This is an extract from Clyde&Co’s report on “Innovating to Net Zero: Funding climate tech from concept to commercialisation to critical mass“.
There has long been a disconnect — even a conflict — between economic growth and environmental protection. Today, as the window to prevent irreversible damage to the planet from climate change becomes smaller and technological advances accelerate, they are finally aligning. Innovation is key to delivering net zero carbon emissions. The right investment conditions are now present to enable ground-breaking “climate tech” ideas to come to fruition. Awareness is growing that it is possible to change the world and drive real value creation at the same time. After earlier false starts, the moment for climate tech’s ascendancy is finally here.
One report forecasts that the market for “green technology and sustainability” will grow by 27% to US$36.3bn by 2025. The route to net zero lies in both rolling out existing technologies along known pathways, leveraging falling costs along the way, and in developing and scaling nascent or unknown solutions to net zero roadblocks. Significant investment opportunities exist, but this emerging area is fraught with pitfalls. However, there is an eroding baseline too: inaction is itself a risk, both in terms of failure to de-risk existing investments and in missing out on opportunities. For entrepreneurs looking to attract the right backing, to corporates seeking suitable ventures with start-ups, and investors seeking rewarding investment opportunities, there’s a huge amount to think about, as we explore here, in specific sections for each. This report gives context to the issues, signposts options and provides food for thought on key issues for decision-makers, from the very earliest steps of investment to the practicalities of getting deals done. By marrying our expertise in corporate deal-making with extensive experience helping clients to build climate change resilience, Clyde & Co is well-placed to deliver insight in this area.
Paths to climate tech investment for investors
The drive for asset managers to take a more sustainable approach to investment has begun. Global investment firm Blackstone has stated that action on climate change is “good economics”, while the launch of initiatives such as the Coalition for Climate Resilient Investment (CCRI), of which Clyde & Co is a member, aims to better integrate climate risks in investment decision-making. Climate tech is a clear area of interest, but there are several considerations investors should bear in mind to create resilient investment strategies, identify suitable opportunities and secure the best deals, such as:
Positioning – (where) do we want to focus?
Since the scope of climate tech is so broad, deciding on a position is the first step for potential investors. After researching the market to understand the different subsectors and their growth potential, and taking existing experience into account, investors will wish to develop a clear approach to climate tech, either as part of existing investment strategy or as a new standalone thesis. Considerations include:
Do you want to take a generalist approach to climate tech investment, with tackling climate change (in a broad sense) as the primary objective? Or focus on a particular challenge area in a specific sub-sector, industry vertical or branch of climate tech? Alternatively, is your strategy towards climate tech opportunistic?
To what extent are financial rewards the most important consideration? Or do you seek to be an impact investor whose priorities also include effecting positive social and/or environmental change? If so, what does that change look like, and how does the climate agenda fit into your wider ESG and sustainability (as well as financial) goals?
Appeal – how do we stand out?
Companies with good ideas, solid business models, demonstrable proofs of concept, and significant growth potential are popular prospects in any sector, but in the climate tech space, demand is such that entrepreneurs can often pick and choose from several suitors. Founders tend to be keen to partner with people who share their goals and their passion, who understand their vision and the market potential, and whose ethos and ideals are aligned with theirs.
Investors may have to “sell” themselves – in terms of interest, enthusiasm, knowledge of the field and positioning, and/or in terms of the additional value they can add via relevant expertise, insight or contacts.
Approach – how do we take this forward?
Thinking about your financial and climate specific priorities and how a potential investment will sit within your investment or business portfolio may have a bearing on how you approach a potential deal. For example, large businesses looking to set up corporate venturing partnerships may have an interest in product development or supply chain issues that the target company could solve, which may impact the bidding process and ongoing investor/ investee relationship. Private equity firms may need to bear overall risk appetite in mind or re-think fund timelines to ensure that their offering and requirements are aligned with those of the target company.
Corporate venturing and venture capital investment can work together, as Mott MacDonald Ventures, the strategic corporate venture arm of global engineering, management, and development consultancy Mott MacDonald, has recently proved. It invested in cleantech start-up Piclo, as part of a £4.7m funding round led by the Clean Growth Fund (which combines public and private investment), and will work closely with Piclo to deliver innovative new digital solutions to businesses in sectors like energy, water and transport.
