A few weeks ago, I had the honor of presenting to Golden Seeds, one of the largest angel groups in the US (and arguably the largest focused on investing in women-led businesses), on climate tech.
I was struggling a bit with figuring out a topic until I started thinking about the role of angel investing in climate tech.
In normal angel investing, angels come in as gap fillers - bridging (figuratively but sometimes literally) friends and family money and VC capital. Traditional angel investing prep founders for the first institutional VC round, which means angel investors primarily look for investments that are VC-worthy. A quick search for angel investing how-to's (AngelList's resource center, SeedInvest's Angel Investing 101, FasterCapital's Comprehensive Guide to Angel Investing) reveals that angel investing is pretty much synonymous with investing in early stage startups and is often discussed in the context of venture capital.
In climate tech, this paradigm doesn't work quite as well. Many businesses are what I would call non-venture models. These include "developer" businesses and new service providers...some examples in the presentation below. These businesses have different, often slower growth trajectories but can get to cash flow quicker. They also don't necessarily need a VC in the next round.
When it comes to angel investing in climate tech, I wondered if there were more creative ways in which angels could make an impact outside of copying the same model as in traditional angel investing. My three suggestions:
As I prefaced while delivering this live, I am new to angel investing myself so would love to foster more of a discussion on these suggestions vs. being overly prescriptive. Especially on #2 since it involves templating a new financial instrument.
See the presentation below. Would love feedback from and to start a discussion with any angel investors out there that are reading this!
I’ve been looking how we might be able to create a financial ecosystem tailored to growing and scaling climate tech and what themes might impact that kind of financial ecosystem. One of these themes is this concept of decentralization.
Many different climate tech sectors rely on decentralized models of producing goods and services, following a broader industrial trend of localizing manufacturing and reshoring industrial facilities. While this goes against the traditional paradigm of centralizing everything to achieve optimal economies of scale, there are clear benefits to following a decentralized model:
On specifically the finance front, decentralization can be an alleviating trend to climate tech’s FOAK problems. As more project sponsors and offtakers buy into building infrastructure for new decentralized paradigms vs. building infrastructure for old centralized paradigms, we may be able to use the VC growth model to scale up more of climate tech.
In the past, my posts have focused on how finance can adapt to scale up climate tech and how scaling climate tech is a uniquely challenging problem…but diving into themes like this is a good reminder that 1) the problem is evolving and 2) that the “compromise” doesn’t necessarily have to be completely from the finance side…perhaps technology can evolve to be more fitting to our financial ecosystem.
I see 11 areas in climate tech clearly embodying the decentralization theme (though I’m sure there are more!):
I thought it would be a good "New Year" exercise to update the FEST map and add some thoughts on each climate tech sector.
As a reminder, FEST is a framework, inspired by Bill Gates' book, that illustrates the impact of climate tech on the different parts of how we live. Emissions can broadly be divided into Food (F), Energy (E), Stuff (S), and Transport (T).
I use this chart as a reference for looking at the different climate technologies in the context of the broader picture. It's by no means comprehensive...at least not yet! This current version has ~170 nodes, with each node representing a niche of climate technologies.
Updating this has generated some interesting ideas for me of what to write about this year. I hope it's as helpful for you as it is for me.
Transport
Ag/Food
Happy New Year!
I spent some time over the holidays making a fun little reference timeline for the IRA credits. The various effective dates can be confusing and I figure it would be helpful to have a birds eye view of when each provision comes into play.
From this angle, we can observe that there are several critical deadlines in which a good chunk of the new IRA credits come into effect or go out of effect: the beginning of this year, 1/1/2023, 1/1/2025, and 1/1/2033.
There are still certain provisions that rely on federal guidance before they are in effect, something that can affect actual deadlines. For example, the guidance for the critical minerals and components requirements for clean vehicles was supposed to be issued by 12/31/2022. Due to a delay in the guidance until March 2023, certain vehicles that qualify for the credit without taking this requirement into consideration can now qualify for the credit until the guidance is issued (like Tesla).
Check out the pdf or spreadsheet versions below and as always, let me know if you have any feedback.
