In 2021 and 2022, it was a climate tech boom time. Investments totaled almost $100 billion, and the passage of the Inflation Reduction Act in August 2022 only fueled the sense that it was a sector to bet on.
Today, though, that frenzy has ended. High interest rates and political uncertainty, among other factors, have cooled the market dramatically, making it harder for startups to attract investor interest, and leaving many languishing in the Valley of Death between Series A and Series B.
But it’s not only startups that are having a harder time raising money. The venture capital funds that early-stage companies largely rely upon are having troubles of their own.
It’s not that VC funds aren’t closing dedicated funds at all — Clean Energy Ventures, Blackhorn Ventures, and The Engine Ventures all announced fund closures in recent months, raising a combined $853 million.
However, the overwhelming perception from stakeholders is that fundraising, which has never been easy, is more challenging than ever. (Blackhorn Ventures, for example, closed its latest fund $50 million short of its original $200 million target; the fund characterized that result as an “excellent outcome” given the market contraction.)
In part, this is the consequence of a market that’s readjusting after a couple of remarkable years. According to Kim Zou, co-founder and CEO of market intelligence platform Sightline Climate, the sheer number of active climate tech investors has skyrocketed, from around 90 back in 2018 to more than 400 this year.
It’s unlikely they will all raise the money they need.
“Many first-time fund managers had to have some investment experience or some exit as a founder, and they were able to raise at least an early-stage, pre-seed fund” a few years ago, Zou told Latitude Media. “Because of that, we’re now in a second to third wave, where a lot of those funds…are coming out to raise their second to third fund. And this is where the rubber hits the road.”
First time, second time, third time
The difficulties climate tech-focused funds face reflect those that venture capital is facing more broadly. And it’s simply a hard time for the sector, with the number of new funds falling 60% from 2022 to 2023; that comes after a boom that saw assets under management jump from $300 billion in 2008 to $3.5 trillion in 2022, according to data by private markets specialist StepStone.
Katie Rae, CEO and managing partner at Engine Ventures, which announced the closing of its third fund with $398 million in commitments last month, said that raising funds almost every year in quick succession like some managers used to do is counterproductive — today’s LPs, i.e. investors in a fund, are not set up for it.
“We’ve always raised funds every three years, methodically,” she said. “And that’s partly because we are deep tech investors. We have to do the technical diligence and really understand what these companies do. We can’t handle more than eight companies a year.”
Engine Ventures invests in climate and advanced systems and infrastructure, as well as human health. One of its most prominent portfolio companies in the climate tech sector is Form Energy, which is developing long-duration batteries.
Sophie Purdom is the founder of Planeteer Capital, an early-stage first-time fund that held its first close in March 2023 and is hoping to reach its $75 million target by the end of the year. She told Latitude Media that a fund manager’s pitch to investors has to evolve over time.
“The pitch for fund one is, ‘do you believe in the [manager], in the space, and the vision?’ The pitch for fund two is, ‘Have I been doing what I said I was going to do, have I been executing according to plan, and do you believe in me?’ ” Purdom said. “Fund three is very different. That’s starting to be based on numbers, outcomes, and returns.”
The exit problem, and the liquidity crunch
To show numbers, outcomes, and returns, VCs need exits. And those have not been easy to come by. According to some reports, climate tech exits have decreased by around 50% from 2022 to 2023
Melissa Cheong, managing partner at Blackhorn Ventures, told Latitude Media that the fact that public markets, which are a potential exit path, have been constrained has been a challenge.
“It’s a vicious cycle,” she said. “There hasn’t been a lot of liquidity in the market. And therefore, all of those large institutional pools have just been locked up and held in positions where they need realizations.”
Zou, who has been observing LPs waiting to get liquidity for their initial investments, describes it as a “cyclical feedback loop.”
“To a certain extent, in climate tech, LPs are still waiting for a lot of exit events,” Zou said. “There haven’t been a ton of exits besides a SPAC period in 2021 and 2022…So there’s the sentiment within the LP ecosystem of waiting, waiting, waiting, and seeing for exits, before they double down in climate tech.”
Another key problem: many institutional investors have already exhausted their climate-tech venture capital allocations.
“There’s been a massive contraction within the allocator landscape in relation to alternatives in general, but primarily early-stage venture [capital],” Cheong said. “Most traditional allocators are just really overweight to their venture targets within their broader portfolios.”
And, as above, it’s unlikely that LPs are going to increase their allocations to the sector before they see some concrete returns.
“These things go through cycles,” said Rae. “On the venture side, we all have to be focused on growing the biggest companies we can, but also returning capital. That is not an easy discipline, but that’s the partnership and promise we have with the LPs.”
A sign of maturity?
Meanwhile, however, VCs are getting accustomed to the concept of climate tech.
“We’ve only been in the market for 18 months, and the main questions LPs want to discuss have shifted dramatically,” Purdom said. “In late 2022, and early 2023, the conversation with LPs in the U.S. was mostly about what climate tech is… Now they’re often asking direct questions around exits and multiples. And those are the right questions to be asking.”
(Purdom noted that the bankruptcy of FTX, which began in late 2022, scared off some potential LPs that were exploring new ventures, but that the ones committed to putting money in climate have since come back).
Investments in climate tech companies have also been declining, totaling $11.3 billion so far in 2024, down 41% compared to the second half of 2023 — which itself represented a downturn compared with 2022 totals. It now takes twice as long as it used to for a startup to raise a Series B. The ones that do raise money, however, are raising bigger sums.
Overall, the market’s optimists are choosing to interpret fundraising difficulties as a sign of maturity.
According to Zou, we are in the midst of a “flight to quality” throughout the venture capital food chain. And it’s a necessary shake-out of an overcrowded sector — as long as it’s limited.
Cleantech 1.0 in the early-aughts or even the internet boom and bust at the start of the century were both examples of a flight to quality that went too far, Zou said, and created too much of a bust. The key today is to avoid that type of market over-correction.
“At the early stage startup journey, it’s natural that there’s some fallout,” she said. “But too much of a bust could scare investors and LPs away from a very necessary growth area.”
