ARTICLE
28 March 2023

Founders Alert: Climate Tech Funding Outlook For 2023

GP
Goodwin Procter LLP

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Despite the uncertain atmosphere with the collapse of Silicon Valley Bank and a drop in venture capital funding last year, the end of 2022 closed out another marquee year for state and private funding...
United States Environment
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Despite the uncertain atmosphere with the collapse of Silicon Valley Bank and a drop in venture capital funding last year, the end of 2022 closed out another marquee year for state and private funding of climate technology and sustainability solutions. This progress signals continued growth and stability for the industry despite exogenous market conditions.1 Climate tech private funding hit a high water mark, now consistently representing more than one in every four venture capital dollars invested, according to PwC's State of Climate Tech 2022. After Congress passed the historic Inflation Reduction Act and the CHIPS Act earlier in the year, the Biden Administration authorized a $1.7 trillion spending package. The package includes the Growing Climate Solutions Act — a new program facilitating farmers' and landowners' transition into the carbon sequestration market — and appropriations for climate technology initiatives within the US Forest Service and the Department of Energy, in addition to investments in blue economy research. A significant amount of funding from these new bills remains to be deployed. As the nexus between public and private capital expands, climate technology companies are poised to take advantage of 2023 funding conditions that are trending toward matching or exceeding historical levels to date despite headwinds in other venture-backed industries and the technology sector more broadly.

Climate tech founders have much to consider when approaching this dynamic fundraising landscape. The first wave of venture capital investing in climate technologies peaked in 2008 and resulted in busts that soured venture capital money to climate tech in the years that followed.2 This history of the climate technology sector (then called "clean tech") forced the venture capital industry to reconsider operating procedures to realize the most lucrative returns. For instance, climate technology companies over-index as "hard tech" companies, and this subset generally requires longer development times coupled with high risk and capital demand, thus requiring a different analysis of return on investment. They may therefore encounter difficulties securing sufficient capital to bridge the "valley of death" between basic research and commercialization when compared to other ventures such as software companies.3

Like all founders, climate tech founders must create realistic milestones to attract investors at different stages. But they must be particularly wary of risks to their runway, including changing procurement and facility costs, supply chain reliability, and other risks not faced by software startups, especially if there is not yet a clear path to market and profitability. In addition, climate technology companies often face knowledge gaps with their funders. While many VC firms leverage their substantial in-house expertise in areas such as enterprise SaaS or fintech to guide portfolio companies, climate technology's dependence on specialized STEM can create a wider knowledge gap. Throughout their negotiations, climate tech founders need to be conscious not only of the quantity and terms of the capital they are raising but also of the value added by the investor.

Climate tech companies often require a different approach than a typical Silicon Valley journey consisting of a handful of venture capital fundraising rounds and a corresponding exit through IPO or sale. A central question for founders is how to structure their unique funding journey — where to look for money first, and whether there is a specific order of operations when it comes to fundraising vehicles. For instance, a climate tech company might need to secure initial scientific legitimacy via a government grant. In addition, capital expenditure is often an inefficient use of equity capital, so founders often resort to debt financing options (which, thankfully for climate tech companies, can often be secured against physical assets). Joint development with universities and agencies may be required to leverage institutional resources.

All of these vehicles require different legal and business acumen, deploy different time frames, and offer different advantages depending on the company's go-to-market strategy. So climate tech founders would be wise to consider their financing strategies holistically, at an early stage and in an order of operations that reflects their long-term needs and goals, rather than on an ad hoc basis. In approaching the current fundraising market, we have identified the following trends that founders should be aware of when scaling their solutions to climate change.

The Convergence of Capital and Innovation

As a rising tide lifts all boats, the recent increase in funding in the climate tech space is creating the conditions for many climate technologies to be successful. Just as climate dollars have represented historical levels in private markets, US federal government spending on climate tech is projected to more than triple this year.4 The market data suggests the resilience of the climate tech sector in the face of reduced venture capital funding5 , yet it is unclear whether this will hold. While total dollars raised in the industry may be down slightly in 2022, total deal activity continued to grow up to 38% this past year, indicating that the pace of invocation remains very strong.

When compared to other climate tech startups that have not secured research grants, those that have been awarded grants from federal agencies are 12% more likely to acquire venture capital funding.6 In addition to raising prospects for success, government grants offer non-dilutive funding that may allow founders to stay in control of their board for longer. This doesn't mean that government grants are dispositive of success — government grant programs are highly competitive, highly technical, and generally result in significantly less funding than an equity fundraise. In addition, many of the first rounds of grant programs supported by the Inflation Reduction Act have closed and will not reopen either for another year or until new appropriations are approved (see below for a list of open and forthcoming grant opportunities). Seeking out grants can be a demanding and resource-intensive process requiring specialized educational and legal backgrounds, whereas venture financings often complete within four to six weeks following the execution of a term sheet. Timelines and terms are more straightforward in financings as opposed to unclear and incomplete grant timelines and oscillating funding pools that may jeopardize your exact grant amount.

