Venture capital investments into climate tech increased 24x within the last decade, with its ecosystem witnessing extraordinary growth, surging by a 60-fold increase in combined value. This surge reflects a growing awareness of the urgent need to combat a climate crisis that is becoming increasingly visible every year and the vital role that innovative solutions play in this context.
After two record years for climate and purpose-driven tech, the first half of 2023 has been slower. Still, Europe’s three largest funding rounds of this year have been in climate tech, with the mega-rounds raised by H2 Green Steel, Northvolt, and Zenobe Energy.
Investors are pivotal here, as there’s a clear need to support climate tech startups that have the potential to play a crucial role in achieving net-zero emissions targets. In this article, we’ve sought insights from prominent venture capitalists who are focused on climate tech investments, asking them two fundamental questions:
- What key factors are you looking for when investing in a climate tech startup?
- What major red flags or deal breakers would make you hesitant or decide against investing in a climate tech startup?
Here we delve into their perspectives and explore the factors that shape their investment decisions, as well as the warning signs that can deter them from committing capital to these ventures. Their responses shed light on the critical considerations in evaluating climate tech startups, providing valuable guidance for fellow investors and founders alike.
Pauline Wink – General Partner at 4impact
4impact is a venture capital fund based in The Hague, investing in European tech4good ventures.
Green flags and critical factors to consider
We have a thorough selection and diligence process. In the initial selection process, we consider whether it fits our investment mandate (digital technology, impact, strong business model, phase, geography). In the diligence process, we assess important factors such as team, market size, competitive landscape, product potential, tech, growth and exit potential, and many more.
I would emphasise four factors specifically:
- The team: A critical component in early-stage ventures. We look at why they founded the company, their overarching objectives, the synergy among team members, and their overall ambition. In the fast-changing world of climate tech, adaptability is crucial, as is the genuine motivation to make a lasting positive impact.
- Impact-revenue link: We prioritize startups that have an intrinsic model wherein their revenue growth is directly tied to the environmental impact they create. In simpler terms, as they grow financially, their positive environmental contribution should proportionally increase.
- Technological moat: Our investment interests lean towards software-driven solutions aimed at addressing climate issues and propelling the energy transition.
- Environmental consciousness: We look for digital technologies that are capable of informing us of facts and/or to support us to make good decisions positively impacting climate at scale. For instance, within our portfolio you can find Satelligence. This startup uses remote sensing technology combined with local data to detect deforestation and inform their blue-chip corporate clients where within their supply chain deforestation is taking place.
- Regulatory Influence: While not universally impactful across industries, it’s advantageous for startups to lend their expertise and connections to mold EU-level regulations. This is an ongoing effort, and the more these rules are influenced by forward-thinking tech pioneers, the more effective they’ll be. Proper lobbying can be a positive force, accelerating business and social impact opportunities. The EU should tap into the insights of these innovators to refine its regulatory framework, ensuring it’s conducive to technological growth and societal impact.
Red flags or deal breakers
Clearly the inverse of the above, such as the absence of authentic vision from the founders that unites impact and financial ambitions (needs more than an impact page in the deck!) or where there are adverse incentives when it comes to impact-revenue link. Is there a risk of the company’s business being more financially successful in a non-impactful use case? If so, this is certainly a red flag we would investigate further.
In addition to this, I would mention the following two points:
- The economics must work: What is the driver of the business case? Is it cost savings, revenue increase, regulatory requirement, or customer sentiment? We see climate tech business models that are driven by the willingness of people/clients to pay more for ‘greener’ solutions or are ultimately more ‘nice to haves’. We believe the ‘green-premium’ is not a long-term business case as these products and services need to be at price parity with existing solutions and need to add value for the customer.
- Hardware dependency: We invest in software companies; however, in certain cases, there can be a need for a hardware component. If this hardware component is too material, too early stage or too reliant on a specific supplier it is not an investment case for us. Emerging technologies, in particular, need a credible fact base and track record for the market to be convinced they need the solution they offer. This can increase the timeline to commercialisation and the need for funding and hence increase the risk.
Romain Diaz, Founder & CEO at Satgana
Satgana is a Luxembourg-based climate tech venture capital firm investing in the future of Earth.
Green flags and critical factors to consider
Like most VCs, we are looking for strong teams, addressing a big problem in a big market with a unique, scalable and technology solution.
On top of this, as a Climate Tech VC, we are looking for strong intentionality in the founders’ drive, a clear technology development roadmap (especially when investing in hardware startup), a business model inherently impactful at scale, an understanding of both positive and negative impacts, and strong values embedded in the company’s ethos.
Red flags or deal breakers
Our job as early-stage investors is to foresee growth (and impact) pathways before they actually materialize. This is as much a science as it is an art in the sense that an intuitive part cannot be understated. Part of our due diligence process is to ensure the founders’ true intentionality.
