From venture debt to project finance: Key considerations for venture debt lenders

Many climate technologies are moving toward commercial-scale deployment. Across sectors, including green hydrogen electrolysis, direct air capture, geothermal energy, and advanced battery storage, some companies that have demonstrated their technology at pilot and demonstration scale are seeking to deploy it across repeatable, bankable projects. This progression from “First-of-a-Kind” (FOAK) technology development to “Nth-of-a-Kind” (NOAK) deployment represents a key capital structure transition.

A company may evolve from a research and development-led startup – financed at the parent (TopCo) level through venture equity and venture debt – into a project sponsor capable of deploying repeatable projects through ring-fenced, project-level special purpose vehicles (SPVs). Project finance is structured at the SPV level. Each project is financed on a standalone, bankruptcy-remote basis by project lenders who take security over the SPV’s assets, contracts, and cash flows. The parent’s venture debt remains in place at the TopCo level, structurally above and outside the project finance perimeter.

This bifurcation can create a structural tension for the venture lender. As the borrower scales, value increasingly migrates to the project SPV. Technology and intellectual property (IP) may be deployed into project SPVs. Cash flows are generated at the project level. The parent may enter into project documents and incur new obligations to, and for, SPVs, and may request that project-level entities be excluded from the venture loan party group.

The assets, revenue, and operational substance that underpin the venture lender’s credit may increasingly reside in entities that are outside the venture loan party group.

This alert highlights four focus areas for venture lenders navigating this transition:

• The loan-party and collateral perimeter: Requests to exclude project SPVs
  
  
• Downstreaming of cash and technology: Project-level SPVs, and requests for pre-consent
  
  
• New obligations: Entry into project documents and incurrence of obligations to and for project SPVs
  
  
• Upstreaming of project cash flows: Distributions and fee streams to the venture debt borrower

Each focus area explores the structural dynamics from the venture lender’s perspective and offers market-oriented considerations to balance the lender’s position with the borrower’s growth in project finance.

1. The loan-party and collateral perimeter: Requests to exclude project SPVs

Venture loans often require the parent borrower to pledge the equity in substantially all of its subsidiaries and, in some cases, to cause those subsidiaries to guarantee the venture debt. This gives the venture lender a direct claim against (and security over) the corporate family.

Project finance operates on fundamentally different principles. Project lenders typically rely on the bankruptcy-remote, ring-fenced nature of the SPV. The SPV’s equity and assets secure the project debt, and project lenders generally do not permit the SPV to guarantee or pledge its assets to the venture lender. The borrower may ask to exclude project-level SPVs from the venture loan-party group as excluded subsidiaries or unrestricted subsidiaries.

This is often commercially necessary, but it creates structural subordination, with the venture lender’s claims remaining at the parent level, while project lenders have recourse to the project-level SPV.

Key considerations:

• Define a narrow, clearly delineated category of excluded project subsidiaries with clear eligibility criteria. For example:
  
  
  • The entity should be a bona fide project company financed by third-party, non-recourse project debt
    
    
  • The project debt should be without recourse to the parent beyond the agreed sponsor support (if any)
    
    
  • Operational assets or IP of the parent should generally remain outside the SPV, except as contemplated by a permitted license
    
    
• Cap aggregate investment in, and value or assets transferred to, excluded SPVs via investment baskets and asset-disposition covenants. This could help limit the transfer of significant assets or value from the parent to ring-fenced project entities.
  
  
• Address turnover and waterfall provisions so that residual distributions from project SPVs (after project-debt service is satisfied) flow to the parent and are captured by the venture lender’s lien.
  
  
• Impose separateness covenants and use-of-proceeds restrictions preventing commingling of parent and SPV resources.
  
  
• Include information and reporting covenants on project performance, project-debt covenant compliance, and any trigger events under project-finance documentation.
  
  
• Consider whether the parent’s retained interest – residual equity, management and development fees, license royalties, and operations and maintenance (O&M) fees – remains within the venture lender’s collateral.
  
  
• Identify the value streams that flow from the project back to the parent – including equity distributions, fee income, royalty income, and residual value – and consider whether each stream is preserved as an asset of the parent; subject to the venture lender’s security interest; and not capable of being diverted, subordinated, or encumbered without consent.

2. Downstreaming of cash and technology to project-level SPVs

The venture lender’s primary source of repayment is often cash resources and future equity financing proceeds. Preserving that cash is a central consideration for venture lenders, particularly where significant amounts may be downstreamed from the parent into project-level SPVs. A particular area of focus is the migration of cash from the parent into project-level SPVs. As the borrower funds development costs, equity contributions, and reserve requirements at the project level, cash that would otherwise service the venture debt can be downstreamed into ring-fenced entities beyond the venture lender’s reach.