Increasingly, nonprofit and educational institutions are developing private investment vehicles to support for-profit climate initiatives. Hybrid industry and government teams are being formed to leverage these synergies in climate innovation as well.7 The federal government has been deploying cooperative research and development agreements (CRADAs) for climate change initiatives, under which federal agencies can share ideas, research, and intellectual property with external private partners. As the nexus between institutional research, private company development, and public funding grows, CRADAs and other strategic hybrid ventures may emerge as a commonplace way to seed climate innovation, defying the once-individualist landscape of technology founders. Collaboration, as it is in science, can be key for climate technology companies. Founders should be keen to identify their sectors and key partnerships early — a strategy that will enable founders to benefit from a collaborative and competitive environment and to develop an early eye for how their product can make the eventual leap toward profitability.

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Contradictory Data, But Consensus on Strength of the Industry

Analysts, while reaching some themes of consensus, released inconsistent data on climate tech venture capital financing in 2022, complicating strategy development for founders. For instance, PwC's report found a decline in both early-stage funding and number of deals, yet a report from Climate Tech VC found that small-sized deals saw growth in each quarter of 2022.8

Although this divergence of data could be due to methodology in defining climate tech, climate tech founders of course want to see clearer trends. On the one hand, CTVC's data suggests that the climate technology industry is still nascent and that opportunities for growth, particularly at the Series A round, are strong. However, PwC's data implies that climate investors may be focusing capital deployment on maintaining their existing portfolios and may not be eager to invest in early-stage rounds, particularly at or under $5 million. We may have to wait until Q1 and Q2 2023 data is released to sort this out. In another contradiction, CTVC found that deal count grew roughly 40% across all climate sectors, whereas PwC noted a decline in deal count in climate tech as a whole and even in its two hottest sectors, data intelligence and carbon capture. Despite PwC's finding of these declines, its data indicates that both of these sectors still raised more in total investment than last year, supporting the proposition that these emerging sectors are areas of high growth.

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Both reports, however, did find that deployment of funds slowed in 2022 while deal count went up. This data suggests that some investors may have temporarily pulled back funds while they watch the market. Despite this trend, investors have actively sought out deal opportunities, even if they want to invest less capital for the time being. Both firms identified that the bust in growth-stage funding in 2022 was driven mostly by the bursting of the SPAC bubble.

PwC and CTVC also came to consensus on midsize and mid-stage Series B/C rounds, providing further data that affirms the "valley of death" phenomenon for climate tech companies. Starting an early-stage company and growing a late-stage company may be supported by positive growth in recent deal activity, but mid-stage fundraising either stalled or decreased in 2022, and Series B investors slowed their deployment more than any other stage. These growing pains felt by capital-intensive climate projects in their middle stages unsurprisingly led to a common solution: bridge or extension rounds, which help startups bridge the valley from early to growth rounds. CTVC found that 33% of climate tech founders raised a bridge round and almost 75% of climate investors had a portfolio company conduct such a round. Bridge rounds, which can be nonpriced, allow investors to postpone and de-risk valuation decisions. With deployment slowing but deal numbers growing, bridge rounds may allow climate founders, particularly those worried about the dreaded valley of death, to extend their runway until VCs feel more comfortable with the market.

The Emergence of Specialized Technologies (and Money)

One of the unique aspects of climate technology is the multidisciplinary nature of many of the solutions. Ending the climate crisis requires specialists in biology, chemistry, physics, environmental science, mathematics, financial innovation, logistics, software, manufacturing, and engineering across a variety of sectors including solar, wind, energy storage, energy transmission, transportation, clean homes, water desalination, carbon capture, alternative fuels, bioplastics, food tech, the blue economy, agtech, climate data and reporting, geothermal energy, nuclear, and nuclear fusion, just to name a few. In response to this diverse marketplace, funders and founders are implementing new solutions, resulting in highly specialized tech and capital sources.

For instance, the new omnibus spending package includes $8 million in spending on wildfire detection technologies.9 This specialization in government funding is correlated with the specialization of private sector funds. Just this year, Convective Capital announced its inaugural venture capital fund solely dedicated to "firetech."10 The package also includes nearly $5 billion in funding for the National Oceanic and Atmospheric Administration to promote research and restoration of oceans and fisheries, an infusion of capital that will support the emerging blue economy in tandem with new private funding. Coinciding with burgeoning public support for ocean sustainability, Propeller, an emerging blue economy venture fund, recently launched its inaugural fund in partnership with nonprofit research think tank Woods Hole Oceanographic Institution.11 Propeller provides ocean entrepreneurs with tailored intellectual property solutions not offered by general venture capital funds or accelerators. Following this trend of specialization, instead of a few behemoth funds emerging as the dominant market players in climate tech, we may see a proliferation of climate capital that could support the widespread growth and diversification of solutions. Indeed, despite the spending strength of a few climate-generalist major VC players, specialist investment firms led in a majority of climate tech sectors in 2022.12 We may continue to witness the trend of existing institutional investors raising their own new vehicles to invest in climate technology solutions13, in addition to newcomer specialists like Propeller and Convective Capital who will continue to emerge in niche sectors.

