How Renewable Energy Startups Can Become Bankable And Deploy Equipment At Scale
- November 26, 2018
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By Hunter Connell, Energy Innovation Associate
To effectively slow down climate change, renewable energy generation cost reductions must continue rapidly and successfully. But renewable energy equipment supplier startups designing and manufacturing clean energy components face immense hurdles, even beyond the typical hardware startup challenges of significant time and capital.
Barriers to entry occur at every step of creating and eventually deploying a product at scale – especially in the energy industry, which faces slow adoption rates and customers skeptical about unproven technology.
Becoming “bankable” is a difficult and ambiguous hurdle renewable energy equipment suppliers encounter while selling to utility scale energy projects. But deploying equipment in bank-backed projects proves that equipment functions at scale and generates sales momentum. No traditionally relied-upon process exists, however applying an incremental, stakeholder-specific framework that mitigates perceived risks makes it easier to achieve bankability.
Wrongs of Bankability: Oversimplification
As nascent technology companies, renewable energy equipment startups offering innovations must actively mitigate customers’ perceived risk in order to successfully sell products within commodity markets.
Many startups tend to underrate the bankability process, instead focusing on selling their virtues in only a few categories: balance sheet, volume of equipment in the field, and 3rd party “bankability reports.” Oversimplification can prevent companies from mitigating the full spectrum of diligence criteria required by banks and investors to participate in projects requiring hundreds of millions of dollars in financing.
Most hardware startups approach bankability too linearly, but this non-comprehensive approach impedes growth.
In fact, becoming bankable is a more complex process requiring stakeholder-specific mitigation of perceived risk across multiple factors at each incrementally-larger project scale. Perceived risk cannot be ignored and requires active mitigation because customers like solar developers, as noted in a Greentech Media profile of a solar tracker hardware company’s 2015 failure, “[are] the most conservative players in a conservative utility power market.”
The utility power market is notoriously intolerant to technical risks and financial exposure, and this trend has grown more severe in response to boom-bust renewable energy market cycles which have driven many equipment manufacturers out of business.
Companies can avoid the oversimplification trap and become bankable by diligently addressing perceived technical risks associated with financial exposure. This framework is essentially a checklist that increases in detail as projects grow larger, reaching full comprehensiveness at the bank-backed level.
The Correct Approach: Bankability is Incremental
Bankability, like commercialization, relies on incremental scaling. Both may be thought of as a funnel: Product deployment first happens in small pilot phases, then larger phases, and eventually fully commercialized phases. Incremental increases in size and number of deployments reduces perceived technology risk among stakeholders with decision-making power, ultimately enabling sale into bank-backed projects.
The Correct Approach: Bankability is Stakeholder-Specific
Innovative renewable energy equipment supplier startups can ascend each step of project scale by achieving bankability with each discrete project. Understanding how to achieve bankability requires drilling down on what bankability means in practice.
Bankability is typically understood from the lender’s perspective as an expression of trust in a borrower’s ability to fulfill debt services and provide secure returns. This is generally accurate, but too narrow to be useful to an energy equipment supplier startup looking to commercialize because the lender-focused perspective masks critical behind-the-scenes action. Myriad stakeholders influence the purchase and deployment of equipment, so a holistic perspective should include project developers; operations and maintenance providers; and engineering, procurement, and construction service providers; all of whom sway the financing decisions of lenders and equity investors.
In the context of traditional renewable energy project finance, bankability depends on each stakeholder’s perceived risk of the equipment supplier and its product. Perceived risk varies by type of stakeholder and type of project, because each stakeholder has their own risk factors. These are essentially diligence criteria and fall into four key categories: supply, product, operations and maintenance, and finance.
Putting it all together
Stakeholders evaluate specific criteria within each category differently, so equipment suppliers should address them accordingly. For example, construction stakeholders concerned with project deadlines will focus on risks that might prevent on-time equipment delivery.
