Why climate tech startups may be positioned for significant VC investment growth

Over the past decade, the climate tech sector has emerged as one of the most promising sources of positive global innovation — generating the kind of solutions that have the potential to benefit our world for generations to come. 

Historically, venture capitalists have strongly supported climate tech companies, driving the growth of numerous startups in the industry. But between late 2021 and early 2023, a noticeable shift occurred. The previously fast-growing VC investments in the climate tech sector sharply declined, mirroring broader investment and growth trends in the global economy. 

Is this funding dip an isolated issue, or a symptom of a larger shift in venture funding patterns? In this article, we’ll take a look at the key factors contributing to the brief pullback — and surprising rebound — of the climate tech sector. 

Why did VC investment in climate tech suddenly decline?

Between 2021 and 2023, the global economy grappled with a series of significant challenges that impacted the investment climate as a whole. Rising inflation, escalating interest rates and soaring energy prices all created a worldwide ripple effect, leading to a broader decline in VC investments across most sectors. The climate tech arena wasn’t the only industry hurt by declining funding — economic uncertainty caused investors to act with greater caution in every funding deal.

In Q2 of 2023, total venture capital investment dropped to just $29.4 billion — a 34% decline from Q1, and well below the $61.3 billion invested in Q2 of 2022. Sectors like information technology, and business and financial services declined by over 45% in Q2 of 2023. Climate tech may be seeing a pullback, but in this VC market, it’s certainly not alone. 

In addition to market uncertainty, investors are shifting focus

When the market becomes volatile, investors tend to shift their funding away from unproven innovations, and towards more defensive investments. Defensive investments are those expected to be less volatile, while still generating healthy returns, no matter what the economy does. They’re typically less risky than growth investments, like emerging tech, but may offer lower returns. 

Some common defensive investments VC companies move towards when the economy is uncertain include healthcare, energy, and consumer goods and services. It’s not surprising, then, that VC investment into the healthcare sector grew by 10% in Q2. 

Climate tech holds promise, but when the global market is on shaky ground, many investors are looking for more “stable” investments in the short term. 

Climate tech companies face a unique set of growth challenges

Climate tech investment dipped between mid-2022 and early 2023. But over the past few months, it has surged to near-peak levels. In Q2 2023, VC investment in the climate tech industry in particular jumped to over $980 million, nearing the previous record of over $1.1 billion in Q1 2022. This dip and resurgence is likely caused, at least in part, by some of the unique challenges the climate tech sector faces: 

1. Climate tech is capital intensive

Climate tech startups can require significant capital to foster the development and deployment of their innovative technologies because these companies often create integrated hardware, software and product-based solutions. Unlike AI tools or information technology software, climate tech includes green infrastructure products like concrete, HVAC systems and building materials. These products have high overhead manufacturing and transportation costs, making the startups that produce them particularly pricey to launch and grow. 

The capital-intensive nature of some climate tech companies can make them less appealing to venture capitalists, particularly when the economic environment is challenging. 

2. Climate tech has a long time horizon

The journey from conceptualization to commercialization for complex climate tech products can be a long one. The development of innovative technology takes time, and navigating manufacturing regulations and supply chain delays further adds to the time it takes to get a viable product to market. 

Investors, especially in uncertain times, tend to seek investments that can generate a quick return on investment, with fewer complications in the process. The long lead time for climate tech companies can be a deterrent, even if the product is transformative. 

3. Climate tech is strongly impacted by regulatory challenges

The regulatory landscape for climate tech startups is a third significant challenge that keeps some VC companies from funding the startups that need it most. 

Climate tech companies often find themselves in sectors that are subject to complex and frequently changing regulations, like commercial or residential construction or infrastructure development. The potential for damaging regulatory shifts can make these companies appear too risky for cautious investors. 

While climate tech investment may have temporarily dipped, it’s certainly not out

If Q2 2023 is any indication of the future of climate tech, there are good things ahead. Despite the hurdles these companies face and the hesitations VC companies have, climate tech is the center of world-changing innovation, ushering in the next generation of sustainable, environmentally friendly solutions. 

Looking ahead, it’s clear that climate tech is full of untapped potential. Even without the kind of multi-billion-dollar investments other sectors are experiencing, climate tech is still performing better than most other emerging tech industries. The industry is a long-term growth sector, meeting the growing demand for clean, future-focused and broadly beneficial technologies that help every one of us enjoy a healthier planet. 

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