There is a shakeout already underway in sustainability private equity, infrastructure, and venture capital. The big question is — will it end in six months or eighteen?
In the back half of 2023, the private markets retrenched. Venture capital financing in the US dropped 30% from 2022 to 2023. Global M&A volumes appear to have dropped 20% yoy. As interest rates rose, global infrastructure fundraising ground to a halt last year.
Sustainability-oriented investments across these asset classes were not immune from the effects. As with the broader private markets, sustainability private equity also pulled back.
There’s no reason to believe this pull-back won’t continue into the first half of 2023. While inflation has come back down, interest rates have continued to stay high, and the forecasts are for them to remain elevated versus historic lows.
So what does this mean for sustainability entrepreneurs and investors?
In the first half of 2024 we’re likely to continue to see both a shakeout and a valuation reset. Anecdotally, at my firm we’re already seeing all of the above, and others agree. Some venture firms have shut down, others have largely sat on their hands for the past few months. We see lots of examples of repricing and lower valuations among venture backed companies, at least among those who are actually able to raise capital right now at all. What I hear firsthand from observers of private infrastructure is that those investors are also likely to be on a pause in the first half of 2024 because of interest rate effects — when debt was cheap, many acquired operating solar and wind assets that in the current debt environment are no longer so profitable, which just dampens enthusiasm for new deals while that’s being sorted out. And of course, leverage being the lifeblood of buyouts, those deals are being pulled back or repriced as well.
Venture-backed companies need to either be able to tell an incredible and obvious growth story to be able to raise new capital, or they need to show a short-term path to cashflow-positive. Some of the growth story could be sectoral. AI, for instance, is red-hot. And, it turns out, sustainability and climate are also somewhat insulated. While “cleantech venture capital” is down like all of venture capital, it’s increased its market share within the asset class during 2023. Sectoral tailwinds matter. And climate remains an obvious megatrend.
Meanwhile, dry powder is at record high across most of these asset categories as well. That’s capital all of these firms have raised that needs to be put to work, as pension funds and other limited partners don’t like to pay management fees for capital that’s just sitting around.
So putting this all together, the first half of 2024 in private sustainability investments looks like it’ll be a period of continued shakeout and flight to quality. Startups, companies and projects that seem like clear “winners” will still be sought after, albeit probably at lower valuations than during the heady times. But those that seem more risky, whether because of high cash burn or just simply riskier prospects going forward, may find tough sledding. Momentum and the perception of risk always matter. In the first half of 2024, more so than usual.
And in the latter half of 2024, given all the dry powder and clear signs of sectoral momentum, sustainability and climate investments will likely be the first to come charging back across VC, PE and infra. As a recent panel session by NRF made clear, infra investors are much more likely to chase any project with “ESG” attributes than “thermal” (as the current euphemism for fossil-fueled power projects goes). And many VCs also agree this is a sector with long-term legs. And the massive wall of federal spending from the Inflation Reduction Act toward climate solutions is only now truly starting to hit.
The wildcard will be the US federal elections. If as the second half of the year approaches, it appears that there is not only a good chance a second Trump presidency but also a likely federal pullback on the Inflation Reduction Act and other existing climate policy frameworks, that could further spook investors. Even then, the megatrend remains clear and a big chunk of the investment opportunity isn’t bound to the U.S. specifically, so that would likely only delay the rush back into the sector.
Barring that scenario, expect a rocky first half of 2024, and then a big influx by private equity back into the sector by the end of the year.