Read time: 10 minutes
In today’s issue, I’m going to show you how securing future revenues can help reduce the risks associated with high upfront investments in climate tech projects, specifically for climate entrepreneurs like yourself.
Securing revenues for your project reduces the risks associated with it. While it will only generate the revenues once you brought the project to life, the reduction in long-term risk can lead to lower interest rates on loans (or even making bank loans possible), making your project more financially viable.
Not only that, but by implementing the actionable steps provided in this article, you’ll set your business apart from the competition and secure a strong financial foundation for your climate tech venture.
Climate Tech Projects that Can Benefit from Securing Future Revenues
No matter in which area of climate tech you are active, your business can profit from securing future revenues. An area where this technique has been used for decades, but recently gained new momentum, are power plants, specifically renewable energy plants.
Solar and wind have very low operational cost, but their total cost of energy is primarily driven by the cost of capital needed for the upfront investment. A few years back, fixed feed-in-tariffs provided the security of revenues for wind and solar plants, and while there are still support mechanisms & subsidies, many projects are now developed on a fully merchant basis.
This means that renewable project developers, just like climate entrepreneurs, have to convince investors of their future revenue projections, proving that their project represents a good return on invest. But how do they do this? After all, power prices have been volatile the past two years and it can be hard to convince investors based only on power price projections.
The magic word is PPA – Power Purchase Agreement.
PPAs are long-term contracts that can cover power sales from 1 to 20 years at a fixed price and for a fixed volume. By closing PPAs with (mostly corporate) electricity buyers, developers secure the revenue their plants will generate for up to 20 years. Having a PPA means that the developer can go to a bank and tell them specifically how much money they will earn with the plant over the next 20 years – no power price projections needed. This drastically reduces the risk for the bank and therefore causes a decrease in the interest rate. Many renewable projects are only becoming economically viable because of this PPA-driven de-risking of debt.
The same thing can be applied to other green infrastructure projects, including carbon capture and storage or the production of sustainable aviation fuels. The plants needed to capture carbon and store it as well as the industrial plants which turn electricity and CO2 into sustainable aviation fuels require heavy upfront investments.
The Process of Securing Future Revenues
By closing contracts for selling most of the sustainable aviation fuel that SkyNRG is going to produce with their new plants in this decade, they were able to finance the upfront investment of their latest plant.
On a similar notion, Climeworks signed 10-year offtake agreements with several corporations, including Microsoft and BCG to remove their emissions from the atmosphere over the next years and decades.
If you are trying to build a climate tech business, long-term offtake agreements might be a great way for you to prove that there is demand for your product, secure revenues for years ahead, and gain the ability to use traditional debt instead of equity to grow your company without losing shares.
Even if you are looking for an equity investment, these offtake agreements will message clearly to every investor that there is demand and trust from customers in your ability to deliver. This will increase your company’s value and put you in a stronger position when it comes to negotiating the terms of the investment in your company.
Many climate tech solutions are risky and require high upfront investment. De-risking this investment as strongly as you can is the best way for you to secure investments of any kind to get going and scale your business and your impact.
This includes PPAs, long-term carbon offset contracts, and other long-term offtake agreements, but it also includes public subsidies like feed-in tariffs, market premiums, and similar schemes. Try to figure out what options are available for your product & business and let me know in the comments!
Actionable Steps for Climate Startup Founders to Secure Future Revenues
Securing future revenues through long-term offtake agreements follows a clear process:
- Identify potential off-takers/customers
- Convince your potential off-takers to sign long-term offtake agreements
- Negotiate the contract terms with them
Let’s have a look at these steps in more detail.
Identifying and Convincing Potential Off-takers for Future Production
Although you don’t have a product yet, you plan to produce and deliver it in the future. This future product is what you are trying to sell to your potential off-takers. Essentially, we are going through the same sales process as if we already had a product, so if you never did sales, especially in the climate tech business, check out my other article “How to Get Started on Your Cleantech Sales in 5 Steps”.
