MARC DESCHAMPS: Debt financing in climate tech set to grow over next decade

Software and technology-enabled businesses were considered risky by debt finance providers a mere decade ago as “classic companies” still dominated the landscape and the perceived threat to disruption from “known unknowns” was almost impossible to predict.

The dot-com crash at the turn of the century constantly reminded investors of the perils of backing nascent technology companies.  Fast forward to 2022 and the outlook could not be more different.

Today many of the world’s most valuable companies are related to technology. A similar revolution is now coming in climate tech. Availability of credit financing (various forms of loan instruments) has enabled entrepreneurs, venture and private equity investors to rapidly build, scale and acquire high growth businesses within the digital transformation and technology-enabled sector.

Given the broad nature of technology it is hard to point to a robust figure for how much technology lending has grown over the past decade. However, using private equity transactions as a barometer, according to Bloomberg in 2021 $146bn of technology company buyouts were accomplished, compared with $42bn in 2011.

There is typically plenty to like about lending to technology-enabled businesses from a lender’s perspective.

The acceleration of digitisation within businesses small and large across the globe driven by increased adoption of cloud, 5G and connectivity, provides a huge opportunity. Rapid transformation of businesses through deployment of software applications in the areas such as payments, supply chain, e-commerce, sales & marketing, and learning & communications has not only enhanced efficiency and automated traditional business processes but also created a loyal, sticky and profitable customer base for technology providers.

These dynamics have enhanced lender appetite for the technology sector, a viewpoint that has been further galvanised by the pivotal role technology played during the recent pandemic. Now the effect of inflationary pressures are becoming evident in the global economy, just like the damage from industrialisation is now apparent in our environment.

Technology is in many ways seen as a panacea to these forces as it can increase automation, facilitate remote collaboration and create operating efficiencies within most processes across multiple sectors.

Technology will play a key role in solving the planet’s largest climate-related challenges. Over the next decade companies offering climate-related technology are expected to garner the same attention from financiers as technology companies have enjoyed.

“Investing in the Green Economy 2022”, a report from the London Stock Exchange’s research arm, suggests the market capitalisation of green equities ballooned from under $2-trillion in 2009 to more than $7-trillion by 2021, almost doubling its share of the global investable market from 4% to 7%. 

Debt financing typically lags equity financing as companies are created through risk capital before accessing any forms of debt finance. Companies harnessing renewable energy or electric energy to replace traditional fossil fuels and reduce carbon emissions or supporting clean water, environmentally friendly packaging, and the circular economy from fashion to electronics are all gaining momentum. Technology and innovation are now seen as a force for good, and this image is further enhanced when it is applied for the betterment of the planet and humankind.

The debt financing universe has also evolved over the past decade in response to this phenomenon and debt is no longer just the preserve of large technology companies. Lenders are increasingly active in the start-up to unicorn universe, alongside profitable software businesses, with the aim of not only capturing good financial returns and a market share, but also to fulfil the environmental, social & governance (ESG) based responsibility finance providers have towards their investors and shareholders.

Lenders’ appetite to finance the wider technology sector is evident from the private equity leveraged buyout sector and penetration of venture debt financing in growth companies since the 2009 global financial crisis and throughout the 2020 pandemic.

Today lenders are offering a wide range of hybrid financing solutions from warrant-based venture debt or convertible loan instruments to traditional term loan finance — determined by the financial and operational maturity levels of the potential borrower.

Tech-enabled companies (including fintech, healthtech, clean energy) with a differentiated high growth business model, robust technology platform (often including intellectual property), reoccurring revenues, sticky client base and profitability or path to profitability (profitable unit economics when paring back any costs deployed for growth such as customer acquisition or marketing costs) can now explore debt funding options alongside traditional funding instruments such as equity.

Similarly, when looking at climate-related sectors debt funding is becoming more prevalent outside traditional capital-intensive project finance opportunities such as solar parks, wind farms and eco-friendly real estate projects. Energy transition opportunities and electric mobility is, for example, a sector that is attracting increasing levels of debt financing. UK electric vehicle subscription service Onto, electric vehicle charging infrastructure developer Gridserve and Germany based e-scooter provider Tier Mobility have all successfully raised different forms of debt.

Alongside attractive financial and commercial prospects, debt fundable companies also tend to have a few rounds of equity investment under their belts, a reasonable funding runway, a strong purpose driven founding team and preferably value add investors as shareholders.

Given the nature of technology companies, typically there is no one-size-fits-all financing solution and potential borrowers need to not only assess the pros and cons of carrying debt, but also create a compelling case and be “match fit” for due diligence processes conducted by financiers. Listed and private peer group valuation metrics may or may not be available to benchmark niches or subsectors within alternative energy, mobility, healthcare and automation, forcing lenders to pay more attention to valuation appraisal processes.

Along with the evolution in debt structures, the financing universe itself is being transformed away from traditional banks to now comprise private credit and specialist asset managers. Equity valuations are being influenced by the global geopolitical uncertainty alongside economic factors such as the impact of inflation on operating models and increasing cost of debt service as interest rates rise, affecting earnings and revenue.

• Deschamps is co-head at DAI Magister.