What's Working and What's Not Working
Our Evolving Hypothesis
We started this series with our initial hypothesis that current funding mechanisms, especially VC, are not appropriate to fuel and accelerate climatetech in AU/NZ, because of either risk appetite, investor constrains, or both. We believed there is a need for an adapted funding mechanism, founded in deeper understanding of the problem-solution space and open to different business models.
We’ve tested our initial hypothesis with 8 different players in the climatetech investment ecosystem, and received a wide variety of different reactions. Everyone is bringing their own unique perspective to the table, and it’s clear that this is a textbook “vuca” (volatile, uncertain, complex, ambiguous) problem space with no one clear approach to, or definition of, success. We’ve deepened our understanding (somewhat), and would like to adjust our hypothesis based on feedback.
Where We Were Wrong
One of our biggest sticking points in the discussion around climatetech was our assumption that VCs, in aggregate, would be motivated more by profit than by impact, to the point of adding drag to the migration towards sustainable investment. However, the industry experts are proving us wrong; we have seen (and met) many investors that are interested in investing for the purpose of solving the climate crisis, and the success measures are starting to adapt accordingly.
There is a growing focus on making a positive climate impact and related changing behaviour amongst limited partners (LPs), who are the funding engines of investment firms; they are often family trusts or high-net-worth individuals and have a significant influence on a VC’s investment decisions. But while this is a great direction of travel, in our opinion there still needs to be more of this to further accelerate.
More importantly, the tradeoff between impact and return on investment (ROI) doesn’t seem to be as big of a barrier as we had feared. The majority of VCs seem to at least measure portfolio impact according to their own definitions, some are experimenting with allowing non-standard timeframes for funds (Outset Ventures), and some are already further touting the correlation between impact and ROI by embedding scope 1, 2, 3 and 4 emissions reduction from the start (Climate VC Fund), or demanding “impact lock” in the core business model - where more profit means more impact (Giant Leap). As an example, this could mean funding a product that not only yields lower emissions but is also cheaper and more effective.
Some specific findings that are so far driving our evolving hypothesis are these:
We undervalued the importance of narrative in investment decision making. Many VCs obsess over the founding team’s vision and determination, and a founder’s perspective can make or break an investment. Emotive decision-making might have a larger impact than we gave the industry credit for, and it highlights the importance of impact-focused founders.
There appears to be an (anecdotal) trend, especially amongst younger and more diverse capital deployers, of rising interest in longer-term and impact investing, versus the previous decades’ focus on software/ SaaS (software as a service).
While, by far, most VCs continue to adhere to the Silicon Valley-style investment fund standard of 10 years and thus see a big opportunity for climatetech startups that fit into that established timeframe, few investors that we spoke to mentioned that this concerned them as a limit. There could be appetite for different fund lengths, and a different approach that is being trialled is offsetting a 10-15+ year cashflow-positive company within a curated portfolio with companies likely to obtain short ROIs.
Where We Were Right
In a few areas, our assumptions have been validated (or at least not challenged) by the people we spoke to:
More so than for many other verticals, both the problem and solution areas in climate(tech) are complex and ambiguous, and heavily politicised. This means that there is a need for access to in-depth expertise, both for more generalist VCs and those with a more specific investment hypothesis.
There is a lack of standards around reporting and metrics, with some funds such as NZ’s Climate VC Fund establishing their own standards and annual reporting cadence, while others forgo impact reporting altogether. There is no central decision maker here and this means there will be a bit of a muddle as the industry comes to consensus over time.
Most investors see measurement of impact as key to getting more traction in the space, and it is hard to state conclusively that a particular startup is doing a particular type of good in the world. Many startups are reliant on other players in the ecosystem evolving in tandem in order to be considered a success.
There is an strong feeling that Government and institutional investors could be doing more, but not strong consensus over what the most impactful next step should be from a growth perspective. This seems to be a symptom of the wider “finger pointing” dynamic in the climate change space, but getting involved in innovation through directing focus to the biggest problem areas might well be a way for public and private investors to test the waters (although of course we would like to see a little bit more action than that).