Full tax code with the IRA adjustments available from Tax Notes
Past IRA analysis / summaries:
There’s been a LOT of money poured into climatetech over the last few years and even with the recent downturn, new money keeps coming in. According to CTVC, 2022 has seen an uptick in the number of new climatetech VC investors announced (45 -> 47), despite rising interest rates and a broader market slowdown for VC. It seems that the LPs of the world – endowments, pension funds, sovereign wealth funds, mega-family offices – are still quite bullish on climate and hungry for new early stage funds in this space. And as climatetech deal activity (as measured by deal count) also hasn’t slowed, new fund managers continue to have opportunities to deploy capital in.
So the environment for being an investor in climatetech seems to be as good as ever these days…but has it evolved at all in other ways? That’s the question I was asking myself after I read this update. I suspected that the VCs that are raising money today in climatetech are of a slightly different flavor than the VCs raising money in climatetech a few years ago.
Examining the climatetech-oriented or related funds that have been raised over the last 6 years, I found that there’s been an interesting evolution that’s been happening when it comes to sector specialization. While most of the funds raised in the early days of climatetech / cleantech were generalist in nature, recent funds seem to have erred to choosing specific niches within climatetech like alternative proteins, buildings, or circular economy.
A taste of some of the announcements this year:
A total of 29 specialist climate funds have been launched this year, up 45% from last year. That’s out of a total of 106 specialist climate funds that are actively investing. These 106 funds span 14 specialties which can be aggregated into 4 main categories. All of this is shown in the chart below.
Some observations:
Overall, specialization is a positive development for the climatetech world. It’s at the very least a signal that climatetech is maturing as an investment category and fund managers are getting more sophisticated. It’s also a good sign that investors are seeing ample opportunities in climatetech for the long term.
The consequences of specialization are net positive. Having more specialized VCs places additional pressure on other VCs to think about finding a differentiated angle to offer to startups. This can push the investor world to developing better, more value-added relationships with their investments. For startups, having more options from specialist VCs increases competition in their favor, while taking money from specialist VCs can offer more strategic channels to the right industry network.
The other side of specialization is that specialist funds have limited options when it comes to pivoting in a challenging macro environment, leaving them vulnerable to industry-level macro shifts. Choosing to specialize is taking a risk that your chosen specialty will be around for years to come. Having an increasing proportion of specialist VCs in the climatetech ecosystem means that the overall capital stack for climatetech has more points of vulnerability.
But all in all, there are benefits of specialization to both the investors and startups.
For investors, specializing allows for:
For startups, specialist funds can allow for:
TLDR; we’re seeing more specialist VCs in climatetech. And that’s a good thing for the ecosystem.
Last time I looked at the history of wave energy and what lessons we can draw from past cycles that could be relevant to today’s climatetech challenges.
This week I wanted to create the actual wave energy market map, in part to get a better sense of the variety of wave energy converters (WEC) that are being developed today and in part to better know and appreciate all of the companies that are working in such a difficult but rewarding space.
Though there have been hundreds of WEC designs proposed in the last few decades (130+ are included in The Liquid Grid’s database and 94 in Net Zero Insights' database), only a small fraction of those are still being developed today. I found 25 that are actively on the path towards commercialization (loosely defined to be: 1- not just a project by an academic institution and 2- having at least one announced milestone in the last year). Those 25 land in six different WEC categories that I could identify.
Included in this map:
A few observations on this set:
It's also worth noting that I made some purposeful exclusions in this landscape.
After looking at the breadth of ocean-based climate solutions last week and having a better understanding around the potential of the ocean, I thought it might be informative to look at wave energy more specifically.
Four things that are worth noting about the wave energy space:
These four characteristics of wave energy – the fact that the market is huge, the problem is hard, the technologies are diverse, and the history is long – make it an interesting case study for other hard tech climatetech spaces, especially those that are going through a similar Cambrian explosion of technology. There are lessons that we can take from looking at this area for not only the future of wave energy development but for the future of other climatetech sectors with a similar profile.
Here's what I observed:
Would love to hear if there are other lessons from those that lived and breathed this cycle or that have seen this play out in other sectors.
Look forward to diving into the wave energy market map next week. Stay tuned!
Most of what we talk about in climatetech happens on land – hydrogen production, power generation, carbon sequestration, grid optimization, industrial decarbonization, residential energy efficiency, etc. This is because the majority of technologies get deployed around people’s homes, in city environments, or industrial complexes, all of which largely occur on land.
But what about the ocean?
