Demystifying Climate Tech

What we can learn from the past …

In the course of my master studies at Rotterdam School of Management, I wrote my thesis about venture capital investments in the cleantech industry. An area that I’m personally interested in, passionate about to be more precise. And a field that I firmly believe will have a positive contribution in shaping our sustainable future and will be one of many enablers to reach our climate goals. I had the chance to speak to various industry experts, from venture capitalists to founders, who provided me with insights and shared their knowledge: thanks for your time and openness and for giving me further inspiration.

In the early 2000s we experienced the first wave of Clean Tech Venture Capital investments which ended with a bloodbath — companies failed, investment dollars were lost, and renowned VC funds stopped investment activities within the sector. These happenings are still in the back of people’s minds, and the sectors’ image still suffers from a bad reputation. This has been reflected by decreasing investment activity after the burst of the bubble. As I started my research, I wanted to profoundly understand why the first wave of cleantech was unsuccessful, why the cleantech industry had such a bad reputation and why investors nowadays tend to be careful when it comes to venture funding in this sector. To better understand the industry dynamics, I figured it is best to look at the past developments of venture capital investments within the industry and to speak to industry participants.

But first, we need to clarify what cleantech exactly is. As with every industry, it might be challenging to get a broad overview, without getting lost in subcategories. CleanTech or Climate Tech, as you might call it these days, is covering several industries such as (1) Energy, (2) Food and Agriculture, (3) Water (4) Alternative Materials, (5) Transportation. In the course of my research, I focused on the subsector of energy.

Cleantech on a rise

So let’s start with looking at the early 2000s. CleanTech start-ups attracted USD 25 billion in VC investment between 2006 and 2011, a trend triggered by rising fossil fuel prices, new regulations, and increasing consumer awareness. Kleiner Perkins, one renowned venture capital fund in the United States, initially allocated $200 million to investments in the CleanTech sector, followed by an announcement to launch a green growth fund worth $500 million. But instead of generating significant returns, a high number of investments were unsuccessful, and the cleantech bubble quickly burst. A financing model usually used for funding software firms was applied to a sector that was, back then, driven by hardware intensive business models and long development cycles.

We know that a broad trend towards a sustainable energy transition triggered investment dollars into that industry in the first place. But if there was a significant trend and public awareness about the need for change, why did the bubble burst? Let’s keep it simple: a combination of long development cycles, capital intensive & unproven technologies and an unstable regulatory framework was responsible for missing returns. Considering all these factors, we have to ask ourselves whether venture capital is the right model for energy innovation and whether venture capitalists can adapt their investment strategy to industry-specific characteristics to make a successful investment and drive innovation.

When I was looking at past developments and analyzed what happened in the early 2000s it triggered me to find out what we can do differently this time to show that venture capital can be a successful financing model. Venture capital investments are, from the nature of this asset class, a high-risk investment coming along with a high number of uncertainties.

… to be prepared for the future

The second wave of Cleantech

In 2019 a record of 36bn USD was poured into climate-related tech, which according to the Cleantech group more than doubled compared to 2015 figures. So today we can see that the cleantech industry is flourishing due to a couple of reasons. First and foremost falling costs of existing technologies have driven an increased level of innovation. Clean technologies have not only become better in performance but also cheaper over the past years. Cost of hardware has been falling, and technologies have been commoditized. Moreover, technical risk has been reduced tremendously, which enables the development of new business models. It opens up opportunities for establishing businesses that are typically financed by venture capital dollars: software models.

Additionally, rising consumer awareness and an increasing urgency for the need to take action have changed consumer behaviour and driven political activism and regulations. Many states, and on the forefront the European Union, are committing to achieve net zero-emission and decarbonize the economy in the upcoming decades. Not only can action be seen on a state level, but also on a company level, as large corporates are starting to commit to “net zero” emission plans.

However, all that glitters is not gold, and the current developments might sound pretty similar to what happened in the early 2000s. Only because technological risk has been reduced and increased awareness can be seen, it doesn’t mean that all risk has been eliminated. Is this just another bubble expecting to burst in the next years?

What we need to keep in mind

I firmly believe that it is different this time. However, we need to adapt our investment behaviour by learning from what happened in the early 2000s to secure VC Climate Tech investments’ success. During my research, I identified three main factors that should be kept in mind when investing:

1. Investment Horizon

Innovative business models and their underlying technologies in the cleantech space have proven to take longer to develop and demand a higher amount of funding to reach a certain maturity level. One way of circumventing this challenge is to extend the investment horizon. Breakthrough Energy Ventures, which was founded by Bill Gates and included investments from two of the most prominent VCs of the last boom, John Doerr and Vinod Khosla, invests on 20-years cycles. An alternative fund structure that circumvents the standard life cycle of a fund is one possible solution. Alternatively, by taking on public funding and benefitting from increased governmental support, funding gaps can be closed and herewith speed of development can be increased.

2. Diverse knowledge and expertise

A team of investors with diverse and contrasting knowledge and expertise helps reduce uncertainty coming along with an investment tremendously. Good venture capitalists can demonstrate multifaceted know-how with a strong focus on technological expertise and business knowledge. To increase the reservoir of knowledge, Co-Investors should be chosen by following the goal to contribute versatile knowledge and expertise to the board. Which brings me to the last point:

3. Industry-specific know-how

Another factor influencing the level of uncertainty coming along with an investment is industry-specific knowledge. Having an investor on board that knows the industry’s specific characteristics and dynamics contributes positively to making successful investments.

Summing up the above, we can see that primarily external and industry-specific factors favour a new era of venture capital investments in climate tech. Whereas technologies in energy innovation dominated the first boom in the climate tech sector, this time, the focus is more broadly, covering all the subsectors mentioned above. As this research focused on energy, the information and findings might not be applicable to all the Climate Tech subsectors.

I strongly believe that failures from the past contributed to the development of the cleantech industry and will enable improved investment behaviour. Let’s not forget what happened in the early 2000s, but instead, use the lessons learned to secure success this time. In my eyes, venture capital is not just an important, but rather an indispensable source for generating innovation and driving change.

Let’s start acting. Let’s start investing.