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From unicorns and clowngrades to moonshots and dawn raids, the world of sustainable finance can be confusing for those not in the know. But whether we understand it or not, we can’t avoid its impacts. When it comes to venture capital (VC), this influence has generally been confined to the apps we browse or software we use, but there is a growing narrative that positions sustainable investment at the forefront of climate solutions. But does VC really shape the climate movement, or is just reflective of a wider shift toward greener technology?
What is venture capital?
VC is private investment in an early-stage project with long-term growth potential, or in a larger company with a high-growth trajectory. Money is invested with the aim of receiving above-average returns, which generally come with higher risk. Venture capital can allow small companies to access much-needed funds, but in return, they must give up some equity (i.e., ownership) and thus control of their enterprise.
Where is VC invested?
Since its beginnings, VC has been synonymous with high tech. In 2023, this really hasn’t changed; the difference is in what that tech looks like. We’ve seen an increasing number of successful companies working with cleaner, greener, climate technology – from electric vehicles to domestic heat pumps – and with this, a stream of VC dollars flowing in.
Despite a market slowdown in the USA, the total money raised by climate tech companies across Europe and North America in 2022 was up 19 percent from 2021. Additionally, more than 25 percent of every venture dollar invested last year went into climate tech, according to PwC’s State of Climate Tech 2022 report.
What’s more, according to Climate Tech VC (CTVC), which offers market insights into VC climate technology, over 4,000 investors took part in at least one climate deal in the United States last year, with 14 percent taking part in five or more. There was also an increase in more generalist investors, rather than impact-specific funds. This marks a broader shift of interest towards climate tech; agnostic (non-industry specific) VC funds also tend to be larger.
Why are VCs investing?
These VC investors are presumably banking on the climate tech start-ups making it big, offering returns on their investment that outstrip anything that a traditional, listed company could offer. This shift, then, can be chalked up to business as usual for VC funds, which certainly seems to be part of the story. “There have been impact companies who are showing they can scale. They are showing they can be commercial,” says Rosalind Bazany, Head of ESG & Impact at Antler, a global early-stage VC firm. “If you think about the impact unicorns [startup companies with a value of over USD 1 billion], we’ve gone from pretty much nothing in 2017 to… 200 plus. There’s now more evidence, so people realize that this is a space that could be interesting from a value-add perspective.”
In other words, climate tech has become a viable investment – which is a relatively recent development. A little over a decade ago, there was a flurry of funding for green technology, which for the most part, quickly went bust. Clearly, with so much money making its way into climate tech again, investors are confident that we’re not going to see history repeated.
“We’re in an entirely different environment now,” says Bazany. “We’ve seen this drive from governments, putting forward or enacting… supportive policies and promoting sustainability, incentivizing capital to flow into this space. There’s also a greater awareness from consumers who are demanding companies to be held more accountable.”
Combined, these drivers create investment opportunities built on more solid foundations – or, as Andrea Canepa, the co-founder and CTO of Net Zero Insights puts it, “a systemic change”, in which people are finally understanding that “there is a lot of money to be made in climate tech.”
And making lots of money is what VCs exist to do. In fact, in many cases, it’s what they are legally bound to do. “When we think about our KPIs [Key Performance Indicators], we are an investor. We have a fiduciary duty to our LPs [Limited Partners] to provide strong risk-adjusted returns,” Bazany says.
Impact vs returns: the new balancing act
However, with the rise in climate tech and impact companies, it’s becoming less necessary – or acceptable – to sacrifice impact for returns. “There are a lot of VCs and founders that have understood that they can have [both],” Canepa explains. What’s more, there is even a shift from simply balancing impact and returns, to understanding that greater impact often means better returns. “In theory, if your impact is growing, your company is also going to be more successful,” says Bazany.
Additionally, a focus on impact during the early stage of a company’s life – the stage where VCs live – can mean “a greater probability of increasing that risk-adjusted return,” she says. If a company is thinking about supply chains, they may highlight vulnerabilities; if they’re thinking about environmental effects, they might choose more sustainable materials. These impact-driven choices mitigate risk from day one: for the company and, in turn, the VC investor.
This impact-driven approach seems to be supported by the shift in funding towards higher-impact enterprises. In 2022, technology targeting sectors responsible for 85 percent of emissions received 52 percent of climate tech investment compared with 39 percent in 2021, according to the PwC report. Similarly, there was an increase in investment in carbon capture, removal and storage – areas that have traditionally received little attention but are vital to limiting warming.
Impact still falls short
That said, we’re not quite there. Investment in these high-impact technologies is still tiny compared to their potential, and as the PwC report notes, “investment is still not aligned with carbon impact, reflecting an inefficient market for investing in climate outcomes.” This is exemplified in the disproportionate amount of VC dollars invested in transportation and energy deals, compared with other critical areas such as greener buildings.
What’s more, investments aren’t distributed equally within the same technologies. Within the sphere of carbon dioxide removal (CDR), for example, direct air capture and direct air carbon capture and storage receive a lot of private investment attention despite only accounting for around two percent of the CDR methods covered in the scientific literature, according to 2023 global CDR assessment The State of Carbon Dioxide Removal.
This is likely due to people’s tendency to follow the herd and stick with what they know. “Once the big names in VC started looking at EVs [electric vehicles] a little bit more, then other people flocked to that industry sector,” Bazany says. The problem is, sticking with what we know isn’t going to get us off the path to climate catastrophe – and if VC investment follows rather than leads, it will always be the support rather than the solution. Ultimately, while it’s clear that venture capital is changing in response to the climate crisis – and supporting projects that could help mitigate some of its effects – real change and innovation must be sought elsewhere.