By Chad Kanoff, Kanika Chandaria, Karan Mohla, Karly Wentz, Narmeen Haider, Parham Peiroo, Raju Sarma, Raj Ganguly and  Sami Ahmad

Between 2006-2011, venture capital firms poured more than $25 billion into climate-focused ventures—part of an era of investment that became known as Clean Tech 1.0. [1]. Yet all the money and attention didn’t seem to pan out. Some 90% of Series A investments in Clean Tech 1.0 failed to return that initial investment, per a 2016 MIT study. Of those that did succeed, market returns were found to be lower than comparable investments in healthcare or software.

Many reasons have been cited for this disappointment. Funding was overly focused on R&D-heavy and capitalintensive sectors that had poor unit economics. Investors failed to adequately account for technology risk and misjudged long development and scaling timelines. Exit opportunities did not materialize. Follow on capital dried up. Changing macroeconomic conditions, including the 2008 financial crisis and declining oil prices, hindered market demand. And China posted much stronger competition than anticipated, specifically in solar. All of this resulted in heavy losses for most venture capitalists.

While the negative headlines were ubiquitous, lost in the adverse press was some success. In fact, as the MIT study revealed, clean tech software investments during the Clean Tech 1.0 era saw 3.5x return rates, including well-known unicorns such as Nest and Opower. Moreover, while investing in physical assets was not as lucrative, there were still some major winners—the investment horizon just took longer than VCs were accustomed to. For example, companies like battery manufacturer QuantumScape and carbon-recycling firm LanzaTech both took over a decade to achieve unicorn status. And despite longer time horizons, some companies generated exceptional returns for investors. Tesla’s market cap topped $1 trillion almost 12 years after it became a public company, and despite a large decline in the past year, its market capitalization is still $100B larger than Toyota, the next largest automaker.

Exhibit 1 | Climate tech investment notably ramped up in 2021
Climate tech deal count & capital invested 2017-2021 [1]

Regardless of one’s opinion on the Clean Tech 1.0 investment era, a new climate tech funding boom, referred to as Climate Tech 2.0 [2] is currently underway. As shown in Exhibit 1, a record $37 billion was invested in the sector in 2021 alone, and 2022 is likely to match or near that record amount. This funding is unlikely to abate anytime soon with $300 billion of dry powder raised according to CTVC. Moreover, a recent BCG analysis asserted that some $100 trillion-$150 trillion of additional investment will be necessary by 2050 to accelerate the world to net-zero—representing the largest investment and economic transition in human history.

We expect that much of this investment will be focused on climate tech, and we see an urgent need for capital deployment and technology development in the immediate term. According to IEA’s Net Zero report, in 2050, ~48% of greenhouse gas emissions reduction in its net-zero emissions (NZE) scenario for the energy sector will come from technology that is currently either in demonstration or prototype stages as demonstrated in Exhibit 2 below. Further, innovation cycles for early-stage climate tech need to be more rapid than what has typically been achieved historically to bring the NZE scenario to fruition as demonstrated in Exhibit 3. This need for accelerated innovation cycles further puts a spotlight on the importance of VC investments, among other things, to help climate tech move from prototype to market.

Exhibit 2 | Climate tech is critical; yet we face a tech gap

Note: This analysis is based on IEA’s NZE scenario which sets out a pathway to achieve net-zero energy related CO2 emissions by 2050, with energy sector being the source of >75% global GHG emissions today. About 51 Gt CO2 emissions reduction through climate tech will be required in 2050 to meet Net-Zero. Source: Net Zero by 2050, IEA 1. Mature: tech has reached market stability with newer tech starting to compete with existing assets (e.g., hydropower turbines); 2. Market uptake: tech is deployed across market but cost and performance gaps where established tech exists (e.g., electrolyzers for H2 production); 3. Demonstration: new tech is introduced at size of a full-scale commercial unit (e.g., a system that captures CO2 from cement plants); 4. Prototype: concept is developed into a design followed by a prototype for a new device (e.g., furnace producing steel with pure H2 instead of coal

