Climate Tech’s Great Re...shuffling?

Venture capital investments in climate tech startups have plummeted 40% this year compared with the first half of 2022, according to a report out on Friday from Climate Tech VC, a market intelligence platform that tracks the space.

The trend is in part a reflection of a larger downturn across the broader startup landscape, which one prominent investor predicted earlier this year would lead to a “Mass Extinction Event” that “will make the ‘08 financial crisis look quaint.” Startups in all sectors are struggling to fundraise, thanks to macro conditions like the Federal Reserve raising interest rates to fight inflation and the related collapse of Silicon Valley Bank.

But the picture may not be quite as dire for climate solutions, which saw less of a decline than overall VC funding, which was down more than 50% in the first quarter of the year, compared to 2022, according to Pitchbook. Some areas, like startups working to cut emissions from buildings and heavy industry, are even seeing a boost, likely due to incentives in the Inflation Reduction Act. So far it’s more of a great reshuffling than a Great Recession.

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“I wouldn't say this is the second coming of clean tech 1.0,” Kim Zou, the co-founder of Climate Tech VC, told me. She was referencing a period in the early 2000s when venture capitalists poured billions into green technology companies and lost more than half of their money. “It's not that all of a sudden, it's a sharp drop off. It's actually that 2021, 2022, one could say that period was a bit of an abnormal peak,” she said.

Helen Lin, a partner at the VC firm At One Ventures, agreed that what’s happening is more of a market correction and a “return to fundamentals” than a calamity. In 2021, as the country was coming out of the worst of the COVID-10 pandemic, there was “a little bit of a bubble forming,” she told me. Lin said company valuations were overly optimistic and investors got a little sloppy, letting go of key metrics for later stage investments like revenue.

“It feels like when you're in one of those kiddie swimming pools and all the kids are thrashing about all at once, and there is all this frothy noise in the water, that's basically how it felt,” she said. “All these kids jumped in the pool because VC looked easy in 2021, there were deals everywhere.”

While overall funding for climate technology startups is down, interest in the sector is clearly not drying up. There was actually an increase in the number of deals made in the first six months of this year compared with last year by about 8%. But most of those deals were at the seed stage, where total funding also grew by 20%. Meanwhile, growth stage funding dropped a significant 64% — twice as high as the drop in growth VC across the economy.

Courtesy of Climate Tech VC

To Zou, that reflects one of the primary challenges with climate technology, which is that companies face a much sharper “valley of death” than in other sectors. Many of the solutions needed are hard technologies that require a lot more capital to get past the proof-of-concept stage. Companies may have to build factories and work out new supply chains, both of which are expensive undertakings.

There’s also been a shift in the types of climate technologies VCs are funding. In 2021, investors made their big bets in electric vehicles and batteries with companies like Rivian and Northvolt raising more than $2 billion each. Now, VCs seem to be less interested in the end-products that directly reduce emissions, like EVs, and more interested in early stage companies that could enable more EVs to get deployed, like those specializing in mining, EV charging optimization, and fleet management.

Lin said that similarly, while enthusiasm for alternative protein companies has cooled slightly after industry leaders Beyond Meat and Impossible reported declining revenues last year, that’s not the full story. There’s still a lot of interest in funding innovative alternative protein startups, but more as a “functional ingredient” to supply to other food companies, rather than as a consumer product.

Investor interest in carbon management startups may also be shuffling around. VC funding in the sector has so far dried up by more than 50% after a big increase last year. Claire Nelson, co-founder of the carbon mineralization startup Cella, which just closed a seed funding round of $3.3 million, told me that investments seem to be shifting from the technologies that capture carbon to the support infrastructure, like carbon transportation and storage. Cella is developing novel injection and monitoring methods for carbon sequestration.

Courtesy of Climate Tech VC

On the flipside, the report notes that startups working to cut emissions from the built environment, like heat pump companies, and from heavy industries, like cement and steel, saw a 7% increase in funding, likely due to new government subsidies in both the E.U. and the U.S. targeting those sectors.

The impact of climate tech funding is more than a financial concern. The International Energy Agency estimates that nearly half of the emissions reductions required to reach net-zero by 2050 will have to come from technologies that aren’t yet commercially available. VC firms don’t just provide the capital for startups to get off the ground, but they also provide a support system for scientists who may have never scaled a business in their lives, said Lin.

“You need people that know how to be the connective tissue between people who speak the language of science, and people who speak the language of scaling up a business in a commercial way,” she told me. “These are all the day-to-day tasks that we work on in a very real way with our portfolio companies.”

Historically, the latter half of the year has been when most VC is deployed, so time will tell if the report truly does reflect a market correction, or foretells a more worrisome trend.

Read more about climate tech:

Climate Tech Hits a Bit of Turbulence

Death of a Climate Bank

The Race to Tesla-ify Heat Pumps