For example, there can be several red flags indicating that a founder may surf the green wave without truly being mission-driven. We also avoid investing in solution spaces that are too crowded, like carbon offset marketplaces or carbon accounting solutions for instance.
Lastly, we also avoid investing in solutions where the impact trade-offs are too important for our risk appetite like it would be the case for radical geoengineering solutions or climate solutions that could also have major detrimental impacts on biodiversity.
Melina Sánchez Montañés, Principal Investor & VP Impact at AENU
AENU is an impact fund that invests in early-stage climate-tech and social impact companies based in Europe.
Green flags and critical factors to consider
AENU has a rigorous impact methodology to assess the climate potential for new technologies or business models. We have six impact guidelines that ensure we are investing in the right solutions for us. These guidelines include intentionality, theory of change, interlock, impact scale, additionality, and impact measurement and management.
From an impact scale perspective, we invest in technologies that have the potential to abate or reduce 100 Mt CO2 emissions (note: at the technology, not company, level). You can learn more about our transparent impact framework here.
From a commercial perspective, AENU invests in seed and Series A startups. We’re thesis-driven investors, which means that we spend time and resources understanding industries and climate problems in depth to be able to identify the right markets (and timing), solutions, and teams. With the help of our network of scientific and industry experts, this process helps us detect the right signal from noise.
Red flags or deal breakers
We use our impact guidelines to filter out opportunities that don’t fit our impact investment strategy.
“Red flags” include when a startup’s potential impact is less than 100Mt CO2 emissions or when the impact could be decoupled from the technology or business model. An example of the former would be last-mile logistics since the total global emissions from last-mile delivery are estimated at 50 Mt CO2e / year. An example of the latter would be a potential retrofit technology that could be used for green hydrogen or for gas alike.
Yair Reem, Partner at Extantia Capital
Extantia Capital is a Berlin-based climate-first venture capital firm accelerating the path to a decarbonised world.
Green flags and critical factors to consider
When evaluating potential investments, there are several key factors that we prioritise at Extantia. We closely examine the market size and the current demand for the climate tech solution being offered; we look for a diverse and capable team with a deep understanding of the problem they are trying to solve. Technology defensibility, Unique Selling Proposition (USP), risk profile and business model also play an important role in our decision-making process. Many general venture capitalists would look at these last four factors too.
There are two key factors that are unique to climate tech investing and set us apart from the generalists.
- The startup’s potential to reduce carbon emissions: This involves not only considering the magnitude of the emissions reduction but also the time it will take to have a notable impact. We refer to this combined assessment as Carbon Math. Recognising the urgency of climate change
- Technologies with a shorter time to impact: While certain technologies may have the potential for significant emissions reduction, if they take an extended period to transition from lab to large-scale application, their immediate impact on climate change may be limited. Think about nuclear fusion for example: it has the potential to create virtually unlimited amounts of carbon-free energy, but the timeline to get net energy out of nuclear fusion could be multiple decades ahead of us.
All these elements collectively shape our decision-making process and guide us towards identifying ventures that have the potential to move the needle on climate change.
Red flags or deal breakers
There are a few major red flags or deal breakers that would make me hesitant or decide against making the investment.
- Cap table: Lately, we’ve been talking a lot about “dirty” cap tables. A cap table is not just about ownership percentages; it’s a critical tool for aligning the company’s goals, motivating the management team, and ensuring sound decision-making. If the financial structure is not well-managed, it can lead to long-term problems such as investors not retaining valuable stock, team members feeling undervalued and leaving, or new investors demanding unfavourable terms or recapitalisation. Such issues can cap the company’s growth potential and represent a major red flag for investment.
- Environmental, Social, and Governance (ESG): As an Article 9 fund, we also evaluate startups based on their ESG practices. These concerns can be deal-breakers for investment in the following ways:
- Poor Governance: Lack of awareness or willingness to address governance issues can be a major red flag. If the founding team shows signs of, for example, ineffective leadership, lack of transparency, or is geographically dispersed without effective communication, it can pose governance risks that may deter investors.
- Environmental Concerns Beyond Carbon: In-depth due diligence is essential for assessing environmental impacts beyond carbon emissions. If there are potential concerns related to biodiversity, energy usage, or the environmental impact of the technology that require extensive research and external consultancy, it can slow down the investment process. Failure to adequately address these concerns can be a deal-breaker.
Maximilian Schwarz, Founder & General Partner at Nucleus Capital
Nucleus Capital is a Berlin-based venture capital fund providing the first capital to purpose-driven entrepreneurs solving systemic challenges to planetary health.
Green flags and critical factors to consider
- Purpose-driven founding team rooted in science and market opportunity in relation to revenue ramp-up timelines.
