12th October 2022

Debt Financing Within Climate Tech Set to Grow Over the Next Few Years

Software and technology enabled businesses were considered risky by debt finance providers a mere decade ago as “classic companies” still dominated the landscape and the perceived threat to disruption from many ‘known unknowns’ was almost impossible to predict. Software and technology enabled businesses were considered risky by debt finance providers a mere decade ago as “classic companies” still dominated the landscape and the perceived threat to disruption from many ‘known unknowns’ was almost impossible to predict.

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Debt Financing Within Climate Tech Set to Grow Over the Next Few Years
Debt Financing

By Marc Deschamps, co-head at DAI Magister

Software and technology enabled businesses were considered risky by debt finance providers a mere decade ago as “classic companies” still dominated the landscape and the perceived threat to disruption from many ‘known unknowns’ was almost impossible to predict. The dotcom crash at the turn of the century constantly reminded investors of the perils of backing nascent technology companies. Fast forward to 2022 and the outlook could not be more different. Today many of the world’s most valuable companies are related to technology. A similar revolution is now coming to Climate Tech.

Availability of credit financing (various forms of loan instruments) has globally enabled entrepreneurs, venture, and private equity investors to rapidly build, scale and acquire high growth businesses within the digital transformation and technology enabled sector. Given the broad nature of technology it is hard to point to a robust figure in how much technology lending has grown over the last decade. However, using private equity transactions as a barometer, according to Bloomberg in 2021, $146bn of technology company buyouts were accomplished compared to $42bn in 2011.

There is typically plenty to like about lending to technology enabled businesses from a lenders perspective. The acceleration of digitisation within businesses small and large across the globe driven by increased adoption of cloud, 5G and connectivity, provides a huge opportunity. Rapid transformation of businesses through deployment of software applications in the areas such as payments, supply chain, e-commerce, sales & marketing, and learning & communications has not only enhanced efficiency and automated traditional business processes but also created a loyal, sticky and highly profitable customer base for technology providers. These dynamics have enhanced lender appetite for the technology sector. This viewpoint has been further galvanized based on the pivotal role technology played during the recent pandemic.

The impact of inflationary pressures is now evident in the global economy, just like the damage from industrialisation is now apparent in our environment. Technology in many ways is seen as the panacea to these forces as it can increase automation, facilitate remote collaboration, and create operating efficiencies within most processes across multiple sectors. Not to mention technology is and will play a key role in solving the planet’s largest climate related challenges.

Over the next decade, it is expected that companies offering climate related technology, will garner the same attention from financiers as technology companies have enjoyed. ‘Investing in the Green Economy 2022’, a report from the London Stock Exchange’s research arm, suggests the market capitalisation of green equities ballooned from under $2 trillion in 2009 to over $7 trillion by 2021, almost doubling its share of the global investable market from 4% to 7%.  Debt financing typically lags equity financing as companies are created through risk capital before accessing any forms of debt finance. Companies harnessing renewable energy or electric energy to replace traditional fossil fuels and reduce carbon emissions or supporting clean water, environmentally friendly packaging, and the circular economy from fashion to electronics to name a few are all gaining significant momentum. Technology and innovation are now firmly seen as a force for good and this image is further enhanced when it is applied for the betterment of the planet and humankind.

The debt financing universe has also evolved over the last decade in response to this phenomenon and debt is no longer just the preserve of large technology companies. Lenders are increasingly active within the start up to unicorn universe alongside profitable software businesses, with the aim of not only capturing good financial returns and a meaningful market share, but also to fulfill the increasing Environmental, Social and Governance (‘ESG’) based responsibility finance providers have towards their investors and shareholders. Lender’s appetite to finance the wider technology sector is highly evident within the private equity leveraged buy out sector and increasing penetration of venture debt financing within growth companies since the 2009 global financial crisis and throughout the 2020 pandemic.

Today lenders are offering a wide range of hybrid financing solutions from warrant-based venture debt or convertible loan instruments to traditional term loan finance – determined by the financial and operational maturity levels of the potential borrower. Tech enabled companies (including fintech, healthtech, clean energy etc.) with a differentiated high growth business model, robust technology platform (often including intellectual property), re-occurring revenues, sticky client base and profitability or path to profitability (profitable unit economics when paring back any costs deployed for growth such as customer acquisition or marketing costs) can now explore debt funding options alongside traditional funding instruments such as equity.

Similarly, when looking at climate related sectors, debt funding is becoming more prevalent outside of traditional capital-intensive project finance opportunities such as solar parks, wind farms and eco-friendly real estate projects. Energy transition opportunities and electric mobility is for example, a sector that is attracting increasing levels of debt financing. UK electric vehicle subscription service Onto, electric vehicle charging infrastructure developer Gridserve and Germany based e-scooter provider Tier Mobility have all successfully raised different forms of debt.

Alongside attractive financial and commercial prospects, debt fundable companies also tend to have a few rounds of equity investment under their belt, a reasonable funding runway, a strong purpose driven founding team and preferably value add investors as shareholders.

Given the nature of technology companies, typically there is no one size fits all financing solution and potential borrowers need to not only assess the pros and cons of carrying debt, but also create a ‘compelling case’ and be ‘match fit’ for due diligence processes conducted by financiers. Listed and private peer group valuation metrics may or may not be available to benchmark niches or sub-sectors within alternative energy, mobility, healthcare and automation, to name a few, forcing lenders to pay more attention to valuation appraisal processes – to determine the level of equity value underpinning the debt structure which in part drives the commercial terms and pricing of debt structures.

Along with the evolution in debt structures, the financing universe itself is being transformed away from traditional banks to now comprise private credit and specialist asset managers such as TPG, Blackrock and KKR, ESG focused government backed funds such as UK’s  Local Electric Vehicle Infrastructure Fund (LEVI), sovereign wealth funds such as Temasek, GIC, Mubadala and infrastructure funds such as Macquarie and M&G to name a few.

Equity valuations are being influenced by the global geopolitical uncertainty alongside economic factors such as the impact of inflation on operating models and increasing cost of debt service as interest rates rise – which affect earnings and revenue. Companies experiencing potential valuation changes are increasingly looking for alternative funding options such as debt. In direct response to this many large asset managers are seemingly gearing up to focus on debt opportunities across the technology and climate sectors.

Whether listed, venture/private equity backed, or founder led, companies should consider ways to reduce their overall cost of capital by considering debt options to finance organic growth or acquisitions. Debt financing can also be a very effective instrument to achieve other strategic objectives such as change in ownership or to finance shareholder dividends in well performing businesses.

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