Debt financing within climate tech is expected to grow over the next few years


By Marc Deschampsco-manager at Magister DAI

Software and technology-based businesses were seen as risky by debt finance providers just a decade ago because “classic businesses” still dominated the landscape and the perceived threat of disruption from many “known unknowns” was almost impossible to predict. The turn-of-the-century dotcom crash constantly reminded investors of the dangers of backing fledgling tech companies. Fast forward to 2022 and the outlook couldn’t be more different. Today, many of the most valuable companies in the world are tied to technology. A similar revolution is happening at Climate Tech.

The availability of credit financing (various forms of lending instruments) has globally enabled entrepreneurs, venture capitalists and private equity investors to rapidly create, expand and acquire high-growth businesses in the digital transformation and technology sector. Given the expansive nature of technology, it is difficult to give a solid number for the growth of technology loans over the past decade. However, using private equity deals as a barometer, according to Bloomberg in 2021, $146 billion in tech company buyouts were made compared to $42 billion in 2011.

There’s usually a lot to like about tech business loans from a lender’s perspective. Accelerating digitalization within small and large businesses across the globe, driven by increased adoption of cloud, 5G and connectivity, presents a huge opportunity. Rapid business transformation through the deployment of software applications in areas such as payments, supply chain, e-commerce, sales and marketing, and learning and communications has not only improved efficiency and automated traditional business processes, but also created a loyal, sticky and highly profitable customer base for technology providers. This momentum has increased lenders’ appetite for the technology sector. This view has been further reinforced based on the central role played by technology during the recent pandemic.

The impact of inflationary pressures is now evident in the global economy, just as the damage of industrialization is now apparent in our environment. In many ways, technology is seen as the panacea to these strengths, as it can increase automation, facilitate remote collaboration, and create operational efficiencies in most processes across multiple industries. Not to mention that technology plays and will play a key role in solving the biggest climate-related challenges on the planet.

Over the next decade, companies offering climate-related technologies are expected to garner the same attention from financiers as technology companies. ‘Investing in the Green Economy 2022‘, a report by the research arm of the London Stock Exchange, suggests that the market capitalization of green stocks has grown from less than $2 trillion in 2009 to more than $7 trillion by 2021, nearly doubling its share of the global investable market from 4% to 7%. Debt financing generally lags behind equity financing because businesses are started with venture capital before accessing any form of debt financing. Companies that harness renewable energy or electric power to replace traditional fossil fuels and reduce carbon emissions or that support clean water, environmentally friendly packaging and the circular economy, from fashion to l Electronics, to name a few, are all gaining in popularity. Technology and innovation are now firmly seen as a force for good and this image is further reinforced when applied for the good of the planet and humanity.

The universe of debt financing has also evolved over the past decade in response to this phenomenon and leverage is no longer the preserve of big tech companies. Lenders are increasingly active in the universe of unicorn start-ups alongside profitable software companies, aiming not only to achieve good financial returns and significant market share, but also to fill the growing responsibility based on environment, social and governance (‘ESG’) that donors have vis-à-vis their investors and shareholders. The appetite of lenders to fund the broader tech sector is most evident in the private equity leveraged buyout sector and the increasing penetration of venture debt financing into growth companies since the 2009 global financial crisis. and throughout the 2020 pandemic.

Today, lenders offer a wide range of hybrid financing solutions, ranging from subprime debt based on warrants or convertible loan instruments to traditional term loan financing – determined by levels of financial maturity and operational of the potential borrower. Technology-enabled companies (including fintech, healthtech, clean energy, etc.) with a high-growth, differentiated business model, robust technology platform (often including intellectual property), recurring revenue, stable customer base and profitability, or path to profitability (profitable unit economy when reducing costs deployed for growth such as customer acquisition or marketing costs) can now explore funding options through borrowing alongside traditional financing instruments such as equity.

Similarly, when it comes to climate-related sectors, debt financing is becoming more prevalent outside of traditional financing opportunities for capital-intensive projects such as solar farms, wind farms and climate-friendly real estate projects. ‘environment. Energy transition opportunities and electric mobility, for example, are a sector that is attracting more and more debt financing. UK electric vehicle subscription service Onto, electric vehicle charging infrastructure developer Gridserve and German electric scooter provider Tier Mobility have all successfully raised different forms of debt.

Along with attractive financial and business prospects, debt-backable companies also tend to have a few equity investment rounds under their belts, a reasonable funding trail, a strong and motivated founding team, and preferably value investors. added as shareholders.

Given the nature of tech companies, there is generally no one-size-fits-all financing solution and potential borrowers must not only weigh the pros and cons of having to take on debt, but also create a “compelling case” and be “able” to exercise due diligence. finance-led processes. Listed and private peer group assessment metrics may or may not be available to benchmark niches or subsectors in alternative energy, mobility, healthcare, and automation, to name a few. -ones, forcing lenders to pay more attention to valuation valuation processes – to determine the level of equity value underlying the debt structure which in part determines commercial terms and pricing debt structures.

Along with changing debt structures, the funding universe itself is shifting from traditional banks to include private credit and specialist asset managers such as TPG, Blackrock and KKR, government-backed ESG funds such as the 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 -ones.

Equity valuations are influenced by global geopolitical uncertainty as well as economic factors such as the impact of inflation on operating models and the rising cost of servicing debt as interest rates rise. interest increases, which affects profits and revenues. Companies facing potential valuation changes are increasingly looking to alternative financing options such as debt. In direct response to this, many large asset managers appear to be gearing up to focus on debt opportunities in the technology and climate sectors.

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

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