I became intrigued by the ocean after observing a renaissance of wave energy recently: the DOE announcement on funding for wave energy technologies and a smattering of news for wave energy companies like Atargis, CalWave, Eco Wave, and Mocean.
But wave energy is just one part of a larger suite of ocean-based climate solutions that have emerged over the last few years. The bigger category includes things like tidal energy, mining, regenerative aquaculture, carbon sequestration, low carbon shipping and maritime transport, hydrogen production, offshore solar, and of course, offshore wind.
All of these technologies are in varying stages of development, but most are early stage and require high amounts of capital going forward. Most also face a bevy of challenges being first-of-a-kind in the ocean: long permitting cycles and evolving regulatory requirements, limited testing sites, potential seawater corrosion or storm damage, lack of interconnections, power supply, and other infrastructure, difficult and expensive maintenance, and digital connectivity issues.
Many of these challenges can be tackled with funding, but ocean technologies consistently are deprioritized compared to land-based technologies. Even offshore wind, arguably the golden child for ocean-based technology deployment, is not growing fast enough. Net zero pathways like Princeton’s Net Zero America, BNEF’s Energy Outlook, and John Doerr’s Speed and Scale often build in limited to no allocation for marine solutions outside of offshore wind and ocean protection. Project Drawdown does include additional categories like ocean power, ocean shipping, and improved fisheries, but ranks them all fairly low on the potential impact scale (even offshore wind ranks 38 in a list of 84 ranked solutions, well below its renewables counterparts on land, which take the top 2).
IEA is the only one that seems to give the blue economy some credit. IEA’s ETP list includes 12 different types of overtly (some categories like CO2 storage lump offshore and land-based together) ocean tech and lists the large majority of them as “High” or “Very high” impact (though it’s worth noting that almost 40% of the list of 503 technologies is either “High” or “Very high” impact).
So to summarize, these are early stage technologies that face lots of challenges, require more funding, and are frequently ignored in net zero pathways. What’s the point in putting dollars to work in this area? Why in the world do we need to go through the trouble of funding these ocean-based climate solutions?
Technologies like regenerative / low carbon aquaculture or low carbon shipping are needed to decarbonize industries that we assume will persist in a net zero scenario. So that’s an easy answer.
But for technologies like offshore wind, offshore solar, wave energy, tidal energy, carbon sequestration, seawater and seabed mining, and hydrogen production, there are comparable land-based alternatives that one can argue obviate the need for more complex ocean solutions. A few thoughts on this category:
TLDR; ocean-based climate solutions present a valuable but underappreciated solution set to the world’s climate challenges. The ocean’s plentiful resources, proximity to demand centers, and high co-location potential present a compelling opportunity for both builders and investors in climatetech.
Companies shown: Sweetch Energy, Heimdal, Alora, Orsted, Makai, Atargis, SolarDuck, T-Omega, Lhyfe, Nauticus Robotics, Running Tide, Boundary Layer Technologies, Impossible Metals
This week I had a grand plan to write about the economics of first commercial facility / FOAK commercial and why it makes complete sense to invest in these projects. But it was much more difficult to make the numbers work than anticipated. Even if a company gets over the FOAK hurdle, the lengthy time to exit coupled with the higher capital need results in returns for venture investors far from competitive to regular way venture investments.
There are paths to achieving competitive returns to regular VC – some existing ways include having philanthropic or government capital come in at FOAK stage, which can ‘lever’ up a project with non-dilutive financing, pursuing a licensing model, which, with the right partner, can allow a company to scale faster with less capital requirements, or recruiting an evergreen fund or fund-like operating entity that can provide flexible financing at multiple stages to accelerate the scale up.
But the path that is most murky (or at least was to me when I decided on this topic) is how to achieve competitive returns with a traditional institutional capital cycle.
After experimenting with a rough model, I found that one way you can achieve competitive returns is by creating a FOAK-focused fund and encouraging companies to early exit to this fund. The early exit helps early stage venture investors find liquidity sooner, increasing IRRs and the likelihood of a successful investment. For the FOAK-focused fund, acquiring the company before FOAK means having the ability to capture all future facility economics vs. competing for 2nd facility and beyond economics with very low cost of capital. The likely levered returns past first facility substantially reward the FOAK investor for taking the FOAK risk.
