, as well as depreciate the cost of the asset over the life of the asset. On the other hand, an operational lease is accounted among the expenses. In this regard, with respect to a bank-financed purchase of assets, the main advantage of lease financing is a significantly lower discounted present value of cash disbursements over the term of the lease. In fact, the aggregate periodic lease rental payments, which result from interest-related financing costs and payments against principal, can be booked by the lessee as a business expense to shield against tax liability on income realized
- Lack of or preserve working capital needed for outright purchase of asset Do not qualify for conventional bank lending The lessor’s credit decision is mainly based on the lessee’s ability to generate cash flow Lease payments generally have priority over loan payments Flexibility and optionality for changing your capital assets frequently
- What’s the difference between structured finance and project finance? – Quora Structured finance refers to a lending facility to an ongoing enterprise (a business, NOT a project) using complicated covenant, guaranty and collateral packages to make the borrower loan-worthy. nvolves a company securitising or "monetising" its accounts receivable for the purposes of a financing arrangement. The company sells the stream of future cash flow from its accounts receivable for a lump sum amount.
- Let me give you an example, one of our customers is a smart city startup spun out of Intel. They are building large-scale smart city projects across multiple cities. These projects have distributed assets like smart cameras and communication networks with energy efficiency technologies that generate valuable data for safety and marketing. They use our platform because they want to offer IaaS, this means, they need to finance the procurement, installation and operation of their hardware assets. To structure a financing facility, they need to develop bankable IaaS contracts these projects needed to be bundled for lenders otherwise are too small for them. 2) they have new hardware technologies scattered throughout thousands of stores so they do not have much value for lenders as collateral – the main security is the quality of the contracts or cash flows, 3) they have various types of customers – large corporations, city governments, small businesses, and transportation agencies - with different types of financing process. This is why financing these projects are hard. They needed a scalable technology for launching multiple projects across different cities and financing and managing them efficiently. This project starts at $50mm assets but will expand to $500mm in 2 years. Without our platform, they would have had to hire an army of analysts scrambling through excel files and getting probably rejected by lenders.