Equity-Free Funding Gains Traction

In a financing landscape where venture capital is becoming increasingly scarce, companies are pivoting towards non-dilutive funding. The climate technology sector, in particular, has experienced a remarkable surge, with non-dilutive funding skyrocketing to 33% in 2023, a significant leap from the previous year’s 22% (data provided by Net Zero Insights).

This sharp increase underscores a pragmatic response to the challenges posed by limited access to traditional funding sources. VC investments into cleantech technologies are still not back to previous levels, after the slump in 2023. New ways of financing are needed when facing the urgency of deploying climate solutions at scale.

Non-ownership financing plays a pivotal role as a catalyst for cleantech innovation. By leveraging grants, loans, and other debt instruments, companies in the cleantech sector can shoulder the high costs of equipment and manufacturing plants when deploying solutions. Non-dilutive funding is a way to receive working capital without venture investment. It stands as an alternative to equity funding where one sells shares in the company in exchange for funds.

The United States leads globally in the allocation of non-dilutive funding from public programs. Each year, federal initiatives earmark approximately $110 billion, crucial for advancing climate and cleantech initiatives. This significant investment underscores a trend of governments worldwide increasing their commitments to funding sustainability-driven projects.

Key federal initiatives include:

• Bipartisan Infrastructure Law (BIL): Allocates $1.2 trillion over five years.
• Inflation Reduction Act (IRA): Designates $396 billion until Fiscal Year 2032.
• Semiconductors (CHIPS) and Science Act: Allots $280 billion until Fiscal Year 2027.

What is being funded?

Climate tech financing reflects a preference for tangible, physical innovations. Cleantech grants predominantly target hardware-based advancements, catering to sectors such as energy, transport, and the circular industry. In the realm of non-dilutive funding, a significant 77% goes to breakthrough-stage physical innovations, compared to just 5.8% for digital alternatives.

In terms of capital utilization, the majority of non-dilutive funds are channeled towards facility construction and capacity expansion. Research and Development (R&D) activities receive a comparatively smaller share, accounting for less than 10% of non-dilutive funding expenditure. This distribution underscores a strategic emphasis on building physical infrastructure when scaling up operations (data by Net Zero Insights).

Public funding for cleantech encompasses four main types:

State Incentives

State incentives, in conjunction with federal programs, play a significant role in supporting cleantech initiatives. States like Georgia, South Carolina, and Michigan offer a range of incentives such as tax credits and cash incentives. These incentives are designed to attract cleantech companies, stimulate economic growth, and generate employment opportunities. It’s crucial to differentiate between two categories of incentives: statutory incentives, which are established by legislation, and discretionary incentives, which involve negotiations with state agencies.

Grant Programs

Grants consist of non-dilutive capital to support specific technologies, research activities, and projects, which can range from smaller prizes to large cost-shared infrastructure investments. Most grants require recipients to match 20% to 50% of the project costs with their funds. Crucially, they are not loans, meaning recipients are not required to repay the funds received.

Grant sizes exhibit a broad spectrum, ranging from $50,000 to a substantial $500 million. Specific programs, such as the Small Business Innovation Research (SBIR) Seed Fund, offer funding in the range of $100,000 to $5 million, albeit with a challenging 15% success rate. Cleantech initiatives, on the other hand, encompass a sizable range, providing grants from $100,000 to as much as $10 million or more.

Government Loans

Government loans offer cleantech companies access to low-interest funding, which is crucial for bridging financial gaps in project development. It’s essential to understand the distinction between loans and loan guarantees, with loan guarantees serving to enhance lender confidence in funding cleantech ventures.

The Department Of Energy’s Loans and Programs Office (LPO) aims to address the funding gap for the commercial deployment of innovative climate technologies, acting as transitional support until private lenders find the projects “bankable.” Establishing bankability requires demonstrating scalability and replicability, a criterion often demanded by major banks and lenders.

Companies successfully navigating LPO’s rigorous evaluation process receive a valuable endorsement, facilitating their quest to secure subsequent private sector funding. Despite facing intense competition among hundreds of applicants, those meeting the stringent criteria can access a minimum loan amount of $100 million.

Tax Credits

Tax credits directly reduce the amount of income tax owed, providing a dollar-for-dollar reduction in tax liability. They can be non-refundable, reducing taxes owed to zero, or refundable, potentially leading to a tax refund.