Exhibit 3 | Innovation cycles need to accelerate rapidly

Source: Net Zero by 2050, IEA

Despite the need for capital, VC investors should note that Climate Tech 2.0 is a tricky investment category. It covers a broad array of sectors with varying levels of technology readiness, abatement potential, production cost, policy support (varying by jurisdiction), regulatory hurdles, corporate / customer demand, supply chain vulnerabilities, investment horizons, and stakeholder sentiment, among other considerations (beyond the scope of this article). That said, when we compare what’s happening in the Climate Tech 2.0 landscape today with Clean Tech 1.0, we see some clear tailwinds suggesting a more attractive opportunity for sophisticated investors with the right climate tech platform:

1. Broader acceptance of climate change: According to the Yale Program on Climate Change, Americans’ belief in climate change has increased greatly in the last 15 years, up to 73% from 59%. Gallup also found that since 2010, the share of Americans who think global warming is exaggerated has dropped to 38% from 48%, while the number of those who believe it is underestimated rose to 40% from 25%. This trend is also being witnessed worldwide, with people’s belief in the threat rising more than 5 points in over 7 countries in the last 7 years, per the Pew Research Center. This trend is especially important to younger generations with recent studies highlighting that Millennials and Gen Z want to work for impact-driven companies. For example, FastCompany found that ~75% of millennial workers would be willing to accept a lower salary to work for environmentally responsible companies. These shifting attitudes have made governments and corporations more amenable to changing their policies and strategies to address climate change (as outlined below) and laid the groundwork for de-risking the go-to-market opportunity for the climate tech ecosystem.

2. Critical mass of public and private climate pledges: In 2006, few governments made pledges to reduce emissions. In fact, the first such net-zero pledge didn’t occur until 2015 (Bhutan). Now, more than 130 countries—including the US, EU, India, and China, which together make up over 50% of global emissions—have pledged to achieve net-zero as highlighted by the Climate Action Tracker. In total, more than 190 countries have pledged to meet the Paris Agreement goals. Similarly, in the private sector, over 800 corporations globally have committed to net-zero emissions within the next two decades; of the Fortune 500, 63% have set a net-zero target by 2050, including some leading oil and gas companies, such as Chevron and ExxonMobil. Lastly, Climate Action 100+, the largest investor initiative on climate change, has signed 700 institutional investors managing a combined $68 trillion in assets to commit to leveraging their power and influence to ensure the world’s largest emitters take necessary action on climate change. To achieve these targets, technological innovation and adoption will be paramount, and these pledges signal a strong likelihood for continued public and private investments in Climate Tech 2.0.

3. Increased regulatory and policy support: While much work remains to be done, particularly in urgency, ambition and scope, countries around the world are activating these pledges by enacting climate-friendly policies. These policies are taking shape both in the form of “carrots” and “sticks” depending on the political context of each country. By way of example, the US recently passed the Inflation Reduction Act, which offers $370 billion in funding to fight climate change, with indications of significant upside to this figure, serving as both an exceptional economic carrot as well as derisking policy support for certain categories of climate tech. Illustrative economic incentives include:

• Carbon-free energy: 165 billion in tax credits for investment in solar, wind, storage, and nuclear
• Clean tech: $9 billion in tax credits to increase the economic incentive to use CCUS and DAC, as well as the production of clean hydrogen and establishment of clean tech hubs
• EVs: $23 billion in subsidies to purchase EVs, funding for EV charging infrastructure, incentives for battery components made in the US

Conversely, other jurisdictions are employing economic sticks, in the form of carbon taxes that incentivize corporates (and heavy emitters in particular) to enact business model innovation and adopt climate tech to mitigate economic loss. Canada, for example, implemented a federal carbon tax in 2019 that will increase each year until it reaches $170 a ton in 2030 to help reduce emissions, ignite innovation, and drive meaningful behavior change. Meanwhile, the EU, Australia, China and South Africa, have introduced other carbon pricing mechanisms. We expect increased regulatory and policy support globally, as countries create climate strategies to both achieve their national determined contributions as well as to build a climate-resilient economy. These types of policy support, both economic carrots and sticks, help de-risk investment into climate tech at a scale unseen in Clean Tech 1.0.

