ClimateTech 2023: Lessons from the CleanTech Bubble
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The climate industry has been a rollercoaster across the last two decades. After a dormant innovation environment for the industry, we’ve seen a record amount of capital raised by private investors and deployed into ClimateTech startups in the last three years. This is a notable increase from the $10B lost during CleanTech over a decade ago, which shattered investor returns and the industry’s reputation. While climate’s “comeback” has been years in the making, we’re big believers in learning from yesterday to understand tomorrow at Equal Ventures. As such, we conducted a deep dive into the market parallels between ClimateTech and CleanTech to identify the lessons from the past that we believe are important to apply to our work in climate today.
Is This Time Different?
While the $40B+ in ClimateTech today dwarfs what we saw across CleanTech by almost 2x, both market cycles mirror each other across 4 key parallels.
Although many of these hypotheses fared well during CleanTech, their successes didn’t necessarily translate into VC returns. Perhaps most pivotal of these was the failure to pass carbon legislation, which ultimately killed projects and technologies reliant on it to achieve economic parity. That said, consumers and investors leapt towards the sustainability imperative, increasing awareness and emphasis on spending for sustainable products across categories ranging from CPG (Burt’s Bees) to EVs (Tesla) or solar (SunRun). Renewable cost curves also came down, achieving economic parity with the high-emission baseload sources historically used for power production. Similar to today’s environment, a tremendous amount of federal funding was indeed committed; however, these dollars delivered mixed results given the varying efficiency of the government disbursement process. Ultimately, while the majority of the hypotheses for CleanTech held true, unfortunately the promise of the revolution did not.
The CleanTech market crashed hard after its rapid run-up, decimating returns (and even some firms). VCs lost over $10B after deploying over $25B and public CleanTech company valuations dropped by almost 70% between 2008-2009. The collapse of this market scared innovation capital away from the sector until recently, taking an immeasurable toll on climate progress.
As we look at today’s set of hypotheses, the early data points are encouraging. Continued market deregulation has created new sets of economic incentives to empower clean energy solutions and DERs. We’ve also seen stakeholders from consumers to corporates put their money where their mouth is, driving over $75T of demand for sustainable products in the last 2 years and standing up massive climate initiatives, like Stripe Climate or Amazon’s Climate Pledge Fund. This has coincided with a flood of ESG capital into the markets looking for a home in climate-related projects and companies. Cost curves also continue to fall rapidly, enabling renewables to now make up 20% of overall grid capacity in the US and we’re witnessing the cost of batteries actually come down faster than what we saw for solar. Although CleanTech legislation stalled, we’re now seeing federal funding commitments for improving renewables economics rise with the passing of the IRA and its proposed 10x increase in energy spend across the next decade. The parallels of these catalysts are uncanny, but the question is whether we can achieve a better result than last time. Our belief is that the only way to yield a different outcome is to learn from our mistakes of the past.
What CleanTech Got Wrong
While CleanTech’s core hypotheses were largely right, we believe there were 3 principle mistakes made by VCs that destroyed the sector and inhibited additional investment for more than a decade.
1) VCs invested in areas they didn't understand, often leading to bad advice and mismatched capital. One of the starkest phenomenon of the CleanTech bubble was the swarm of traditional software investors migrating to hardware and material science innovations. Simply put, this led to a lot of investors with great competency in digital technologies giving advice and direction to founders in an entirely different arena where they had zero experience. As we wrote in The Great ClimateTech Debate, “I don’t think the venture community would provide the same leeway to a hedge fund manager or nuclear scientist (both of which are undeniably very smart) investing in a seed stage SaaS company.” Scaling frontier technologies with meaningful climate impact, albeit a longer timeline to commercialization, requires a different type of expertise in the boardroom than scaling digital solutions that more closely resemble the software businesses VCs have seen the most success with. This lack of investor <> market experience alignment translated directly into abysmal returns for CleanTech’s hardware and material science companies, which lost 80-95% on the dollar compared to digital investments, which returned almost 3x the capital invested. As we consider the future, we think it’s important to adhere to what we know (aka the “prepared mind”), rather than use a founder’s company as an opportunity for us to learn. We’re digital investors because that’s where we have the most experience and where we believe we are best able to help founders.
