“Everyone is eager to be second or third, but no one is eager to be first,” says Sarah Jewett, VP of strategy at Fervo Energy.

The Houston-based startup is trying to scale up its new geothermal energy system for commercial customers. But it is coming up against the problem that many energy transition startups face: trying to find investors willing to take a risk on an unproven technology.

Not only is its method of drilling horizontally to fracture underground hot rocks something that has not been tried before, Jewett and the rest of the team have to contend with geothermal energy’s poor past record on big projects.

“Fervo is having to atone for the sins of geothermal operators past. The narrative that geothermal has never done well before is a heavy weight over everything,” says Jewett.

The company has raised $420m in investment over multiple funding rounds but is now finding it difficult to convince financial backers to put up funding for the company’s first large-scale, greenfield project, says Jewett. There is a conventional narrative that geothermal is not scalable, which Fervo had to battle.

Scaling up

This is the classic problem that faces any industrial or hardware-heavy startup that is trying to scale up a first-of-a-kind (FOAK) project. A pilot project may have proven the technology, but scaling it up by 10x to the point where it can actually make an impact means bringing in a different type of investor with a much lower risk tolerance.

“We had so much interest in our fundraising for this, but because this is a first-of-a-kind thing, it’s amazing how many investors fell away,” says Suvi Sharma, the co-founder and CEO of Solarcycle, a solar recycling startup also looking to build its first commercial facility.

Scaling up an energy startup is a different prospect to scaling up a software company, says Tina Tosukhowong, investment director at TDK Ventures.

“We had so much interest in our fundraising for this, but because this is a first-of-a-kind thing, it’s amazing how many investors fell away”

 

Suvi Sharma, Co-founder and CEO of Solarcycle

“You don’t hear the word FOAK in software – the design-build-test cycle is so short. For, the cycle is long and very costly,” she says.

Climate tech and energy transition startups, in particular, find themselves in a Catch-22 of needing to prove they can scale the business in order to raise the money to scale the business.

Getting out of the bind may mean taking a creative approach and finding ways to be very frugal. Fervo, for example, found a way to test the system with a first client in a low-cost way that required little infrastructure build-out. A deal with a big name customer, Google, also helped allay investor concerns.

Solarcycle, meanwhile, took a modular approach, finding a way to build out its recycling facility in stages rather than needing a large capital outlay all at once. Securing offtake agreements also helped build confidence.

Corporate investors trying to guide their portfolio companies on the scaling journey can play a role in taking them through this first-of-a-kind bottleneck. Often they have the advantage in understanding how new technologies scale. The parent company may be able to help with the testing or can plug the startups into their networks to find first customers and growth-stage investors.

The case studies of Fervo and Solarcycle  in this report can offer insight on how energy transition startups – and their corporate investors – can navigate through the so-called valley of death for first-of-a-kind projects.

Image courtesy of Fervo Energy

Growth funding rules

Getting a FOAK project off the ground means raising growth capital, this is when everything that was already hard about raising startup funding suddenly becomes even harder. Proof points become more important to investors.

Though the technology may have been proven at large lab scale or pilot scale, growth investors want to know that it can credibly grow 10x.

Will it become more expensive per unit of output as it scales? Will the process be as efficient?

On top of that, is the market real and is it strong? Does it have real customers who want it, or does the technology depend too much on government or other support?

“We’ll take subsidies and green premiums to help get over that gap all day long but it cannot be what you need structurally,” says Rachel Slaybaugh, partner at venture capital firm DCVC, which led Fervo’s series B round in 2022.

Because of the large amount of capital needed at the scaling stage, investors also want to see a strong team that’s financially competent and able to attract project finance. If they don’t quite have the financial know-how, do they have solid plans to bring a good CFO on board?

Startups also need to look at unit economics, especially in the type of B2B markets into which cleantech FOAK projects will likely be selling.

“These legacy industries are already seeing their margins squeezed by commodity pricing and supply chain costs. We need to see both enough feasibility with equipment that we know could be scaled the right way, which equates to appropriate unit economics,” says Ginger Rothrock, senior director at HG Ventures, the CVC arm of The Heritage Group, which co-led a series A round for Solarcycle as it built out its FOAK in iterative stages.

