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Circular Economy

What are examples of circular financing?

Many companies apply circular business models and – in cooperation with financial institutions – develop new financing solutions. Below are examples for the four types of circular business models: circular design, optimal use, value recovery and network organisation.

Circular Design: Fairphone

Fairphone, has developed a fair and modular smartphone. Fairphone’s value proposition combined with a large group of dedicated customers (more than 10,000 pre-sold phones) contributed to a commercial bank’s positive credit decision to finance the company. Building a good relationship with the bank and obtaining support from government guarantees helped Fairphone to obtain this bank loan (Fischer and Achterberg, 2017).

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Financial information or collateral alone would not have helped Fairphone in its financing, because the machines that produce the phones are not owned by Fairphone and are therefore not eligible to be pledged as collateral. The smartphones themselves are sold and therefore cannot be used as collateral. Financial statements or a credit score would also have led to a negative decision, as the company only existed for a few years at the time the loan was applied for.

Fairphone as a Service?

Fairphone’s business model is initially based on sales, which means that the company loses control of the phones after sale. Together with lawyers, financiers and NGOs, Fairphone has developed a service model that helps to keep a grip on the phones and to optimize their reuse. The advantage of involving financiers and lawyers at an early stage is that the business model is efficiently designed in terms of financeability, legal feasibility and circularity.

The Fairphone-as-a-Service (FaaS) proposition can be successfully funded by combining existing financial instruments based on detailed financial models and by exploiting the strengths of the service. For FaaS, a 5-year cash flow projection was made at module level. The steps required for this can be found here. A contract was also drawn up, which was found to be financially viable. This has been made available as open source.

Optimal Use 1: Bundles

Bundles is a start-up that sells washes instead of washing machines (pay-per-use, product-as-a-service). Bundles is responsible for the installation, maintenance and repair of the machine, as well as replacement if the machine breaks down. This model brings several challenges for financing (Working Group FinanCE, 2016, p50).

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Bundles offers its customers an operational lease, which means that Bundles remains the owner of the washing machine. This requires an investment of around € 1,000 per new machine for each new customer, until the fleet is large enough to circulate washing machines that are fully paid for. This pre-investment has a payback period of five to six years and therefore inevitably leads to a demand for financing.

The situation has several challenges. First, the washer extractors need to be financed, but they have a longer payback time than if they were sold, which puts pressure on cash flows. Secondly, the balance sheet is swelling as Bundles remains the owner of the washing machines, which entails a long-term capital requirement. Thirdly, there is not yet an end-of-life processor that can upgrade old washing machines, which makes it difficult to include the residual value in the lease construction.

In collaboration with Rabobank, Bouwinvest and Miele, Bundles is exploring the possibility of structuring a long-term investment.

Optimal Use 2: BMA Ergonomics

BMA Ergonomics (“BMA”) produces office chairs according to ergonomic principles. Since the start, BMA has designed the chairs for easy disassembly to facilitate cleaning and maintenance. Now BMA benefits from the efficient use of materials and the circularity of the business model. BMA has translated this into a model in which the company rents out office chairs (product-as-a-service) for a period of ten years (ING Economics department, 2015, p47).

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The business model works in such a way that customers pay a fixed instalment during the first five years, after which this rate decreases by almost 50 percent for the remaining five years. The customer also pays a deposit per seat which is refunded when the seat is returned.

ING has developed a model to analyse the finances of BMA in the transition to the circular business model. This resulted in two important financial implications:

  • Gross margin: The shift from sales to rental has a significant impact on the gross margin. In the linear model the margin is stable, in the circular model the margin starts low and recovers over the years. The production costs were not covered by the first instalments at the start. But in the long run, the margin in the circular model will be higher, as BMA will be able to repair and reuse used seats. This reduces production costs.
  • Working capital: Pre-financing the production of the chairs increases the working capital requirement. The deposits could compensate for this, but since they have to be paid back to customers, the question is to what extent this capital can be used freely.

Value recovery: Blackbear Carbon

Blackbear Carbon is a good example of a risky circular company with a large financing requirement (building factories) that was able to mitigate risks in various ways and was therefore successful in raising bank finance from Rabobank (Ewen et al., 2017).

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To start with, Blackbear reduced the technological risk by first testing the processing of car tyres into black pigment in existing plants. After this technological process had been proven in this way, Blackbear set up a separate legal entity to build its own plant. Through such a separate entity, certain risky activities can be isolated from other less risky parts of the company.

Good and early relationships are often a success factor in obtaining financing. Both the relationship with financiers and with chain partners and customers. Blackbear, for example, started talking to Rabobank at an early stage. But also in the chain, by entering into a joint venture with Cargro, the largest tyre collector in the Benelux, which reduced the bank’s risk. Blackbear even set up its own financing fund together with the European Investment Bank – “Blackbear Capital” – in order to obtain financing more quickly for setting up factories in various European countries. The larger scale, through a fund, makes it more interesting for financiers to participate. This is particularly relevant for circular initiatives that want to undertake several rounds of financing (e.g. for several factories). The market risk was also hedged by early collection of letters of intent from some thirty large customers.

Finally, Blackbear is also characterised by a team of highly experienced and well-trained entrepreneurs. This has also increased the confidence of financiers.

Network organisation: Circular Service

The Circular Service (CiSe) Platform has the potential to dramatically scale up the circular economy. It not only offers the possibility to easily integrate chain partners in a circular product-as-a-service model, but also offers (replicable) structures that are legally, financially and accountancy compliant in advance. And all this at low costs (Achterberg, 2019).

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How does the platform work?

If the end user, for example, washes his clothes, he pays a usage fee via a digital wallet. This payment is automatically distributed, via smart contracts, to all companies involved in the service of the washing machine:

  • service providers (e.g. Bundles),
  • hardware providers (e.g. the washing machine manufacturer),
  • consumable providers (e.g. detergent, water or energy), but also
  • financiers (e.g. the crowd, banks or investors)

How does this make funding easier?

  • Risks and returns are automatically distributed over a network of chain partners;
  • Split payments: All stakeholders in the supply chain network are directly compensated for their contribution, including financiers;
  • Who is entitled to which part of the cash flow is clearly defined;
  • This provides greater control over assets, making complex ownership relationships transparent, traceable and controllable;
  • Large volumes of small micro-payments (e.g. for one minute light) become manageable and cheaper;
  • Accounts receivable risk is drastically reduced because security for payment is 100%;

This makes it easier to make financing decisions.