Edinburgh University-based Carbogenics wants to re-use containers that are currently hard to re-process because they have a plastic lining.
The firm uses an already-established process to turn the waste into a range of useful products.
It has won this year's Converge Challenge, an initiative set up to help some of Scotland's new entrepreneurs.
§ Why are 99.75% of coffee cups not recycled?
§ Hugh Fearnley-Whittingstall: 'Wanton waste'
The difficulty in recycling most takeaway coffee cups was highlighted by TV chef Hugh Fearnley-Whittingstall in a documentary three years ago.
The vast majority of cups are incinerated or end up in landfill because of difficulties separating the paper and plastic in their inner lining which makes them leak and heatproof.
Carbogenics uses an old technique called pyrolysis which involves heating such products to very high temperatures in the absence of oxygen.
The cups can be broken down into gas and bio-oil which can be used to produce energy. It also leaves behind a carbon-rich solid, known as CreChar which can also be used as a fertiliser.
Lidia Krzynowek, from Carbogenics, said the technique could be used to reprocess a range of similar products.
"It will basically divide the carbon bit of the cups which is a nice fibre-rich material, and the plastic lining is going to evaporate into a gas that will power our plants," she told BBC Scotland's Good Morning Scotland programme.
"It's a really good technology and it might be one of the solutions to the problem."
The firm is moving on to commercial testing and hopes to have a demonstration production plant up and running in Edinburgh next year.
Olga Kozlova, from Converge Challenge, said it was working with all Scottish universities, helping to turn innovative research into commercial ventures.
She said: "We help them with training, to discover their markets, to write a business plan, to secure investment.
"So Carbogenics was a clear winner for the judges - we have an independent judging panel.
"They saw a combination of a very strong team and fantastic technology."