We need to rethink climate investing

This is part two of a three-part series on the potential “winter” for the climate tech sector. Continue reading with part one and part three.

For climate tech to scale, the collaboration between climate tech founders and capital providers will need  to change. It will need to be a durable — and dare we say, sustainable? — relationship, and one designed for deep partnership. 

To get a sense of what this might look like, it is worth looking backward: to the very first days of Silicon Valley venture capital and the case of Intel. The company was founded by Robert Noyce and Gordon Moore with an innovative capital model proposed by Arthur Rock. Intel was given a $2.5 million pre-money valuation in 1968 — the equivalent of $21 million today — and Rock invested $2.5 million. 

Today, there are few founders and VCs who would seek out, much less agree to, a fifty-fifty split of this type. Founders have been trained to sell 20% to 25% of their company at a time, and to be suspicious of the partnership and advice of their capital providers. And VCs aren’t interested in 50% ownership because of the worry that large ownership stakes will scare off other investors. 

These risks are real, but it is worth considering the upside of a deeper relationship between founders and capital. Climate tech is different from other sectors because it requires more skills and knowledge; you need to be sharp on energy, hardware, software, policy, and also business models and capital. Very few founders, or founding teams, can tackle these challenges alone. There is a lot to be gained in having capital partners with expertise who are fully committed to growing your business rather than just thinking of your business as another horse in the stable.

For VCs, we see the same opportunity. Yes, it’s hard to know which companies will succeed, but it is possible to make high conviction bets early on and then flood resources to those companies so that they really win. And, crucially, there is the opportunity to define winning not as raising an up-round so that there are paper profits, but as actually building a business with a working model that can attract investors in any economic climate.

Lessons from biotech

A version of this approach is already happening today in biotech.

Biotech companies share many similarities with climate companies. They often have both technical risk, and regulatory risk. They may require large pools of capital. And the time between developing first prototypes and then scaling applications — the so-called Valley of Death — may be longer than many investors can stomach. 

But venture capital firms have built ecosystems around biotech to support their growth. There are investors who often have both business expertise and scientific expertise. There are pools of operators who are familiar both with the hard work of bringing a scientific product to market, and the critical regulatory pathways that will unlock success. 

Moderna is a classic example of this model at work. In 2013, Alexion Pharmaceuticals backed Moderna (at the time, Moderna Therapeutics) with a $125 million investment. While the funds were reserved, Alexion did not make them available all at once. Alexion provided Moderna with $25 million upfront, with the rest held in reserve as milestones were met. Moderna went on to develop one of the most effective vaccines for COVID-19, which became part of the portfolio of drugs that led pharmaceutical giant Astrazeneca to acquire Alexion for $39 billion in 2021.

There are, of course, important differences between biotech and climate tech. In particular, biotech has a clearly defined set of regulatory milestones that companies must pass to bring a drug to market, a process which makes risk much easier to estimate at each stage of development. But it is our belief nonetheless that some climate tech investments can and should be structured in similar ways.

It might look like this:

1. Raise the initial capital to prove the concept: This is where capital is most abundant today.
2. Third party validates early results: The regulatory approvals required of biotech effectively force firms to prove the science. There can and should be a similar validation for climate tech. We think this type of outsourced, and perhaps standardized, diligence might plug a very real gap in the climate ecosystem.
3. First-of-a-kind capital: A much discussed hole in the climate ecosystem is around first-of-a-kind, or FOAK, capital. This is the large-scale capital needed to build a manufacturing facility or demonstration project.
4. Growth capital: Large-scale capital is needed for repeatable projects. In the climate space, this is likely to also include components of debt, project finance, and equity.

We think a structured roadmap, preferably created by a single capital provider, would help to provide both the rigor and capital for important projects to succeed. 

Like biotech, many climate tech ventures involve significant upfront research and development costs, long timelines to market, and regulatory hurdles. A milestone-based funding approach in climate tech might tie capital infusions to key technical achievements, pilot project outcomes, or regulatory approvals, for instance.

Michael Sachse is a private investor, and previously was the CEO of Dandelion Energy, CMO of Opower, and was an entrepreneur in residence at New Enterprise Associates. Jim Kapsis is the founder and CEO of the Ad Hoc Group, and previously was the VP of market development at Opower, as well as an official in the U.S. Treasury Department. The opinions represented in this contributed article are solely those of the authors, and do not reflect the views of Latitude Media or any of its staff.