There’s been a lot of talk recently among climate investors around the “first-of-a-kind” or “FOAK” challenge.
Billions of dollars, both private and public, have been invested into the invention and development of new climate solutions — across the energy, waste, transportation, food and water landscape. And many amazing new innovations have resulted from this effort.
But none of that matters unless those innovations get deployed widely in significant enough volume to make a real economic and climate impact. We can see what the end point of that looks like when it’s successful — see the example of today’s rooftop solar market in the U.S., where two decades of technical, industrial, policy, finance, and business model innovations have come together to form a robust market, funded by mainstream project finance, at meaningful volumes. But getting the other 99% of climate innovations to that point isn’t easy.
Back in the mid-2000s, at the height of that decade’s “cleantech bubble”, I got to sit in rooms with various senior, really smart venture capital investors. And all of us had a collective blind spot about just how difficult it is to take a new technology from lab to mass deployment. There was an explicit expectation (borne of collective VC naivety around what project finance is looking for) that once a technological innovation can be shown to work, then infrastructure capital and project developers will appear and take the innovation broadly to market. Nearly two decades later, most climate tech investors now recognize that there’s a lot more to it. To oversimplify, venture capitalists race to be the first to do something; core-plus infrastructure investors “race” to be the first to do the tenth of something. Expecting institutionally-backed infra investors to jump into the uncertainties and limited upside of first-of-a-kind project development is never going to work out.
At my firm, Spring Lane Capital, we seek to address the “missing middle” between early commercialization efforts and traditional infrastructure capital. We go in earlier than the mainstream infra teams. But even we have a hard time addressing true first-of-a-kind implementations of new technologies, as returns-focused investors. For entrepreneurs, doing their first deployment is just really, really hard. And that’s without even addressing any technology risk.
Take your typical climate-innovation startup. They have been told by their pre-commercialization investors, “Move fast and break stuff!” But now that they’ve successfully invented something that has worked as a prototype or in the lab, they have to actually build something at commercial scale. That rarely moves quickly, and definitely shouldn’t involve breaking stuff. They now have to transition from being inventors and commercializers, to becoming a project developer (or at least figuring out how to effectively attract and partner with project developers).
The first successful commercial-scale project will involve so many details they’re impossible to list here. The sales contracts have to be won, and have to be underwritable. The feedstock contracts have to be negotiated, and have to be underwritable. Contractors / EPCs have to be identified and vetted, negotiated and contracted, and managed. Sites have to be acquired. Permits have to be obtained. Engineering needs to be completed, has to be accurate, has to be adapted to the realities of the real world and actual site, has to be done to the nth-level detail, and also has to meet the cost needs. Procurement, insurance, interconnections, the list goes on and on. Each one of these areas is not only a new thing to learn, it’s also a potential point of failure that can by itself hold up an entire project, create massive cost and time overruns, or even risk the viability of the project altogether.
And that’s without even addressing whatever the core innovation is for this FOAK project. It’s not enough to say “Yes, this new gasification vessel design works, it does turn biomass into syngas” (for example). To attract financing for projects using the innovation, investors will need to feel confident predicting underwritable operating characteristics — what is the yield, how consistent is it, how specific does the input quality have to be, what is the uptime, how much opex will be required to keep it going, etc.
Is it any wonder that even the most adventurous infrastructure investors most often won’t touch a FOAK project with a ten foot pole?
Some climate innovations are small enough that a few first commercial installations can be funded by a startup on their balance sheet.
But many of these innovations are either themselves large-scale, or will require large-scale manufacturing and production capabilities. Biofuels refineries, utility-connected battery projects, industrial-scale wastewater treatment systems, small modular nuclear power plants, and so forth. Most of the innovations that are exciting to venture capitalists and everyday investors alike will need significant scale project deployments to become reality.
And there WILL be unavoidable mistakes made via the transition from lab-scale to commercial scale. I’ve seen projects with “proven” innovations foiled because of very simple scale-up engineering challenges that had nothing to do with the core innovations, for example. A biofuel fermentation FOAK that ran into major problems figuring out how just to evenly distribute syngas throughout a commercial-scale vessel. A waste gasification plant that had to go through millions of dollars and months of overruns because of mis-engineered components that had nothing to do with the actual gasification itself. A recycling plant where they had to re-do everything because they designed in the wrong diameter pipes. Even experienced contractors and engineers will make these kinds of mistakes with a FOAK.
So who will fund the FOAK projects for climate innovations?
