There’s a hole in the finance world. Fighting climate change means scaling up lots of new technologies, but financing those first-of-a-kind (FOAK) projects is incredibly difficult. New technologies involving things like sustainable aviation fuel, geothermal and direct air capture can take a decade or more to scale up. But venture capital is too expensive for FOAK projects, while infrastructure finance is too risk-averse.
So what solutions could solve the FOAK financing problem?
In this episode, Shayle talks to longtime climatetech investor David Yeh. David has spent over 20 years in climatetech, including in roles at the Obama White House, Generation Investment Management, and the World Bank.
They cover topics including:
- Different approaches to financing FOAK technology: off-balance-sheet, structured finance, catalytic capital and government programs.
- Examples of companies that solved the FOAK problem.
- Code-switching between venture capitalists and infrastructure financiers (try using the word “innovative” with traditional bankers).
- David’s checklist for FOAK entrepreneurs.
Recommended resources
- Bloomberg: Grant from Bill Gates–led fund will make green jet fuel as cheap as fossil fuels
- CTVC: What the FOAK?
Sign up for Latitude Media’s Frontier Forum on January 31, featuring Crux CEO Alfred Johnson, who will break down the budding market for clean energy tax credits. We’ll dissect current transactions and pricing, compare buyer and seller expectations, and look at where the market is headed in 2024.
Transcript
Shayle Kann: I’m Shayle Kann, and this is Catalyst. Interesting. You could build a glossary of vocabulary that is applicable to one financial audience and is banned when you’re talking to a different financial audience.
David Yeh: I have a cheat sheet which I give to a lot of these entrepreneurs saying, “Hey, this is what you can say when you’re in front of a VC. This is what you can say when you’re in front of a project financier.”
Shayle Kann: You did it. You’ve designed and engineered a brand new technology that’s going to help combat climate change. You’re ready to prove it in the field. You’ve got a real customer. Now comes the fun part, first-of-a-kind financing.
I’m Shayle Kann. I invest in revolutionary climate technologies at Energy Impact Partners. Welcome. All right, so at this point, I think it’s a truism that financing a first-of-a-kind project, a hardware project anyway, sucks. It just does. It’s basically definitionally difficult. You’ve never built the thing before, at least at that scale, so it’s inherently risky or at least will be viewed as such. And the economics are basically never as good as you expect them to be in the long term because it is a first-of-a-kind thing. Your most readily available form of money, which is venture capital, corporate equity from people like me, is also basically the most expensive capital out there. But you have some technical proof, hopefully you have real customers who are proving real demand, and this seems like the kind of thing that the world of finance would’ve figured out. We’re great at transferring risk and creating esoteric structures. Where there’s a finance vacuum, there’s usually some intrepid investor class coming along to solve it.
Yes, there have been some attempts at solutions here, but I would argue nothing truly scalable yet across technology types that has emerged and is a universal solution. But it is a big problem. If we’re going to bring dozens or hundreds of new technologies to market over the next decade to solve the harder problems of climate change, we’re going to have to have hundreds or thousands of first-of-a-kind financing bottlenecks to break through.
So I have this conversation partially in the hopes that someone cracks the code once and for all. But in the absence of that, there are still actually a bunch of ways to get it done. I don’t mean to be overly negative here. People do build first-of-a-kind things, and they will continue to, and I think it will continue to get easier as time goes on. But the way that they get built generally are more creative typically and more situation-specific than you might like.
They do work, though, so let’s talk through them. For this one, I brought in David Yeh, who’s been thinking basically nonstop about first-of-a-kind financing for years. He’s a climate OG. He’s been at the White House, at Generation Investment Management, most recently at CIBC, which is on the debt side. He has a lot of thoughts on how to do and how not to do FOAK. So with no further ado, here’s David. David, welcome.
David Yeh: Thank you for having me. Shayle, I’ve wanted to do this for a long time. First time caller, long time listener to the Catalyst podcast.