In short, you will have to do marketing and sales in parallel, to build a presence for your business and brand that allows your potential long-term off-takers to trust your expertise.
To really streamline your sales and marketing approach, you should define a target customer persona, which describes what your target customer is like, and then search the internet and your network until you have a very long list of potential customers (leads) to follow up with.
Compared to software subscription that can be cancelled every month, selling a 10-year offtake agreement is much more difficult to sell. Not only do you need to convince your customers that you are capable of delivering what you promise, but you will also need to convince them that your (future) business model is stable enough to deliver in full over the whole timeframe.
Many companies, small and big alike, don’t like long-term commitments like this in new areas. Most people would probably think twice before they commit to paying you a monthly fee for the next ten years if they are unsure whether they will still need it even in 2 years.
Luckily for us climate entrepreneurs, most companies and especially corporates, don’t have much choice. Climate regulations are already in place in many countries and regions and not a single company is expecting them to go away in the near future. On the contrary, carbon prices are already projected to increase continuously over the next 20 years, and regulations are expected to tighten even more. So, when you are trying to convince your potential customers, try to put yourself into their perspective and paint them a picture of what part of their future you are de-risking and supporting over the next 10 years.
For corporates like Microsoft, BCG, VW, RWE, and other industrials, investment timeframes can often be longer than 10 years, try to build connections there and work them until your get to negotiate a contract.
Negotiating the Long-Term Contracts to Secure Future Revenues
When negotiating contracts, there are of course a lot of legal things to consider. Therefore, especially with long-term contracts, you should get a lawyer to advise you on the content and to check the paper work before you sign anything.
However, the most important parts of your long-term offtake agreements to secure future revenues will be negotiated around the following properties:
- Tenor: The duration of your contract. This can be anything from a single year up to two decades. Shorter durations might be easier to sell, while longer durations are more valuable since they secure more future revenue.
- Price per Unit: Whether you are selling power or carbon removals, you will need to set a price for the sold goods. Often this price is based on the revenue you could achieve on the market with the same product over the observed time horizon. For example, to calculate a 10-year PPA price, you would take wholesale power price projections for the next 10 years, discount them based on inflation, and then set a single fixed price which will lead to the same net present value after 10 years.
- Volume: Of course, you need to determine the volume of products. Someone who is only off taking 1 % of your production might need to pay a higher price than someone willing to take 20 % of your annual production.
When negotiating these things, you should keep in mind that how good the terms end up to be for you, depends on your initial negotiating power and position. Especially if it is one of the first projects in your niche, there should be many potential customers who could drive your growth. By negotiating with many potential customers, actually more than you could serve initially, you are driving up demand around a very scarce product – your product. Through this, you get yourself into a good position to negotiate better conditions for your company.
And another thing to keep in mind: While it is nice if a single customer is willing to buy most or all of your product from the planned project, you are making yourself dependent of this single customer. Even large companies go down sometimes and you don’t want to be tied to a sinking ship. To reduce your counterparty risk, you should apply hedging strategies and structure your financing, but you can also check creditworthiness of any company. By serving multiple customers, you reduce the risk of expected revenues not realising, and at the same time you might be able to achieve a better price for your product by covering more markets and timeframes.
Securing future revenues can enable you to get more funding under better conditions for your business. This allows you to grow both your business and your impact much faster, and achieve what you went out to reach in the first place.
Long-term offtake agreements like PPAs and carbon removal contracts already showed what these contracts can enable companies to achieve and by looking closer at them, you will be able to learn how to apply the same principle to your own work.
While securing future revenues may require more effort and expertise than traditional startup financing methods, it is a viable alternative to venture capital and can help climate startup founders secure the funding they need for their projects, even with high upfront investments.
Have you considered securing future revenues as a way to finance your projects? What are your experiences with it? Let me know in the comments!
No matter which way you choose to secure the funding for your project, by thinking it through strategically and then executing with perseverance, you will be able to realize your project!
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Photo by Benjamin Davies on Unsplash