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Will 2024 Be the Year of micro-M&A in Climate?
5 reasons why climate M&A is primed for an active 2024
In the last quarter, the oil and gas industry transacted almost $150B in mergers and acquisitions. Exxon acquiring Pioneer and Chevron acquiring Hess received all the headlines, but there were "smaller" acquisitions, too.
Climate tech has a decade or more before it will reach this scale. These numbers, however, give us a sense of what is possible in the years to come. But we have to start somewhere, and 2024 could be where it all begins.
We've seen record startup funding in climate over the last five years, and for the first time in a while, valuations make sense and have remained steady. As a result, the bid-ask spread is decreasing - a precursor to more activity.
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Record Funding Sets the Stage
From 2019-2021, over 2,000 climate tech companies were funded by venture capital, an overwhelming amount being pre-Series C. These numbers dwarf any previous period and create the companies needed for both sides of M&A transactions.
Many of these companies have or will stall at less than $10M in revenue. This isn't a commentary on the industry's maturity but represents the normal progression of all software startups.
These record funding and the number of companies that started in the last few years set the stage on both sides of the M&A equation. We have a record number of buyers and sellers at the same time.
Private Equity and Strategics Require Scale
Like the funding environment, the exit market accelerated from 2019-2021. PE firms and strategics purchased companies at record rates at much smaller revenues than in previous cycles.
During this time, the average acquisition was less than $25M in revenue, according to Energize’s analysis, and well below profitability. Most of these companies were still high-growth, but even that ceased to be a prerequisite in a hot sector.
Fast forward to today, and the market has changed. Exits have grind to a screeching halt, and those still happen do so at scale. The average exit to a strategic or PE firm in the last 18 months has tripled to $75M, and profitability is a requirement. These firms are back to buying platforms (PE) or business units (strategics) - this is the norm, not 2019-2021
As a result, a lot of firms with sub $20M in revenue and 50% growth will be left without obvious homes. Well-funded private companies will be the natural best fit.
Investors Increase Standards and Protect Their Own Portfolio
Private equity and corporations weren't the only ones to increase their standards over the last 24 months. Venture capital investors have also raised the bar on what is required to raise significant capital.
As startups raised capital at record rates, venture capital firms in climate were doing the same. Yet, climate tech funding plummeted despite these funds being squarely in their investment periods.
There are two culprits. The first is that venture firms have raised the bar for what's investible. Gone are the days of growth at all costs. Instead, investors are looking for high-growth but with reasonable unit economics. If you're spending for the sake of spending, you've become a lot less attractive.
The second is reserves. With a tightened market for new investments, venture firms are reserving more than ever. The smart money plows more capital into winners and spends very little protecting companies that have trouble finding traction. The remainder of the reserves go into companies that are likely to have an exit and need capital to make it there. Those companies are primed to be acquisition targets.
Platforms Start to Emerge
One consequence of the tightened fundraising market over the last two years was that the rich got richer. If you were a high-growth, capital-efficient company, investors were knocking down your door to get on the cap table. As a result, these companies now have war chests to acquire competitors in a market with suppressed valuations.
In the recent past, it was easy to assume that if a startup raised a large round, it must have meant the burn was incredibly high. Today, if a company raises a massive round, it's just as safe to assume it's a quality company fortifying its balance sheet to become the dominant player in a sector.
These companies are now primed to buy the features they don't have and do so in a way that makes sense for their scale and integration capabilities.
AI Demotes Startups to Features
Yes, I had to include AI here, but hear me out. There are a lot of technologies that AI made features overnight.
On-site image capture with a great UI/UX was once considered an excellent investment. Now, capturing images as a data input for AI will become table stakes for many platforms looking to become systems of record.
Low-code platforms and chatbots are now superpowered and can be built by anyone, thanks to AI-powered IDEs and ChatGPT.
Overnight, the enterprise value and investability of a lot of startups decreased. They would, however, make great add-ons for companies well on their way to becoming platforms in emerging sectors.