Shayle Kann: Well, I appreciate it. I’ve been wanting to do a conversation on first-of-a-kind project finance for a long time. People have been asking me to do it actually for a long time, for good reason because I think universally everybody appreciates that this is hard. This is a problem. To the extent that capital markets have really emerged in support of climate tech, this is probably the one area that to me still feels like the biggest gap, but not unsolvable. So I think our point is to talk about, what are the challenges with financing a first-of-a-kind thing, but also what are some of the emergent solutions? Let’s start with why it’s hard. Can you just give an overview of, I think it’s probably obvious that it is hard but not to everybody, exactly why first of a kind has been such a tough nut to crack.
David Yeh: Do you mind if we start off saying why is it important? Because I think FOAK now is increasingly becoming a term, but people don’t often speak about why it’s important. They just say, “Oh, it needs to get done.”
Shayle Kann: Sure, that’s a good point. Also, we should say, you think FOAK is… I’ve never heard anybody actually pronounce the acronym, but now I’m going to start using it.
David Yeh: Oh, it’s actually even worse. Me and a few other, let’s say, FOAK evangelists or entrepreneurs have been calling ourselves FOAKers.
Shayle Kann: FOAKers, yeah, mother FOAKer, okay. Briefly, I think it’s probably self-explanatory, but you tell me if not, why is FOAK important?
David Yeh: I think the first thing is the climate crisis is an existential crisis, and we need to deploy, deploy, deploy to keep ourselves at, let’s say, two degrees or two and a half degrees Celsius. Right now, a lot of climate tech, hard tech companies do not make their impact till they become infrastructure, till they start bending steel, laying concrete. In order for us to have gigatons of carbon abatement, we need to deploy gigawatts, GigaPanels, giga-everything. You can’t deploy anything at the scale of the billions until you do the first one, and the first one is by far the hardest.
For me, I’ve been doing climate for, I would say, 20, 25 years, so I’m really aging myself, and people were talking about, “Oh, what is the climate solution?” A lot of people just talk about it almost as a technology vertical. Is it green hydrogen? Is it green cement? Is it more solar? Is it more wind? To me, I think one of the biggest climate solutions is FOAK, which is a horizontal financing solution that can essentially be the one financing solution to help catalyze them all. Because most of these climate tech, hard tech companies, in order for them to start their path to make an impact, they have to build their first-of-its-kind factory or first-of-its-kind project. FOAK is a financing approach that’s applicable to geothermal, to energy storage, to cement, to getting it done.
Shayle Kann: Maybe it’s like, I’m thinking it’s too obvious because this is the world I live in. I specifically invest in companies that, at some point in the future, generally after I invest, are going to have to build a first-of-a-kind thing, so I’m deep in it. But I think it’s well put the importance of… The point being, we’re going to need dozens, hundreds of new technologies to get to the type of infrastructure scale that you’re talking about over the next couple of decades. Every one of those is going to have to build a first of a kind at some point. Let’s get back to why it’s hard though. Infrastructure finance is very mature. Why has it not solved the FOAK problem?
David Yeh: The reason they haven’t solved that problem is because FOAK is at the intersection between venture capital and infrastructure. These are two asset classes that, for lack of a better word, are not well suited to doing first of its kind. So for VC, it’s basically too expensive and likely too large or dilutive of a check for them to build a first-of-its-kind plant with venture dollars. I’m saying most first-of-its-kind plants are in the hundreds of millions dollars.
For the world of project finance and infrastructure, they have a different risk tolerance. So putting on my hat as a debt provider, most debt lenders for project finance, they’re focused on credit and risk management, and they’re not going to… Their return is getting their debt back plus interest. So if you are investing in the next Tesla, and Tesla is now, what, a $700, $800-billion company, they don’t see any of that upside. It doesn’t make a real difference to them. To use that old maximum, you’re getting debt-level returns for equity-level risk. So that’s one of the issues.
Also, I think there’s a bit of a cultural divide. I think in order to create this bridge between venture capital and infrastructure, and I like to call it venture infrastructure at times, you have to be able to translate. If you look at venture capitalists and then look at project financiers, they speak different languages, they have different risk tolerances, and it’s hard to get them to translate. I remember, this is when I was still at the White House, there was a friend who was launching a new groundbreaking geothermal company with a disruptive new technology. So I reached out to a friend of mine who worked at one of the most prominent energy infrastructure firms and gave him the pitch, saying, “Oh, you should really talk to him.” My friend at the infrastructure firm says, “If I see the word disruptive, innovative, I automatically can’t invest in it.”