Over the years a few things have been attempted to address this gap:
- Some startups have been able to raise very significant amounts of venture capital funding to help finance their initial deployments off of their own balance sheets. This can work, for the few who can raise tens of millions of dollars just to fund putting steel in the ground. But the dumb way venture capital valuation math works (if you raise $50m at a $100m pre-money valuation, your new valuation on paper is $150m) and the very high 5-10x returns expectations of those investors (so, that $150m better turn into $1B within a very few years) makes that incredibly expensive, and adds a ton of risk. Not to mention the simple cost-of-capital mismatch — most capital projects won’t yield anything close to the 35%+ IRRs that venture capitalist investors will be expecting to get off of each dollar invested into them. So venture capital as a potential FOAK solution has been only sporadically available, and has in my opinion killed more promising startups (via overly high valuation and cashburn) than it has helped to bridge the missing middle.
- Some startups have been able to partner with large, established companies to do their FOAK projects as joint ventures. This also often runs into challenges, however. The big oil company you’re trying to do your FOAK sustainable aviation fuel refinery with may know how to build a refinery and have the resources to do so, but you the startup will have to give up so much control and economics to them that you may not get what you want out of it other than a proof of concept. And it’ll take years. And the big company won’t know how to run lean or run efficiently along the way.
- There are some terrific philanthropic efforts out there tackling the FOAK challenge. Some have some significant dollars attached to them. Breakthrough Catalyst, PRIME
PRIME
Coalition, and Elemental Excelerator (among others) are all doing some great efforts to help address this gap. But even the biggest philanthropies out there have limited financial and staff resources that are only a drop in the bucket relative to the scale of the funding required to address the FOAK gap. Breakthrough Catalyst, for example, is focusing on just a short list of innovations that they seek to fund. All really valuable efforts, to be clear. But necessarily limited in scale and scope versus the magnitude of the challenge. - Government dollars could step in more strongly, of course. But even the revitalized DOE Loan Programs Office effort has limitations, and one of those is that backing FOAK projects (which necessarily won’t always succeed) can create political firestorms when they don’t work out. In 2009, the effort to help bridge the FOAK funding gap for a new photovoltaic manufacturing technology led to the Solyndra debacle. The DOE LPO is doing some really impressive and aggressive work, and there are various state-level green banks doing their part to help accelerate greentech scale-up. But all these entities remain naturally reticent to take on true FOAK project funding.
- I increasingly see venture capitalists talking about banding together to form “FOAK funds” to help their companies get the funding needed to bridge these gaps. But these efforts also run afoul of the “how will you actually make good returns investing into FOAKs” dilemma, and at times honestly remind me of those same conversations back in the 2000s when I use to sit into those rooms with other VCs, none of us truly understanding the scope and specifics of this challenge. To be determined.
- In “Direct Air Capture” for atmospheric carbon, some forward-thinking customers of carbon credits have provided underwritable and attractive offtake contracts to help solve one part of the FOAK challenge. This has been super helpful, but is limited so far to DAC and is so out of the money that the long term viability of the markets for DAC remains in doubt even as things get built.
- And in general there are a lot of really smart people thinking about how to innovate some ways to use limited philanthropic and/or government dollars matched with the other sources of capital described above, to encourage private investment dollars to come into FOAK projects. “First-loss capital” for example. Lots of good ideas percolating but none that have gained any real traction yet.
In addition to all these money-focused efforts, there also needs to be a talent-focused effort around FOAKs as well. Someone needs to fund training programs for engineers and project developers; engagement efforts with the big engineering firms and contractors; and help climate innovators and entrepreneurs learn how to talk and think like project developers (my firm is doing our own small effort in this latter regard, but we’re just scratching the surface). Even if we can figure out how to attract the necessary investment dollars into FOAK projects, we still need capable talent to make them work!
Overall, there is broad recognition that first-of-a-kind projects remain a major finance and execution gap that is holding back scores of great climate innovations from gaining mainstream adoption. And there is fairly broad recognition of the structural and financial barriers preventing returns-focused investors from going into FOAK projects. And there are lots of really interesting conversations going on right now about how to overcome those barriers. It’s a fascinating time for these discussions and brainstorms. But nothing has broken through quite yet. Heck, circulating around these conversations I don’t even hear agreement on how to pronounce “FOAK” (is it “F-O-A-K”? “Foke”? “Fo-ack”?).
We need to figure this out. Thus far the pace of deployment of innovative climate solutions isn’t keeping pace with the timeframes necessary to address climate change.
Fixing the FOAK gap could not only unlock accelerated deployment, it could also launch multiple new multi-billion-dollar infrastructure investment markets just as happened with rooftop solar over the past two decades. Which would be really exciting for investors large and small. If we can only figure it out…
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