What Is Driving Climate Tech VC?
An empirical analysis of Climate Tech Venture Capital in 2013–2020
Introduction
The world has under 10 years to cut global greenhouse gas emissions in half and needs to be net-zero by mid-century in order to avoid warming of above 1.5*C. This calls for a wide-scale transformation of the world economy, and a global mobilisation similar to the scale of WW2. Entrepreneurs are critical drivers of innovation, as are the venture capitalists that help to fund & scale their technologies.
Having lost more than half of the $25bn piled into clean tech startups between 2006–11 (‘clean tech 1.0'), many VCs re-directed their focus to software start-ups that returned capital faster, more often and in a bigger way¹. Climate-focused venture capital has returned in the latter half of the 2010s, this time more deep-rooted and wide-reaching.
Climate Tech: Clean Tech 2.0
What is climate tech? While clean tech focused predominantly on more capital-intensive clean solutions in the power and transportation sectors, the latest wave of technologies is concerned with direct mitigation and removal of carbon emissions as well as adaptation across a multitude of sectors, from food & agriculture to supply chain and logistics. It spans a wider range of technologies with clearer paths of scale, many leveraging existing capabilities without requiring large capital outlays.
What has changed? A lot has changed since the 2000s. Political, economic and technological forces are aligning to encourage founders and VCs. Cost curves have come down, with renewables now largely competing with coal and natural gas, and software advancements have made it possible to push hardware beyond its previous limits. A more diverse set of actors are at play, with VCs increasingly partnering with governments, corporations and climate-conscious HNWs, and adapting to evaluate start-ups on longer time horizons. Governments are aligning to establish legislation and net-zero transition plans, with the US, China and Europe pledging to half emissions by 2030. Challenges still remain though — many of the necessary technologies are yet to be commercialised if not conceptualised, and face longer and more arduous routes to market.
What Is Driving Climate Tech VC?
Climate tech VC has seen impressive growth in recent years — venture deals reached approximately $16bn in 2020, 10x the level in 2013². A recent seminal report by PwC³ found that climate-focused VC is growing 3x the rate of venture funding for artificial intelligence.
As discussed, it is clear that there are various driving forces at play here. Though, in order to make some statistical inferences, I performed a regression analysis on 3 factors of interest that could be captured quantitatively: public awareness via Google Trends, climate excess stock market returns and aggregate R&D.
1. Public Awareness: Google Search Interest of “Climate Change”
Public concern over climate change has increased substantially over the past decade according to recent studies⁴. Consumers can have a huge impact on the demand-side for zero-carbon alternative products, driving their innovation & adoption. Google Trends search query data is a well-used measure of contemporary awareness. Here we look at searches for “climate change”.
A 2020 IBM survey found that 60% of consumers are willing to change their consumption habits to reduce environmental impact⁴
The results found a statistically significant relationship: a 1% increase in Google search interest was associated with a 1.7% increase in climate tech venture capital funding.
2. Total R&D Expenditure
More than half of the technologies we need to get to net-zero are in development or not yet conceptualised⁵. Many studies argue the importance of government policy in directly driving & setting the stage for climate technology innovation, particularly via R&D sponsorship. Aggregate R&D expenditure captures innovation effects from both the public and private sector. The observations are lagged two years to allow for the impact of spending to materialise into applied technology.
Early-stage R&D subsidies to startups approximately double the probability of landing VC funding⁶
The results were particularly interesting, suggesting that a 1% increase in aggregate R&D was associated with an impressive 6.6% increase in climate tech VC.
3. Climate Tech Stock Market Returns
Part of the problem in the previous collapse was that risk-adjusted returns (IRR realised through acquisitions or IPOs) for clean techs were unsatisfactory relative to other industries. Also, it is well documented that much of VC market volatility is owed to shifting activity and signals of industry attractiveness in the public markets⁷. The recent wave of climate tech unicorns such as Tesla and Beyond Meat has showcased the viability of disruptive sustainability impact, and climate indexes are outperforming the broader technology market. This analysis observed the excess monthly returns of the NASDAQ Clean Edge Index relative to the NYSE Arca Tech Index.
The results suggested another statistically significant and positive association: a 1% increase in climate excess returns was associated with a 0.5% increase in climate VC.
Conclusion
To conclude, the results of this regression analysis support the hypothesis that consumer, innovation and stock market dynamics have positive associations with climate venture capital and are key components of its growth. Government interventions are particularly critical in fostering innovation both on the supply-side, by providing early-stage R&D subsidies and direct financing to bridge the commercialisation valley of death, as well as on the demand-side, by setting the stage in terms of regulation and incentives to encourage private sector flows.
There has been remarkable growth in the venture-backing of start-ups that are finding smart ways to tackle climate change, but there is a lot yet to be done: every sector of the global economy has to deeply transform in order to achieve deep decarbonisation by mid-century. In addition to bringing the technologies we already have to market, we have to invest more in R&D for the high-hanging fruit (e.g. carbon capture, cement and steel) and use policies designed specifically to drive & scale the breakthroughs we need. An expansive effort from a myriad of actors (VCs included) to align technology, policy and markets will be crucial to driving necessary innovation and getting on the path to net-zero, particularly over the next decade. And these necessary innovations present a multi trillion-dollar opportunity for venture capitalists.
A special thanks to Dr Bruce Morley for his guidance as well as to George Mennem (Lazard), Nathan Ricks (G2VP) and James Wark (PwC) for their views & support.
Footnotes
- Gaddy, B., Sivaram, V., Jones, T., et al. 2017. Venture Capital and Cleantech: The wrong model for energy innovation. Energy Policy.
- As per Pitchbook data
- Azhar, A., Herweijer, Celine, Dr. 2020. The State of Climate Tech 2020: The next frontier for venture capital. PricewaterhouseCoopers.
- IBM. 2020. Meet the 2020 consumers driving change. IBM Research Insights, Kronthal-Sacco, R., Whelan, T. 2019. Research: Actually, Consumers Do Buy Sustainable Products. Harvard Business Review
- International Energy Agency. 2020. Clean Energy Innovation: Flagship Report July 2020.
- Howell, S.T. 2010. Financing innovation: Evidence from R&D Grants. American Economic Review.
- Gompers, P., Lerner, J. 2008. Venture capital investment cycles: The impact of public markets. Journal of Financial Economics
