Can ‘deeptech’ venture capital solve the climate crisis?
To kick off this newsletter, I'm going to break down a brilliant episode from the podcast Catalyst.
The episode is called “Can ‘deeptech’ venture capital solve climate change?”, and is a conversation between the podcast host Shayle Kann and Ramez Naam, two renowned climatetech investors.
After the first wave of investment in the climatetech sector (referred to as cleantech 1.0), many draw the conclusion that climate deeptech doesn't work for venture capital. To illustrate, Ben Gaddy and Varun Sivaram published in 2016 the MIT report Venture Capital and Cleantech: The Wrong Model for Clean Energy Innovation.
However, much has changed since then.
Shayle and Ramez dissect the four biggest arguments against climate deeptech venture capital to see how much they hold up today. Let’s break down each one.
Argument #1: Climate deeptech is too capital intensive
The first argument that Shayle and Ramez bring up is that climate deeptech takes too much capital to scale. They admit that, indeed, many physical hardware technologies require large-scale investments to scale. But to tackle the argument that it’s too capital-intensive, Shayle and Ramez highlight three points.
Point #1: Many successful VC-funded businesses have been capital-intensive
First, Ramez points out that numerous successful tech companies have required substantial capital to grow, yet they have thrived and delivered significant returns. This suggests that high capital requirements alone do not preclude the potential for success.
“If you look at, you know, some real darlings of the tech VC world, companies like Uber or Lyft or WeWork, you see companies that have burned through an enormous amount of capital—far more than most cleantech companies ever have or ever will. So I'm not sure that, on its own, the too-much-capital-to-scale argument really holds that much water.”
- Ramez Naam
Point #2: The capital is available
Second, both Ramez and Shayle emphasize that the financing landscape for climatetech has changed dramatically, with a significant amount of follow-on capital now available.
"We're in a funding environment where the scale of capital available to companies that have big promise, big markets, and so on, is unprecedented.”
- Shayle Kann
Point #3: It just puts you at a higher bar for exit
Lastly, Shayle brings up the relationship between the scale of investment needed and the potential size of the exit.
"You can't build a really expensive manufacturing hardware climatetech company that's going to take $400 million to reach manufacturing scale, that then doesn't have a huge opportunity on the other side."
- Shayle Kann
Argument #2: The competition in commodity markets leaves no opportunity for margins
The second argument that is brought up in the discussion is that many climatetech companies compete in commodity markets, which makes the economics of the business model unattractive due to low margins. To counter this argument, these are the points Shayle and Ramez bring up.
Point #1: Policy is now a driving force to count with
Shayle and Ramez both acknowledge the significant challenges of competing in commodity markets. However, they also highlight the evolving policy landscape and argue that it’s becoming increasingly clear that climatetech policies are coming and will reshape the playing field.
“I do think it's very different now with policy that is really driving scale of clean solutions.”
- Ramez Naam
Point #2: There are customers willing to pay a green premium
Shayle and Ramez also explain how there are increasingly more customers willing to pay a green premium. The companies doing so believe that they will reap the benefits of it down the road, for example in terms of increased stakeholder alignment and the establishment of a positive brand halo. So in some cases, you don't need to price at parity in a commodity market.
“I'm willing to say, at least in some of these sectors, that it's actually okay to assume a green premium while you are initially scaling. In the long term, you need to be cost-competitive, there's no question. But can you come to market not being the cheapest source of X on day one? I think in some markets the answer to that is yes.”
- Shayle Kann
Argument #3: Climate deeptech takes too long to scale
A common argument against venture-backing climate deeptech is that the timeline to commercialization is too long. This is what Shayle and Ramez have to say about that.
Point #1: There are exit opportunities before commercialization
The timeline for hardware-related tech is indeed longer, and that’s definitely a challenge for venture capital. However, Ramez highlights that we no longer have to wait for a product to reach commercial scale before achieving an exit.
“You can start a B2C software company or a B2B SaaS company and be selling products a year or two years on the road. Cleantech or anything really deep hardware-related, it's not going to be that fast. That said, now we start to see exits happening before commercialization has been achieved.”
- Ramez Naam
Point #2: Increased urgency from buyers
Shayle also notes that there is much more urgency from buyers now than before. For example, electric aviation companies are receiving orders for electric planes from major airlines long before having a product to deliver. This increases the credibility of the technology and makes it easier to raise capital.
“There's a lot more urgency from buyers of these future products than there was historically. And so it's I think easier for credible solutions to get firm orders.”
- Shayle Kann
Point #3: Faster technology iteration is now possible
Another point that Shayle highlights is the increased possibility for faster technology iteration.
“We now have the applications of machine learning and AI to R&D in ways that we never did before. We have new tools like synthetic biology that are being applied. You know, all these things mean that there is sort of an opportunity for faster technology iteration that can bring things to market faster purely from a technology perspective.”
- Shayle Kann
Point #4: Tough to build, difficult to replicate
Shayle also points out that there are clear advantages to the long and complex timeline.
"The hand in hand with it taking a long time to do things is that it's tough to do those things. And so when you succeed, to the victor go the spoils, [and] you should have a pretty clear moat. Whereas, as you said, you can build an enterprise software company pretty fast, it doesn't inherently mean there can't be another competitor that builds the same thing even faster."
- Shayle Kann
Argument #4: There’s no attractive exit landscape
The last argument that Shayle and Ramez deal with is the idea that the exit landscape for climate tech is unattractive. This, say both Shayle and Ramez, is the one that has changed the most since cleantech 1.0. Let’s break down their points on this one.
Point #1: The acquisition landscape is evolving
The first aspect brought up in the discussion is the increasingly attractive acquisition landscape.
“European oil and gas companies—like them or hate them—what you see is, they all understand that there's a clock ticking on their current cash cows, and they're all trying to get a piece of the new pie in cleantech. That's provided some of the, you know, best exits for companies like EV charging companies. I think you'll see that in sectors like hydrogen as well. So it's a more robust exit landscape in both the public markets and in acquisitions.”
- Ramez Naam
Point #2: The traditional IPO market has started to open up
Second, Shayle notes that an increasing number of exits are happening through conventional IPOs.
“The sort of IPO market, traditional IPO market, has started to open up to some of this stuff as well. So it's not just SPACs.”
- Shayle Kann
Point #3: Climatetech is performing well in the public markets
Lastly, Shayle and Ramez point out that climatetech is performing well in the public markets compared to other indexes.
“The stuff that is deemed climatetech, at least as I've defined it, is performing well in the public markets as well.”
- Shayle Kann
Ending words
In the introduction of the podcast, Shayle emphasizes that this question—whether climate deeptech can succeed with venture capital—is the most important question guiding his professional life.
And it’s an important question for all of us. There’s an urgent need for an increased flow of capital to climate deeptech, and venture capital is indeed an important part of that puzzle.
Fortunately, both Shayle and Ramez conclude that the landscape has changed dramatically since cleantech 1.0. We are now seeing more and more examples of venture bets succeeding in bringing climate technologies to market and achieving large-scale decarbonization.
Ramez puts it well in the end:
“We're in the middle, or honestly at the early stages, of a $100 trillion clean energy revolution. That number sounds made-up, but when you look at the infrastructure turnover needed to address climate change, it really is that big.”
- Ramez Naam