Unprecedented net zero commitments by governments and businesses; increasing demand for clean energy solutions; decreasing renewable, battery, and other technology costs; and an escalating shift toward sustainable investing all point toward an optimistic outlook for climate tech.
Capital-intensive climate tech companies tend to require longer to reach scale than asset light high-tech firms; however, early data indicates that performance is improving and becoming comparable with wider private investment universe.
1. Understand the Market
Climate technology presents us with an incredible opportunity to transform our world for the better, particularly as more businesses adopt ambitious Net Zero goals backed up by Paris Agreement and financial system’s clear emphasis on carbon accounting.
But many of the technologies needed to advance progress remain under development – making securing venture capital an even tougher hurdle for start-ups seeking progress. Investment has often focused on sectors with higher emission contributions like mobility compared to those reducing heavy industry impact or improving energy efficiency, according to PwC reports. As a result, innovations aimed at mitigating these impacts or improving energy efficiency may get less attention than they deserve.
Thankfully, the market is evolving. More industrial companies are seeing the value of climate tech and investing their own capital in innovations that will help them meet their Net Zero goals, ultimately expanding the overall pool of capital available for climate start-ups.
At the same time, there is an increasing awareness that combatting climate change will require more than innovation from start-ups alone. Major banks are making strides toward this end goal as well.
As demand for clean technologies surges, so too do their financing challenges. In order to attract more investors, start-ups must do a better job demonstrating how their technologies will address climate change while being tailored specifically for individual markets. Furthermore, their business models should also adapt with changing market needs.
At this point, the skills gap becomes obvious. While software companies can often be scaled by entrepreneurs with strong engineering knowledge and the ability to sell their ideas effectively, climate tech requires additional abilities such as project management and an in-depth financial knowledge base for success.
At present, many of the tools that have helped software firms thrive are also available to climate start-ups. Accelerators now offer tailored courses for budding clean tech entrepreneurs seeking capital, while larger VC firms have dedicated teams dedicated to teaching start-ups how to navigate the complex world of finance.
2. Understand the Technology
As we race to maintain 1.5C temperatures, it’s critical that we boost innovation in climate technology. This includes technologies necessary for decarbonizing energy use, transportation, heavy industry processes, food and land use as well as our built environment. These innovations also generate economic advantages by creating social value while remaining cost competitive over time.
These technologies range from carbon-neutral energy sources (renewables, batteries and carbon capture and storage) to advanced materials like green concrete and net zero chemicals – but their development can be slow and challenging. Venture capital firms typically don’t see these as suitable investments due to a lack of cash flow for future expansion – while private equity may also lack interest due to insufficient commercial applications and too early stage businesses being built for them to attract significant bank financing.
Capital-intensive climate tech solutions often involve new production processes that are challenging for even experienced engineering professionals to oversee. To reassure investors and secure project debt finance, such companies must demonstrate that their production process is both viable and robust through an engineering certification study or other independent third-party assessment; also making clear its cost effectiveness compared with existing products or services that they’re replacing.
An increasing number of startups are developing proof-of-concepts and, thanks to groundbreaking government programs (such as US IRA and EU Green Deal), more funding for capital-intensive climate technology could become available in the near future. But for any industry to advance quickly, its leaders must also take measures to reduce risks and accelerate deployment.
Attaining this goal involves mitigating political and construction risks in emerging economies through blended-finance partnerships led by multilateral or bilateral development banks; diversifying production and supply chains as much as possible to avoid overreliance on any single supplier; this strategy ensures companies across sectors can benefit from climate tech; for instance, creating a carbon neutral city requires numerous climate-friendly technologies ranging from advanced building systems and transportation infrastructure, waste management strategies and smart grids – among others.
3. Understand the Business Model
Tesla and Amazon have taken the lead in developing zero-emission cars and buildings, placing sustainability at the core of business strategy. Sustainability-minded startups are springing up across sectors that offer solutions that tackle climate change. Their solutions have attracted billions in investment dollars while creating jobs.
But all isn’t well with climate tech businesses; capital-intensive climate tech such as green steel and carbon capture and storage require large initial investments of capital in order to fully realise their potential, with much longer horizons required to break even and scale than software or asset-light businesses.
Successful climate tech businesses leverage relationships with equipment providers, suppliers of materials and components and engineering, procurement and construction firms in order to secure supply contracts. Additionally, these successful capital-intensive climate tech businesses often negotiate long-term supply agreements in order to meet their growth ambitions and reduce costs by employing technical expertise that may not be readily available within the wider VC community.
Climate-tech sectors often face obstacles in accessing private capital due to significant upfront investments and long timelines for reaching commercial viability, making private capital scarcer than usual. Compounding these challenges are the company’s needs for building internal capabilities not required by most VCs – such as project management expertise and financial acumen that typically is not taught in business schools.
Unlocking private capital for climate-tech opportunities requires an international effort involving entrepreneurs, venture capitalists and investors; banks that support growth stage investments; strategic corporate or institutional buyers and governments with policy incentives to speed the energy transition. For instance, HSBC is working alongside other global institutions to connect early stage climate tech companies with potential off-takers and buyers.
No easy feat, yet this effort is essential if we wish to prevent climate change’s worst impacts, which would be devastating for businesses and society globally. Although challenges will certainly arise from this initiative, we remain confident that its success can be assured.
4. Understand the Financials
Business models for physical and digital solutions to mitigate climate change can be complex. First-of-their-kind infrastructure projects often require significant capital, while investors accustomed to low-risk, cash-flow positive enterprises may find them hard to finance. Due to these complications, there is currently a $2 trillion funding gap for climate tech – this figure includes both existing technologies such as hydrogen production, sustainable aviation fuels, carbon removal technology as well as waste-to-value systems, waste storage and long-duration energy storage technologies.
As the Paris Agreement increased investor trust and set clear emission reduction goals by 2030, investment into climate solutions has dramatically increased. A growing interest is evident by ‘climate tech unicorns’ (startups with valuations exceeding $1 billion) becoming available; yet venture capital and private equity funding may not reach scale necessary for successful implementation of climate solutions.
Capital-intensive climate tech solutions must develop a financing roadmap and plan to access lower-cost equity, project finance and debt at scale. To do this, they will require skills not typically found among start-ups – including supply chain buildout, engagement with regulators and policymakers, risk management, financial structuring and marketing expertise – in addition to access to corporate buyers or public sector off-takers. This may necessitate alliances with larger institutions that specialize in these areas as well as accessing corporate buyers or public sector off-takers for financing needs at scale.
An industrial company seeking to invest in greener facilities could benefit from partnering with a global bank like HSBC, who works closely with global institutions to connect early-stage climate tech firms with potential partners who could assist with expanding their business, provide strategic advice or invest alongside them.
One key consideration is balancing investments across sectors in accordance with their contributions to overall emissions. Mobility tech has been overfunded given its emissions contribution (although this trend may have reversed by 2023), while food and land use technologies remain underfunded. We believe this imbalance can be addressed by creating an ecosystem of institutions and stakeholders – governments, philanthropists, foundations and development banks among them – who together could offer tailored support to entrepreneurs so they can unlock all of their potential.