2) VCs invested in business models that were not a fit for venture. For venture firms looking for 10x returns across 5-10 year fund life cycles, business models without a clear, near-term path to market (and monetization) ultimately were not a fit. Despite the known commercialization timelines, capital requirements and long-term margin profiles of these businesses, CleanTech VCs funneled a high percentage of their capital into frontier tech companies that would require billions of dollars to develop and test, with very few of these ever making it to any stage of commercialization. Those that did make it to market, like Solyndra and Aurora Algae, faced stiff competition from China’s manufacturing prowess and cheap labor, which ultimately reverse-engineered IP innovations and leapfrogged progress on rapid manufacturing expertise. This eroded most technology advantages and caused the companies to fold. More than 90% of venture-backed CleanTech companies failed to return even the initial capital invested and we believe this was principally driven by a misallocation of funds. Simply put, venture capital is one of many forms of capital available within the market, and many of these projects and companies would have been far better suited for other forms of capital with lower cost, deeper pockets and greater patience. As an extension of the prior lesson, we believe this comes down to making sure your capital is an appropriate fit for a company and its needs, not an angular bet on the growth dynamics of that industry sub-sector (batteries, nuclear, hydrogen, etc.). It’s possible for an investor to believe that a given sub-sector will grow into a massive category, and for it to be equally true that the return potential of that category will be dismal and/or inappropriate for their capital. We think this is the case for much of the frontier tech being invested in by VCs today. While we are big believers in many of the macro moves in these sub-sectors, we feel our capital is best placed (for both our and the founder’s benefits) into highly scalable, digital business models, rather than funding R&D or manufacturing capabilities with unknown timelines and large capital requirements for commercialization.
3) VCs invested in businesses that required government intervention or support, like carbon cap-and-trade. During CleanTech, despite carbon legislation drawing bi-partisan support, it ultimately failed to pass, disincentivizing corporates from taking active steps to reduce emissions through venture-backed solutions. Lack of federally-mandated emissions monitoring lowered willingness to pay, which translated to lack of adoption, inhibiting many venture-backed companies from scaling. Core customer segments for these venture-backed solutions, whether carbon accounting or building retrofits, evaporated almost instantaneously without the top-down federal emissions reductions requirements. As we look to the future, we’re believers in the Montgomery Burns Principle (an homage to the evil capitalist billionaire from the Simpsons), which states that the best companies will produce economic impact that can stand on its own, rather than only demonstrating environmental impact or requiring top-down legislative catalysts to scale. We orient ourselves to markets where climate solutions have strong business fundamentals and don’t require propping up by the government in the long run. We worry about sub-sectors within climate with artificial economics propped up by IRA funding and instead, focus on the solutions that have dominant economic profiles in the long run, like distributed renewable energy in emerging markets.
Looking Ahead
Our best hope to move forward and continue making progress in climate is learning from our industry’s past mistakes. As Mark Twain said, “history does not repeat itself, but it does rhyme.” As part of this exercise, we identified 3 guiding principles for navigating today’s climate market at Equal Ventures. These guiding principles serve as the backbone for Equal’s climate practice, from thesis development to deal execution to portfolio support. We’re excited to share them below in the hopes that they may be helpful for other investors, founders and operators across climate.
None of us have a crystal ball, but we do have the data points and learnings from last time around that we can apply to our work today. As Sir John Templeton said, “the four most dangerous words in investing are ‘this time it’s different’” and we couldn’t agree more. At Equal Ventures, we believe technology represents a massive accelerant for positive climate impact, but are also highly cognizant of the parallels between market cycles. As stewards of capital, we owe it to the founders working to safeguard our future to ensure we are deploying our funds appropriately.
Read more about Equal’s work in climate in our Prepared Mind report here and reach out to Rick or Simran if you’d like to chat.