The wrong way to finance a factory

The opinions expressed here by Trellis expert contributors are their own, not those of Trellis.​

One of the most daunting discussions in the climate world today is the valley of death that’s presented by First-of-a-Kind (FOAK) manufacturing risk. 

This typically surfaces when a company reaches a B or C funding round and needs $100-plus million to build its first production-scale plant that proves the full economic model. This is a tough task in generous markets, but seems near impossible during slower markets. 

Yet if we’re serious about industrial decarbonization, this challenge cannot be avoided. There’s no pathway to materially reduce emissions from steel, cement, chemicals, fuels or materials without changing how they’re physically produced. The question isn’t  whether to build — it’s how to structure the build intelligently.

From my and my team’s experience in manufacturing, technology deployment and plant design and construction, the FOAK framing sets up the industry for failure. It suggests that these types of builds should happen in large equity rounds, massively limiting the number of firms that could plausibly support such an effort. The investments that we need are wider than the aperture of growth-stage climate capital, and taking on a FOAK project is not a great way to get equity-level returns. 

So what to do instead? Plenty. Let’s dig in.

Alternatives to FOAK

Fundamentally, the underlying mantra of investing is that equity should fund equity-level returns; debt should fund debt-level returns.

This is simple enough to say, but a look at the use of proceeds for the few FOAK mega-rounds would suggest that climate venture capitalists aren’t savvy at meeting this mantra. This is a mistake pattern we should’ve grown out of by now, as it happened in CleanTech 1.0. There’s no reason we can’t just move past this type of error. 

You might be saying: the return profile might be debt-like, but we have to use venture dollars because the risk profile is more venture-like. That’s not an investment that makes sense for any investor, and we can address this through what we call the 3 Shells approach.

Instead of thinking of a facility as a monolithic FOAK facility, break up the function of the facility into three encapsulating shells:

• The envelope
• The MEP (mechanical, electrical, plumbing)
• The secret sauce

Each shell carries distinct risk and financing characteristics.

The envelope

The envelope’s main function is to keep the rain and wind off you, maintain a clean environment, provide offices or quality control labs, secure access, and keep the temperature and humidity right if it’s a climate-controlled facility. That’s all the outer shell needs to do. 

Across industrial regions, there’s significant inventory of underutilized industrial space. Moving into an existing envelope can eliminate lengthy permitting cycles and reduce construction risk. For corporate sustainability teams piloting new production assets, adaptive reuse can compress timelines by more than a year and materially lower capital expenditures.

If a city or county has too many underutilized envelopes they will often be open to tax or other incentives to move businesses into those buildings. This means that on top of saving the time and cost of building yourself, you may even be actively rewarded. This decision can easily take one-third out of FOAK costs and shorten delivery timeline by 18 months.

The MEP layer

Short for mechanical, electrical, plumbing, this refers to the building infrastructure that helps you move power, materials, working liquids (like steam or hydraulic oil) and materials used in your manufacturing process, like piping.

Companies often argue for ground-up builds due to specialized infrastructure needs — high-temperature processes, wastewater handling, flue gas systems, heavy power loads or overhead cranes.

In reality, no matter how special a company thinks its MEP requirements are, there’s always a nearest-neighbor industry that shares most of the same MEP requirements. For example, most heavy equipment manufacturing features ceiling cranes and most chemical manufacturing facilities include special plumbing for wastewater handling. If one is able to shop envelopes from those industries, then they’ll save time on the envelope build, and likely avoid needing to build 80 percent of the MEP.  

The remaining retrofit will need to be equity financed. All that said, this type of directed-site shopping can bring another 25 percent off the total FOAK cost.

The secret sauce

The innermost shell is the differentiated manufacturing process, the actual production line. 

When you get to this shell, you might think that it must all be equity financed, since this was the breakthrough process the founder developed as a grad student or learned the techniques for at their last research post. 

That said, there are still ways to reduce the total equity requirement.

Most manufacturing lines consist of four to 15 process steps. Most require no modifications, just standard industrial machinery performing standard functions, like heat exchange, conveyance, extrusion, separation, drying. Very few rely on major modification or newly-invented equipment.

So, if, say, seven of nine steps are the normal equipment doing the normal thing, that can actually be supported by asset-backed capital equipment loans. They don’t need to be financed/procured via equity dollars. One can see how only needing to equity finance the two stations that have newly-invented equipment or highly-modified equipment can reduce the total equity requirement.

The financial result

Assuming that capital equipment equity financing comes down by roughly half, this 3-Shell model can reduce a $100 million equity-heavy facility to closer to $35 million in true equity requirement.

For Fortune 1000 partners and sustainability leaders evaluating deployment risk, this shift is significant. It broadens the pool of capital sources, aligns financing with asset risk, reduces the burn of waiting for construction, and accelerates timelines to full operation.

Of course, since debt has liquidation preference over equity, one needs to be thoughtful about the debt terms taken on, but this type of risk is manageable. In comparison to the daunting nature of facing a $100 million financing that’s not likely to happen, this type of solution is far easier. It’s also more aligned with how the business will scale if the product or service gets strong pick-up, and is closer to what big companies do when they bring up new production.

What looks like a $100 million leap of faith is usually a set of much smaller, more knowable risks that have simply been bundled together. If we unbundle them and finance each layer according to its true risk, it stops being a cliff to scale and becomes what it always was: the disciplined work of learning how to build.