4. Corporates require climate tech to meet their commitments and transition their businesses: Climate tech companies will be essential in supporting corporates in achieving their net-zero pledges. We are seeing early signposts that large corporates, particularly in the US, are heeding this opportunity (albeit much work remains) to strategically partner with, invest in, or carry out first demonstration pilots, and act as initial off-takers. For instance, Amazon ordered 100,000 EV trucks from Rivian well before the company had reached commercial scale, helping kickstart their operations and compress the R&D, pilot, and commercialization timeline. Moreover, we are seeing powerful consortiums form to aggregate demand, accelerate development, and bring down cost curves of critical climate tech—such as NextGen, a consortium between South Pole, Boston Consulting Group, LGT, Mitsui O.S.K Lines, Swiss Re. and UBS, which pledged to purchase over one million tons of verified carbon dioxide removals by 2025 from a range of innovative technology providers.

Beyond being incentivized to work with climate tech companies to achieve net-zero pledges, we expect industry leaders to increasingly think about what their business will look like in the context of a climate economy, and increasingly engage with climate tech companies to build advantage through access to technology, talent, and offtakes of scarce resources, among other things. Increased engagement from corporate champions will help de-risk investments and create a positive feedback loop to further propel the climate tech ecosystem (acknowledging it is still early days, and much work remains to be done to activate corporate climate tech strategies more broadly).

5. Technology readiness and production costs continue to improve across discrete categories: there is a great range of technology readiness levels across different categories of climate tech, there are several that have achieved a level of maturity and commercial viability that did not exist in Clean Tech 1.0. For example, solar and wind power and EVs are no longer nascent technologies but are increasingly adopted across the world due to a combination of technological advancements, economies of scale, and policy support. In fact, as demonstrated by Lazard’s Levelized Cost of Energy Report, renewable power is cheaper than fossil fuels, with the price of solar dropping 90% from 2010 to $65/MWh, while coal has remained constant at around $110/MWh. This price point enables normal economic forces to drive adoption and it catalyzes adjacent software and services sectors that enable and market such technologies. In categories of Climate Tech 2.0 that continue to carry a green premium, there’s an emergence of monetary levers to incentivize production, such as tax credits put forward by the IRA towards hydrogen and engineered removals (as described above). Additionally, we are seeing the rise of public and private sector coalitions like Breakthrough Energy Catalyst that are committing capital, research, and policy advocacy to support commercial demonstration projects for critical technologies that have already been proven at a pilot scale including clean hydrogen, direct air capture, long duration energy storage, and sustainable aviation fuel.

Advancement in climate tech is more urgently needed today than ever, and there are a variety of tailwinds that make it a more attractive investment category than its predecessor – Clean Tech 1.0 – for the right investor. Consumer attitudes and behavior are dramatically shifting towards sustainability, a fast-growing number of governments and businesses are making net-zero pledges with greater scrutiny, policy support (through economic incentives and sticks) is picking up momentum with powerful monetary levers, and major technological developments are converging towards compelling climate tech solutions that are achieving price parity with non-green solutions. Moreover, the expanded focus of Climate Tech 2.0 opens a wider range of investment opportunities in areas with significant addressable markets that must be actioned urgently to meet 2030 Paris-aligned goals. It will be up to investors to meet the moment by articulating the right theses, building relevant expertise and sophistication to underwrite investments intelligibly, setting investment horizons that befit the technological and commercial readiness of the climate tech category, and supporting portfolio value creation through ecosystem-building and go-to-market partners including corporate champions.

[1] For the purposes of this article, we define Clean Tech 1.0 as the first wave of clean technology development, investment and deployment, which occurred primarily in the 2000s. Clean Tech 1.0 was characterized by a focus on technologies to increase performance, productivity, and/or efficiency of production while minimizing negative impacts on the environment. Solutions were mainly centered on energy generation breakthroughs such as solar, batteries and biofuels as well as topics such as clean water, recycling and waste, and air quality and pollution.

[2] Climate Tech 2.0, on the other hand, is broader and scope and includes all technologies that aim to address the full range of challenges related to climate change including both mitigation and adaptation efforts across all sectors such as energy, transportation, buildings, manufacturing, agriculture, and retail.