You are in one of these two camps — those who believe that clean energy is the future and those who think the future is uncertain.
VCs were in the first camp in 2006. By 2011, they decamped, and funds for clean tech dried up [Fig 1]. As of 2008, over 8% of venture capital rounds (Series A to J) were allocated to clean energy firms; that number declined to just 3% by 2020 [3]. Despite losing more than half of their investments ($25B+) in clean energy between 2006 and 2011, VCs are now betting on clean energy again!
Fig 1. VC Investment in Clean Energy from 2005–2022 [1,2]
The Present is the Key to the Past
The only way to fully understand what happened to the clean energy investments years ago is to look at the present.
VCs do not invest where there are no established exit mechanisms and when this was the case in clean energy 12 years ago, VC funds dried up in the sector. Unlike in other sectors such as biotech where big pharma provides acquisition pathways for biotech startups even before successful clinical trials, the big energy companies were not turning up for those clean energy startups. For instance, in 2009, Shell announced that it would not invest in wind and solar, and BP left the solar industry in 2011[1]. Well, at that time, it made absolute sense given the unprofitability of the clean energy business. The big energy folks are in the oil and gas business — the cash cow, and in the glorious times of rising oil prices, these firms reinvested more in oil and gas. Even worse, when oil and gas prices suffered like in 2008 -2011, they cut off unprofitable ventures like clean energy. This obstacle in the scaling-up process triggers a chain reaction, restricting venture capitalists’ capacity to invest in pre-commercial technologies in this sector. Hence, the bust.
“When macroeconomy is rough and returns are harder to come by, corporations focus on one or two areas that have the highest probabilities of generating higher returns.” — Nathaniel Harding, Managing Partner at Cortado Ventures — an early-stage VC firm based in Oklahoma City.
Back to Fundamentals
There are a few reasons behind the failed journey of VCs in clean energy, and perhaps the main cause lies in the business models of both the venture capital and the clean energy industries. Venture capitalism is a high-risk, high-return model. VCs typically invest in relatively less capital-intensive ventures that have unlimited upside potential. They want to get in at the early to late stages of a company and, within the next 10 years, exit with very high return multiples (10x — 100x) when the company is acquired or goes public. Given the high-risk portfolio, it is no surprise that not every portfolio company turns out to be a home run. In fact, the model is a bet on just a small proportion of the portfolio companies becoming huge successes. Typically, when VC funds make a hundred investments, they anticipate that most will fail, several may break even, and around five to ten will succeed spectacularly, making up for the investments in all of the failed deals.
On the other hand, clean energy (excluding the software segment) is very capital-intensive. While a typical successful company would raise $100M — $200M in all financing rounds (from pre-seed to late-stage), it is not uncommon for clean energy companies to seek hundreds of millions of dollars in a single round. For example, by 2009, Solyndra, a company that specializes in the manufacture of photovoltaic systems using thin-film technology, had raised a total of $970 million through equity financing!
Fig 2. Capital Intensity — Risk Graph [4]
But here is the catch; clean energy investments have much lower returns!
“Many clean energy deals are capital intensive, have significant science risk and almost never drive venture level returns” — Blake Bixler, CEO at Senslytics — a VC-backed start-up that develops unique causation-based AI applications for use in energy.
Given that energy is a commodity — the consumer cannot differentiate between energy sources, clean energy battles fiercely with other energy sources and is reduced to a low-margin business. So, you have an industry earmarked with high capital and low returns — a losing combination for VCs! But, they missed it! Why? Increasing fossil fuel prices bolstered the investment thesis that clean energy would become a high-growth market. Between 2002 and 2008, the rising cost of natural gas caused U.S. electricity prices to increase by 38%, and from 1998 to 2008, gasoline prices roughly quadrupled. Financial analysts predicted that oil prices would continue to rise and there were a lot of incentives from the government that did nothing but boost the confidence of investors in the sector [1].
Playing long term — The Present
Here is the good news! If you have an idea to execute in the cleantech space, this is the time because in the past few years, the story has been different; very different. VCs are back pumping money into clean energy. Well, not just the VCs, corporate venture capital firms (CVCs) have skin in the game too. In fact, as fuel prices were in decline in 2022, VCs poured a record-breaking $16.2 billion into 582 clean energy deals — an 810% increase from 2017 [Fig 1].
Apart from the boom experienced in the VC sector as a whole, the major reason behind this development is the increasing demand for clean energy. As climate change awareness increases, energy is becoming less of a commodity as people start to care about the source of energy. According to a 2023 survey by The Pew Research Center, 67% of 10,329 U.S. adults prioritize developing alternative energy sources like wind, solar, and hydrogen power over boosting fossil fuel energy production [5]. Unsurprisingly, the majority of the proponents of clean energy are Gen Zs and Millennials who would be more concerned about the future. In one study carried out three years ago, over 79% of Gen Z and 60% of millennials are willing to pay more for clean energy compared to 34% of baby boomers, and VCs and CVCs are betting on this trend [6]. In 2021, Blackrock CEO Larry Fink argued that the next 1,000 unicorns — startups valued at $1 billion or more — will be focused on climate technology [7].