- Clear competitive moats and positioning: It’s important for a startup to not just have a unique offering, but to also have established protective barriers against potential competitors. We value businesses that can demonstrate these moats—whether it’s through proprietary technology, intellectual property or other unique assets. These attributes not only differentiate them in the market but also provide sustained competitive advantages.
- We have a faible for vertical solutions in hard-to-abate industries, especially those that are traditionally challenging or have been resistant to innovation. There’s significant value in transforming these hard-to-abate sectors.
Red flags or deal breakers
- Lack of business model: While innovative ideas are essential, they need to be backed by a feasible business model. If a startup can’t demonstrate how it plans to be profitable and sustain its operations in the long run, that’s a significant concern for us.
- Red ocean market with heavily funded startup competitors: We’re wary of markets that are saturated with competitors, especially if those competitors are well-funded startups. Such a ‘red ocean’ scenario, often leads to a price war challenging a growth environment.
- Lack of trust with the founders: Trust is the foundation of any partnership. If, for any reason, we feel we cannot fully trust the founders or there’s a lack of transparency in their dealings, it’s a major deal breaker. Mutual respect and trust are essential for a successful collaboration.
Carlos Esteban, Partner at Faber
Faber is a Lisbon-based venture capital fund investing in early-stage teams that innovate at the intersection of science and technology to drive digital transformation and climate action.
Green flags and critical factors to consider
When evaluating a climate tech startup, we look for factors such as the uniqueness of their technology, the scalability of their solutions, their alignment with global climate goals, their potential for market disruption, their ability to attract partnerships, customers, and investors and a committed team with relevant expertise.
Here are a few aspects we would like to highlight:
- Innovative Technology: We assess the uniqueness and innovation of the technology or solution the startup offers. Does it have the potential to significantly reduce greenhouse gas emissions or address pressing climate-related challenges? Is it scalable and adaptable to different markets and geographies? Can it be protected by patents or other means?
- Market Potential: We evaluate the market size and growth potential. Is there a substantial and growing demand for the solution? A big market is good for economic return and a wider positive environmental impact.
- Sustainability Impact: How does the startup’s technology or product contribute to sustainability and climate mitigation? Does it align with global climate goals, such as reducing greenhouse gas emissions, conserving resources, or protecting biodiversity? How much?
- Regulatory and Policy Environment: Understanding the regulatory landscape is vital. Are there favourable policies, incentives, or regulations that support the adoption of the startup’s technology? Conversely, are there potential regulatory hurdles or risks?
Ultimately, the decision to invest in a climate tech startup would involve a comprehensive analysis of these factors, together with the team commitment and expertise mentioned above, and a thorough due diligence process. The goal is to identify startups with the potential to generate significant environmental impact while also delivering a strong financial return on investment.
Red flags or deal breakers
When considering investments in climate tech startups, there are several red flags that would make us hesitant or decide against investing as they indicate significant risks or challenges that may outweigh the potential benefits of the investment.
Here are some major red flags:
- Lack of Clear Environmental Impact: If the startup’s technology or solution does not have a clear and substantial positive impact on addressing climate-related challenges, it would be a major concern. The core mission of climate tech is to mitigate or adapt to climate change, so a lack of meaningful impact is a significant red flag.
- Inadequate Market Validation: If the startup cannot demonstrate a market need for its product or service through pilot projects, customer interest, or partnerships, it raises concerns about whether there is a viable market for the offering.
- High Capital Intensity with Unclear ROI: Climate tech ventures often require substantial capital for research, development, and deployment. If the startup’s business model lacks a clear path to profitability or requires continuous large investments without a corresponding return, it’s a red flag.
- Insufficient Intellectual Property Protection: If the startup’s technology can be easily replicated or lacks adequate intellectual property protection, it may face challenges from competitors.
These red flags are not exhaustive, and their significance can vary depending on the specific circumstances and the stage of the startup. However, they serve as important indicators that we carefully consider when we evaluate climate tech investment opportunities.
Carlos Fisch, Partner at Seaya Andromeda
Seaya Andromeda is a Madrid-based climate tech venture capital fund addressing global climate challenges through technology.
Green flags and critical factors to consider
We look for a combination of four factors: outstanding founders, market opportunity, product-market fit, and technology differentiation.
Our ultimate aim is to identify and support the next wave of companies poised to make a profound global impact and offer innovative solutions to the pressing climate crisis.
Red flags or deal breakers
- Founder fit is absolutely critical. Our main question is: “Would I leave my job to work for this founder?” – if the answer is no, we would never invest.
- Healthy unit economics to demonstrate that the technology has the potential to scale in a fast and sustainable way.
Read the orginal article: https://www.eu-startups.com/2023/10/what-vcs-look-for-in-climate-tech-startups-opportunities-and-deal-breakers/