Shayle Kann: That’s funny. That definitely reflects the different language. In VC world, that’s all you want to hear. In infrastructure and debt world, that’s the last thing you want to hear.
David Yeh: Yeah. I think, again, they have different but equally valuable risk reward profiles. I thought one of the smartest things I’ve heard about the difference between venture capital and private equity and infrastructure is that I think if you’re a great venture capital firm, you’re providing 20-plus percent returns for 10 years. If you’re a great infrastructure firm, you’re providing 15% or mid-teens returns for 20 years. Both pretty compelling, but how they make their money is different.
Shayle Kann: The way that I’ve described it, because I think there also have been a bunch of attempts to create vehicles for first of a kind, and some of them are still ongoing and may work. But I feel like the two places where everybody runs into a brick wall generally are, one, the risk/reward on that first of a kind, and the challenge, they’re often… It’s not like the first-of-a-kind project is the most lucrative project either, generally. There are exceptions to this.
But oftentimes, the first of a kind is at the beginning of the cost curve. Whatever the thing is going to get only cheaper as you build more of it, but the first one is going to be the most expensive one you ever build, and it’s not like you always have a customer who’s ready to pay five times the ultimate price for the thing. So it’s not like the returns are so, so much better, but the risk is inherently higher because it is a first of a kind. You can talk about how you can buy down that risk and so on. But just fundamentally, if you look at it purely as a financially-moded infrastructure investor of one kind or another, that’s a tough risk/return equation for you to wrap your head around.
Then the second problem, I think, is the sort of scale opportunity of it, which is that infrastructure capital, generally bigger pools of capital than you see in venture capital. They want to deploy a lot of money repeatably into something that doesn’t need to be underwritten individually every single time, but almost by definition, first of a kind is a unique snowflake. So you do a lot of work because you have to figure out how to underwrite it and understand the risk profile and so on. So you do all this work, and your prize for doing all the work is you get to invest in one of them, at least at the start. So those two things, I think, in combination have made it really difficult to exactly, as you said, find that bridge between the world of private equity and venture capital on one side and the world of infrastructure on the other side.
David Yeh: I think you just hit the nail on the head. I think for most venture capitalists, first-of-its-kind is probably the only-of-its-kind project that they’ll be investing in. For them, again, the risk/reward does not make sense. Their capital is too expensive. A lot of this is going outside their expertise. Then when you’re trying to find that bridge to infrastructure investors and project financiers, first of its kind looks too risky.
This is something I kind of learned from my good friends at LanzaTech. In order to do first of its kind, to be an investor that’s an anchor or a catalytic investor, you have to be long-term greedy. I think that’s understanding that the first-of-its-kind project you’re doing is not the only project you’re doing. You’re doing the first of its kind so you can then do the second, third, and fourth. I think the common analogy or metaphor that I use to describe is that you’re trying to invest into the next solar or invest in the next Tesla. If you can get your first of its kind right, you’re on that path to do that.
Shayle Kann: Right. Let’s talk about… Obviously, we’re describing why it’s hard, and it is hard and everybody knows it’s hard. That said, lots of first-of-a-kind things have gotten done, so it’s not like it’s impossible. So I think we should talk through this sort of categories. If you’re a company who needs to build a first-of-a-kind thing, what is the suite of options that is generally available to you today? And let’s talk about the trade-offs amongst those.
So the first option, and perhaps the one that actually I think has been… was the predominant option for sure up through 2021 in the period of zero-interest rate policy and money flowing freely was to just continue to use the source of capital that you’ve been using to fund the company, which is generally venture capital dollars, corporate equity, to fund your first of a kind. So talk a little bit about the trade-offs there, whether you see that continuing to be a viable option, and how the availability and cost there is changing.
David Yeh: I would say right now, financing first of its kind, it’s a menu of options. I think the simplest option is financing it off your balance sheet. That’s the brute force method. I would say it’s almost like the Climeworks’ method, where they raise a $600-million-plus round in their Series F to go build Orca and then build Mammoth, which is their two, I say, near-utility-scale or commercial-scale DAC facilities. I think the key issue behind that is, one, not every company can raise a $600-million round. Two, if you raise a $600-million round, it’s a bit of a double-edged sword. Because when you’re raising $600 million, no matter what the valuation is, you’re going to be diluting your company, the existing investors, and especially the founders and the team greatly. To me, I think that’s a big risk.
