The last two years have seen changing sentiment towards early-stage investment in climate tech, meaning founders now have to think differently to secure additional capital, writes Andrew Coull, Head of Cleantech & Renewables at Gneiss Energy.
Times are tougher for climate tech founders now than they were even a few years ago, when techno-optimism, buoyed by strong ESG sentiment and low interest rates, made early investment rounds if not easy, then easier than they are today.
That world has changed. In many sectors, delivery timescales are extending, and new technologies are not being adopted as quickly as initially thought. This has led to mounting commercial pressures, with delays in profitability necessitating additional funding requirements from often fatigued existing investors.
Combined with a reassessment of their approach to ESG amongst some investment firms, the net result is a more cautious investment community less willing to support the lofty valuations of 2021-22, with many founders now looking at flat future rounds at best.
In addition, early-stage climate tech is also often hardware-based, requiring significant capex and ‘first of a kind’ (FOAK) funding, sometimes with many years still to go before reaching profitability. For some sectors, the market for adoption may not yet exist, and to make one strong political buy-in is still required to create one, based on a subsidy, tariff or carbon tax – such as for hydrogen or CCS. In an environment of huge political and regulatory uncertainty however, government support to underpin climate initiatives is increasingly unstable.
In contrast, many software companies are seen as able to scale without a substantial step up in investment, and as a consequence some climate-tech-focused investors have gravitated toward the current venture capital preference for low capex, SaaS products with less upfront investment and faster time to market.
In summary therefore, the world has changed substantially for climate tech founders seeking investment.
Finding a match
However, equity investment is still available for founders able to demonstrate a strong fit with investors’ key criteria in the new world, particularly as, in a market saturated with AI-driven software plays, the energy sector stands out as a space where critical hardware technologies, underpinned by patents and deep in-house technical expertise, can offer defensible commercial positions. Here are some pointers:
1. Revenue matters more than ever
Cash is king and the days of funding endless product development with multiple equity rounds are over. Investors now see revenues as an important source of ongoing financing for the business and the number of funds investing in pre-revenue companies has dropped significantly.
Many funds now have a £1 million ARR requirement for potential investee companies – chosen to demonstrate market traction with a proven technology. Founders need to recognise this and specifically build an early-stage business plan which allows them to achieve these revenue levels before they go out to mainstream VC funds.
Similarly, at £5 million ARR another category of investors – growth equity – starts to become available to fund the scale up phase of the business, and founders need to reflect this in their growth plans.
2. Don’t rely on the green premium
Investors are increasingly cautious about business plans which are based on substantial green premium pricing. Even where evidence of pricing multiples for clean product alternatives exists in current markets, investors are unlikely to accept these conditions will continue in the longer term and will expect investee companies to have modelled the impact of price reduction over time.
Founders therefore need to develop business models that can withstand green price reversion to 1.5-2.0 times the ‘non-green’ price per unit, or at least be able to demonstrate this through sensitivities and scenario analysis.
3. Don’t rely on regulation
During the last ten years, new regulations designed to reduce carbon emissions have created new markets and opportunities for climate tech founders throughout the value chain. However, as political will and social pressure to follow through on these regulations begins to falter, investors are becoming increasingly nervous that ESG legislation may go backwards and companies whose products or services are reliant on ‘regulatory-pull’ to force their adoption at scale, are at risk.
While regulatory support is still valuable, founders need to ensure that their business model is not entirely reliant on it in the long term and they can do this by demonstrating the fundamental need and value to their customers even in the absence of regulatory drivers.
4. Consider corporate
For companies developing hardware technologies, we have seen the increasing importance of corporate capital coming to the table – where a good fit can bring investment as well as knowhow and a clear route to market.
The right corporate can be the ideal investor/partner, with a longer time horizon, product synergy and nameplate recognition – ideal for many customers where safety and reliability are top considerations. For example, GEA’s recent £10 million investment in heat storage scale up Caldera, where the German industrial heat pump leader has taken a stake in a complementary but new technology.
Coming out of a relatively benign economic and political environment into the current market where interest rates are higher and being a green alternative does not automatically open up the taps to funding and a higher valuation, founders seeking investment need to understand the new investor mindset and design their business model and investment proposition accordingly.
This includes presenting a base case and growth scenarios which can be driven as much as possible by the company itself rather than relying on external market conditions or current regulations. It also requires founders to align their revenue forecasts with projected funding needs to ensure they are not asking investors to take more commercial risk than they are willing to accept, or where that is not possible, they are approaching investors with wider strategic objectives such as corporates and CVCs.