“Millennials and Gen Zs are much more concerned about the environment” — Nathaniel Harding
The change is here?
Despite the seemingly good news, a deeper look into these investments in clean energy sheds light on where the money is going into. When you zoom in, you realize that VCs are simply moving to the bottom right quadrant of the capital intensity–risk graph [Fig 3] and are dumping money into whatever fits such model in the clean energy space whether that is energy efficiency software, lighting, electric vehicles, fuel cells, power storage or wind and solar components of unproven technologies.
Fig 3. Sub-sectors within Clean Energy [4]
Hence, although investments in clean energy are on the rise, the ballooning is coming from these VC-fit segments and not investments in renewable energy such as wind farms and commercial plants for unproven solar cell technologies.
Fig 4. VC investment in energy start-ups, by technology area, for early-stage and growth-stage deals, 2004–2023e [8]
“Solar and wind energy, while more mature technologies, still must overcome their intermittency problem through storage solutions. That’s one reason why more than two-thirds of global VC clean energy funding in 2022 went to battery, storage, and renewables” [9] — Leopold Zangemeister, Energy and Natural Resources Principal at Olyver Wyman
But, what about the future?
Perhaps the near future may not be as green as most would want, but there are things that could speed up the journey.
The most crucial one is to get the unit economics right!
Owing to the intrinsic nature of humans to seek maximum profitability and utility, no matter how loud one might want to blow the trumpet of climate change and the need to go green, the only sustainable way to get clean energy to stay is to make it compete well with dirty energy. For this to happen, there needs to be incessant massive investments to encourage innovation in the space.
“Even though clean energy is where the world should be headed to, at a certain price, it would not work” — Blake highlighted during my interview with him.
Unfortunately, and unsurprisingly, we are so behind. To put that into context, the Intergovernmental Panel on Climate Change (IPCC) in its 2022 report highlighted the urgent need to invest $2.3 trillion annually in low-carbon electricity technologies to keep global warming within 1.5°C above pre-industrial levels. But despite this imperative, according to Bloomberg New Energy Finance, global investments in energy transition sectors hovered around $755 billion in 2021 — less than a third of the amount [10].
Also, while supporting the supply end of the clean energy chain is crucial, it is pertinent to establish predictable and long-term policy measures that would fuel the demand for clean energy.
Finally, for VCs to continue investing in the other quadrants above [Fig. 3], established exit mechanisms must be in place for startups who champion innovations in this sector. The obvious implication is that the big energy firms must be willing to provide exit capital, but they would come around only if there is enough demand to justify such investments — back to unit economics!
“If institutional investors like pension funds, multinational companies and investments banks take climate change seriously, then VCs take it seriously, then more people would start companies in the clean energy space. Right now, institutional investors are not broadly focused on clean energy because of its low returns on investment” — Nathaniel emphasized.
To wrap up, I do not see drastic changes as regards VCs investments in clean energy unless something drastic happens — something that would change the way people view climate change. However, like Nathaniel, I think we just got on the trajectory of the clean energy future albeit at a very slow pace.
“We are now at the beginning of an inextricable increase in opportunities in climate tech investments. It was just too early in the last cycle because renewable technologies such as solar and wind were not efficient enough” — Nathaniel
About Cortado Ventures
Cortado Ventures is an early-stage venture capital firm that invests in ambitious, growth-driven companies to define a new generation of economic prosperity for the Midcontinent region. As one of the largest VC funds in Oklahoma, Cortado’s focus is on tech companies bringing innovative solutions to the energy, logistics, life sciences, aerospace, and the future of work sectors. For more information, visit cortado.ventures.
References
[1] Gaddy et al (2016, July) Venture Capital and Cleantech: The Wrong Model for Clean Energy Innovation
[2] Q4 2022 clean energy report | Pitchbook.
[3] IEA. Global early-stage venture capital investments in energy technology start-ups — charts — Data & Statistics. IEA.
[4] Ghosh et al (2010) Venture Capital Investment in the Clean Energy Sector
[5] Kennedy, B. (2023, June 28). Majorities of Americans prioritize renewable energy, back steps to address climate change. Pew Research Center.
[6] Lucía Fernández, & 8, F. (2023, February 8). Demand for clean energy from customers 2021. Statista.
[7] CatClifford. (2021, October 25). Blackrock CEO Larry Fink: The next 1,000 billion-dollar start-ups will be in climate tech. CNBC.
[8] IEA (2023) Word Energy Investment 2023
[9] Fritz, T., Pellerin, M., & Zangemeister, L. (2023, May 18). Why funding for startups in clean energy is booming. Oliver Wyman — Impact-Driven Strategy Advisors.
[10] The role of venture capital and governments in Clean Energy: Lessons from the first cleantech bubble | CEPR. (n.d.-b).
[11] Blake Bixler, CEO at Senslytics
[12] Nathaniel Harding, General Partner at Cortado Ventures