Government incentives like the Production and Investment Tax Credits offer dollar-for-dollar reductions to promote clean energy technologies, as extended and revised under the Inflation Reduction Act. The Production Tax Credit (PTC) offers a tax rebate to producers of alternative energy based on electricity generated. Meanwhile, the Investment Tax Credit (ITC) provides a direct tax rebate for investments in qualified assets such as solar and wind technologies. One key difference between the PTC and ITC is that the PTC continues based on energy production, while the ITC requires an upfront investment.

Tax credits can be transferable. Businesses can monetize unused credits by selling them to others, allowing them to extract value from credits that might otherwise go unused. A recent report by tax credit marketplace company Crux indicates significant momentum in the nascent tax credit transfer market. Bids on Crux’s platform have nearly doubled compared to last year, with estimates suggesting that transfers of renewable tax credits could reach close to $20 billion in 2024.

Best practices for navigating public funding and debt instruments

It’s widely acknowledged that securing non-dilutive funding can be challenging, with the application process often being intricate and time-consuming. Depending on the specific grant or loan, both federal and state funding may necessitate approval procedures before funds can be utilized, sometimes disbursed in stages. Delays in fund allocation consequently impede progress for recipient organizations. This delay is particularly impactful for startups, inherently designed for speed in achieving milestones, securing additional funding, and perpetuating growth cycles.

Here are some ideas to help a cleantech company succeed in non-dilutive funding:

Get legal expertise around grant agreements

Lawyering up is essential for grantees to ensure that they fully understand the legal implications of the grant agreement and to protect their rights and interests. For example, grant funding agencies may sometimes retain certain rights associated with the funded projects or assets. These rights could encompass aspects such as ownership, intellectual property, or commercialization rights, potentially impacting the autonomy and future direction of the project for the grantee. Lawyers also ensure that grantees comply with all legal requirements and regulations associated with the grant, reducing the risk of potential disputes or legal issues down the line.

Audits and Record-Keeping

When companies receive federal funding, they are subject to stringent auditing requirements to ensure transparency and accountability in using taxpayer dollars. This involves thorough examinations of financial records, compliance with regulations, and adherence to the terms of the funding agreement. To meet these auditing standards, companies must maintain meticulous recordkeeping and timekeeping practices, accurately documenting expenses, activities, and outcomes related to the funded projects. Failure to maintain comprehensive records could result in audit findings, financial penalties, or even legal repercussions, underscoring the critical importance of robust recordkeeping and timekeeping systems for entities receiving federal funds

Use debt to finance your grant portion

Companies can leverage borrowed funds to cover the matching or co-funding requirement often associated with grant programs. This strategy offers several advantages. Firstly, grant recipients can maintain liquidity and preserve existing capital for other operational needs or investments. Additionally, debt financing provides flexibility in managing cash flow, as repayment terms can be structured to align with the expected timeline of grant disbursements.

Debt is great for equipment finance

Debt instruments are favored for equipment finance due to their structured repayment schedules, which help businesses budget effectively. By leveraging debt, businesses can preserve capital for other needs while aligning repayment with the expected lifespan of the equipment. Additionally, tax benefits, ownership retention, and flexible financing options make debt instruments an attractive choice for businesses seeking efficient equipment financing solutions.

Use loan guarantee programs

Loan guarantee programs like the one provided by the Bay Area Air Quality Management District make borrowers more attractive to lenders by reducing the risk associated with the loan. Lenders are more willing to extend credit when they have assurance that a portion of the loan will be repaid if the borrower defaults, thus increasing access to financing for borrowers participating in these programs.

Avoid debt traps

When considering financing options, it’s crucial to steer clear of using your intellectual property (IP) as collateral for debt, as it puts your valuable assets at risk in case of default. Always meticulously review loan terms to ensure they are favorable and manageable, avoiding hidden fees or unfavorable conditions that could lead to financial strain. Additionally, refrain from providing personal guarantees, as they put your personal assets on the line and can have severe consequences in the event of business difficulties or default. By prioritizing careful assessment of loan terms and avoiding risky financial arrangements, you can safeguard your assets and financial well-being.

Interested in learning more about the financing options available to your organization?  Book a complementary introduction with Verus von Plotho here.