“Some people will say that project finance is this thing we will figure out later without necessarily thinking about what you have to prove to get that finance. Sometimes, people don’t dig in enough and try to validate the assumptions of how will this get cost competitive,” says Slaybaugh

There sometimes tends to be a fingers-crossed attitude that the costs will just come down eventually, she adds, with the underlying reasoning not necessarily being played out.

Growth investors will want predictability, proof from processes that have run for tens of thousands of hours, with significant uptime, throughout much of the year.

One way to do this is to systematically identify where the bottlenecks in the process are and prioritise them.

“We want to see that t he yield of the process in every unit operation being measured so that you can say which unit has the highest risk and [which], therefore, you need to put the focus and effort on improving,” says Tosukhowong.

That data would go into a front-end engineering design (FEED) study to define the parameters, the risk mitigation processes, and the cost estimations for the FOAK, which can proceed from there.

Different pots of capital

First-of-a-kind projects are usually financed by some combination of equity, debt and grant funding – the more of the latter two, the better. Such a big capex commitment financed entirely from the company’s equity would be painful in terms of cost of capital and dilution.

Existing investors have a big role to play here in helping source those diverse pockets of money, including lenders. Investors such as TDK Ventures may come in when a startup finishes its proof of concept and is about to build the pilot that will provide the data to prove to lenders that the process is bankable. Tosukhowong says the plan is always to participate in the following fund round and to help bring more people on board.

“Our job is providing the catalytic capital to really help them build good sets of data and bring in additional co-investors that can write bigger checks and de-risk the technologies so that we can get them ready to build the FOAK”

 

Tina Tosukhowong, Investment director, TDK Venture

“Our job is providing the catalytic capital to really help them build good sets of data and bring in additional co-investors that can write bigger checks and de-risk the technologies so that we can get them ready to build the FOAK,” says Tosukhowong.

Ideally, traditional infrastructure investors will also come into first-of-a-kind projects to put money in at the asset level – not taking equity in the startup, but taking a share of the project’s upside. Infrastructure investors appear to have become more willing to take on more scale-up risk and come in earlier, at the FOAK stage, as opposed to the de-risked nth-of-a-kind (NOAKs) that are usually their bread and butter. Two of the largest infrastructure investors in the world, Brookfield and BlackRock, for example, have invested asset-level cash in FOAKs for sustainable aviation fuel producer Infinium and carbon capture company Carbon Engineering, respectively.

In terms of grants, cleantech has a built-in advantage of being a high-priority area for public sector bodies. Grants, tax credits and production tax credits are up for grabs and are hard policies to row back on. However, to get these, startups will often have to show that a good portion of the project funding is already in place.

What lenders want to see

Debt and lenders add another challenge. While banks may be willing to fund as much as 80% of a project involving a well-known proven technology, for something novel it is likely to be less than half.

Like many large infrastructure projects, FOAKs are often structured as special-purpose vehicles (SPVs) – subsidiaries of a company that exist only to own the project, owe the associated debt, and would bear the brunt of any potential bankruptcy. The project assets serve as collateral – but no bank wants to have to try to sell a motley array of assets to recover part of its loss.

So, what they usually want is data, and a lot of it, on every aspect of the technology and proposed project. They want to see that it is reliable, and they will want numbers from the pilots and demonstrations to back that up, as well as proof that there are customers ready to buy the product.

“Fervo’s first project in Nevada has now been producing for more than a year, so it needed a year’s worth of data showing that the well quality did not degrade. It needed flow tests at its new site showing that the steam production is what it needed to be. So it was really a lot of investment and data to get these groups to have confidence that you are probably right”

 

Rachel Slaybaugh, Partner, DCVC

This is especially true when it comes to an area such as geothermal energy, where many investors have lost money in the past.

In the case of geothermal startup Fervo, for example, which recently signed the biggest geothermal power-purchase agreement in history and also got a $100m bridge loan to construct its new facility, lenders wanted to see everything.

“Fervo needed the drilling data from all of the wells that it has drilled – it has shown really rapid improvement in drilling speeds and cost reduction – it needed all of the commercial offtake,” says Slaybaugh.

