Climate tech’s strong performance will be tough act to repeat

Climate-tech startups have quickly gained ground on the broader startup market. But what do they do for an encore?

In 2017, climate-tech startups had the worst expected returns relative to nine other emerging tech verticals. The category now has the sixth-best outlook, according to new PitchBook research that uses a novel quantitative method to assess opportunities in emerging technologies.

VC investment and valuations held up better in climate tech than in other verticals last year. These companies have grown headcount faster than their tech peers, and they have significantly increased their share of patents filed, the report found.

Within the climate category, the carbon-tech subsegment presents the most attractive opportunities for early stage investors, according to the analysis. This cohort includes carbon-capture startups and firms writing the software needed to measure and account for emissions.

A repeat performance will be hard to pull off, but not impossible.

Obstacles ahead

The first headwind facing the segment is the poor stock market performance of climate-tech companies. Many startups that build electric vehicles, flying taxis and batteries went public during the 2020-2021 SPAC boom. Investors have punished them for missing forecasts.

“There was a lot of selling the dream and not the financials,” said Abe Yokell, managing partner at climate VC Congruent Ventures, which raised a $275 million fund in December.

Even segment leaders like electric vehicle maker Rivian have struggled to keep investors’ faith: its shares, already battered, have fallen an additional 46% this year. Rival automaker Fisker issued a going-concern warning alongside layoffs this week. Days earlier, Apple reportedly ended its plans to make an electric car, a sign that tech money sees better opportunities elsewhere.

This underperformance has an impact on late-stage companies. In the past 12 months, the Morningstar PitchBook Global Unicorn Index rose 14.5%, reflecting a recovery of unicorn valuations. Meanwhile, the Climate Tech Unicorn Index fell 1.5%.

Another challenge is that energy markets are not complying with startups’ climate ambitions.

Oil majors recorded another year of strong earnings in their core business. That performance could take the sheen off of investing in low-carbon bets that lose money.

Electricity prices also remain elevated relative to historical levels. That’s a problem for the large cohort of climate companies that depend on cheap renewable electricity to be financially viable.

While climate has been relatively insulated from the VC pullback, due diligence has increased. Investors are adding scrutiny to financial results, roadmaps and permitting plans, PitchBook senior analyst John MacDonagh said.

The next generation of climate companies to go public will be judged not on five-year visions—as was the case in the blank-check era—but on robust topline revenue, fast growth and sound unit economics, Yokell said.

Saving graces

The good news for today’s climate-tech cohort is that it has youth on its side and can weather near-term headwinds. More investment has spawned a new generation of companies with years to mature.

A handful of more seasoned climate startups are now in the business of building factories. Those include Carson City, Nev.-based battery recycler Redwood Materials and Sweden’s H2 Green Steel, whose steelmaking process uses hydrogen made from renewable electricity. Houston-based Fervo Energy this week raised $244 million led by Devon Energy to fund a new advanced geothermal project in Utah.

Not every company in the segment will need large infrastructure investments to grow.

As climate tech has expanded, so have opportunities for software and light-hardware companies that don’t require technological breakthrougsh to succeed, said Murray McCaig, co-founder and managing partner at Vancouver-based ArcTern Ventures, which closed a $335 million climate fund earlier this year.

For those that do, there’s more capital than ever to fund deep tech breakthroughs.

“We’re seeing a lot more activity around the hard-to-decarbonize applications,” said Martin Richards, head of climate tech and sustainable finance at HSBC. Many of those projects require blended finance to support building first-of-a-kind projects, which draw from equity, debt, grants, loan guarantees and other sources.

A decade ago, there simply wasn’t capital available for these investments, said McCaig, whose firm raised its first climate fund in 2012. “Companies that need a lot of capital to execute on a big vision can succeed today,” he added.

Regulation is also more supportive than it has been at any point in history, MacDonagh said. That has made areas like low-emissions cement and steel viable for the first time. Policies like the Inflation Reduction Act take time to work their way into the system, and some areas of climate tech are only now seeing dollars from the 2022 law.

Given abundant time, money and supportive policy, the sector’s near-term hurdles seem surmountable. But the road ahead will be harder than the one behind.