Where We Were Surprised
One of the best parts of these conversations so far is learning something altogether new. There were a few areas where our understanding has grown:
The biggest issue, especially in AU/NZ and especially for broader climate solutions that have the widest impact, may very well be PR! The public opinion is shaped by voices of those with varying agendas, and at the moment a lack of understanding around the urgency of the climate crisis is driving negativity around spending (public) money on solutions - ranging from technology solutions to public infrastructure and policy change. The potential role of Government and media in shaping public opinion around climatetech cannot be understated, and there might well be an opportunity for the VC and startup community to hone their excellent PR skills - it just may need to focus its attention here.
One thing the climatetech sector hasn’t had a lot of yet, are big exits, especially in AU/NZ. A successful climatetech exit creates a model for other startups and investors to follow, and to look up to. An example would be LanzaTech’s $2B USD listing, which did encourage more investor activity in the vertical. A few investors cited big wins as a necessary component to draw in more widespread interest. In lieu of other major actual returns, the initial funds are reaching an over-leveraged point in AU/NZ. There seems to be a dichotomy between the initial impact-focused funds’ experience of finding it difficult to attract further investment, and the trends around awareness of and interest in impact investing.
While there are many early-stage impact funds that are making a big splash, there is an emerging funding gap after early stage for companies that are beginning to scale up. This may be because AU/NZ is too small for a certain type of (especially hardware-focused) company (think waste recycling, for instance), but it also means that more Series B, C & D investors such as corporations or banks need to step up to fill the space here in AU/NZ.
Finally, an interesting point we hadn’t considered is the impact of macroeconomics. Increasing interest rates due to increased inflation puts upward pressure on hurdle rates, which means that portfolio companies need to be promising even larger returns to even be considered. Furthermore, this creates a liquidity crunch for many investors who need the cash before a future investment can be considered. In an emerging, cash-hungry industry like climatetech, this might mean that good companies get left unfunded.
Where To Next?
We asked what people felt the climatetech industry needed the most in order to accelerate, and we got a wide variety of answers. In addition to what is mentioned above, we would love to deep-dive into some of these areas:
How do we get more big exits in climatetech, and who are the best bets?
How do we get more Government or institutional funding in AU/NZ? How do we get established industries involved in the fight?
How might we further influence the wider public opinion about the climate crisis in order to grow support for public investment? Could we leverage some of VCs PR skills?
How might we incentivise (industry) players who have not been involved in climatetech, and/or who feel negatively impacted by climatetech, to get more involved?
What is AU/NZ’s competitive advantage on the world stage? How can we make the biggest impact?
What opportunities are emerging from (the likes of) BlackRock’s investment in the NZ green economy, and how might this shape the climatetech landscape?
How do we better inform the public about the scope of the problem? At the moment there is a low sense of urgency and, as one NZ public poll recently proved, a low understanding of what actually makes a difference in this space.
How do we build consensus on what success looks like? We need both more expertise within investment firms, and better standards industry-wide.
How do we get more support to early-stage founders so that we get more founders overall? This was something we heard a few times… that as the money comes in there might well be a shortage of founders to invest in!
How do we get more impact investment happening across the board? Based on trends, this likely means more diversity in the investment landscape and bringing in new perspectives such as the NZTE Māori investment scheme.
How do we get more long-term thinking besides putting out the immediate fires (pun intended)? What is the industry’s vision for the future?
How do we create more (access to) in-depth climate expertise for climatetech investors?
As part of this journey for us, we want to talk to more people! If you are an investor, founder, or participant in this space, and you want to add to or challenge our point of view, we would welcome your input! Please reach out to us and we’ll add your thoughts to our growing understanding of this critical industry.
We thank the following people for their generous time and willingness to share their ideas and perspectives: Kate de Ridder (Bridgewest), Jez Weston (Climate VC Fund), Jo Wickham (Icehouse Ventures), Ada Yin (AirTree), Pau Medrano and Benjamin Pearson (UniServices), Angus Blair (Outset Ventures), and Katarina Throssell (Giant Leap).