Crossing the Startup Financing Chasm: Using FinTech Business Models to Scale CapEx-Heavy Startups

This is a sponsored message from Blackhorn Ventures.

Many deserving start-ups in the core industrial sectors where Blackhorn invests get less attention because they are hardware-centered or project finance dependent and require significant non-dilutive capital beyond VC equity capital to fuel growth. In particular, costly hardware and large-scale project deployments are frequently needed to fully scale revenue and capture the decarbonization benefits from climate impact solutions. Consequently, these companies are often viewed as too capital-intensive for many VCs, excepting the largest multi-stage VC funds.

However, it is difficult or impossible for startups to source many non-dilutive funding sources other than venture debt or grant funding for immature technologies early on. And later, when the non-dilutive debt or other financing is needed, sourcing these alternative funding sources requires specialized skills. Crossing this financing chasm merits careful consideration.

Founders rarely have time to give their future financing needs attention as they build initial product and business models in search of product-market fit signals. The growth and even survival of their business can be threatened if a strategy for incorporating alternative funding sources, and building out the prerequisites for doing this, are not already well-formed by the time they are required. Most frequently, this surfaces when start ups are bridging between, or advancing from, A rounds to later-stage B, C and D funding rounds.

Additionally, most early-stage VCs are poorly positioned to help start-ups address this need. They frequently only invest in Seed and A Rounds, and are generally drawn to software/SaaS solutions, given their potential for recurring revenues, high growth and capital efficiency. Additionally, their funding sources, expertise, and networks are generally more limited to equity funding and venture debt during a narrow window of the start-up lifecycle.

Startups and early stage investors often err on the side of “build it and they will come!”—“they” being alternative non-dilutive funding sources. This can weaken the startup’s ability to negotiate favorable terms with subsequent financing sources, and can existentially stall an otherwise promising high-growth business.

The Bottom Line: The financing roadmap needs to be a proactive “design and build” process that continuously evolves to align with the timing and scale of the product and commercial roadmaps for the enterprise.

More specifically, we would suggest the following must-dos:

1. Educate and proactively plan to secure alternative non-dilutive funding sources, including when each one might be appropriate for the business, and to prepare for the likely timing and prerequisites to source those resources. Market researcher CTVC has tracked and published a relatively comprehensive taxonomy of non-dilutive financing options to consider, how they relate to each stage of the start-up life, and some of the typical options for sourcing each type of capital: The Climate Capital Stack, and also, The Sophisticating Climate Capital Stack.

2. Purposely select and design a capital efficient business model to clarify which alternative financing resources to pursue, and align/stage to support the evolution of the broader commercial and product roadmaps. Here are the most common archetypes we frequently see:

• Contract manufacturing: Leverage other people’s assets.
• License and white labeling: Expand the footprint of market makers.
• Project finance: Ring-fence replicable pools of projects with predictable financial performance in special purpose vehicles (SPVs).
• Offtake or other contractual commitments: Leveraging creditworthy customers’ or partners’ agreements including advanced purchase agreements, ITC and carbon credits.
• Off-balance-sheet SPV/LLCs

3. Notably, the most compelling business models frequently build-in a distinctive fintech-style edge that (a) materially increases the value proposition to the end customer, (b) stabilizes financial resilience, and (c) helps draw in a more diverse set of financial partners early in the process. These tools frequently leverage data-analytics that strengthen the value proposition, deepen the competitive moat and/or establish recurring revenue streams.

4. Build-out the financing roadmap, including:

• Identify potential partners that are drawn to early stage candidates for the type of funding they offer vs. what the business will need.
• Develop alternative financing structures to allow for, and to incorporate, these resources—e.g., structured equity-plus-debt “project financing,”  financing based on firm contracts with more creditworthy customers.
• And develop more standardized documents that can reduce the cost and time required to bank these funding infusions.
• When needed, be prepared to create wholly owned or jointly owned subsidiaries with different corporate forms—e.g., special purpose vehicles for project finance, LLCs for service-oriented subsidiaries, etc.

5. Invest your time and source specialized resources to lead the development:

• Consciously invest CEO-time to imagine the financing roadmap and build that thinking into the overall company pitch.
• Contract with or hire a fractional CFO with experience and strong networks in the financial sectors you plan to draw on sooner than you might normally expect.
• Leverage financial partners to brainstorm future needs and begin building a pipeline of possibilities.
• Allocate the time and resources to develop these alternative financing relationships the same way CEOs already nurture equity investors long before a future raise.

Additionally, watch out for the following traps to avoid:

• Don’t get trapped in an “equity and venture-debt only” funding mindset.
• Don’t wait too long to bring on board the necessary financial thought partners to design a more complete financial roadmap. The early-on pressure to preserve cash can lead to debilitating constraints down the road.
• Don’t wait until you need money to start nurturing relationships with a broader set of non-dilutive funding options. It’s almost always better to ask future funding partners for advice long before you need them to write a check.
• Avoid single party dependencies and start building out Plan B options as soon as possible even if your initial partners suggest they can be a sole source provider over the long term.
• Shun costly debt (high interest rates, excessive numbers of warrants) or restrictive loan covenants that may preclude or limit future optionality. At a minimum, build in trap doors and expiration dates that give you a way out at the right time.