Resilience – how do we make this work?
Front of mind will be how to de-risk investments in this emerging sector. Investors should bear their overall climate risk mitigation strategies in mind when selecting investments and give advance thought to the importance of measuring and monitoring non-financial performance. For example, sustainable technology investor Earth Capital has created an award-winning scorecard called the “Earth Dividend™” to measure the ESG impacts and benefits of portfolio companies. Finally, consider how formal the process for gauging progress against targets should be. Do such metrics need to be “baked in” to the deal itself as part of the contract (see Deal Dynamics section)? It’s also important to assess what the target company’s future funding requirements might be going forward, and whether a suitable strategy to secure follow-on private equity investment, grant funding, or bank debt that passes lenders’ stress-tests exists or can be developed.
Paths to investment for climate tech companies
With more than US$16bn of venture capital poured into climate tech in 201912 alone, it’s clear that there is a large and expanding pool of capital ready to back and scale the climate tech innovations. Initiatives such as the US$2bn Amazon Climate Pledge Fund13, the US$1bn Microsoft Climate Innovation Fund14, and the US$1bn Oil & Gas Climate Initiative (OCGI) low carbon investment fund signpost the direction of travel. Even traditionally slow movers such as public authorities and large corporations are showing a willingness to adopt a more flexible and entrepreneurial mindset, for example by providing grants of public money (see separate box), creating public/private fund partnerships, or trialling new technologies through venturing initiatives.
When it comes to taking on external private investors, entrepreneurs and business owners need to think about:
Positioning — what sort of investor(s) do we want onboard?
Ask yourself what sort of investor(s) would add the most value to your business model and map out your requirements. Is this purely a cash transaction, or do you have specific pre-requisites that investors must meet or red lines that would rule them out of the running, to help you filter potential investment candidates?
For example, it may be important to check out their wider investment background or corporate positioning on ESG issues. Some investors are purely focussed on delivering financial returns, while others, known as impact investors, may have very specific ESG goals as well. They may be prepared to pay a premium for green credentials, but also have high expectations for monitoring performance and measuring value added against ESG criteria.
Appeal — what to look for in an investment partner?
Ethos matters. Businesses and investors need mutual understanding and aligned objectives – never more so than in the climate tech space. A degree of knowledge about, and enthusiasm for, the sector or product concerned will be important criteria for many climate tech entrepreneurs, so ask about the investor’s investment thesis. Following the successful conclusion of a recent fundraising round.
Partnering with strategic investors who can bring valuable experience and other resources to the table may also be important, such as one that has a track record in helping scale similar businesses at speed or useful contacts in a particular area. Remember that in such an in demand sector, investors should be able to “sell” themselves to you, as much as you need to attract them.
Approach — how to secure investment?
Be clear about your goals and how you will achieve them, as well as how you differentiate yourself from the competition and how what you are offering is new. Be upfront about what your financial proposition is, and what your non-financial proposition is (and why it’s important). Explain what your non-financial expectations of potential investors are. Doing so at an early stage will prevent time from being wasted and ensure discussions progress quickly. Be aware that communities and initiatives exist to support climate tech innovation. For example, accelerators can provide vital access to specific expertise, usually in exchange for an equity stake. Examples include the global ClimAccelerator programme and venture builder Carbon1316. Tapping into these kinds of resources opens up another path to funding and can also help attract investors by giving them confidence that you have a wealth of support.
Resilience — how to make the relationship work?
Be realistic about what you promise investors and what you require of them. For example, be aware that investors may be at an early stage of a journey into sustainable investing and may not yet be able to demonstrate a long track record of performance. Define your (climate-related as well as purely financial) criteria for success and think about to what extent those criteria need to be incorporated formally into the deal itself to create a resilient framework for your ongoing working relationship. Also consider how investment resources will be allocated to improve climate-related as well as financial performance monitoring/measurement.
There are some important differences when it comes to deal-making in the climate tech space compared to deals in other sectors. Due diligence may need to be adjusted to ask deeper or broader questions around climate-related issues that go well beyond the standard compliance-focused questions.
