This is the final installment of a three-part series on the potential “winter” for the climate tech sector. The first installment was published here and the second was published here.
Building a climate tech company is not for the faint-of-heart.
No part of the process is easy; the tech is difficult, customers can be decidedly old-school, and regulation is often complex, for instance. And too often, the innate challenge for founders is compounded by the weight of high valuations, enormous growth targets, and limited exit options.
We don’t have all the answers for navigating what is an increasingly complicated market, but we do have some advice.
Don’t be seduced by the stories of companies with huge valuations
There will always be companies that capture the attention of capital providers. The competition to invest in these companies generates stories that too often define founder expectations. Founders trade these stories with each other. As a result, too many believe that VCs are irrational trend-chasers who will throw big money at you if you deliver the perfect sales pitch.
This perception is sometimes underscored by VCs themselves, who often speculate about how to manipulate their industry’s psychology. The temptation that these stories provide is hard to overstate: who wouldn’t want to be handed millions of dollars with seemingly little justification?
As a result, many founders assume that if they can tell a good enough story, backed up by topline numbers like initial bookings and revenue, then they will be able to earn the next round of venture capital.
Of course, each time the valuation goes up, so do the expectations. When a company is backed at a $200-million valuation, both investors and founders plan for a company worth five to 10 times that amount. That expectation leads to attempts at rapid growth, a promise that scale will solve every unit economic problem, and a business plan that is often rooted more in optimism than hard metrics.
In general, we think that founders would do well to discount stories of large sums of money handed to companies with slim revenues and products. We think this is especially critical for climate tech founders. The strategy for capitalizing a climate tech company depends much more on its business model than it does on its mission.
If you’re building a company with a 40% gross margin that can reasonably hit $50 million in annual recurring revenue (ARR), then find investors who are comfortable with that kind of performance. But don’t fit your company into the VC return profile if that’s not who you are. Most startups will not deliver 90% gross margins with $250 million ARR and then go public — and that’s okay. What is not okay is pretending you’re something you’re not.
Know what kind of business you are building
Every founder is trained by VCs to say they’re building a billion-dollar business. In some cases, that is surely the case. If you genuinely believe you’re building a multi-billion-dollar public company with the business model and margins to support it, then you’re a good candidate for venture capital.
Other companies may be headed for less lofty heights — but they may also have a greater likelihood of success.
We would encourage founders to focus on maximizing their expected value. If raising huge amounts of venture capital and seeking a massive exit is your surest path to success, then go for it. But be realistic. Sometimes the right approach is to burn less capital, take less cash, and retain more ownership.
The way you calculate expected value can and should depend on the type of company you’re building. For instance, a services company like an HVAC or solar installation business is far more likely to be worth $100 million than $1 billion. These types of companies are more likely to be funded with friends and family capital, grow steadily into profitable businesses, and then be acquired by a private equity firm or larger service provider.
If you’re building a capital-intensive industrial business like a green cement company, though, you may need to raise significant non-dilutive capital from government or philanthropy to help you with your first-of-a-kind project, and possibly for your first several. Once you’ve built a few projects and figured out your unit economics, then you can attract project finance, which requires modest but predictable returns relative to venture capital.
Each of these paths can be fruitful. The trick is to know which one you’re on.
Know your personal goals
We’ve spoken with plenty of founders who really don’t know what they’re trying to build. And we’d argue that if you’re not clear on your own goals then you’re setting yourself up for failure.
Is your goal to get the company off the ground and then hand over the reins? Is your goal to run the show? Are you looking to do this for a decade, or for a few years? How much money do you want to make in a perfect world and what would be enough?
We have both had the privilege of working with Kathy Hannun, the founder of Dandelion Energy. She knew what she wanted: to build a company that was large and had an impact. Her goal wasn’t to accrue power. Indeed, she thought the surest path to success was to find the best people she could to come in and run the company with her.That’s the sort of clear-headedness about building a company that deserves to be admired, and replicated. (Editor’s note: Michael Sachse was CEO of Dandelion Energy from 2020-2023.)
It’s worth thinking hard about impact goals as well. Very few climate founders chose the sector solely to make money. Impact can and often should be a critical part of the equation.
We encourage founders to be as clear about the impact they want as the outcome they want. Building a profitable, regionally focused business that is making homes more efficient or putting more renewables on the grid is a climate win — even if it will never scale to be a billion-dollar company. But be careful not to be blinded by your mission. Some companies might be great for the climate on paper, but if they’re terrible businesses, they both won’t have any impact and won’t make anyone any money.
Always look for exits (even if you don’t take them)
Good exits don’t just magically happen — they are the result of careful strategic thought. Even if you believe your startup has the chance to be the Salesforce of climate tech, things inevitably happen that are out of your control.
For example, no one could have predicted the COVID pandemic, nor the interest rate ramp-up that followed. So figure out a backup plan early on for if you’re not able to achieve your dream of global domination: what is an alternative that would still make you, your investors, and your employees feel pretty good about the outcome?
Can the company become profitable without more outside capital? If so, then focus on profitability. Once you’re profitable, you will have more control over your own destiny.
Or is a merger or acquisition the more appropriate end goal? If so, you should be building relationships with possible acquirers years in advance of a sale. Build relationships with the corporates and private equity firms most likely to be interested in your company. Try to set up commercial arrangements like offtake arrangements with corporates to build trust and long term credibility. It’s amazing how many startups we know who are not doing this soon enough.
You’re much more likely to be acquired on reasonable terms at a time of your choosing if you’ve invested time in the relationship. This could be multiple years, but it could be the difference between selling your company in a fire sale and selling for a healthy, life-changing profit.
We believe
We say all this as cheerleaders for climate tech.
We are deeply connected to the climate ecosystem and desperately want to see it succeed. We admire the smarts, dedication, and mission-driven culture of climate founders and their investors.
And yet, we are worried. Climate tech needs to be a win for investors and for founders. We need this generation of successes to seed the next generation of investments. And that can only happen if the founders and the capital are clear-eyed about the task in front of them.
Michael Sachse is a private investor, and previously was the CEO of Dandelion Energy, CMO of Opower, and was an entrepreneur in residence at New Enterprise Associates. Jim Kapsis is the founder and CEO of the Ad Hoc Group, and previously was the VP of market development at Opower, as well as an official in the U.S. Treasury Department. The opinions represented in this contributed article are solely those of the authors, and do not reflect the views of Latitude Media or any of its staff.
