Doing Better for Climate Change: Part I

[This is Part I in a series that explores the climate technology landscape. See Part II here.]

In the late 1930s, Guy Callendar, an amateur scientist, stumbled upon a startling revelation that our planet's temperature had risen by 0.3°C over half a century. This early observation laid the groundwork for our understanding of today's pressing global challenge: climate change (sorry Tucker Carlson!). Instigated by significant shifts in global temperatures and weather patterns, climate change is primarily catalysed by human activities, notably the burning of fossil fuels, deforestation, and industrial processes. 

Despite international efforts like the Paris Agreement, the world has warmed by 2°C since Callendar's discovery, and the polar ice caps continue their alarming retreat. As we stand at this critical juncture, propelling the world into decarbonisation is as important as ever. 

When discussing climate innovation, Bill Gates believes that when “we focus on all three things at once—technology, policies, and markets—we can encourage innovation, spark new companies, and get new products into the market fast”. Venture capital (VC), a potent force in shaping technology and markets, bears a significant responsibility to wield its influence more effectively.

Following the failures of Cleantech 1.0 where VCs spent over $25 billion funding clean-tech companies from 2011-16 and lost over half their money, concerns arose on whether the venture model was the best partner for climate innovation. It’s important to address these concerns and discuss why certain climate startups struggle to raise venture funding. 

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Why VCs Struggle To Fund Climate Tech:

During Cleantech 1.0, the startups that received the most funding were those utilising technical engineering with an emphasis on chemistry and hardware. These ventures typically demanded significant R&D investment and extended timelines to achieve market readiness.

From a VC perspective, a pivotal consideration in investing is the scalability and commercial viability of such technologies. Yet, the inherent nature of these startups means they seek capital upfront, with scalability tested in their later phases. This dynamic poses a challenge, as it diverges from the conventional VC investment cadence. Additionally, the capital intensity of such startups can depress early-stage RoE, given the significant equity stake (the denominator in RoE calculation) relative to initial modest or negative earnings (the numerator in RoE calculation).

Furthermore, the extended exit timelines ingrained in many hardware and deep tech climate solutions often don’t sync with current VC fund life cycles. Consider this: constructing a solar farm in rural Australia will always demand a longer scaling period than a B2B SaaS. Such prolonged development phases misalign with the norms of conventional VC funds, which typically span 10 years and target exits within a 5 to 7-year window. Examples include QuantumScape and LanzaTech which both took over a decade to reach unicorn status (private company w/ $1b+ val). Once an exit is achieved, the exit multiples are often less than their SaaS counterparts because the value realization comes after the successful commercialisation of their complex technologies, which can take time. Thus, there is an argument to be made that these deep-tech or hardware climate startups may be a better fit for private equity-style investors who might be content with a 20%+ RoR without necessarily seeking the 10x exit multiple that a VC would target.

Exceptions to this include climate tech and deep-tech specialist funds that have extended fund life cycles and return targets to accommodate the nature of their investments. Examples include Breakthrough Energy Ventures (20-year life cycle) and BDC’s Deep Tech Venture Fund (12 years with an optional 4-year extension life cycle). 

‍Note: The aforementioned observations pertain primarily to conventional venture fund structures and do not encompass the diverse array of venture models and strategic fund approaches that may be in operation.

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Venture Funding Must Triple to Reach Net Zero by 2050

​​While venture funding for climate tech has been robust, it's not enough to combat the climate crisis. To achieve the net zero target set by the 2015 Paris Agreement, global climate tech investments must triple instantly. With an estimated $300 billion in dry powder, VCs must sit at the centre of this movement and amplify their efforts to reach net zero. 

With the current tailwinds, there has never been a better time to build and invest in climate tech. 

Globally, the United States Congress passed the Inflation Reduction Act in August 2022, containing $520b worth of programs and funding to accelerate the transition to net zero. This represents a monumental step in the U.S.'s commitment to addressing the climate crisis and is hailed as the most significant investment in climate and energy in American history. 

In Australia, the momentum is paralleled by its strong capital-raising activities. From 2021 to 2022, there was a significant surge in funds, with the total capital raised jumping from $338m to $553m. This uptick underscores Australia's growing commitment to climate solutions and mirrors the global emphasis on green investments. As more stakeholders recognize the potential of climate tech, the sector is poised for further growth, attracting both domestic and international investors eager to contribute to a greener future.

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Special thanks to the industry experts who helped shape this work: Annelieke de Wit, PhD, Stanley Tanudjaja, Allen Fan, Visakhan Vythilingam, Alfred Lo.