Jonathan Strimling stood at a crossroads. After nine years of refining chemical processes, his enterprise accomplished a breakthrough: transforming old cardboard into superior building insulation. This innovation from CleanFiber yielded a product that installers preferred, thanks to its purity and reduced dust compared to traditional cellulose insulation derived from newspapers.
Yet, the success brought a daunting task for CleanFiber: substantially scaling up production.
Strimling, the CEO, candidly shared the challenges of transitioning from experimental to commercial phases, noting both cost overruns and time delays – a common narrative in the startup world.
For startups, risk is inherent, particularly in the early stages where technology validation and market acceptance remain uncertain. However, investors during this phase are usually more amenable to risk given the smaller capital needed compared to more mature ventures.
The real test begins as startups mature, particularly for those dealing with physical products rather than digital services.
“Hardware, hard tech, and infrastructure investments are often approached with trepidation,” stated Matt Rogers, co-founder of Nest and Mill, underscoring the difficulties facing climate-focused startups that generally fall into these categories.
The financial and climate sectors are abuzz with discussions on the challenges that emerging companies face in securing funds for their first large-scale commercial projects.
Lara Pierpoint, managing director at Trellis Climate of Prime Coalition, describes this transition as extremely challenging, noting that neither venture capital nor traditional institutional investors are set up to manage the associated risks.
This funding dilemma has been termed the ‘first of a kind’ problem, the ‘missing middle,’ or more starkly, the ‘commercial valley of death,’ a phrase coined by Ashwin Shashindranath, a partner at Energy Impact Partners.
Sean Sandbach, principal at Spring Lane Capital, goes as far as to label it the gravest threat to climate tech companies.
The ‘valley of death’ is not unique to climate tech, but it is particularly daunting for those aiming to decarbonize industries. As Rogers puts it, the capital requirements for hardware ventures are simply on a different scale.
Consider two hypothetical climate tech firms: a SaaS startup seeking a moderate investment compared to a deep tech company requiring a hefty $50 million for its pioneering project. The latter scenario, as Abe Yokell of Congruent Ventures points out, poses a far greater challenge in raising capital.
Startups often need to knock on hundreds of doors to find willing investors, as the traditional venture capital model has largely shifted away from hardware challenges in favor of digital innovations, according to Saloni Multani, co-head of venture and growth at Galvanize Climate Solutions.
Historical examples abound of companies succumbing to the ‘valley of death,’ from battery maker A123 Systems to solar tech firm Sunfolding, and even electric bus producer Proterra. Each struggled with their own unique production and scaling challenges, often leading to financial ruin.
Adam Sharkawy, co-founder of Material Impact, emphasizes that startups frequently lose focus on their core value proposition as they prematurely strive to build their ecosystem and scale infrastructure.
To bridge this gap, investors encourage startups to hire experienced personnel in manufacturing and project management earlier in their growth. Mario Fernandez of Breakthrough Energy Catalyst advocates for such early appointments, and Shashindranath of EIP concurs, noting the lack of large-scale project experience among many startups.
Nonetheless, the right team is moot if funding dries up. Investors often have to commit more capital or seek alternative financing methods, such as asset-backed equipment loans, suggested by Tom Chi of At One Ventures. These loans provide a safety net, allowing companies to liquidate equipment in the worst-case scenarios to manage debt.
However, for cutting-edge projects like fusion energy, even these strategies have their limits. The enormity of required investment before generating significant revenue challenges the traditional venture capital model, as pointed out by Francis O’Sullivan of S2G Ventures. Achieving venture-like returns becomes increasingly difficult as startups transition to capital-intensive, commodity-producing stages.
O’Sullivan suggests that aiming for lower returns, similar to those sought by growth equity funds, might be more realistic for hardware-focused climate tech startups to bridge the funding gap before transitioning to infrastructure investors.
Additionally, Shomik Dutta of Overture sees opportunity in differentiating genuine technology risks from perceived ones, which could unlock new avenues for investment.
Some firms, like Spring Lane Capital, adopt a hybrid approach to investing, combining due diligence akin to large infrastructure funds with a blend of equity and debt. This strategy, complemented by a team of scaling experts, offers a tailored solution to navigating the commercialization challenges.
Prime Coalition’s Pierpoint advocates for catalytic capital, which encompasses a spectrum from government grants to philanthropic funding, to absorb risks that conventional investors might shy away from. Over time, as investors gain a more nuanced understanding of the risks associated with mid-stage climate tech ventures, they might independently engage more readily.
Despite the financial hurdles, the urgency of developing climate solutions remains paramount. Countries aim to eradicate carbon emissions within the next quarter-century, a daunting timeline considering the years required to build a single factory. To stay below the 1.5°C warming threshold, the construction of numerous unprecedented factories is necessary, demanding substantial investment.
At CleanFiber, Strimling’s team has not only completed their first facility but expanded it, now capable of insulating 20,000 homes annually. Although the initial hurdles were significant, including an unforeseen pandemic, the path to scalability has now been paved. The journey to replicate such success across various industries will be neither simple nor inexpensive, but investor optimism persists, with a shared belief that the future will indeed diverge from the past, as Multani concludes.