O&M stakeholders concerned with keeping a plant operational might focus on risks that impact operational uptime, not only through product reliability but also complexity of maintenance and access to spare parts throughout the plant lifecycle.
Finally, financiers will want to validate the expected performance of equipment under the real world conditions as those of projects where the product will be used. This can be accomplished through accelerated lifetime testing and/or provision of sufficient operating data. The supplier should comprehensively address these intersecting sets of risk factors in order to qualify for approval to supply equipment to a project.
The process of addressing these criteria can occur through a checklist, or ‘bankability suite,’ applied on a stakeholder-by-stakeholder basis. The following table illustrates diligence categories of a bankability suite at the utility, bank-backed scale (fewer factors are necessary for projects that don’t need bank or investor financing). Some variation exists in categories, order of priority, and relevance of factors to specific stakeholders, depending on equipment and project type as well as project geography. For an in-depth explanation of the utility-scale solar tracker bankability suite, see DNV-GL’s “Tracker Bankability Reviews: Guidelines for Stakeholders.”
Financial Risk Mitigation: the Warranty Backstop
One of the perceived risks that startup suppliers must address involves longevity. Energy projects must be reliable over long lifetimes, but nascent companies supplying parts to these projects have a chance of failing before that lifecycle is complete. Energy projects must also operate autonomously as their own LLCs, meaning project proformas have to balance revenue with expense over their economic useful life (typically 30-40 years). This could be disrupted by the failure of a company supplying equipment to a project.
Even if a product has a compelling warranty, that warranty is typically no longer valid if the company offering it ceases to exist, which can make investing in novel renewable energy equipment unpalatable, no matter how groundbreaking.
To mitigate this underlying warranty claims concern, companies can introduce a warranty backstop mechanism that provides replacement cash, parts, or service when a company cannot fulfill its warranty obligations. A warranty backstop, included in the bankability suite above, is especially effective in reducing perceived risk for stakeholders with the most decision-making power (like banks and project investors), because it guarantees warranty agreement protection.
Traditional approaches to “backstopping” a warranty include insurance products, parent guarantees, and balance sheet reserves. Unfortunately, those mechanisms alone render the warranty claim process time consuming and inadequate. In the case of hardware, these mechanisms often don’t even provide customers with easy access to the parts they need to repair their projects. For example, if a specific vendor needs to make a custom part for a site, an insurance policy may not include the vendor list, part specification, or authorization to buy the requisite IP-protected parts.
At best these offerings get cash alone (not parts) to the customer, and at worst they create such a mountain of paperwork that it’s not worth going through the process. Savvy customers recognize the faulty nature of traditional backstop mechanisms.
How an effective warranty backstop works
An innovative warranty backstop strategy would allow customers to easily access parts, intellectual property, or service no matter what happens to the original equipment supplier. This might involve creating a bankruptcy-isolated account called a Warranty Backstop Special Escrow Account (escrow or other) that contains capital inaccessible except for fulfilling warranty obligations a customer may require.
If the equipment supplier goes out of business or becomes otherwise unable to meet warranty obligations, the Warranty Backstop Special Escrow Account activates and provides funds to a Warranty Provider – a third party contracted at the initiation of the warranty to perform required work. This contract may include vendor lists, parts specifications, and a complete operations and maintenance manual. In this case, it’s the Warranty Provider who performs the work for the customer, which prevents the customer from enduring the more cumbersome process to service their plant.
The Correct Approach Requires a Diligent and Meticulous Team
Selling to projects that qualify for traditional project financing requires awareness of the full bankability suite, including diligence criteria and relevant stakeholders. Active risk mitigation during sales is a complex endeavor requiring staff traits including willingness to learn, comfort with failure, execution aptitude, and ability to pivot quickly.
The process is highly technical, but relies on the ability to cultivate relationships and industry trust. Diligently seeking out a broad set of stakeholders and helping shape their perspectives will make all the difference in successfully increasing deployment of innovative emissions-reducing equipment in projects.