When entrepreneurs think about founding a for-profit sustainable business, they often focus on the area in which to build their company or how and to whom to sell their product or service. While these are important, it is even more critical to consider the type of financing model you will use to build a company in the sustainability space.
A common pitfall is assuming that you have to stick to an innovation-driven, risk capital-financed model. But, as we learn at MIT, there are several other options and some hybrid approaches. Founders should weigh the pros and cons of each option for their particular business.
Since graduating from MIT, I have founded several companies using each type of model. By avoiding a “one size fits all” approach to financing, I was able to grow each company into a successful venture. When considering what type of approach is right for you, here are a few things to keep in mind:
Regular Revenue Model
The revenue model is perhaps the most common financing model and it is often found in service-based sustainable businesses like consulting. I used this model for my company, Scaletech.org. The advantages are it is low risk and there is no need for upfront investment. The disadvantage is there is limited upside. The revenues start near zero and fluctuate around an average, hopefully on the positive side.
Credit-Financed Product Development Model
This model is for founders who have upfront collateral and can use it (and the current low-term interest rates) to borrow against for their startup. We used it for a sustainable housing venture. The founder retains full control of the business as long as they pay the loans. On the other hand, the founder is at the mercy of a bank’s bureaucracy. I have had to halt construction in the sustainable housing business for weeks because the relevant loan officers were too slow. Also, the attractiveness of this model depends on the interest rate. As for how revenue develops under this model: It starts substantially below zero, then rises, but not exponentially. It tapers off as the market becomes saturated with the new product.
Initial Subsidy/Grant Model
In this model, the initial grant comes from a sustainability fund for the likely impact of the startup, or for separate purposes, like building your headquarters in a disadvantaged region and therefore contributing to local employment. This model might be used for a new service that needs to be developed. In my case, that is technology scaling consulting. The obvious advantage of this model is, well: free money. The disadvantage is you have to fit and stick with the broader purpose that the grant is given for. This may restrict your ability to pivot in exchange for the small financial sweetener the grant represents. And you are often dealing with funding institutions with little entrepreneurial expertise. As for how your revenue develops: It starts substantially below zero (assuming that the grant doesn’t cover your entire startup costs, forcing you to take a small loan), but not as low as in a credit-financed approach. Then, it rises non-exponentially.
Risk Capital-Based Product Development Model
This model is often seen in cleantech hardware and software, and requires upfront capital and labor investment. An example from my work is a business that applies AI to efficiency of growth processes in greenhouses. This model comes with a huge financial upside, but there is risk in developing truly innovative technology, as well as a need for secrecy. Moreover, the funder only retains partial ownership of the company, and the risk capital provider often will want to – and can – replace initial sustainability goals with commercial goals.
Additional models to consider include intrapreneurship, where you use your employer’s names and contacts to develop your idea. But the fruits of the labor belong to that company – not you.You also could integrate your idea into the core business of your main company, like Patagonia does with clothing and Google does in clean energy. However, you often will end up fixing problems that your firm or industry helped create in the first place, such as the plastic industry currently investing in reducing ocean plastics after massively ramping up plastics sales in countries with limited waste infrastructure.
You could also consider hybrid models that combine two or more approaches. But this could result in multiple and potentially contradictory reporting lines. You can also try to separate the profit-making entity from an associated foundation, but this may be little more than a public relations exercise.
When to use which model
The Regular Revenue Model is a good choice if you do not need upfront investment and are sure to have a market. Try to avoid using risk capital unless you have a clear strategy on how you will be able to retain control over your impact focus (and your company!). And if you need upfront capital, consider seeking a loan with a grant or subsidy “sweetener.” What financing model is best for your sustainable venture?
Georg Caspary, EMBA ’17, is CEO of Scaletech in Berlin, Germany. He has worked with early-stage clients such as the World Bank, Google and major cleantech accelerators and is the recipient of three MIT innovation grants and 150K in grants from EU funds.