Capping the downstreaming of cash to project SPVs is key to venture lenders managing this risk. Uncontrolled equity investment in and funding of project SPVs can reduce parent-level liquidity at a time that the venture lender would ordinarily look to it for repayment.

The borrower’s technology and IP may also be relevant to the venture lender, though typically as a value driver rather than as a primary enforcement asset. In many venture debt transactions, a venture lender does not take the IP itself as collateral. Instead, it typically takes a negative pledge over the IP in its favor, together with a security interest in the proceeds of that IP – for example, license royalties and the proceeds of any sale or other disposition. The venture lender’s concern with downstreaming is focused on the treatment of those proceeds and the preservation of the negative pledge, rather than obtaining ownership of the technology.

As the borrower transitions from FOAK development to repeatable deployment, its technology may need to be made available to each project-level SPV to enable the project to be built and operated. The structure of this “downstreaming” may have implications for the venture lender’s credit and collateral analysis:

• Assignment or exclusive license: If core IP is assigned to, or exclusively licensed to, a project SPV, the parent may lose the royalty and disposition proceeds on which the venture lender relies, and may breach the negative pledge, which could reduce the value available to the venture lender on enforcement.
  
  
• Contribution as equity: Contributing IP to an SPV as an equity contribution transfers the asset, and its proceeds, outside the parent’s direct ownership and subordinates any recovery to the project lender.
  
  
• Non-exclusive license: A properly structured, non-exclusive license permits the SPV to use the technology for the project while the parent retains ownership and the associated royalty stream, preserving the value available to the venture lender.
  
  
• Pre-consent to future transfers. Borrowers frequently ask the venture lender to provide pre-consent to future downstreaming of cash and technology to project SPVs, on the basis that borrowers may view speed and certainty of execution as important when deploying repeatable projects. A blanket pre-consent, however, may create an uncontrolled leakage path from the parent’s cash and the proceeds of its technology.

Key considerations:

• Cap the downstreaming of cash to project SPVs – including equity contributions and subordinated loans – through investment baskets, rather than relying on general permitted-investment capacity.
  
  
• Specify that proceeds upstreamed from project SPVs are applied or made available to service the venture debt, and are not re-downstreamed without consent.
  
  
• Permit only non-exclusive, project-specific licenses under a pre-approved form of license agreement, not assignments or exclusive licenses, so the parent retains ownership and the royalty stream.
  
  
• Consider provisions addressing the parent’s retention of ownership of all background and core IP, as well as the preservation of the venture lender’s negative pledge and its security interest in the proceeds of that IP.
  
  
• Cap the scope, field of use, and territory of each license, and tie it to a defined permitted project.
  
  
• Set per-project and aggregate baskets, together with advance notice and reporting requirements, so the venture lender has visibility into the pace and scale of both cash and technology downstreaming.

The overarching objective is to help ensure the parent’s access to cash and technology-related proceeds remains available to the venture lender, and that enforcement against the parent does not inadvertently cause material contract terminations or loss of the technology’s value deployed across operating projects.

3. New obligations: Entry into project documents and incurrence of obligations

To deliver repeatable projects, the parent borrower enters into a suite of project documents – and may incur direct obligations – including:

• Engineering, procurement, and construction contracts under which the parent may provide completion support or performance guarantees
  
  
• O&M agreements under which the parent operates the project and bears performance risk
  
  
• Technology and license agreements under which the parent licenses its IP to the SPV
  
  
• Supply and offtake agreements where the parent is a counterparty
  
  
• Sponsor support undertakings and equity contribution commitments under which the parent may be required to fund cost overruns, shortfalls, or reserve deficiencies at the project level

These obligations could create risks for the venture lender, such as:

• New liabilities and indebtedness. Completion guarantees and sponsor support commitments may create contingent liabilities that, depending on their scope, could convert “non-recourse” project debt into effective recourse to the venture lender’s borrower, consuming parent resources and ranking with or effectively ahead of venture-debt claims.
  
  
• Performance and penalty exposure. O&M and technology agreements may expose the parent to liquidated damages, performance penalties, and warranty claims that could affect cash flow and enterprise value.
  
  
• Cross-default and termination risk. A default by the parent under a project document – or a venture loan enforcement action that triggers change-of-control provisions in project documents – could, in some circumstances, result in project-level terminations, step-in by the project lender, or loss of fee income.

Key considerations:

• Consider whether venture loan covenants capture project-related obligations. The definitions of “permitted indebtedness,” “permitted liens,” “restricted payments,” and “affiliate transactions” should be reviewed to address and cap sponsor support, completion and performance guarantees, and equity contribution undertakings. Generic baskets may not capture these bespoke project finance obligations.
  
  
• Consider arm’s length terms for parent-to-SPV agreements (i.e., O&M, license, services) and protect the associated fee streams as venture lender collateral. This may help preserve the associated fee streams and reduce the risk of value extraction through below-market intercompany arrangements.
  