Three Startups Using Alternative Capital Sources

Three of Blackhorn’s portfolio companies with different business models have leveraged their VC dollars with fintech-fueled strategies to accelerate sourcing other kinds of non-dilutive capital as they crossed the early stage financing chasm. We summarize their integrated product, market and financing roadmaps next:

King Energy—A FinTech Business Model for Providing Solar Power to Multi-Tenant Properties

King Energy uses an innovative fintech model and proprietary “OneBill” software platform to solve the split-incentive challenge that unlocks commercial-scale solar in the multi-tenant commercial property space—i.e., malls and shopping centers. King Energy achieves this by:

• Renting the property roof space, thereby improving the owner’s net operating income,
• Using software to cost effectively develop financially attractive projects that meet local utility interconnect requirements,
• Leveraging local installer capacity to deploy the systems cost effectively and then,
• Providing individually metered tenants a single integrated King/utility monthly bill that shows the discounted energy cost and attributable decarbonization benefits.

This blended offering of lower energy cost and measurable impact is particularly attractive to multi-asset property owners and national account retailers, who also carry higher credit worthiness to the projects.

King Energy leverages these economically attractive and replicable pools of projects, enhanced with innovative hedging strategies, to attract capital partners that provide project financing and monetize the federal investment tax credit benefits.

As an added benefit, the natural footprint of strip malls, one of King Energy’s primary customer segments, correlates with serving low- and moderate-income communities which enhances King’s fit with even larger and lower cost supplemental funding programs, e.g. U.S. Department of Energy Loan Programs Office and state level programs.

Formic—Financial Innovation for Robots as a Service (RaaS)

Formic is augmenting frontline labor through a full-stack RaaS platform offering that comprises an AI-powered design and implementation software coupled with a fintech approach for financing robotic automation for manufacturing customers. The company’s offering allows for businesses of all sizes to  de-risk automation adoption at a substantive discounting in markets where labor shortages continue to cause increasing issues and delays in production.

The process of automating most facilities is inherently complex, oftentimes has misaligned incentives between OEMs and plant operators, all while creating uncertainties in outcome with large capex, high commitment and unclear returns. Most businesses do not have in-house technical capacity to implement and manage robotics, not to mention the financial position to purchase the robots necessary to automate key processes.

Formic designs, purchases, installs and manages robots as a service to its customers. This enables its customers to deploy robots to address labor shortages that are increasingly challenging to address without needing the expertise and capital to design, purchase, install, operate and maintain the robots themselves.

Customers sign multi-year RaaS agreements and pay hourly for the robots in their facilities. Formic then finances the underlying capex for the robots with loans from multiple capital partners, collateralized for each creditworthy customer against its multi-year RaaS contract. Thus Formic shifts what would otherwise be customer capex costs into opex.

CoFi — A FinTech Business Model for Construction Loans

CoFi developed SaaS software to digitize construction loan documents for lenders. During Covid, CoFi learned that geo-located, time-stamped 3D camera images, in lieu of multiple inspections, were acceptable to verify progress for GCs, owners and banks. This shortened the payment lags for builders from 70 days to under 5 days!

CoFi pivoted to become a direct construction lender. This required back-leverage debt to fund its loans. The back-leverage providers required CoFi to contribute 10-20% of each loan, limiting CoFI’s growth.

CoFi proactively brought sophisticated fintech investors Tenacity Ventures and Westerly-Winds into its Seed and A Rounds, respectively.  Tenacity helped CoFI to source the back leverage; and Westerly-Winds helped CoFi launch an equity + debt fund to contribute CoFi’s share of each loan allowing them to scale faster.

CoFi has now begun to sell its loans after one or two loan draws to recycle the lenders’ and fund’s capital into new loans. This fintech business model is enabling CoFi to scale rapidly enough that it will be able to start bundling and selling its loans as tradable securities in the near future to further recycle its capital.

Conclusion
Blackhorn Ventures has helped several portfolio companies of this type evolve their financing strategies to fund their later stage growth with non-dilutive capital sources. We aspire to be more proactive in bringing this thinking to the table from the very beginning of our relationships with startups.

 

Mark Loch and Ray Levitt are operating partners at Blackhorn Ventures, along with Analyst Cameron Carver and Partner Stephan Cizmar. Meet Ray Levitt and Stephen Cizmar at the BuiltWorlds Paris Summit, June 24-27, where they will host a panel discussion on AI in construction. Blackhorn Ventures is a Gold Sponsor of the 2024 Paris Summit.