Right now, we’re also now in a much more expensive kind of capital-constrained environment. So to me, that’s one of the big issues about doing it on a balance sheet. It can be done, but it’s very expensive and it’s difficult. There’s now more and more sources of non-dilutive off-balance sheet financing that people need to explore and, to be honest, be more creative about how they do first of its kind.
Most of my background, I came from the world of venture capital and growth equity where financing is pretty simple. It’s preferred equity. You may put some bells and whistles on it, but typically you don’t spend too much time thinking about credit or thinking about structured finance or off-balance sheet items. It’s just simply not part of the menu.
When I think about FOAK financing, it’s not like this fixed pathway or concrete recipe. I wish I could give to all the founders and new CFOs out there, saying, “These are the 10 steps to get your FOAK financing done.” It’s really a new approach. It’s blended capital. It’s using growth equity. It’s using government finance. It’s using catalytic capital. It’s using infrastructure finance. It’s a lot of new thinking, and it’s a lot of creativity. I think, for me, one of the key things to understand about FOAK financing is that you need to embrace government as a strategic partner and be able to look for new non-dilutive capital sources including a lot of this catalytic capital there, like Breakthrough’s Catalyst program.
Shayle Kann: Let’s talk about some of those others. Just to reframe it again, financing on your balance sheet is an option if you have that option available to you. Some companies do; some companies don’t. Even if it is available to you, it may be suboptimal because of the cost of that capital, the dilution that it delivers to you, the post-money valuation that you’re going to have to earn your way into in the next round and so on. So if you can avoid it and the other options are tenable, you may go for the other options. So let’s talk about what some of the other options are. You, I think, breezed through a few of them. I want to spend a little bit more time on a couple.
Let’s talk about the government side of it. You mentioned that. That’s obviously one that has been pretty ripe for the past couple of years thanks in part to the infrastructure bill which deployed a lot of money and then the IRA which deployed a lot of money as well, so in the US and in Europe to some extent, too. The world of non-dilutive or mostly non-dilutive government funding is richer than it was, but also kind of idiosyncratic and sort of depends what you’re doing. What have you seen as successful mechanisms to use government funding to deliver first of a kind?
David Yeh: I would say right now, I think the big game changer is that government now has literally hundreds of billions dollars available for first of its kind, both through the DOE’s LPO program, which I helped run back in the day, as well as now new programs for DAC hub funding or hydrogen hub funding, which is measured in the tens of billions of dollars. I think the key thing is that government is now really viewed as a strategic ally. Not only is government willing to partner with the private sector, the private sector is willing to partner with government.
I think the two ways that you can really leverage government as your partner for FOAK is, one, working with OSED and other parts of the DOE to do your pilot/first-of-its-kind funding, as well as applying to the LPO. I think the LPO now, with IRA money, has about $400 billion in resources. I think they’ve become, for lack of a better word, must-see TV or the key stuff for any company that’s doing an ambitious climate-tech, hard-tech startup, whether it’s changing mobility, green hydrogen or even green cement.
Shayle Kann: So there’s government funding, obviously. If you could tap into that, that’s generally attractive. You also mentioned other catalytic capital sources, like Breakthrough Catalyst, and there are a few others out there. How do you think about them as fitting into the mix here?
David Yeh: I think they’re very important. Because I think for building these new blended capital stacks, we’re going to be looking… it’s going to be a portion of growth equity. It’s going to be a portion of strategic equity. It’s going to be a portion of maybe some debt and credit or structured finance. But there needs to be this what I call flexible capital. That can be equity. It can be debt. It can be something in between. It can be a loan loss reserve that can get these deals done.
I think one of the best examples is Breakthrough Catalyst’s program that put in $50 million of grant money to build LanzaJet’s Freedom Pines facility, which I think is the biggest and first sustainable aviation fuel facility being built out in the US. We need more of that, and I give kudos to Gates and Mario, who’s running the Catalyst program, for running what I think is probably one of the most important platforms getting first-of-its-kind facilities done.