The Explosion of Carbon Capture: Only One Way Up

Private investment in carbon capture technologies was highly speculative only years ago, but emerging tech has made groundbreaking steps to prove that carbon sequestration can be scalable and affordable. Just recently, demand for carbon removal products was essentially zero dollars. Today, it's a billion-dollar industry14. With the DOE announcing in December a $3.5 billion program consisting of a new slate of grants, prizes, and research, and the announcement of the development of four domestic air capture hubs authorized by the IRA, the industry has seen an explosion from pipe dreams to blueprints for large-scale carbon capture facilities.15 Institutional investing in carbon sequestration in 2022 was nearly twice that of 2021, suggesting that the carbon sequestration market is rapidly growing as technologies outpace original milestones and scientists continue to identify the innumerable ways in which carbon is stored naturally.

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Not only have research and funding been skyrocketing, but carbon sequestration companies are already essentially going to market. A coalition of companies has already announced the massive launch of a carbon buy-back program that looks to offset corporate carbon emissions with sequestration efforts.16 Charm Industrial has already completed a 5,000-ton carbon removal underground injection for customers including Stripe, Shopify, and Microsoft.17 Whereas other climate technology companies may be pushing toward profitability, profitability is knocking on the door of carbon capture companies that just years ago were told they would never scale to address climate change.

The solutions are coming from everywhere, too. While some carbon sequestration initiatives rely on industrial tech, high energy demands, or expensive infrastructure, others are eyeing low-energy and natural alternatives, from storing carbon in the ocean to leveraging farming techniques that capture more carbon in soil. As mentioned above, the newly authorized Growing Climate Solutions Act helps farmers and landowners to generate carbon credits authenticated by a third-party USDA certification process. These carbon capture solutions are multiplying, and the market for carbon credit purchasing is escalating exponentially. As more companies continue to announce carbon buy-back programs, we anticipate this sector will have another historic year in 2023.

Federal Funding Opportunity Announcements (FOAs) and Other Grants on the Horizon

  • The IRA established the Energy Infrastructure Reinvestment (EIR) Program18, providing loans to projects that "repower, repurpose, or replace energy infrastructure that has ceased operations, or enable operating energy infrastructure to avoid, reduce, utilize, or sequester air pollutants or anthropogenic emissions of greenhouse gasses." The IRA appropriates $5 billion through 2026 to launch the EIR, with a total cap on loans of up to $250 billion. Please note the extensive application process. Interested applicants can request a pre-application consultation by emailing lpo@hq.doe.gov.
  • The IRA also amended the Clean Air Act to create the Greenhouse Gas Reduction Fund, authorizing $27 billion to be spent by the EPA on grants supporting zero-emissions technologies, with a focus on projects in low-income and disadvantaged communities.19
  • The American-Made Direct Air Capture (DAC) Prizes, funded by the DOE Office of Fossil Energy and Carbon Management (FECM), will consist of $115 million to be split among three award types — one supporting carbon capture incubators and community engagement, one supporting pre-commercial technology efforts, and the other awarding cash prizes to teams that developed a working carbon capture product scaled to a removal target. Teams will have opportunities to win larger prizes as they successfully scale up. The competition will be hosted on HeroX, with official rules to be released in early 2023.20
  • FECM will now manage the Carbon Utilization Procurement Grants Program, with grants totaling up to $100 million for governments and utilities to support production of commercial and industrial products from captured carbon emissions.
  • OCED and FECM will manage up to $2.54 billion to develop six new carbon capture projects that can be installed at fossil fuel power plants.21
  • OCED opened applications in September for $7 billion in funding for clean hydrogen hubs (H2Hubs), aiming to select six to 10 hubs that will produce clean hydrogen. Final applications are due by April 7, 2023.22
  • Applications are open for $40 million in awards under cooperative agreements with the DOE to improve solar technologies23, as well as $20 million to support solar materials recycling24 and $40 million for wind energy recycling.25
  • DOE announced a FOA to support materials and manufacturing technologies, including EV battery manufacturing and increased conductivity metals.26
  • DOE has almost $2 billion in loan guarantee authority for energy projects on Tribal lands, including transmission, storage, and electricity generation.27
  • DOE's Vehicle Technologies Office plans on issuing a FOA to support projects that reduce the weight and cost of batteries, develop EV charging infrastructure, or advance public transit innovations.28
  • DOE has issued a $12 million FOA addressing the domestic supply chain for lithium batteries, with a focus on environmentally and socially responsible manufacturing.29
  • DOE's Bioenergy Technologies Office (BETO) announced its intent to issue two funding opportunity announcements (FOAs) in early 2023. These potential FOAs — "Reducing Agricultural Carbon Intensity and Protecting Algal Crops (RACIPAC)" and the "2023 Conversion R&D" — will fund the sustainable use of domestic biomass and waste resources to produce biofuels and bioproducts.30
  • Funded by the IRA, the Industrial Demonstrations Program received a combined $6.3 billion to support the advancement of transformational technologies necessary to decarbonize the industrial energy sector, focusing on high-emissions industrial materials, including iron, steel, steel mill products, aluminum, cement, concrete, glass, pulp, paper, and industrial ceramics.31
  • DOE's Grid Deployment Office is administering a $10.5 billion Grid Resilience and Innovation Partnerships (GRIP) Program to enhance grid flexibility and improve the resilience of the power system against growing threats of extreme weather and climate change.32 This includes $3 billion in Smart Grid Grants to increase the flexibility, efficiency, and reliability of the electric power system, with particular focus on increasing the capacity of the transmission system, preventing faults that may lead to wildfires or other system disturbances, integrating renewable energy at the transmission and distribution levels, and facilitating the integration of increasing electrified vehicles, buildings, and other grid-edge devices.
  • Supporting the emerging blue economy, the DOE has announced its intention to issue a FOA for up to $45 million to fund tidal or river hydroelectric projects, with the specific goal of funding at least one in-water demonstration of a tidal energy system.33

