Closing the “Missing Middle”: Helping Climate Solutions Scale

Heather Zichal is the global head of sustainability at JPMorganChase. She can be reached at sustainability.jpmc@jpmchase.com.

Ramaswamy Variankaval is global head of corporate advisory & sustainable solutions at J.P. Morgan. He can be reached at sustainability.jpmc@jpmchase.com.

This article originally appeared on Cipher News.

The first time doing something is usually the hardest. And accelerating climate solutions means doing lots of things for the first time.

Allocating capital to bring novel climate tech solutions online will be critical if we hope to go from developing promising innovations to electrifying everything. And you can’t have impact if you don’t have scale.

Unfortunately, there is a financing gap in the economy for getting so-called ‘first of their kind’ projects to scale.

Many companies ready to go big commercially will have already attracted hundreds of millions in venture capital and proven their technology works in a lab. But when they go to manufacture and deploy that technology at scale, they encounter a very different set of considerations, from operating costs to technical risks.

As companies once backed by early-stage venture capital move into more capital-intensive, project-oriented phases, they can face mismatches in risk-return profiles (the trade-off between the potential return on an investment and the risk of losing money) for available sources of capital. This is commonly called the ‘missing middle’ or the ‘valley of death.’

Until these climate tech companies can reach bankability — meaning they can check all the boxes to meet the risk/return profile investors need — they may be stuck.

Earlier this year, we convened knowledgeable leaders from the energy industry, the government sector and the financial services arena to discuss actionable solutions that could help crack this problem.

A few initial learnings emerged:

Structure new solutions

Closing the gap will require investors deploying capital and companies raising it to think differently.

Some companies can raise capital at the project level but struggle to raise it at the corporate level. It is relatively easy for would-be investors to evaluate the merits of a specific construction project with consistent operations that produces assets. By comparison, raising capital for a company itself may be riskier for capital providers and therefore more challenging.

Savvy investors with the capacity to take on some risk could invest at both the project level and the corporate level, better balancing the risk across both entities and fortifying a strategic relationship with companies they believe are positioned for long-term success. The startup Electric Hydrogen recently secured $100 million in corporate credit financing (including from JPMorganChase) to support clean hydrogen producing plants and company-wide growth, marking a step change in their access to capital and maturity as a business.

Also, building low-carbon infrastructure is capital, labor and time intensive. As a result, some early-stage companies may ultimately need to raise capital in market conditions that are more challenging.

Take a long-term approach to valuation

Young companies should think of investors as long-term partners, while investors should aim to build strong economic businesses rather than chase short-term growth.

Startups that raised capital while interest rates were low now face valuation challenges while rates remain high, making it harder for some investors to achieve attractive exits and for founders to raise additional money. This dynamic is further exacerbated by the capital-intensive nature of many emerging climate technologies.

Investors and founders would be wise to strategically look across market cycles in seeking durable returns.

When fundraising in “good times,” founders should seek the best long-term partner, not just the highest valuation. And when investing in “bad times,” financiers should seek to invest in companies with strong value propositions that are poised for long-term success beyond the next market cycle. As we work through the aftermath of an over-exuberant funding market, which sought hyper-growth businesses, this reset will take time, but it should settle into a more balanced market with better funding availability.

Create leverage for private capital

Government policy can help encourage other investors and scale financing.

Well-placed public investments can attract additional private finance at scale. For example, federal incentives contained in laws like the 2022 Inflation Reduction Act have helped solar tracker and software solutions company Nextracker to operationalize over 20 factories, catalyzing thousands of jobs.

Forms of catalytic capital, like debt, equity or guarantees that take disproportionate risks or accept concessionary returns to unlock other investments, are often provided by governments, multilateral development banks and non-profit institutions.

The U.S. Energy Department’s Loan Program Office has helped reduce the risk of investing in emerging technologies with their early landmark loans, loan guarantees and investments. These moves in turn have helped kickstart American manufacturing. The department made a $9 billion loan last year to auto giant Ford to build electric vehicle factories in Kentucky and Tennessee, creating thousands of construction and operating jobs.

Similar tools include first-loss protection, below-market-rate debt and more. While these tools exist today, they may need to be refined and must be deployed at scale in close partnership with private financial institutions.

Large corporations could also play a role by making strategic investments with emerging companies. When those investments or partnerships are well-structured, such as Chevron’s strategic investment in Canadian innovator Svante to boost emerging carbon capture technology, the support from a large corporation could help change the economic calculus enough to leverage additional private capital. Earlier this year, shale oil and gas pioneer Devon Energy led a $244 million financing round for geothermal power company Fervo Energy, helping unlock their next phase of growth.

In our gathering earlier this year, and in myriad other interactions, we’re learning just how difficult it is for climate technology companies to traverse the commercial valley of death.

Evolving a science project to a commercial outfit is also particularly difficult in an economy where our capital stack was built for digital innovation rather than hardware advances. Helping innovative companies clear this valley will require us to think differently about capital in the ways we’ve just outlined here.

Cipher News Editor’s note: Electric Hydrogen’s investors include Breakthrough Energy Ventures, a program of Breakthrough Energy, which also supports Cipher.