There are a number of other entities jumping in. I think Just Climate, which came from Generation, my old place I used to love working at, was they’re catalyzing transformational solutions. They are trying to back early, high-impact climate solutions. Then I’m noticing that a lot of family offices who are leaning into this as well, so CREO, which is a syndicate of family offices, leaning into climate as well as other family offices saying, “Please show us the deals that need flexible capital to get deals done. And given to our resources, we’re willing to do that. And returns, for lack of a better word, are secondary.”
Shayle Kann: That’s the fundamental characteristic of this category of catalytic capital, which is that it is often semi-concessionary. It’s generally return-seeking, but it is not expecting above market returns. It is not promising to its LPs or its investors that this is going to be the best return on the planet. There’s an additional consideration that is at the forefront, which is impact, and this is an area where I think the impact is or at least can be quite large. So it’s somewhere in between, I think, of the pure private sector, like return-seeking money, the government, which is generally not return-seeking, put an asterisk on stuff like the LPO, which does expect to get returns, but somewhere in between there is this sort of private catalytic capital world.
There’s one other category, though, I want to talk about, too, which is the emergence of strategics or customers, for that matter, who are willing to bear some of that first-of-a-kind risk because they are so hungry to get new products into the market. I’ve seen some of that that’s actually been pretty powerful with some of our portfolio companies, where historically the first of a kind, they would’ve had to finance it themselves, and they would’ve gone through this whole rigmarole. Instead, if they have sufficient evidence and the customer has sufficient need, they’re able to basically say, “Look, you pay for it,” to the customer. How much of that do you see out there?
David Yeh: I think when we’re trying to look at the history of FOAK, the first few FOAK deals that were done were done with strategics. So to me, I think one of the best kind of climate OGs is LanzaTech. They’ve been doing carbon value before carbon value was even a term. They built their first three to four plants by working with strategics, by licensing their technologies with steel companies in China to build real, real projects at scale.
Then I think a second example is strategics can also be, I would say, the integrated partner. One example that I’ve used a lot in the past is LNG. LNG now is a very mature project infrastructure market, but, say, 10-plus years ago, it was not that. Strategists came in where they’re both the sponsor, the developer, the offtaker, and sometimes even providing the supply. What I’ve been talking with a lot of these climate tech startups is that strategists can be that powerful for you. We’ve been using this LNG example a lot when we talk about green hydrogen and blue hydrogen. You find strategic can do all those things for you.
Shayle Kann: These are various flavors that you can mix and match and try to combine. In some ways, it depends on the scale of your first of a kind, how complicated it needs to be, I think. There are companies for whom first of a kind is a few million dollars or $10 or $20 million or something like that. A very different equation if that’s true versus if you’re building a steel plant or a cement plant or something that is going to cost hundreds of millions of dollars. It’s obviously more complex, more capital, and you probably need to tap into more of these sources.
But I think there are some semi-universal lessons from all of this that earlier-stage companies can probably employ as to how they should be preparing for first of a kind and what you’re going to need to have in place. There’s a checklist that is pretty universal about the things that make a thing financeable regardless of the source of financing. So walk me through at the high level, if you’re advising a Series A technology company, they haven’t built a first of a kind yet, they know they’re going to need to in the next few years, what are the things they need to be thinking about immediately?
David Yeh: Well, I think for the last few years I’ve been doing a lot of what I call FOAK or project finance 101 with this generation of climate tech startups. It’s kind of been refined to this short checklist. I think the first thing, you need to start thinking about your FOAK project at the Series A. These projects take years to get ready and then take years to build and finance, so you want to start this early. This needs to be part of your business plan. It needs to be part of your regular board discussions. One of the things that I’m really encouraged by is that this generation of climate unicorns are starting to do that. So my friends at Arbor Energy, who are bringing kind of SpaceX technology to biomass, they’ve already embraced this and made this part of their strategic plan, as well as Antora, who’s doing really smart industrial de-carbonization through heat batteries, is also embracing this type of approach. So I think that’s the first thing is make this a priority, part of your business plan.