This FOAK fund is not unlike a private equity firm that aims to acquire a company and lever it up before exiting in a few years. The difference is that this FOAK fund would aim for infra-like returns (10 - 15%, or the higher end of infra) at the portfolio level and private equity-like returns (20 - 30%) at the individual investment level, building in some expected failure rate (in the example below, 2 out of 3 investments can fail and the portfolio will be fine) similar to a venture fund to go from the individual investment to portfolio level returns.
The FOAK fund is a novel concept because 1) infra investors are generally extremely risk averse and don’t think about their portfolio in failure terms, 2) private equity investors do balance their portfolio according to expected return but also don’t necessarily build in a failure rate and don’t aim for as modest of a portfolio return, and 3) venture investors do think about failure rate but don’t typically look for opportunities to optimize for cash flow or lever up an investment. A vehicle that combines elements of private equity, infrastructure, and venture capital can address the imperfect match of each one of these traditional vehicles with the FOAK problem.
I don’t think there is something out there in the market today that looks like this…the closest is Generate Capital and their strategy of acquiring, operating, and scaling sustainable infrastructure companies. But I haven’t seen an institutional investor that addresses the FOAK problem. Perhaps someone can correct me here!
Here’s how the returns stack up in this illustrative example:
A typical venture cycle runs 4 - 5 rounds of funding before a company exit. Because of the high failure rate of startups, VC investors target a homerun exit – $1B or more in less than 10 years. Putting in some reasonable assumptions for round sizes and valuations up until that point, we get that, for this individual investment, a Pre-Seed investor can expect a return of 76% IRR / 92x MOIC, a Seed investor can expect a 68% IRR / 39x MOIC, a Series A investor can expect a 69% IRR / 23x MOIC, a Series B investor can expect a 68% IRR / 10x MOIC, and a Series C investor can expect an 88% IRR / 6.7x MOIC.
If we assume these returns for the successful homerun investment, that means that, in order to achieve a minimum of 20% portfolio IRRs, a Pre-Seed investor can have 20 failures to one successful investment, a Seed investor can have 10 failures, a Series A investor can have 7 failures, a Series B investor can have 4 failures, and finally a Series C investor has the least amount of wiggle room with 3 failures.
Moving on to the hard tech example, we assume that the round sizes increase due to greater capital intensity, two more rounds of capital are added to fund additional development, and exit gets prolonged 3 years until the 12th year of the startup’s existence. In this case, the returns are lowered to 40% / 39x for a Pre-Seed, 32% / 16x for seed, 30% / 10x for Series A, 25% / 5.2x for Series B, and 26% / 3.9x for Series C. Series D and E investors get a 20 – 21% or 1.7 – 2.6x return. The failure tolerances are significantly decreased, with Pre-Seed investors only allowed 4 failures to maintain a 20% portfolio return, Seed investors 2 failures, Series A investors 1 failure, and all other later stage investors no failures (i.e. every investment must be a success, a tall order for this type of risk capital).
Now we come onto the early exit case. In this scenario, the company raises a few rounds of capital to develop the technology to the point where it’s ready for FOAK commercial. Then, the company exits early to a FOAK fund. The FOAK fund acquires the company at a lower discount rate than what the VC investors would normally target, therefore being able to pay more than what a VC would have valued the company. After the FOAK fund acquires the company, it helps the company get past FOAK and move onto being a levered fully functioning infrastructure owner-operator, after which it can be exited.
Exiting early allows the Pre-Seed investors to realize a 77% / 18x return, the Seed investors a 64% / 7.3x return, the Series A investors a 67% / 4.7x return, and the Series B investors a 76% / 2.3x return. Though the MOIC is lower, the IRRs compare since the capital is returned a lot sooner. Exiting early also allows for a lower failure threshold, since the liquidity event for these investors is no longer dependent on getting past FOAK. Thus the 6 failures for Pre-Seed, 3 for Seed, 2 for Series A, and 1 for Series B, while lower than in traditional VC, reflect an easier success case.
For the FOAK fund investor that invested with a premium valuation to a VC, they would still be able to realize an exit at nearly 30% IRR and 5.7x MOIC, a very healthy return for any private equity or infrastructure investment. Because this investor is taking FOAK risk, there is a chance that the investment fails in a binary fashion (vs. half-failing or generating a partial return), similar to a VC investment. In this case, with a 28% individual investment return, the FOAK fund investor can tolerate a reasonable 2 failures for every success case to achieve a “risky infra” return of 12%.
