Climate tech software investment is booming but who’s paying for the hardware?
Christian Hernandez (2150 VC)
To put the current climate crisis into perspective, the last 7 years have been the warmest on record. By 2050, over 1.6 billion people across 1,000 cities face extreme heat waves, which could in turn affect access to basic human necessities and health.
Decarbonising the world’s urban environment - responsible for 40% of all global emissions - will be crucial to combating climate change. And while a large amount of climate technology investment has focused on software solutions to problems such as reducing carbon footprints and making supply chains more efficient and environmentally sustainable, decarbonising our planet is going to be hard. It’s going to require investment in infrastructure and physical technologies for the built environment, or hardware for short.
And even when investment flows into hardware, it’s not being allocated correctly against the largest problem set. PWC’s State of ClimateTech report for 2021 highlighted that 61% of VC funding between 2013 and 2021 had gone into mobility, which represents 16% of global emissions. The built environment (which represents 21% of emissions), received just 4% of investment.
There are, however, signs that the tide may be turning. San Francisco-based green infrastructure technology investor Generate Capital raised $2 billion of investment in 2021 to fund sustainable projects in the US, while Breakthrough Energy’s Catalyst programme also launched in the same year with $1.5 billion to back and fund CAPEX intensive solutions in the US and Europe such as direct air capture and green hydrogen. With COP26 behind us and targets agreed by world leaders, the real work to close this innovation gap and accelerate the pace of decarbonisation must start now.
Future-proofing our cities
According to Unhabitat, cities consume 75% of global primary energy, and emit around 50-60% of the world’s total greenhouse gasses. Building and deploying climate tech - much of which will include a hardware component - into the built environment will play an integral role in our planet’s net-zero transition.
Central to this transition is the ‘urban stack’ which comprises every part of the built environment from the way our cities are designed, constructed and powered, to the way people live, work and are cared for. Take air conditioning, for example. The IEA estimates that there are over 2 billion AC units in the world today, and that is expected to cross 5.5 billion by 2050. Improving the efficiency and refrigerants used in AC units could mitigate up to 460 gigatonnes of CO2 over the next four decades.
But driving this change will require innovation in the architecture of cooling systems, and trillions of dollars of investment into hardware units. These are the types of technologies we need to be backing, but the hardware component makes many investors shy away.
The construction sector meanwhile currently contributes around 23% of global CO2 emissions driven mostly by our continued addiction to cement and steel to build our cities and the energy required to power generators, cranes and drills. These “hard things'' will have to be replaced by sustainable hard things. The last few years have seen an increasing interest in funding of cement and concrete startups, and the two winners of the $20 million Carbon X Prize were both tackling that challenge.
Hardware solutions are key to changes such as lowering embodied carbon, improving air quality and building a more sustainable future for the industry. Solutions such as Aeroseal - whose technology seals HVAC air ducts to increase energy efficiency, CarbonCure Technologies which sequesters and mitigates CO2 in concrete, and Ampd Energy - which replaces dirty diesel generators in construction sites with efficient battery packs are vital, in order to accelerate their adoption worldwide.
Capital strategies to fund hardware
There’s no doubting that venture capital will play a critical role in supporting these nascent technologies. The VC funding model enables early-stage companies to take risks in a way that larger corporations can’t afford, funding experimental technologies that rely on innovations of startups in the field. Similarly, investors can push the climate agenda forward in legacy industries, like construction and manufacturing which have historically been slower to react to disruption.
On the other hand, growth capital is increasingly playing a greater role in funding this innovation. The world’s largest asset managers have all launched sustainability-focused vehicles within the last two years: TPG ($5.4 billion raised), General Atlantic ($4bn), KKR ($1.3bn) and EQT (€4bn). Alongside them we see global sovereign funds including Singapore’s Temasek and GIC actively investing in later-stage climate tech companies. This scale of capital is also critical to accelerate the rollout of proven technologies, and works hand-in-hand with earlier stage VC funding on a path towards a common solution.
However, private capital alone is not enough. Many countries are recognising that public-private partnerships will be key to moving the climate agenda forward and the UK for example has already kick-started efforts here, with Prime Minister Boris Johnson and Bill Gates announcing a £400 million partnership with Breakthrough Energy to boost green investment. In Europe, the Danish government’s €3.6 billion “Green Future Fund” has been launched to back funds, projects and technologies that “contribute to the green transformation of society” while in the US the Department of Energy’s recently announced $100m energy technologies program provides further examples of initiatives backing early stages R&D and catalytic funding.
Project and asset finance also have an important role to play in funding climate solutions, especially those requiring hardware components. These are both typically used to finance large, high cost, long-duration infrastructure and energy assets by relying on future cash flows to pay off debt and equity costs incurred in the process. Today, private investors are increasingly getting involved alongside lenders and project sponsors - either from the public or private sectors - to drive completion of ambitious projects that would normally be difficult to fund either way by themselves. There’s also mounting evidence that global banks are combining their fixed income and green finance teams to focus on this growing arena, given it will be a critically required component of the financing mix for years to come.
Change begins by ensuring that both startups and investors that are involved with these technologies hold themselves accountable, but this in turn requires the presence and enforcement of both voluntary and legally compulsory regulatory frameworks.
Frameworks such as the United Nations’ 17 Sustainable Development Goals (SDG’s), the UN’s Principles for Responsible Investing (PRI) or Leaders for Climate Action’s sustainability clauses need to be actively promoted within both political and business communities as principles , investment activities and company mission statements - and both investors and backed companies have to hold each other to account. When it comes to global regulations and laws - which continue to evolve and shift over time as COP26 has recently borne out - these must have clear KPIs and standards against which to measure effort in order to drive tangible change.
In recent years the Gigacorn framework has become a particularly useful tool to measure the environmental impact of investor portfolios, particularly for VCs. The term refers to a commercially viable company able to mitigate or capture 1 gigatonne of CO2 per year and when you put it into perspective, the emissions of each gigacorn are equivalent to the weight of 10,000 fully loaded aircraft carriers. This measurement is tracked through how many millions of tonnes has been saved, recycled and upcycled, which is then reported back to LP’s and investors. Other tools such as Prime Coalition's CRANE or Blackrock’s Aladin help standardise forward forecasting, tracking and reporting of a company’s impact.
Every element of our built world has the ongoing challenge of reducing its carbon footprint, which is why both hardware and software technologies will be key to drive this change. A number of industries are already showing encouraging signs of achieving measurable impact and potential gigacorn status such as the mobility industry and market for meat alternatives, a market expected to reach $16.7 billion by 2026. In an urban context, the potential for seismic CO2 reductions in the concrete, steel and chemicals industries has also become apparent in the past few years. In 2021 the IEA forecasted that these industries could remove 60 Gigatons of CO2 emissions within one investment cycle alone - by 2060. In the end there isn’t a single solution to this problem, but incentivising all actors in the green value chain - from regulators to private capital and public sector stakeholders - to collaborate effectively will be key. Cities are the foundation of our future as human beings, and collectively we cannot risk neglecting their development in the race to meet emissions targets and provide a better future. Prudent capital investment into both software and hardware technologies as well as tracking collectively agreed upon metrics will be vital in order to maintain visibility on progress and drive effective action on climate change.