  
• Consider notice of, and covenant compliance certificates around, material project documents, and any sponsor support calls. This reporting could help provide visibility into the parent’s project-level exposure.
  
  
• Coordinate cross-default definitions so that contained, project-level operational issues do not cascade unnecessarily to the venture loan, while preserving early-warning triggers for material events. Tiered approaches are available, such as:
  
  
  • Full cross-default to project-document terminations, which may be more venture lender-friendly and offer maximum protection or
    
    
  • Selective cross-default limited to major events such as acceleration of project debt, termination of material project documents, or calls on sponsor support above a threshold – an approach that may reduce the risk of false triggers from routine project-level disputes
    
    
• Review step-in, direct-agreement, and non-disturbance arrangements. Understand where the venture lender sits relative to the project lender’s step-in rights under direct agreements. Consider whether a venture loan enforcement inadvertently disrupts operating projects – and, conversely, that project-lender step-in does not eliminate or materially impair the parent’s fee income or license rights without notice and cure.

The venture lender may wish to consider approaching the parent’s growing project document obligations as a dynamic credit issue. New projects may add incremental liability, contingent exposure, and operational complexity at the parent level. The covenant package should account for the borrower’s project portfolio, not merely to capture a static set of obligations at closing.

4. Upstreaming of project cash flows to the venture debt borrower

The venture lender generally looks to the parent’s cash resources for repayment. Once cash is generated at the project level, repayment at the parent level may depend on the ability to upstream cash – whether as equity distributions, management fees, O&M fees, license royalties, or other permitted payments. However, project finance documentation imposes constraints on upstreaming:

• Distribution waterfalls and lock-ups: Project cash is applied first to operating costs, then to senior debt service, then to reserve account funding, and only then to equity distributions – subject to distribution lock-up tests, typically through a debt service coverage ratio (DSCR) or DSCR test.
  
  
• Debt service reserve accounts: Cash must fund reserves before distributions are permitted.
  
  
• Cash sweep mechanics: Excess cash may be swept to prepay project debt, reducing available distributions.
  
  
• Project lender priority: The project lender sits ahead of any equity distribution in the waterfall.

This produces a structural cash-flow tension: the venture lender may depend on distributions that are subject to project lender controls. In early project years – when FOAK and early NOAK projects are ramping up to full commercial operation – equity distributions may be limited, even as the venture lender’s debt matures or amortizes.

Key considerations:

• Review the project finance waterfall and lock-up mechanics before the venture loan closes (if timing allows) or before consenting to the borrower’s entry into project finance. Understand the conditions under which cash can reach the parent and model the timing and quantum of expected distributions.
  
  
• Consider covenant protection obligating the parent to use commercially reasonable efforts to cause distributions to be made when permitted under project finance documents, and to direct upstreamed cash through deposit accounts subject to the venture lender’s control agreement or lien.
  
  
• Distinguish between equity distributions and fee income. Management fees, development fees, O&M fees, and license royalties payable to the parent are typically permitted ahead of equity distributions in the project waterfall (as operating costs of the project). These may provide a more regular and predictable cash stream for the venture lender. Consider whether they are contractually required (not discretionary), and set at arm’s length rates.
  
  
• Consider whether the loan agreement appropriately addresses the scenario in which the borrower’s revenue model shifts from direct operations (a single-entity model) to a portfolio model (distributions and fees from multiple project SPVs). Financial covenants and borrowing-base mechanics, if any, could be calibrated to this reality.

Conclusion

The transition from FOAK developer to repeatable NOAK project deployment could reflect a company’s progression toward broader commercial deployment and success. This transition may present opportunities for venture lenders alongside new structural considerations. The migration of value, technology, cash flows, and obligations from the parent to project-level SPVs may materially change aspects of the venture lender’s credit position and risk analysis.

Venture lenders may wish to consider the following when evaluating this transition:

• Controlling the excluded subsidiaries boundary with narrow eligibility criteria, investment caps, equity pledges, and turnover provisions
  
  
• Capping the downstreaming of cash to project SPVs, and preserving access to proceeds generated from the borrower’s technology through a negative pledge and conditioned, non-exclusive licenses rather than blanket pre-consents
  
  
• Addressing project-related obligations within the venture-loan covenant package and coordinating cross-default mechanics to provide early warning without unnecessary cascading risk
  
  
• Preserving access to upstreamed project cash and addressing recurring fee streams (i.e., management, O&M, and license fees) as distinct and prioritized collateral

Careful drafting, clearly defined ring-fencing arrangements, appropriately conditioned consents, and ongoing reporting may help balance lender protections with the borrower's transition to project-finance structures.

For more information, please contact the authors.