2021 was a banner year for climate tech fundraising, with at least $60 billion invested in the first half of the year alone, according to PwC. This is more than double the total funds the sector raised in the whole of 2020 — a welcome indicator that the investment community we are proud to be part of is waking up to carbon-reducing technology and the urgency of the climate crisis.
But are investors’ dollars really making a difference? The same PwC study reveals that since 2013, the technology areas with the potential to reduce emissions by more than 80 percent, such as solar power, wind power, food waste technology and alternative foods, have received just 25 percent of total investment. Instead, software and marketplace investments and micromobility have received the majority of climate tech funding as seemingly “safe bets” for investors.
This is a fundamental misreading of where we are not just as a planet, but also as investors. Essentially, venture capitalists (VCs) need to put more money into companies directly affecting emissions — not just because of the planet but also because since 2014, climate tech startups have financially outperformed the rest of the startup world. The problem, then, is not the expected returns from climate tech, but a common misconception that the businesses that create impact can’t generate returns. Thankfully, that is beginning to change.
Winter isn’t coming for climate tech
We’re in the midst of the most significant downturn in the technology market in recent memory. Big Tech stocks are highly volatile and private money appears to be in retreat, with even the most active funds scaling back on deals. But it’s almost as if climate tech is operating in a parallel universe to the rest of the VC world — there is no sell-off, slowdown or winter appearing.
Russia’s illegal invasion of Ukraine has been a big catalyst for increased interest in climate tech — specifically energy-focused climate tech that takes us away from petrochemicals and fossil fuels — as Europe has been so dependent on Russian energy for so long. On top of this, we’re seeing a lot of money from previously overheated sectors naturally moving to climate tech. That is primarily because of the real world applications climate tech offers and the obvious contrast when compared with businesses that secured tens of millions at inflated valuations without a product or a team in place in the past 24 months — in rapid grocery delivery or cryptocurrency trading, for example. This means we’re seeing valuations and rounds in climate tech holding their ground as the wider market slumps.
More due diligence, more often
But it’s certainly not all go, all the time. What we are seeing now among those investing in climate tech is much deeper analysis — such as World Fund’s Climate Performance Potential (CPP) metric or initiatives such as Project Frame. No longer can market hype be a justifiable reason to back a company, and investors are doing more rigorous and longer due diligence for each funding round. At World Fund (of which Danijel is the founder), that’s always been our MO, but other investors are joining us in taking a more deliberate approach, which is very important for the ecosystem as a whole.
Investors still want to back great ideas and great people; they’re just taking a little longer to write the check. This should encourage climate tech founders. Their pitches may be more complex, but the problems they’re tackling are undeniably important — and urgent.
However, the nature of urgency is different in climate and investing circles. VCs tend to back companies with an intention of earning significant multiples on their initial investments in a timeframe of three to five years. But climate is a different beast: Planetary science often can’t be product-managed like software. Tiny startups are attempting to apply new science to transform massive, slow-moving industries, and it’s going to take longer than a few years.
The investor’s mindset
VCs too often invest only in what’s been proven. Accurately estimating the climate return potential of a product is a highly complex matter. That’s why most money makes its way to business models that have already demonstrated worth, representing a much safer bet even if the odds aren’t quite as good.
This is a cultural challenge. VCs are data hungry, relying on metrics to inform decision-making. That’s why at World Fund, before any investment we make, we assess the startup’s Climate Performance Potential. This is a way to ensure that the technology behind the startup actually has the potential it claims.
We know that those startups that have the potential to save at least 100 metric tons of carbon dioxide equivalent per year will be the most valuable companies of the next decade. That’s because economic data alone cannot reveal the full potential of any given investment, and climate performance is becoming a core value creator of the global economy. We actively encourage other investors to take a similar approach and use data to find the startups that will not only make a real difference to the fight against climate change, but also make a real difference to their bottom lines.
Another way forward
Some pioneering investors have already woken up to the longer-term prospects presented by climate tech startups, sharing a belief that they have the potential to become the most valuable companies over the next decade and beyond.
Investing in climate tech currently presents one of the biggest financing opportunities in history — BCG estimates global investments up to $150 trillion are needed to reach net zero by 2050. Government-backed incentives, such as the $369 billion package of climate investments provisioned in the Inflation Reduction Act, will also proliferate as voters demand increased action on green issues. A 2020 study by the Pew Research Center found that two-thirds of Americans didn’t think the government was doing enough on climate change.
Here are three changes investors can make to capitalize on this positive momentum and play a real part in saving the planet:
1. Rethink what growth and value means
Seven years just isn’t enough time for the tech currently being developed to deliver the kind of returns most VC models are built on. Climate tech doesn’t scale in the same way as a consumer-facing app that can rapidly acquire a customer base. But that does not mean climate startups cannot deliver value. Instead, VCs need to prepare for longer product development cycles and greater levels of investment before income can be generated. We’re building brand new tech, and it will take time to get things right — the wait will be worth it.
2. Align on the data
For the prolonged health of our planet and the economy, investors and climate tech startups need to get better at understanding one another. So it makes sense to agree on a common metric, such as Climate Performance Potential, to assess impact and performance. The most readily deployable and trusted metric is an organization’s overall impact on the production of CO2 and other greenhouse gases. We know that using this metric isn’t a perfect solution; however, a crisis calls for pragmatism, and it makes sense to first address the most urgent priorities.
3. Mind the knowledge gap — and address it
VCs predominantly come from an entrepreneurial background. And that’s a good thing. They understand the fundamentals of a good business and know how to make money. They have been successful in the technology space because they easily grasp the benefits that products can bring to individuals or businesses and monetize accordingly. But alongside this, VCs do need to be able to quickly develop a working understanding of quite complex scientific concepts — across physics, chemistry, biology and climate science.
Therefore, any investment team worth its salt should also consist of people who understand deep tech: mechanical engineers; chemical engineers; nuclear physicists; mathematicians; chemists. VCs should look to invest in in-house expertise to support green investments to plug any knowledge gaps with specialist skill sets that will help them identify the most exciting opportunities in the green tech space.
The call to action
With the Ukraine crisis focusing minds on the urgent need for the green energy transition and the increasingly high returns on investment, climate tech investment faces a perfect storm. It’s imperative that investors double down on the bets they’re making, through continued intelligent use of data and metrics and a focus on the startups that will make a real impact in the battle against climate change.
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