Capital Stack Strategies for Next Gen Factories, Integrating Operations with Financial Engineering from the Start
Thank you all for your enthusiasm in the NextGen Industry Group! We've received overwhelming emails of support and inquiries about getting involved.
As the U.S. pivots from decades of outsourcing to putting our own shovels in the ground to build hundreds of factories, we need the brightest minds to power this industrial renaissance. Our manufacturing capabilities have lay fallow, and it will take time to nuture growth across all disciplines, from site selection and labor force development to business integration & funding strategies.
While most stories of our industrial future in the popular press focus on robots and Factory 4.0, we must actually start at a much more foundational layer. Today, we'll discuss why our first step in planning an industrial reawakening should be integrating operational strategy with financial engineering. This piece is the positioning post for a series of future interviews with industrial leaders on how they shaped their operational strategy to open additional sources of capital. In essence, how they built their manufacturing operation leveraging a thoughtfully curated and diverse capital stack.
Startup operational strategy differs significantly from that of mature companies. Steady state manufacturing strategy is all about profit optimization while minimizing disruption risk. But startups must focus on proving product-market fit while demonstrating the ability to ramp with improving unit economics. Therefore, the goal of startup operational strategy is to deliver product to paying customers at increasing volumes as fast as possible. For startups, this means making a significant volume of product for multiple customers in an effort to convert interest to contracts. These contracts are critically important to the business because when combined with the gross margin forecast, they form the basis for the company’s enterprise value. Greater enterprise value unlocks access to capital – the key resource required to reach global scale.
Capital for mature industrial operations come via many different financial vehicles, including equity, debt, project capital, and tax equity. Traditionally, venture-backed startups industrializing advanced technologies have only had access to equity. As we enter this period of heavy industrialization, thinking strategically about designing the capital structure to leverage a wider cross section of these financial tools is essential. Using equity to build factories is the most expensive (and thus least attractive) strategy to fund hardware-oriented companies. Equity is raised by selling a portion of the business. But, when equity is leveraged for building production capacity, it actually dilutes investor and employee ownership while failing to really move the needle on enterprise value. This has a reinforcing negative impact on industrialization-stage venture funds, driving down returns and, over the long term, reducing the number of investors and dry powder available to industrial startups.
New financial vehicles and efficient operational strategies are increasingly available, reducing the equity requirements for industrial companies. A company’s operational strategy will determine which of these financial instruments it will leverage to build production facilities. These instruments, created in response to the recent surge in onshoring and supported by government policies like the IRA and Chips Acts, have revitalized the industrial financial sector. Adapting these tools to private sector applications is key to the success of North American manufacturing.
Beyond federal and state incentives, here are some of our favorite operational driven runway-extending methods that can promote long-term sustainable enterprise value creation:
Equipment Finance: Loans for standard industry equipment.
Build Plan Throttling: Limits production of cash-consuming, gross margin-negative products until non-volume related cost-down milestones are implemented.
Modular, Phased Facility Design: Accelerates access to project capital by breaking down large facilities into multiple smaller factories validating the production process more quickly.
Tax Equity: Project investment in exchange for tax credits and project cash flows.
Inventory Revolver: Funds valuable commodity purchases using a similar structure to traditionally finished goods revolvers.
Customer Purchase Order Financing: Provides cash advances against customer purchase orders, though typically require the added cost of insurance and increased liquidity.
Contract Manufacturing: Uses capital-light, ready-to-go facilities, in Asia and increasingly Mexico, offering the capability to build both large complex integrated assemblies as well as simple subassemblies. These relationships often come with lines of credit and sometimes equity investments.
Strategic & EPC Partners: Leverage strategic partners for introductions to industry leading engineering, procurement, and construction (EPC) partners as well as preferred access to high quality suppliers and equipment providers.
A key objective of the NextGen Industry Group is helping to unlock capital for companies commercilaizing new and innovative technologies in North America. To achieve this, the ecosystem must pioneer new ways to fund growth. By integrating operational strategy with financial engineering early on, we can access new financial instruments and reduce capital intensity during production ramp-up.
We are excited to present a series of interviews with operational and financial experts who will explore these methodologies, lessons learned, and cost-benefit analyses. If you have questions or examples of efficient strategies, please share them with us for inclusion in our series.
