The Investment Potential Of Today’s Climate Tech

Climate tech encompasses a diverse range of technologies and applications focused on mitigating climate change, either by reducing greenhouse gas emissions across various industries and processes or by removing previously emitted carbon dioxide from the atmosphere. Key sectors for climate tech include mobility & transport, energy generation & distribution, industrial processing & manufacturing, food & agriculture, and the built environment. Many climate technologies offer alternatives to conventional high-carbon processes, such as renewable energy sources and chemical production that do not use fossil fuel resources. Others are designed to complement existing high-carbon processes, for example, by capturing carbon from industrial or energy-producing facilities.

In 2017, climate-tech startups had the lowest expected returns compared to nine other emerging tech verticals (agtech, AI & ML, cybersecurity, fintech, foodtech, gaming, IoT, mobility tech, SaaS). However, VC investment in climate tech saw rapid growth between 2021 and the end of 2022, influenced by overall market conditions for VCs and a growing global recognition of the need to combat climate change. Since late 2022, however, the challenging market conditions for VCs have reduced deal activity in the sector. According to new PitchBook research, which employs a novel quantitative method to assess opportunities in emerging technologies, the category now ranks sixth in terms of outlook.

Last year, VC investment and valuations in climate tech fared better than in other verticals. These companies have increased their headcount more quickly than their tech counterparts and have significantly boosted their share of patent filings, the report indicates. Within the climate category, the carbon-tech subsegment is highlighted as offering the most attractive opportunities for early-stage investors, including carbon-capture startups and firms developing software for emissions measurement and accounting. This analysis ranks electric vehicles, industry, and land use as following in terms of investment appeal.

Grace Sai, Co-Founder and CEO at Unravel Carbon, a climate-tech startup that is backed by investors such as Sequoia and Y Combinator, believes CarbonTech has garnered significant VC interest because it has become the standardized unit of measurement in a low-carbon economy.

“All 7 GHGs are converted into carbon dioxide equivalents. The old adage ‘What gets measured gets managed’ is applicable here. In the ESG paradigm, ‘carbon’ is likely the most quantifiable metric after profit margins. To date, there has been a lack of carbon accounting, management, storage, utilization, and capture technologies across the spectrum, despite an increasing addressable market size, hence its investability.”

The growth of these four cross-segments is credited to their alignment with climate change mitigation goals and the demand for innovative solutions. Monette Stephens, Founder of Conscious League, which includes Conscious Venture Studio — a platform that collaborates with global projects dedicated to products and services positively impacting climate, energy, and social equity — elaborates, “Carbon tech offers opportunities in carbon capture, emissions accounting, and tracking. Electric vehicles address the need for sustainable transportation, lower emissions, and cutting back on the use of fossil fuels. Industrial processing & manufacturing focuses on reducing emissions in manufacturing processes, while land use tackles sustainability in agriculture and forestry.”

Grace Sai adds, “92% of the world’s GDP has made Net Zero pledges in the past decade. This decade is all about execution. More than 5000 companies are SBTI-approved, adding both public and private sector focus onto planetary decarbonization. The spoken and unspoken risks of not meeting these targets include public scrutiny or penalties/taxes that result in the encroachment of enterprise value. In short, non-financial, climate-driven decision-making is going to be as important as financial reporting in the years to come, pushing carbon management platforms like Unravel Carbon, as well as decarbonization solutions across sectors as mentioned above, to the forefront.”

The Factors Preventing Growth

Among the factors that stimulate growth, several negatively impact the industry. Experts point to the poor stock market performance of climate-tech companies as a significant obstacle. Many startups, including those building electric vehicles, flying taxis, and batteries, went public during the 2020-2021 SPAC boom and were penalized by investors for missing forecasts. Even sector leaders like electric vehicle maker Rivian have struggled to maintain investor confidence, its shares have fallen an additional 46% this year.

Another challenge is the misalignment of energy markets with startups’ climate ambitions. Oil majors have recorded another year of strong earnings in their core business, which could deter investments in unprofitable low-carbon ventures. Monette Stephens explains, “The biggest obstacles ahead include poor stock market performance, investor skepticism stemming from missed forecasts by climate-tech companies, and challenges in energy markets where traditional players continue to thrive, potentially overshadowing investments in low-carbon technologies.”

Grace adds, “Political will and leadership conviction (or the lack of) in ushering a low carbon economy would be in my opinion the biggest obstacle in the market adoption of low carbon technologies. A ‘wait and see’ mindset amongst country and business leaders alike signify the inherent perception of ‘negative externality’ of an issue as global and serious as climate change. The hope is that the ‘halo effect’ of action amongst progressive leaders would similarly create the followership that is required to cross a material chasm in enabling a low carbon world.”