Footnotes

1. https://www.ctvc.co/40b-and-1-000-deals-in-2022-market-downtick

2. https://www.ft.com/content/f6cf7f42-5b61-4ff1-9ae9-d7c3ab8b17fd

3. https://www.sciencedirect.com/science/article/abs/pii/S0959652622035557

4. https://www.pwc.com/gx/en/services/sustainability/publications/overcoming-inertia-in-climate-tech-investing.html

5. https://www.pwc.com/gx/en/services/sustainability/publications/overcoming-inertia-in-climate-tech-investing.html

6. https://www.sciencedirect.com/science/article/abs/pii/S088390261730811X

7. https://nereidbio.org

8. https://www.ctvc.co/40b-and-1-000-deals-in-2022-market-downtick

9. https://www.science.org/content/article/research-gets-boost-final-2023-spending-agreement

10. https://www.bloomberg.com/news/articles/2022-10-07/new-venture-fund-convective-capital-only-backs-tech-to-fight-wildfires

11. https://www.axios.com/2022/10/20/propeller-ocean-tech-venture-fund

12. https://www.ctvc.co/a-pulse-check-on-climate-vc-market-sentiment

13. https://www.theinformation.com/articles/union-square-ventures-doubles-down-on-climate-with-200-million-fund

14. https://lowercarboncapital.com/2022/04/14/clean-up-on-aisle-earth

15. https://www.energy.gov/articles/biden-administration-launches-35-billion-program-capture-carbon-pollution-air

16. https://www.ctvc.co/a-new-frontier-for-drawing-carbon

17. https://charmindustrial.com/blog/largest-permanent-carbon-removal-delivery-of-all-time

18. https://www.energy.gov/lpo/energy-infrastructure-reinvestment

19. https://www.epa.gov/inflation-reduction-act/greenhouse-gas-reduction-fund

20. https://www.herox.com/DAC-commercial/teams

21. https://netl.doe.gov/node/12239

22. https://www.energy.gov/oced/regional-clean-hydrogen-hubs

23. https://www.energy.gov/bil/solar-improvement-research-development

24. https://www.energy.gov/bil/solar-recycling-research-development

25. https://www.energy.gov/bil/wind-energy-tech-recycling-research-development

26. https://www.energy.gov/eere/amo/fy22-advanced-materials-and-manufacturing-technologies-building-technologies-office-multi

27. https://www.energy.gov/articles/department-energy-issues-2-billion-tribal-energy-loan-guarantee-program-solicitation

28. https://eere-exchange.energy.gov/Default.aspx#FoaId8ac4a3fd-663d-4409-9f94-3e104ec4c0d3

29. https://www.greencarcongress.com/2022/11/20221110-geothermal.html

30. https://www.greencarcongress.com/2022/12/20221216-beto.html

31. https://www.energy.gov/oced/industrial-demonstrations-program

32. https://www.energy.gov/gdo/grid-resilience-and-innovation-partnerships-grip-program

33. https://eere-exchange.energy.gov/Default.aspx#FoaId110aceb4-394b-4aa2-8c3e-1232302c0ab2

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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