Following the money!
2021 was a hot year for climate tech, no pun intended.
Investors poured money into decarbonizing technologies at record levels. Between the second half of 2020 and the first half of 2021, a total of $88bn was invested in climate tech with the first half of 2021 posting a record $60bn. This was more than 3X the investment in the same period in 2020. Some of the major markets like the USA are indicative of a maturing sector as exhibited by an underlying shift in investments from early to late-stage companies. New investors both traditional and non-traditional climate tech investors like Insight partners and Tiger Global have entered the space as the technologies move beyond proof of concept to commercialization.
Unfortunately, out of the $88bn invested globally in climate tech startups, only 4% went towards the rest of the world (i.e., outside of China, Europe & North America). By extension, the number is even smaller for Africa. According to Partech, only 4% of the $5.2BN raised in VC funding in Africa was towards cleantech companies in 2021. While this was a modest improvement in investment activity, investor appetite in the sector is yet to fully trickle down. For the sector to achieve escape velocity f, the commercialization of climate technologies in the African market must be proven out. For the investor community evaluating Africa’s early-stage tech companies, the pause has always been ‘Can they cross the chasm and achieve commercialization in a way that’s still profitable to them?’. The scars of the cleantech 1.0 wave have many lessons for skeptics and present opportunities for founders on how to position their business.
A bit of background
Cleantech 1.0, refers to the 1st wave of cleantech investing that saw the sector experience a boom between 2006 and 2011 where VCs invested a total of $25bn. Many of the cleantech companies at the time presented innovative hard-science solutions but equally, many, were never venture-backable. Many of these startups ended up requiring much more capital and time. Consequently, VCs lost over 50% of these investments.
Post cleantech 1.0 most investors concluded VC does not make sense for climate solutions given that most of these startups often include hard tech, regulatory arbitrage, or commoditized solutions. Three of the main arguments against these solutions have been 1.) It’s too Capex intensive 2.) It takes a long time to commercialize and 3.) Exits are difficult to come by.
However, since climate tech 1.0, the global landscape has evolved. Today we demystify the 3 arguments highlighted above, in the context of Africa.
1. Capital intensity
Although this is true, this risk bares more weight in a world where there’s limited capital for follow-on. As Richard L. Kauffman puts in his working paper, “ The dearth of growth investors in clean energy was one of the reasons that VCs had to commit much more capital than their usual VC commitment during Cleantech 1.0 to support manufacturers. Then stepping into the shoes of growth investors, VCs realized that the next link–project financing for deployment–didn’t exist either”. Thus, in this new climate tech 2.0 wave, if these businesses are to succeed, sufficient follow-on capital is key.
In Africa, the capital stack for climate technologies is modestly taking shape as private capital (both early and growth stage) as well as corporates start to pay attention. Traditionally, a lot of the funding for climate tech companies has been from DFIs such as AFDB, Proparco, IFC, etc. who provide grants, catalytic capital, and debt but this is no longer just a public money game.
At the very early stages, we have venture builders like Factor E, and Satgana, who support founding teams to form a team or proof of concept and help de-risk these businesses.
Between last year and this year, we have seen traditional VC funds like ourselves refine our focus on the sector while other early-stage sector-focused funds like Energy Entrepreneurs Growth Fund (EEGF) and Energy Access now called E3 have raised capital.
Global sector-focused funds are paying more attention to the space as indicated by recent raises; Koko Networks, one of our portfolio companies, recently announced a growth round backed by Microsoft Climate Innovation Fund. Shift EV, an Egyptian-based e-mobility startup just raised Series A from Union Square Ventures. Sun King raised $260 million in series D funding backed by Beyond NetZero, the climate investing venture of General Atlantic while Mkopa raised a $75mn growth round- just to highlight a few examples.
Beyond growth capital from venture capital and private equity funds, other players such as Sunfunder, provide structured finance tools such as project finance, collateralized debt obligations, asset-backed securities, and export finance which form the next important link for climate tech companies as they scale.
2. Time to commercialization is longer thanks to the multiple death traps and already established incumbents.
Venture capitalists refer to the period during which startups receive initial funding to the time they start generating positive cashflows as the valley of death. For software-driven tech innovations, the valley of death follows the J-curve, which in a nutshell means these companies struggle to find a product-market fit, but once they do, they can scale faster as they do not require heavy infrastructure.
Unlike software-driven businesses, most climate tech startups follow a more complex path towards commercialization in what might be referred to as the S-curve. This is however not only true for these climate tech businesses but also any hardware business.
The Rocky Mountain Institute describes climate tech’s four valleys of death as; 1.) Startup formation 2.) Product development 3.) Market validation 4.) Establishing a track record. The first valley of death is a result of a startup transitioning from an early lab or accelerator stage, where it may not have a fully formed team, and hasn’t achieved enough proof points a VC investor may require to mitigate their product and market risk. With the second and third valleys of death, founders must navigate the complex market to identify a proper market entry point, achieve product-market-fit, prove commercial viability and finally scale.
