When Green Bonds are Worthwhile for Start-up Financing

In the world of sustainable finance, more and more is revolving around green corporate bonds. But is it also worth it for start-ups?

February 28 was certainly a day of joy for Martin Siddiqui. Finally, the co-founder of Pacifico Renewables Yield AG could publicly announce the closing of his financing round. The special feature: Siddiqui took a rather unusual route. He managed to raise money without bringing new investors on board who now want to have a say in decisions - and without taking out a classic loan.

Siddiqui relied on a so-called green bond, i.e. a green corporate bond. He has raised 35 million euros in this way. The money comes from the Swiss bank UBS. In view of this, Siddiqui even speaks of an "accolade" for his young company. Can the financial instrument also be worthwhile for other start-ups? Startbase makes the check.

How Green Bonds work

At first glance, green bonds hardly differ from normal bonds. Both their structure and their risk profile, and thus ultimately their expected return for investors, are similar. However, anyone wishing to issue a green bond usually has to meet a number of requirements. While there is not yet a uniform standard, the so-called "ICMA Green Bond Principles" probably come closest. "These include the fact that they are earmarked and that, as a rule, a second party opinion must be obtained," explains Lukas Adamski from GLS Bank, which focuses on sustainability.

It does get a little more complicated than with normal bonds - and than with a conventional financing round. Those who issue a green bond usually do so in order to finance sustainable and climate-friendly projects. This could be the construction of wind farms, for example. In theory, companies thus specifically finance measures for which they would not receive money on the conventional financial market at interest rates below the market average. Social bonds also function according to the same principle, which are then based on social criteria.

The second party opinion is usually provided by a rating agency specializing in sustainability. It basically assesses whether the project in question is "green" enough. In rare cases, companies get around such an assessment. "We as GLS Bank recently structured a bond to Chancen eG that could meet the criteria of a social bond. However, we refrained from labeling it accordingly, as the placement was secured in this way and we did not want to unnecessarily increase the costs of issuing the bond," says Adamski. A second party opinion was therefore not necessary.

Obtaining this evaluation, commissioning a bank to structure the green bond, and finally registering the whole thing with the German Federal Financial Supervisory Authority (Bafin) all cost money - and a lot of time. At GLS, for example, they estimate that it takes four to six months just to prepare a securities prospectus, set up the technical set-up and obtain Bafin approval.

Particularly the earmarking makes green bonds and likewise social bonds rather unsuitable for financing start-ups, says Adamski. "It basically only works if they can demonstrate that their entire business concept serves these purposes."

At what point is a business model sustainable

With Pacifico, however, that's exactly what they've managed to do. The startup is getting involved in the construction of wind and solar power plants, investing as soon as regulatory approvals have been obtained, the financial risk is acceptable and it can estimate the upcoming returns. Pacifico is thus, in a sense, an electricity producer on the one hand and an investor on the other. "Our goal is to bring the construction and especially the operation of renewable energy to the market as a good and simple capital investment," says Martin Siddiqui.

Strictly speaking, there are two Pacificos for this. One company, Pacifico Energy Partners, takes on the much riskier part of planning the plant in question. Once that is complete, Pacifico Renewables Yield AG can then buy the plant. "This allows us to have a clean and clear separation of the development risks borne by our development partners and the stable and predictable cash flow profile of operating the plants, from which we benefit as operators," says Siddiqui.

It is a business model that is hardly used in Germany, but is more common in the Anglo-Saxon world. It is called Yieldco, a combination of the words "yield" and "company" - and ultimately describes listed electricity producers who want to convince investors with returns.

But it wasn't easy to set up a green bond. Among other things, Pacifico gave itself a 16-page Green Finance Framework to demonstrate how sustainable it is. "Such a due diligence process is very elaborate. Debt funds value a detailed review of the entire portfolio," says Siddiqui. You have to allow six months for all of that, he says. "But it also helps to go through all your own processes, assets, etc. once with the financing experts at UBS." As an entrepreneur, you also learn a lot yourself. Because unlike traditional VCs, investors who facilitate such green financing look at everything that can go wrong in the company and less at the growth perspective.

Green bonds are worthwhile under these conditions

Siddiqui now sees the benefits of a green bond above all else. "We've also worked with mezzanine financing in the past, but it's often at eight percent interest or above. The terms of the green financing with UBS are significantly lower at 4.85 percent," he says.

Lukas Adamski of GLS Bank sees, especially in comparison to a classic round of investors, rather disadvantages for start-ups, given the large effort. Those who nevertheless want to invest in sustainable bonds should, according to him, rather focus on sustainable bonds. These have the advantage that they fulfill both social and ecological criteria. A start-up would then have to have a business model that is not only green or only social, but could argue that it is partly active in both fields.