How to get debt-ready: A guide for climate companies

In a recent post, we outlined the role of first debt facilities in helping climate originators gain early traction. We now turn to the process that is required to raise these facilities, and, crucially, the steps that climate originators can take to accelerate the process of raising this capital at better terms.

Off-balance sheet debt facilities are a critical tool for climate finance companies. As we have written about in previous Ezra Insights articles, they can be an ideal source of capital for several reasons—including the fact that they are structured against customer assets and typically are sized and may be tenored to match those cash flows. This can protect originators from existential risk in the case of poor loan performance, and improve the terms of the capital made available.

However, raising these facilities is a complex and difficult process today. This is for a number of reasons, including:

• Deep technical expertise required to negotiate them
• Unfavorable loan terms that early-stage climate companies can be offered
• High transaction costs

There are a number of steps that climate companies can take before entering negotiations to mitigate these issues. This entails more than just having a clear idea of how much capital is required and the ideal rates on offer from lenders. Rather, it spans all of the processes, data, and expertise that lead capital providers to view an originator as ‘a good borrower.’

In our experience, investment in these processes, data, and expertise can meaningfully accelerate the process of raising off-balance sheet financing, and improve the outcomes of negotiations.

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Processes

Developing a debt facility strategy: Raising an off-balance sheet facility is a strategic choice that climate finance originators can make in order to spur early growth. Companies should set out to define a clear roadmap for raising this kind of capital, including the optimal facility size, terms, timeline, and how it forms a glidepath to larger warehouse facilities in the future. Companies should also lay out a list of potentially-suitable capital providers to target, and develop an outreach strategy for them (See this a16z mapping of capital providers as a starting point).

Building a thorough loan management process with a competent tech stack: Loan disbursement, management, and monitoring are a critical components of any off-balance sheet facility. Many capital providers will have strict requirements in place to ensure that originators are correctly overseeing these processes. Climate originators can pre-empt these requirements by ensuring they have effective tools and systems in place. This will improve the perception amongst capital providers of an originator’s ability to responsibly disburse and manage capital. (It will also accelerate the time it takes for the deal to close and funds to be transferred.) The following are examples of what we expect from originators ready to receive capital from lenders:

• A controls system in place to manage loans - At a minimum, originators should ensure that all lending is recorded in a single source of data—whether in a spreadsheet or dedicated loan management software. There are many originators who track loans across disparate files, due to the busy and unstructured processes that many early-stage start-ups have. The controls system should be linked to automated tools and manual processes that allow the originator to track receivables in real-time.

• ‍High-quality project models that link to prospective loan terms - Many originators do not have adequate models available. Project models should be consistent with the formats and structures that most capital providers would recognize. They should clearly link to key loan terms, such as when P&I is paid, the waterfall structure, reserves, and financial covenants.‍

• A back-up servicing regime in place - Originators should have engaged some kind of agent to provide back-up servicing, in the case that borrowers do not meet their repayment obligations. This can be a dedicated servicing company or an in-house team. Almost all capital providers will request that this is in place before agreeing to lend to an originator.

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Data

Preparing a data room: The climate space has unique types of assets and is rapidly expanding into new geographies and customer segments. As a result, many capital providers will not have deep familiarity with the kind of lending that climate originators seek to undertake. These originators will have to put together comprehensive data rooms in order to address many of the questions that are likely to come up during the capital raising process. We have seen a variety of data room requests from different capital providers in our experience building climate originators. The following is a list of documentation and data that any climate originator should have prepared in advance of negotiating an off-balance sheet facility:

• Latest fundraising deck

• Cap table, including plans for future equity fundraising

• Current org chart, including executive team CVs, overview of the board of directors, and details and a timeline for planned future hires

• Historical financials, including the historical monthly financial close (at least 24 months where possible, and featuring monthly burn, cash position, and net income)

• Financial model, including a monthly forecast at least two years out, revenue targets, and detail on modeling assumptions such as underlying unit economics and customer acquisition costs

• Credit policy and loan operations details, including underwriting policies, an overview of the process used to assess customers, and credit committee details (where relevant)

• Sales pipeline, including a categorization of high likelihood customers vs. potential customers, estimated loan size, and projected time to close

• Capital formation plans for past and future, covering all on- and off-balance sheet financings across equity (amount raised to date and amount/timing of next fundraise) and debt

• Revenue performance tape, such as monthly customer-level revenue data, cohort analysis, and calculation of industry-specific KPIs

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Personnel‍

Originators should make sure that they have expertise—be that hires, contractors, or consultants—across three key areas:

Credit and risk expertise: Climate originators will need to ensure they can match the deep experience on the other side of the negotiating table. Small details in term sheets can have significant implications for a business. It is critical to have someone who can dissect potential agreements and interpret their implications for the business. Moreover, there are a number of internal policies and processes that are required in order to make an originator both a good lender and a good borrower. Originators should ensure they have someone leading both of these elements within the organization.

Capital markets: It can be difficult for originators to identify suitable capital providers. Even when potential fits have been found, many require a warm introduction. Originators should ensure they have a capital markets expert who can help navigate potential capital providers and begin conversations.

Systems and technology: Effective data and technology systems are critical parts of the lending process. It is important to have technological leadership who understands the different components required for an effective lending tech stack.