TLDR;
Investors, new or existing in climatetech, can create a functioning FOAK strategy that can make investing in FOAK a financially attractive proposition.
Founders in hard tech climatetech can look to early exits as a means of scaling and providing liquidity to early investors. Also early exits to risk-taking infra investors can be more lucrative than continuing with the venture cycle.
Service providers can consider encouraging and supporting the creation of these FOAK funds.
After discussing types of FOAK last week, this week I wanted to see if I could find a good estimate for the amount of FOAK funding we need.
One way to look at this is to try to pare down estimated infrastructure spend to what will be spent on FOAK technologies.
Most infra spend estimates land at ~$4 to $9 trillion / year. These numbers are never detailed enough to understand specific technologies they’re actually building in, but we can kind of glean from the breakouts an upper-end limit for what spend might be:
So all of the estimates roughly point to $1.5 - 2T / year being spent on technologies that have not yet scaled. Over the next 28 years, that’s $42 – 56T in total. Let’s just call it $50T as a midpoint.
To estimate how much we’d need for FOAK, we can just ballpark how much funding we can assign to deployed facilities (2nd facility and beyond) for every FOAK – or, assuming FOAK cost is around the commercial cost, basically how many deployed facilities for every FOAK facility. As one bookend, we can say that 1 out of every 100 facilities requires a FOAK. This is very high level but not crazy to assume. There are only 109 biodiesel plants in the US, 31 years after the first biodiesel plant in Kansas. There are only 18 renewable diesel plants (5 - 6 current renewable diesel plants with another 12 under construction), 12 years after the first renewable diesel plant in Louisiana. Using 1/100, that means we’d need to spend $500B for FOAK assets.
Another bookend would be looking at solar farms as a comp. There are 2,500 solar farms in the US, 39 years after the first solar farm in California. Let’s assume there’s 4 different types of PV (monocrystalline, polycrystalline, multijunction, and thin film) and that these 2,500 only needed 4 FOAKs (probably a very wrong assumption). If we assume 4 out of every 2,500 facilities requires a FOAK, we’d need $80B for FOAK assets.
So somewhere between $80B - $500B is probably the right number here…
To put this into context, PE funding in cleantech is at around $20 – 25B / year, while late stage VC funding is at ~$24B / year. If all of this funding was directed towards FOAK, we’d have enough…but part of this funding is used for digital technologies and for stages other than FOAK. If we assume that we have to put all of the FOAK in place by the halfway mark, we only really have $700B in place for potential FOAK funding. At the low end, 11% of our late stage – PE capital should be directed to FOAK. At the high end, 70% of that capital should be directed to FOAK.
I can tell you anecdotally that that true percentage of capital being directed to FOAK is nowhere near 11%, much less 70%.
If you’re not convinced by this top-down method of estimating potential FOAK spend, we can try to do a bottoms-up approach. We can assume that each startup that survives to FOAK needs FOAK funding…so we need an estimate the number of climatetech startups that are out there that will survive to FOAK.
Using Net Zero Insights’ database, I isolated 32 key areas that will likely need chunky FOAK funding, separated by the approximate types they’ll be in:
18,182 startups were identified as being in these categories. Let’s assume that 25% of the large plants, 10% of large assets, and 5% of large manufacturing faciltiies make it to FOAK. At $100mm per FOAK, that would mean we need $193B in funding for FOAK with just the startups that exist today. If we attempt to get more granular on individual category funding needs and assume the large plants need an average of $100mm, assets need $20mm, and manufacturing facilities need $50mm, we get $150B. At $150 – 193B of FOAK need, we’d need 21 - 28% of late stage VC + PE capital directed to FOAK, implying that one out of every 4 of these late stage deals need to be funding a FOAK.
I realize that a lot of this exercise is very hand-wavey…but it does at a high level illustrate an important need to direct more funding to FOAK facilities. We either need to be deliberately setting targets for the proportion of institutional deals that are FOAK OR we need to be bringing more capital in the door to help fund FOAK. In that latter case, the government, non-profits, and non-traditional capital sources like family offices and sovereign wealth funds will play an important role.
TLDR; FOAK funding will cost us billions, likely hundreds of billions, of dollars. We need more funding directed to it.
