The Paradox

Writing demands time and the brightest spark of inspiration and, this piece is no different.

Yesterday, Sarah Nolet’s words on Climate Salad’s post on LinkedIn about #climatetech #predictions2024 were the spark I needed to put into words these thoughts that were in my mind for months, and I quote:

“climate tech solutions are transforming atoms and molecules, not just bits and bytes”.

In other words, climate-tech startups work with tangibles — the atoms and molecules ;) — to create solutions, oftentimes hardware-based, that solve pressing climate problems. Something, by the way, extremely hard to achieve that in investment terms could be translated as:

1. Very risky
2. CAPEX-intensive
3. Involving longer capital return periods

… and such a triad of very risky, CAPEX-intensive, and longer capital return periods are not today's VC’s cup of tea.

I repeat, are not today’s VC’s cup of tea, but the oppossite was the case in the 1960s.

In fact, the VC industry was the financial innovation that the US financial market came up with in the 60s to provide large amounts of capital for a very risky and CAPEX-intensive industry: the semiconductors industry.

That is what I call a paradox. Wouldn’t you agree?

Hold on, there is more!

The very risky, hardware.based, CAPEX-intensive semiconductors industry, became fertile ground for another way more profitable than its granddaddy: the software industry — those bits and bytes :) A more profitable industry, because in software the innovation cycles, unlike those of granddaddy, happened faster, with very low CAPEX while generating bigger multiples for investors, starting at 5x, then 10x, 20x, 30x, 50x, and, now even 100x.

The first wave happened in the 70s with Microsoft, Oracle, Apple, Adobe, Cisco… The 90s followed with Google, Netscape, Amazon, eBay, Yahoo, Salesforce.. Then in the 00’s with SaaS and Social web…

In other words, for the same amount of risk, investing in software was way more profitable as the return cycles shortened while capital multiples grew almost exponentially. Which makes sense for any private investor.

Still, I wonder: would these profitable waves have had a perverse effect on the VC ecosystem, reining it in, avoiding risk, and choosing the path of least resistance?

If the answer to that is yes, it would explain why climate-tech and particularly hardware-based startups are not getting the attention of VCs and other sources of private capital as the semiconductors had.

In my view, if private investors settle and avoid investing in climate-tech and particularly hardware-based startups, they may be making a big mistake, as the green economy is a trillion dollar business a year, according to McKinsey.

Don’t you see the resemblances between semiconductors and the climate-tech industry? They both:

1. Create a new technological paradigm.
2. At the onset both wre high-risk, CAPEX-intensive, and with longer capital return times.
3. Become a fertile ground for other industries to flourish generating business growth and global wealth.

So, if investing in climate tech and particularly hardware-based startups — those working with molecules and atoms ;) — is the way to go, then it is imperative to come up with a proper answer to the following question:

How do we transmute risk into excitement, so VCs and other sources of private capital invest with confidence in this new paradigm? What is the financial and legal innovation needed for that to happen?

My take: Make collaboration among agents in the value-creation chain the key instrument to dilute risk while exponentially accelerating value creation and wealth. For that, some legal and financial innovation would be needed.

Additionally, I believe that it would bring a lot of clarity and it would make capital allocation more efficient and effective if family offices were more visible in the ecosystem so it was clear to others what their investment thesis and expectations are.

My ideas aside, there is a very interesting research piece led by @planet A in Germany that analyzed if there was a funding gap with hardware-based climate-tech startups, and if so, why and how could be overcome. The answer is YES there is a huge gap, and these are the potential solutions to allocate more capital:

1. De-risk the market through regulations and legislation.
2. Promote publicly backed programs for long-term patient capital.
3. Promote investment facilitation and encourage institutional investors.

I’m looking forward to reading your comments, and I hope despite the interest rates being still high private capital will flow to support this new economic paradigm: the green economy and particularly climate-tech hardware-based startups.

You can access the research piece here: https://sustainable-finance-beirat.de/wp-content/uploads/2023/12/SFB_Discussionpaper_Startups_Transformations_Finance_2023.pdf

To read the 2024 prediction post, follow this link: https://www.climatesalad.com/posts/2024-bold-predictions