“Fervo’s first project in Nevada has now been producing for more than a year, so it needed a year’s worth of data showing that the well quality did not degrade. It needed flow tests at its new site showing that the steam production is what it needed to be. So it was really a lot of investment and data to get these groups to have confidence that you are probably right.”

Lenders also want to see that there are enough equity investors and that they are committed and reserving enough capital to cover possible spending overruns. Banks do not want to take on these risks themselves.

Where corporates can help

One of the ways that corporate investors say they often help on first-of-a-kind projects is by providing intelligence about the market.

“You can give them comfort with the market,” says one growth investor who backed a FOAK in the plastics recycling space. “In the case of our market, this is all about regulation and it is almost a perfect spot,” he says, pointing out that by around 2030, almost overnight, people will need to have anywhere between 20%-30% recycled plastics in the products, which are often currently at zero.

Narrative-shaping is a big part of what investors can contribute here

Every technology was a FOAK at one point, including the clean energy technologies that reign supreme today. Investors with a background in industry can remind bankers of how risky solar and wind power were once considered, and how the incumbents were of them.

“We typically provide the narrative,” says the plastics investor. “You need to explain to them that these are the risks, this is how we can mitigate these risks, and this is why you probably should accept those risks.”

On a more practical level corporate investors can often help startups secure the supply chains needed for their first-of-a-kind projects. FOAKs often use much of the same supply chain as existing industries, for example oil and gas, and corporate investors can help with access to equipment and know-how.

“You want relationships with that supply chain so that you can make sure you can get access to the equipment you need. If we are going to be using the drill rigs from H&P, we want them on the cap table so that they share in the upside, so they are really motivated to supply those drill rigs and a good crew,” says DCVC’s Slaybaugh.

Corporates can also be a source of feedstock, an offtake customer, or other stakeholder in the project – but these will nearly always be a separate and independent agreement from the investment by the venture arm.

Modularity

Not everything needs to be huge, though. Modularity is an increasingly popular approach – building things at a smaller, more distributed, or iterative scale. The advantage is that it makes things more repeatable and predictable. Each modular unit carries a lower risk and each produces data you can use.

The fact that small plants can be located close to where the product might be used can bring what HG Ventures’s Rothrock calls “economies of logistics”, as opposed to the economies of scale that come from a huge facility.

“If you talk about a first of a kind, there are probably two truths. It takes longer and it will cost more. There is never going to be a project that will be delivered on budget and on time unless the contingencies are such that there are enough buffers, but, typically, that is not the case”

 

Growth investor

“With things such as localisation and decentralisation, your cost of logistics goes down. If you can de-risk enough to know that a small-scale plant will work, you do not have to spend a billion dollars to create your FOAK. Instead, your FOAKs are containers or small pads of equipment that are in the $1m-40m range, not a $1bn plant,” she says.

A modular approach will not work for every project, as some pieces of equipment are either very difficult to scale down, or get significantly cheaper as you scale up. Large new cement or certain chemical plants, for example, as hard to do piecemeal. But many types of recycling, hydrogen and renewable generation projects can be distributed or built bit by bit, without a massive capital commitment to begin with.

Running multiple smaller plants can also help on the data gathering side, as you can test improvements more quickly.

Plan earlier, budget more

Getting a first-of-a-kind project off the ground is an undertaking that begins long before startups even start talking to growth investors.

Even choosing the size of the pilot project that preceeds the FOAK needs careful thought. Large pilots are costly, but a pilot that is too small might not provide enough data to move on to a FOAK.

And when startups move to scale up 10x, new problems crop up that were not apparent in the pilot. “Sometimes engineers don’t know what they don’t know when they scale 10x,” says TDK’s Tosukhowong.

The best way to prepare, say investors, is to overprepare in terms of cost and timing.

“If you talk about a first of a kind, there are probably two truths. It takes longer and it will cost more. There is never going to be a project that will be delivered on budget and on time unless the contingencies are such that there are enough buffers, but, typically, that is not the case,” says one growth investor.

“If it normally takes 12 months, then add a few months to it. If it takes $10m, then add a few million to it. And it does not mean you become lax in the way you manage a project, but it does mean that you are in a strong position when you ask for more money.