Something isn’t fitting right
Venture capital for climate solutions appears to have weathered the storm and is slowly re-emerging.
That’s encouraging for sustainability entrepreneurs. Especially right now, as I hear from many of them that they are stressed about the challenging prospects of raising new capital over the next 12 months. Uncertainty over the U.S. election, rising anti-ESG sentiments in the financial world, and unclear macroeconomic indicators (soft landing or a recession?) are still leading many venture capital and growth equity investors to sit back and wait rather than actively writing checks.
The slightly good news comes in the form of recent market numbers. For example, Pitchbook recently put out their Q1 Clean Energy Report, which did show a decline of venture capital investments in the sector in 2023 and into 1Q24, but certainly not a collapse. The terrific CTVC newsletter showed that early stage (seed to Series B) investments grew from 2H23 to 1H24 (albeit down from 1H23, of course). And there are reasons to expect further growth and recovery as Inflation Reduction Act dollars finally start hitting the market in the form of actual deployments — Rhodium Group and MIT CEEPR recently showed how much overall clean energy investments (beyond just venture capital) have been growing steadily over the past few years.
And while the US election later this year is adding uncertainty to the market, I expect that no matter the outcome we will see continued growth in deployment and venture capital investments in 2025. After all, such investments grew well during the Trump presidency, even prior to the Inflation Reduction Act. And while there is some justifiable fear that major parts of the IRA could be rolled back under a Trump administration, there are already signs that there really isn’t a lot of true political appetite for repealing major parts of the law. After all, (shocking, I know…) taking away incentive programs is never popular among the political donor class. So while some IRA policies could be reversed, and while certainly the results of the US election could significantly affect the pace of investment growth, we can still expect investors to react to ANY electoral outcome by once again getting out their checkbooks and getting to work. At least at some level.
So that’s all encouraging if your goal is to see venture and growth dollars flowing more readily into the sector over the next year. But there is a major hole in the climate solution venture capital story right now: Exits.
If venture and growth investors don’t make returns, they won’t keep putting capital into the sector over the long run. It’s that simple. And the major two ways they make returns are when the companies they’ve invested in IPO (rare) or get bought by bigger companies. Sometimes there are “secondary sales” of their shares while a company remains privately-held, but that’s not a dominant form of exit.
IPOs have been hard to come by for startups across ALL sectors since the capital market reforms of the mid-2000s. And especially for sustainability startups, which to be honest have rarely been ready (as in: big and growing revenues, with obvious and predictable profitability) for IPOs. There were a couple of recent years when the SPAC wave created a window for “early IPOs” but that window has closed and the results of de-SPACed clean energy companies have, for the most part, been unimpressive.
“Trade sales”, or acquisition by larger companies, have always been the more predominant form of exit in any case across all startup sectors. But disconcertingly, the Pitchbook report linked above shows that those have not been very available for clean energy venture and growth investors and their portfolio companies. The “clean energy VC exit activity” chart in that report shows that exits fell off a cliff in 1Q24.
This fits an overall frustrating theme I’ve personally seen in the clean energy sector. Many of the venture- and growth-backed startups in the space are technology developers, not project deployers. They’re technology innovators, not generally putting “steel in the ground”. Who will buy companies that are technology innovators in such industrial type markets? The group of buyers for certain types of industrial innovations tend to be very limited. In efficient lighting, for instance, it’s essentially an oligopsony of incumbent lighting manufacturers. In automotive, the universe of large companies is small and getting smaller. In power equipment, again it’s a small universe of big incumbents. And even worse, unlike in the IT industry, these big incumbents tend to be slow and unwilling to spend much on an acquisition. Over the years, I have personally seen how painful it is to invest into a really great startup in these sectors, spend years seeing brilliant entrepreneurs build products of proven value and with growing revenues, and still not be able to fetch a premium when it’s time for the company to get acquired.
To put it bluntly, the natural set of buyers for these innovations quite often suck. At least from the entrepreneurs’ perspective.
And yet, the vast majority of climate solutions venture and growth investors continue to view the sector primarily as a hard-technology innovation sector. Some do focus on software innovations over hardware innovations. But few focus on deployment-style business models, like project developers. Because, naturally, what’s “proprietary” (a/k/a unique) about what such businesses are bringing to the table?
At my firm, which focuses on partnering with relatively early deployment-style businesses in sustainability (those actually putting steel in the ground), we’ve seen a few exits over the past few years… but where the acquirers were bigger infrastructure investment firms. Not bigger entrenched equipment OEMs, but project finance firms that wanted access hundreds of millions in project pipelines and proven management teams with proven solutions. These haven’t been in “sexy” sectors that top the list for most clean energy venture and growth investors, but instead in more “boring” sectors like municipal composting and industrial wastewater treatment. These have been companies that are successfully deploying projects and have a long list of signed-up projects ahead of them. And we’re not alone — if you look back at the slim history of successful exits in the climate space, a disproportionate number of them are “downstream” business model innovators, not hard-tech innovators. And quite often, they’ve been sold to even bigger deployers, not to industrial OEMs.
The good news is that such big infrastructure investors currently have a lot of dry powder and are desperate for deal opportunities, which means they will be motivated in 2025 to put more capital to work, which could hopefully mean more such acquisition activity. The bad news is that so many venture- and growth-capital investors aren’t investing into the types of business that such infra acquirers will be looking for. And while hopefully the acquisition activity of more technology-focused incumbent OEMs will pick up post-election, that’s not a given. And who knows when the IPO windows will open and shut.
Exit activity has almost always been a big hole in the climate solution venture and growth investment story. My fear is that such investors continue to set themselves up to be subjected to the vagaries of unpredictable and/or unattractive exit paths. I hope not, but it’s at least something to be very aware of.