I think the second thing is that you need to actually get project finance and project development DNA into your firm. I think that old analogy that people talk about, venture capital, it’s like, what are the top three things you pick for a venture capital startup? It’s team, team, team. This applies also to FOAK. You need the people who have project finance and project development experience in your company in order to do first-of-its-kind projects. I think a good example is a friend of mine at Sublime. Sublime is doing true zero green cement. They hired my friend, Becky, who was a veteran from SunPower and a veteran from Avangrid. She’s an expert on how to do solar and wind, and now she’s applying to, how can you apply those best practices and project development in solar or wind to a totally new sector which is green cement?
I think there’s this really good analogy from the world of Chinese art. For many Chinese artists, in order for them to start doing abstracting, do their own thing, they first have to be experts and be able to reproduce what their master’s done down to the stroke. Then you can start innovating and disrupting off that. I think that’s kind of important, too. You need to first really understand the fundamentals of project finance and project development, and then from there, you can move on and say, how can we then apply these things to new sectors like hydrogen or to green cement or thermal batteries?
Shayle Kann: So start planning it early, get project finance DNA into your company early. I agree with both of these things, by the way. I think all the best companies either inherently knew this or figured it out pretty quickly. Then there’s the actual… what do you need to show with regard to your technology before you do the first of a kind such that you can do the first of a kind, such that you can finance the first of a kind? How do you think about that?
David Yeh: I think there are many things to do, but there are two main things I would focus on first. You have first have to derisk your technology with pilots. I’m emphasizing the word plural. Many of the projects that I’m looking at are trying to go straight from lab scale to utility scale, so they’re trying to scale 30X, 100X. That is very hard to be seen as bankable in the project finance and infrastructure markets.
I think a good example of someone who’s done a good job of being a measured approach to growth is Climeworks. In 2012, they built a demo. A few years later, they did a bigger demo. 2017, they did their first commercial scale. Now a few years ago, they did Orca, and now they’re going to be doing Mammoth. So they took multiple steps to get to commercial scale. While a lot of the startups now, they’re trying to go straight past go and go from, let’s use the analogy, a few thousand tons to a million tons, and that’s just hard.
Shayle Kann: This is an interesting one. It’s very situation specific, I think. I have sort of mixed feelings about this one. On one hand, obviously, the traditional incremental scale up, which is basically every next step is one order of magnitude bigger than the previous step, that is a tried and true way to scale up technologies. If you can do it and everything else works out, it makes a lot of sense to me. Climeworks is a good example of that.
On the other hand, that timeline that you just described for Climeworks was extremely long. I think a lot of companies right now would look at that and say, “Oh, my investors are not going to sit around and wait for me to scale up for a decade.” So they’re trying to figure out how to short circuit that process. Though going from lab scale to full commercial scale almost never makes sense, I do think that some entrepreneurs that I’ve seen take as gospel this notion of the order of magnitude to scale up that isn’t necessarily true to their technology.
The real question should be, what is the next scale that I need to do to prove out my technology, to prove it works, to prove the cost down, whatever are the big open questions? That may indeed be one order of magnitude each time you build a new thing. It may be that you can scale up faster than that. But you need to ask it from that context, not just start from the perspective of like, “Okay, this is how it works. I go from 10th of a ton to a ton to 10 tons to 100 tons, 2,000 tons, two million tons.
David Yeh: I totally agree. But I think, again, it has to be specific to that technology, and sometimes you can rush through. But for me, I’m trying to take the perspective of the person on the other side of the table who isn’t a venture capitalist. It’s someone who is a project financier, who’s an independent engineer, or a debt provider. They’re going to be having these same exact questions saying, “You can’t do a 30X scale up.” Then the burden of proof is on the startup to say how they can do that. What I think, for me, I’m trying to say is that you don’t have to have four or five steps to get to commercial scale, but it’s hard to go from lab to commercial scale in one go.
Shayle Kann: Yeah, I think that’s right. Then there’s the element of, what do you have to prove with the technology? Obviously, there’s way more detail to that. Just having a pilot in and of itself or having multiple pilots, as you said, is insufficient. It’s the question of performance of those pilots and uptime and cost and all these things. But set that aside. The other category here that I think is important to talk about is customers. Because the other thing that your future project finance provider or infrastructure investor, whoever it is, cares about is how firm is the offtake for the things that you’re building, and what’s willingness to pay, what is the credit worthiness of the off-taker, etc.? So how do you think of offtake for a first of a kind? What is required there?