Recently, Apple reportedly shelved its plans to develop an electric car, raising questions about whether tech investment is shifting to more lucrative opportunities.

Monette disagrees, “The recent struggles of climate-tech companies in the stock market may indicate investor preference for other sectors perceived as offering better returns. However, the long-term viability and necessity of climate tech solutions remain strong, suggesting that market fluctuations may not accurately reflect the sector’s potential. Different market growth reports indicate that growth rates appear to be around 25% for the climate tech market, which is healthy. In addition, the development of new technologies focused on resource efficiency also overlaps with the climate tech sector. This is mitigated by increased power consumption requirements for AI. It will be interesting to see what happens with increased requirements needed to support adjacent technology sectors and its impact on Climate Tech.”

Grace compares Climate Tech with Gen AI regarding investor interest, stating, “both technologies are being the pillars of our economic and societal future”. She adds, “Both have attracted the most VC money in the past years even when the overall market had softened. Both are incessantly ‘talked about’ but insufficiently executed upon, mainly because society at large is still wrapping our heads around these new concepts – both its promises and its risks.”

Helena Merk, CEO and Co-Founder at Streamline Climate, AI-Powered grant and RFP writing for ambitious climate companies, explains, “It’s not that tech money see a better opportunity, it’s that you need to be really smart to invest correctly into a climate-tech company. Because climate funds in particular, they understand that there’s this diverse capital stack need, and a lot of generalist funds have not really caught on to that. But they have been investing in the hype cycle that is climate. But I don’t know if they know what they’re getting into.”

Encouraging energy companies to invest in low-carbon bets

Encouraging energy companies to invest in low-carbon technologies may involve implementing supportive policies, providing financial incentives, and fostering partnerships between traditional energy players and climate-tech startups. As Monette mentions, “Ensuring alignment with energy corporations’ interests requires demonstrating the economic viability and long-term benefits of low-carbon investments.”

Grace, Co-Founder and CEO at Unravel Carbon, adds, “Energy companies need sufficient incentive for the early closure of high-emitting assets that may still have a useful life. Financial incentive arrangements across South-East Asia for the early closure of coal-fired power stations are one such example. Another significant incentive is strong carbon pricing designed to effect change. According to the IEA, developing world carbon prices should be around $90 USD/tonne to ensure appropriate investment in low-carbon technologies.”

Electricity prices also remain elevated compared to historical levels, posing a challenge for many climate companies that rely on affordable renewable electricity to be financially viable. Grace points out that Climate tech companies can indeed be profitable. “Focusing on our sector, Climate tech software can have profitable business models. For instance, our SaaS model has a gross margin of over 80%, consistent with traditional SaaS models. However, regulatory pressures are necessary to unlock significant market sizes for adoption.”

Monette believes that profitability isn’t just about making companies profitable, they can achieve this in the same manner as other companies, but it’s crucial to develop products supported by market demand. She elaborates, “Through optimizing business models, solid management, hiring and building productive teams, reducing costs through innovation, accessing funding sources, and leveraging supportive regulatory environments, climate tech companies can become successful and gain market share.”

What are investors looking for?

While the climate sector has remained relatively shielded from the venture capital pullback, the level of due diligence has escalated. Investors are intensifying their scrutiny of financial outcomes, development roadmaps, and permitting strategies. They are in search of tangible evidence of market traction, scalability, cost-efficiency, and adherence to regulatory standards. Monette highlights, “Founders are tasked with demonstrating a definite roadmap to profitability, strategies for sustainable growth, and adept risk management.”

In the realm of climate tech software, traditional performance metrics are still relevant. Grace points out, “Metrics such as Net Revenue Retention, engagement levels, churn rates, and the LTV/CAC ratio are crucial.” Yet, she notes the challenge of “extended sales cycles, as certain companies adopt a ‘wait and see’ stance.” This situation, however, is expected to change as mandates, regulatory pressures, and taxes become more prevalent across various regions.

An emerging trend among veteran climate startups is their foray into manufacturing. Notable examples include Carson City, Nevada-based Redwood Materials, a battery recycling firm, and H2 Green Steel from Sweden, known for its steel production utilizing hydrogen generated from renewable sources. Recently Houston’s Fervo Energy secured $244 million, led by Devon Energy, to finance a novel advanced geothermal project in Utah. Not every entity within this sector requires substantial infrastructure investments for growth. As the scope of climate tech widens, the opportunities for software and lighter hardware companies that don’t depend on major technological innovations have increased. For those that do, there is an unprecedented level of capital available to support deep tech advancements—a stark contrast to the scenario a decade ago.

