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Climate Tech Needs More Growth Capital
Why now is the time to be a Growth investor in climate.
It’s never been a better time to be a growth investor in climate. John and I wrote the following article for Forbes this week. Enjoy the long weekend!
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In recent years, the once-tumultuous climate tech sector has proved itself to be capable of handling the growing pains that come with emerging markets. The sector has remained resilient in hard times and maximized gains during economic booms.
Take the period from 2019 to 2021 – a bright spot for the market broadly and for climate tech in particular. Climate tech funding had reached all-time highs, founders were starting new companies daily, talent rushed into the space, and the surge of SPACs provided liquidity to some of the companies that had survived the cleantech 1.0 cycle. In retrospect, we should have known the SPAC phase was too good to be true. But it highlighted a critical and still largely unfulfilled need for maturing climate companies: growth capital.
Now, the climate tech market is entering a new era. The balance between investors and founders is being restored at the same time as climate companies are graduating past their early stages and looking for capital partners.
The result? This is likely the best environment in five years for growth-stage investing in climate.
In today’s down market, growth-stage funding is particularly hard to come by
While resilient, the climate space has not been immune to the broader funding slowdown within the private markets over the last year. According to CTVC, since reaching a record year in 2021, climate tech funding dropped over 40% from 2022 to 2023. But a closer look at those numbers paints an even bleaker picture for the growth equity space. Funding for companies raising a Series C round or later dropped an astounding 68%year-over-year in the first half of 2023. These fundings made up only 20% of the total dollars allocated to climate tech companies, a discrepancy made more significant considering growth-stage fundings typically involve larger check sizes.
Climate isn’t the only sector reeling; the technology space more broadly has seen a slowdown in growth equity funding. In some ways, this trend makes sense for tech companies – especially those with software at their core. Software business models are effective because, in the best companies, spend can be ramped down quickly, and burn can be controlled appropriately when the market landscape turns rocky. These same companies also need time to grow into the lofty valuations handed out over the past few years. Less burn plus more time equals fewer new rounds.
But that rationale doesn’t tell the full story. Most capital-efficient climate software startups eventually require additional funding to grow into large-scale businesses. Yet this capital is proving more and more difficult to come by. Investors are raising their bars for late-stage capital and holding additional reserves for existing portfolio companies that may need more time to grow into inflated valuations. As a result, much of the “dry powder” we’re hearing about is reserved and unavailable for new funding.
These funding headwinds are compounded by the fact that it is not uncommon for generalist investors to (rightfully) prioritize their core strategies over new ones during risk-off cycles. Major firms like Sequoia Capital have announced they are paring down their crypto and fund-of-funds strategies. If it’s happening in those spaces, you can be sure it’s also happening in the climate sector.
A swell of climate software companies is ready for more funding
Meanwhile, more and more high-performing climate companies are emerging from the climate tech funding boom. Early-stage climate firms have been more immune to the overall drop in funding – in the past two years, over 2,000 companies have raised at least a seed-stage funding round.
A subset of those firms will advance to be the next climate leaders in the coming months and years, and their market potential is significant. Analysis from my firm, Energize Capital, indicates the top-performing climate software companies are on track to reach a scale similar to the top public climate companies. Today’s climate SaaS startups are producing real revenues, real profits, and real impact, and they’re doing so against the backdrop of the massive revenue opportunity presented by the energy transition. Ironically, those growing, high-performing climate companies currently have fewer options for funding than they did when they were just starting out.
While not specific to climate, Pitchbook’s VC Valuations Report for Q2 2023 highlights how that scarcity of funding is affecting valuations. According to the report, in the first half of this year, the median pre-money valuation for growth startups plummeted by more than 64% compared with the record high in 2021, dropping from $350 million to $125 million.
These numbers point to an exciting opportunity to invest in climate. The lower valuations will equate to greater ownership for investors, lending the opportunity for higher returns. Lower valuations can also benefit founders because they aren't forced to spend to grow into lofty valuations.
Between the leveling of the investor-founder relationship, the surge of companies ready to fundraise, and the acceleration of the market, climate tech is showing all signs of a growth-stage golden era. The next wave of climate success stories is coming, but getting there will require growth capital.