Impact investors may ask portfolio companies to provide sustainability reporting as part of their due diligence and beyond, but companies may be too small or early stage to do so. Indeed, this can be challenging even for large corporates to do, and it is something that investment firms who are less embedded in the climate arena may be grappling with themselves.
Investors may need to manage their own expectations and think about how best to support investee businesses to deliver what they need.
If there is to be a mixture of primarily financially-focussed and impact investors coming on board, thought will need to be given as to how to balance any potentially competing goals and align objectives sensibly and realistically, and to determine if and how those issues should be factored into investment documentation. Specific clauses and terms could be included such as Green Acquisition Obligations, which add wording to SPAs to incentivise a purchaser (through the payment of a Repayable Consideration) to maintain or improve an investee company’s green credentials post acquisition.
The Chancery Lane Project, a pro-bono collaboration of law firms to which Clyde & Co has contributed extensively, has put forward several sample clauses that could be implemented in real-world scenarios to improve climate-related performance. Its Climate Contract Playbook (now in its third edition) provides a valuable resource. For example, clauses could be used to ensure that companies will behave in a sustainable way with investors’ agreement, such as by buying clean energy or using recyclable packaging, even if doing so is more expensive and therefore less profitable.
Harnessing the value of data
Data is almost always going to be central to the success of a climate tech business. For example, data could be used to deliver a climate benefit in and of itself (such as by using data analytics to understand how to make infrastructure more energy efficient), or it could be used to provide evidence that a particular climate tech innovation is having a positive environmental impact. By their very nature, climate tech companies will typically either generate data through their operations, or their business models will rely on using thirdparty data. It is therefore essential for climate tech companies to ensure they have the rights to use data in the way that they need to; but also that they protect the value in the data that they create – particularly where their business model requires them to share that information with third parties.
Understanding the nature of data
The nature of data and what you can and cannot do with it is, from a legal perspective, commonly misunderstood. The first step in understanding data is understanding the nature of data. Businesses often mistakenly think that they ‘own’ data; that they can do what they like with it. However, in truth, there are no property rights in data per se: no one owns data. Unlike tangible property, no one owns a number or value, a time or date stamp, or any other fact or piece of information that is recorded in a database cell. There are, however, rights, obligations and restrictions that apply concerning the use of data. Common examples include intellectual property rights (such as database rights), confidentiality restrictions, contractual restrictions on the use of data, and legal restrictions imposed by the type of data (for example, data protection laws applying in relation to personal data). These rights, obligations and restrictions may have an impact on whether a climate tech business can use data in the way that it wants or needs to.
Why is this important for climate tech businesses and their investors? Well, for climate tech businesses, it’s essential that they get their house in order and make sure they can use data in the way that they want to right from the beginning – to make sure that they use data legitimately, to protect the integrity of their business model and minimise the risk of disputes. For investors, it’s ultimately about protecting the value of their investment – by making sure the business has been set up properly and that any value in data created is also protected. Just as climate tech businesses need to make sure that they have the right to use data in the way that they want to, they also need to think about how they share data with third parties such as customers and other organisations with whom they collaborate – something that many new climate technologies and data solutions rely upon. In short, businesses need to make sure that the data they share is only used in the way, and by the persons, that they are comfortable with. That way, the value in the data shared may be protected.
Climate tech businesses can do this by utilising the rights, restrictions and obligations mentioned above – for example, by including appropriate terms in its customer and other commercial contracts confirming that the data shared is the business’ confidential information and by contractually restricting the use of such data to certain agreed purposes. Again, this is something that needs to be built into the business’ data strategy.
Tackling climate change and meeting net zero commitments cannot be achieved without significant investment in climate tech innovations – investment which must be appropriately directed and managed. The scale of the challenge is vast but so too is the opportunity set: from software that can re-shape consumer behaviour to technologies that deliver a fundamental structural shift in how many industry sectors operate.
Demand is high, but getting these technologies developed, commercialised, and scaled requires careful planning from the outset, with transparency and alignment around financial and nonfinancial goals needed at every stage of the journey, and hard-wired into contracts if necessary.
In many ways, climate tech represents a new frontier for risk and reward: for entrepreneurs, investors, and the world at large. Resilient deal structures will be central to capitalising on good ideas for the good of society and the environment, as well as for financial gain.
The complete report can be accessed here