David Yeh: I think the first thing you have to understand what your commercial model is for your first-of-its-kind plant. You need to go out and get agreements, as you said, offtake. I think everyone is looking for the equivalent of a 20-year PPA because that is very bankable. So people are looking for that for direct air capture and their current carbon credits. They’re looking to that for various green molecules. So that is fantastic.
But I think this is where the rub lies. Many markets that need to be carbonized don’t work on long-term contracts. They’re spot. They’re merchant. How do you figure out that solution? This is where… it’s great about having entrepreneurs and their animal spirits. They’re creative and persistent on trying to figure out how to hack this part of the problem. How can we turn a commodity market that has spot and merchant into long-term agreements? Some of my friends at some of these green cement companies, they’re realizing what they’re producing for green cement is a premium product where buyers, especially a lot of the large tech companies, are willing to change the commercial model of offtake, spot, merchant to long-term contracts.
Shayle Kann: There’s also interesting hybrids there, too, right? I think sustainable aviation fuel is one of the more interesting categories with this right now where you’re starting to see these trilateral agreements. There was actually one announced just recently with Infinium, and I can’t remember who it was, American Airlines and Citigroup or something like that.
Basically, you have a customer who ultimately wants to reduce their Scope 3 emissions and is willing to pay to do that, wants to buy the credits from the sustainable aviation fuel. You have an airline sitting in the middle who’s responsible for buying jet fuel. That jet fuel obviously is generally on spot and those prices move. Then you have a producer who needs to finance a facility of one kind or another. I don’t know what that specific contract structure was, but you could imagine either the end customer, Citigroup in this case, says, “I’ll pay a fixed price for a long time,” or they could say, “I’ll pay a fixed premium for a long time or something like that.” Either way, providing some measure of visibility to the asset that is building or developing the sustainable aviation fuel such that you can finance the thing. But as you’re saying… We see this in other sectors, too. Fertilizer is another one. People are trying to produce green ammonia. Ammonia also a category that is generally not long-term contracted, and so you have to figure out how to get around that.
David Yeh: I think this is where you bring in the world of Wall Street where people are used to slicing and dicing financial products. This is what we’re starting… They’re bringing this world to climate tech where I’m seeing green… Again, let’s visit the green cement example where they’re selling the green cement at a price, but they’re then slicing off the carbon neutral attributes and selling that to another customer at a different price. This is one way, I think, you need to be creative and be persistent. These are new models, and this allows you to buy the time to buy down the green premium as you scale up your facilities.
Shayle Kann: I’m a big fan of the idea of book and claim for some of these novel technologies. Find the buyer who’s willing to pay. That may not be the immediate customer of the first-of-a-kind thing. Use financial engineering to solve for that. As long as everything is above board and well counted and measured and verified and so on, I think it’s actually a pretty good mechanism to get this stuff built.
You’ve got some various flavors of customer demand, offtake, whatever. I think a big part of the message, by the way, so far across the board, whether it’s how you’re going to finance the thing, how you’re going to find the customers, etc., is a fair amount of creativity. That’s one of the… I mean, it’s a good thing. It’s also probably a challenge. To what extent, I guess stepping back, do you see there is being a repeatable playbook versus to what extent is every first-of-a-kind thing for a different thing going to be a unique snowflake that’s going to require a bunch of time and effort and expertise to figure out?
David Yeh: Going back to my biology roots, I think there’s a good analogy from that. There’s this concept when you look at biology when they say it’s unique to form, diversity of pattern. I think this applies to FOAK, where there can be certain guidelines that go across all sectors in all verticals, but how it’s actually implemented for each specific FOAK. Whether it’s a green hydrogen FOAK or a green cement FOAK or a green steel FOAK, it’s going to be specific to that sector and specific to that company.
I think the second thing is that what we’re trying to do now is build a FOAK asset class. As you get more and more dedicated investors in FOAK, it’ll become easier and easier because they will have their own pattern recognition of what they’re looking for. To me, one of the things that I’d like to add as an important part of the checklist for making your projects FOAK bankable is that a lot of these CFOs and CEOs of these new climate tech startups have to learn the language of infrastructure and project finance, and specifically, they have to be able to code-switch from speaking, “VC language is disruptive, innovation home runs, power log,” to saying, “This is proven off-the-shelf technology. There is no binary technology risk. Oh, we are totally investment grade. We’ll pay back the loan and have a debt service cover ratio that’s approaching two.” I think those are the things that you need to be able to do as one of the key parts of being able to build your FOAK project.