Monette concurs, “Indeed, some ventures, especially those aiming for significant infrastructural shifts within the energy sector, EVs, and AgTech, are in dire need of substantial capital. Deep-tech enterprises have traditionally been capital-heavy. Success hinges on a myriad of factors including the right product-market fit, market demand, effective execution, regulatory backing, and the ability to attract and retain top talent. All these elements are vital for nurturing and launching resilient companies into the market. The demand for firms that can meet the market’s needs in the Climate Tech domain is on the rise, yet it remains imperative for these companies to embody all the qualities investors seek when allocating their capital.”

Helena echoes this sentiment, “I think there’s more funding now than ever. I don’t think there’s anywhere near enough.”

Is regulation getting more supportive towards Climate Tech initiatives?

Regulation and policy play pivotal roles in the adoption of climate technologies, which often represent costlier alternatives to conventional methods, especially given the nascent state of some technologies in the sector. Recent regulatory developments have rendered previously unviable sectors like low-emissions cement and steel feasible for the first time. Legislation such as the Inflation Reduction Act is gradually influencing the market, with certain climate tech areas only beginning to benefit from the funds allocated in 2022.

Despite progress, Monette, Founder of Conscious Leaugue, notes room for enhancement, “Gaps still exist in certain areas, requiring policymakers to address challenges such as regulatory uncertainty, funding gaps, and the need for international cooperation to tackle global climate issues.”

Grace highlights, “Regulation and policy is certainly supportive with respect to deep tech that’s focused on decarbonisation efforts (e.g., the Inflation Reduction Act and other programs to address market failure in decarbonisation). In other areas, the regulation provides a place for technology to be deployed – e.g., a regulatory requirement for disclosure opens up the landscape for technology based tools to assist. This is then an area where Governments can provide incentives to implement new systems to address regulatory requirements; e.g., grants for software deployment.”

Helena agrees that support is growing, albeit with complexities, “So, yes, it’s becoming more supportive. But it’s overwhelming and hard to navigate in ways that can be changed, make it easier to navigate.”

She mentions the difficulties faced when applying for grants, “I work in the world of grants and helping climate companies navigate the grant landscape. The challenge when there’s a new process introduced is that nobody knows how to do it. And things are getting delayed, delayed and delayed. Nobody has the resources to build out these processes. So people instead just aren’t applying to the funds. Yes, we help Climate Technology companies apply for these grants. But we’ve also been helping like local communities and community benefit organizations and local governments. And these groups get the most like they have no bandwidth to navigate a complicated grant process.”

In summary, while regulatory and policy environments are evolving to better support climate tech innovations, there’s a consensus on the need for further refinement to make these systems more accessible and effective for all stakeholders involved.

What should we expect in 2024?

Helena Merk shares an optimistic view, saying, “We’re kind of reaching a market low point, but things are improving this year. Things are indeed getting better.”

Grace is equally positive about the future of Climate tech, stating, “We expect investor interest to increase in 2024. More and more countries are following through on executing on their Paris Climate Agreement pledges and penalties as we all as opportunities will only be made more concrete, more direct and more urgent. The markets will respond to these forces and continuous tailwinds are expected in this sector. Honestly, as a planetary species, we don’t really have a choice.”

Monette echoes this sentiment, “Having been involved in the Climate tech ecosystem since 2019, 2024 is proving to be an exciting year. There is increased interest in a variety of climate-focused sectors from companies that are developing AI for analytics, different types of Electric vehicles, and replacing petroleum-based products with plant or other non-petroleum products.”

She believes that, despite possible challenges in the wider economic context, the momentum for climate tech innovation will continue, propelled by changing market dynamics, regulatory progress, and increased public consciousness of climate issues. Monette is especially excited about a few companies: “Enso Tyres, which utilizes recycled and plant-based materials, focusing on the EV industry to provide more range and less tire pollution. Another noteworthy company is Lit Motors, which is developing an enclosed 2-wheel, self-balancing electric vehicle. The Lit Motors AEV (Autonomous-balancing Electric Vehicle) merges the advantages of two- and four-wheeled travel without compromising comfort, safety, speed, performance, or cost. A third company, Pentatonic is offering tools to support the circular economy.”

As the world confronts the urgent need for climate action, climate tech stands out as a key field of innovation and investment. Closing the gap between ambitious climate objectives and the present market scenario demands collective efforts from startups, investors, policymakers, and established energy firms. The path forward is intricate but vital for fostering a sustainable and resilient global economy.

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