Welcome back to Deep Tech Catalyst, the channel by The Scenarionist where science meets venture!
Today, I'm thrilled to welcome Carlota Ochoa Neven Du Mont, Principal at Extantia.
In our chat, we delved into the crucial stages from prototype to FOAK, optimizing funding strategies, and the role of venture debt in scaling climate tech startups.
Here’s what you’ll learn in this episode:
🏭 What is a First-Of-A-Kind (FOAK) in the Context of TRL?
🤔 What are the Key Differences Between a Pilot and a FOAK?
🎯 Optimizing Funding Strategy from Prototype to FOAK
💸 Understanding Venture Debt
📈 How Does Reaching the FOAK Stage Affect a Climate Tech Startup's Valuation?
🎧 Prefer to Listen?
KEY INSIGHTS FROM THE EPISODE
🏭 What is a First-Of-A-Kind (FOAK) in the Context of TRL?
It's important to note that the journey to achieving a "First of a Kind" (FOAK) varies and FOAK plans are diverse. Generally, the process starts with developing a prototype, often within a lab or bench-scale setting, aimed at proving the technology. This phase typically aligns with Technology Readiness Levels (TRL) 4 to 5.
The Pilot (TRL 6)
Following this, the development progresses to a pilot plant at TRL 6. The pilot plant phase is designed to demonstrate the system or prototype in a relevant environment, proving the technology's capability at a larger scale and optimizing the process. This stage aims to transition from producing small quantities, like grams, to larger quantities, such as kilograms, or scaling up from watts to kilowatts.
The FOAK (TRL 7/8)
The next significant step is achieving the "First of a Kind" status, which involves demonstrating the technology at a full operational scale, corresponding to TRL 7 to 8. This phase showcases the system or prototype in a real-world operational environment. The objectives here include:
Demonstrating scalability before moving to a full commercial plant.
Producing outputs in larger quantities (e.g., tons or megawatts) to instill confidence in customers about large-scale production capabilities.
Proving the unit economics, which is crucial for securing later-stage funding, infrastructure investment, and debt financing.
🤔 What are the Key Differences Between a Pilot and a FOAK?
The approach to developing a pilot (TRL 6) versus a FOAK (TRL 7/8) varies significantly across companies and depends largely on the technology's complexity.
Some companies engage third-party engineering partners early on, even during the prototype phase, to help design and implement the prototype in a lab setting for the research team to refine and optimize.
Conversely, other companies prefer to build both the prototype and pilot in-house and only involve third-party engineering firms during the FOAK phase. This decision often hinges on the complexity of the technology. For highly complex engineering projects, engaging third-party firms earlier can accelerate development.
A Cost-Benefit Consideration
Engineering firms typically use standard sizes, so custom solutions at smaller scales often require bespoke components, increasing costs. Outsourcing these custom units can be more expensive compared to assembling them in-house.
The decision also depends on the available talent within the company. Companies with a strong engineering-focused founding team, especially those with mechanical engineers, are more likely to build prototypes and pilots internally, benefiting from faster iterations and direct learning.
On the other hand, teams primarily composed of fundamental scientists, such as chemists and biologists, may find it more advantageous to rely on third-party firms for system development.
🎯 Optimizing Funding Strategy from Prototype to FOAK
Typically, early-stage R&D, particularly in hardware-heavy and R&D-intensive projects, is conducted within research institutions like universities, often funded by university resources or tied to academic research such as PhD projects.
Prototyping Stage
As startups move into the prototyping phase, they may begin raising external or equity capital, although it’s common for prototypes to be almost entirely grant-funded. Various grants at national and EU levels can cover up to 100% of prototype development costs. This stage focuses on transforming academic research into tangible prototypes, leveraging grants to minimize equity dilution.
Pilot Stage
Transitioning to the pilot stage generally involves a mix of grants and equity funding. A typical split might be 25% grants and 75% equity. This balance allows startups to remain agile while securing substantial equity investment to expedite development. Grant processes can be time-consuming, so combining them with equity funding ensures timely progress and financial flexibility.
First of a Kind (FOAK) Stage
For FOAK projects, which can cost between $10 to $30 million, a balanced funding strategy often involves 50% grants and 50% equity. At this stage, demonstrating early commercial traction, such as securing off-take agreements, can be crucial. These agreements can sometimes enable startups to access venture debt, albeit this is less common until the technology is further de-risked.
Leveraging Venture Debt
While venture debt providers usually prefer to engage post-FOAK, early commercial traction through off-take agreements can sometimes allow startups to secure venture debt earlier. In some cases, venture debt might cover 20-30% of the capital required for a FOAK plant, supplementing the grant and equity mix.
To Recap
Early R&D (TRL 1-3): University-funded or academic research grants.
Prototyping (TRL 4-5): Predominantly grant-funded, with potential for early equity capital.
Pilot Stage (TRL 6): 25% grants, 75% equity to maintain agility and speed.
FOAK Stage (TRL 7-8): 50% grants, 50% equity, with potential venture debt leveraging off-take agreements.
🏦 Understanding Venture Debt
Venture Capital (VC) investments involve providing funds in exchange for equity, giving investors a stake in the company. In contrast, Venture Debt is a loan provided to companies, often those with less robust balance sheets. Venture Debt providers have a higher risk tolerance compared to traditional banks, making them more suitable for high-growth startups.
Characteristics of Venture Debt
Higher Risk Tolerance: Venture Debt is designed for companies that may not qualify for traditional bank loans due to their financial profiles.
Milestone-Based: The debt is often contingent on achieving specific business milestones.
Commercial Traction: Demonstrating revenue streams to service the debt is crucial.
Capital Stack Position: Venture Debt is senior to equity, meaning debt holders are prioritized for repayment in case of bankruptcy or liquidation.
Operational Considerations
In general, for companies with a service model owning the facility, Venture Debt providers might require a unit to be operational for about six months to validate the unit economics. However, with off-take agreements, securing Venture Debt earlier can be possible.
📈 Impact of Reaching FOAK Stage on Climate Tech Startup Valuation
Achieving the FOAK stage significantly enhances a startup’s valuation due to the de-risking of the technology. This de-risking addresses major concerns for investors and debt providers, leading to a valuation uptick.
Benefits of De-risking Technology
Increased Investor Confidence: de-risked technology attracts more investors and potential debt providers.
Access to Infrastructure Capital: de-risked technologies are more likely to attract substantial infrastructure financing, which is abundant in the climate tech sector but often underutilized due to the lack of sufficiently advanced technologies.
Final Considerations
Financing Plans for FOAK: Having a robust financing plan and technical demonstrations can significantly boost valuation.
Investor Attraction: Investors are keen on opportunities that present growth potential and reduced risks post-FOAK.
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