Shayle Kann: It’s interesting. You could build a glossary of vocabulary that is applicable to one financial audience and is banned when you’re talking to a different financial audience.
David Yeh: I have a cheat sheet which I give to a lot of these entrepreneurs saying, “Hey, this is what you can say when you’re in front of a VC. This is what you can say when you’re in front of a project financier.”
Shayle Kann: That’s funny. I guess final question for you, we’ve been talking about FOAK. Obviously, the journey doesn’t end at first of a kind. Then you have to build second, third, fourth, fifth up to nth of a kind. I think we should spend just a minute talking about that because I think, for good reason, there is a lot of focus on first of a kind. But it’s not like you go from first of a kind to now you’re an infrastructure asset class, like solar and wind are today, that’s like extraordinarily mature and cheap cost of capital and so on. There’s an entire journey to go on after that. So how do you think about that next phase? You’ve built the first of a kind now. You succeeded, and it’s operating and it works. What does the next phase? Getting from first of a kind to boring, mature asset class, which is where you ultimately want to be, what does that journey look like?
David Yeh: It’s a journey. So first of its kind is important because the first step. Once you get your FOAK plant successfully built, then you can go to the next step which is SOAK, which is second of a kind and third of its kind. At each step-
Shayle Kann: TOAK.
David Yeh: … the universe-
Shayle Kann: ThOAK.
David Yeh: … ThOAK, ThOAK-
Shayle Kann: ThOAK, yeah, ThOAK.
David Yeh: … are getting larger and larger. For me, what I talk with a lot of these climate tech entrepreneurs is that you want to move from the world of private equity and venture capital to the world of sovereign wealth funds and infrastructure investors, investors that literally write 500-million-dollar, billion-dollar checks. To me, this transition is thinking about creating, for lack of a better word, development companies where, once you prove out your project, and it’s not necessarily the first of its kind that’ll prove it, for many of these mainstream project financiers and infrastructure investors, they may not look at this stuff till it’s project three. But then at project three, they can lean in and these firms can write 500-million-dollar, billion-dollar commitments to go build your fourth, fifth, and sixth plant.
To me, a lot of this future is like systematic change. We need to have FOAK-driven strategies within global asset managers. We need to have FOAK allocation within infrastructure and private equity investors. Ultimately, what you’re playing for is some of these big mainstream exits. So I think when a lot of venture capitalists and climate tech entrepreneurs think about an exit, it’s simply binary. Either it’s an IPO or a strategic sale. But there is this world of DevCos and the world of infrastructure that is also very attractive where you start building these development companies that are developing gigawatts and gigawatts of clean energy. As these projects mature, they then sell them to sovereign wealth funds, pension funds. The dollars around this is incredible.
I think I was fortunate enough to be involved with the $3 billion Blackstone investment in Invenergy, which is one of the largest IPPs and development companies. They put $3 billion in just to own part of this, what I call this development machine. I kind of think about a lot of these companies are now coming up, these next great climate tech leaders, like Fervo, which is doing next generation geothermal. I think their future is being a development company for geothermal and producing gigawatts of power, clean 24/7 power.
Shayle Kann: All right, David, always much more to talk about in first of a kind or sorry, FOAK-land, I’m going to get used to using the acronym, but this was a great start. We’ll dig in deeper later. In the meantime, thank you so much for joining.
David Yeh: Thank you for having me.
Shayle Kann: David Yeh is, in his own words, a climate OG. He’s been in organizations from CIBC to the White House to Generation to many other places. This show is a co-production of Latitude Media and Canary Media. You can head over to canarymedia.com for links to today’s topics. Latitude, as always, is supported by Prelude Ventures. Prelude backs visionaries accelerating climate innovation that will reshape the global economy for the betterment of people and planet. You can learn more at preludeventures.com. This episode is produced by Daniel Woldorff, mixing by Roy Campanella and Sean Marquand, theme song by Sean Marquand. I’m Shayle Kann, and this is Catalyst.