Be that as it may, the complex path to commercialization doesn’t mean that it’s going to be a straight-up ‘NO’ from investors for a few reasons. One from a tech perspective, founders today can iterate their product faster thanks to emerging tech like AI, machine learning, blockchain, etc. Two, there is more urgency for buyers to get these products before they are produced thus companies are getting LOIs before they are even produced. Last year Opibus, one of the e-mobility players in Africa announced a partnership with Uber to supply up to 3000 electric bikes as well as partnering with Uber to scale across multiple markets. Such partnerships or commercialization opportunities often help these startups prove feasibility for large-scale deployment.
3. The exits are difficult to come by.
In cleantech 1.0 governments were interested but corporates were not as such very few corporates were willing to acquire these businesses. Additionally, public markets were not so friendly to green companies but that has since changed as indicated by the Energy Impact Partners Climate Tech Index — which tracks public climate tech companies — that has outperformed the NASDAQ Composite Index since 2017. SPACS has also been an enabler with at least 28 companies being acquired by SPACS as of last year and raising USD 7.5bn.
Another interesting observation is, that there are opportunities for exits even before these businesses reach full commercialization. For instance Quantum Scape, the lithium-ion battery manufacturer went public in 2021 but aims to be commercially viable by 2024.
While aiming for a similar scenario in Africa’s young ecosystem is a stretch, strategic acquisitions by global corporates looking for growth opportunities in emerging markets are a better bet. The renewable energy space has seen a few exit opportunities over the past couple of years, for instance, in 2019, Shell’s New Energy acquired a minority stake in D.light a Solar Home Systems (SHS) company. Engie a global energy player acquired Mobisol-an off-grid energy company, Fenix International-a lease-to-own solar home systems company, and Simpa Networks.
Another exit route would be via M&A activity. Despite a relatively slow M&A activity compared to the e-commerce and fintech sectors, there have been several consolidations in the energy sector as companies seek a competitive advantage and economies of scale. Mobisol, a vertically integrated SHS company, acquired Lumeter, an off-grid software company, Greenlight Planet, a product- and software-focused SHS company, acquired Global Cycle Solutions, a solar product distribution company while Earlier this year, BBox a manufacturer and distributor of plug and play solar kits acquired PEG another solar company.
These exits serve as proof points for investors to have confidence in the sector while allowing early-stage investors to recycle their capital or earn returns.
What next?
Having addressed the primary factors contributing to an unfavorable risk/return profile for early climate VC investors. We then answer the question of how investors should think about investing.
Looking at technological inflection points, BCG put out a climate solution innovation canvas detailing approaches climate tech companies can use in innovating. The same approach gives us a road map to use when investing in this space. In this 1st part, we explore this framework and will extensively discuss opportunities in each area in part two.
Solutions scaling existing business models or markets
Startups that play on this side of the quadrant, are likely to face fewer hurdles when scaling. This is because they often do not have to change consumer behavior; instead, they focus on improving already well-understood business models.
For instance, with EV startups whether it’s 2,3, or 4-wheelers, the idea of owning a car is not foreign to consumers only that instead of the traditional Internal Combustion Engine vehicles we have electric ones. In energy, think of solutions like renewable energy resource companies like M-kopa.
Solutions scaling new business models or markets
These are companies that fulfill evolving consumer needs in a new way. Although these companies can be the first movers in a young ecosystem, they may require consumer education before they can attain maximum potential.
For example, think of new business model innovations like carbon accounting and markets or new models resulting from EV adoption e.g., charging infrastructure. In the energy space, consider concepts such as power trading.
Solutions building on existing models but using more disruptive tech
The right side of the quadrant represents solutions using breakthrough technologies to achieve scale. Technologies such as wind-generated electric power, have established their viability in the marketplace but need a technological improvement to reach scale.
Think of solutions like renewable energy storage solutions or grid management solutions that offer real-time energy usage analysis and optimization on the cloud.
Solutions building new models using disruptive tech
These startups face significant technological and commercialization risks but have the highest potential for outsized returns. Here we can consider most deep tech solutions like carbon capture technologies, use of low carbon materials in manufacturing, alternative proteins, etc.
Currently, most startups playing on this side of the quadrant are in the main global innovation hubs (Europe, USA, China) with largely sector-focused VCs backing these businesses. However, as climate tech matures, we will likely see improved risk appetites as VCs move towards backing such businesses.
Conclusion
Despite the substantial global growth rates, we find in this sector, it is still a nascent one. Compared to other sectors like fintech, capital remains thin rather than abundant.
That said, I am sure that climate tech will grow in Africa albeit from a low base. A lot of it hinges on government support, an entrepreneurial culture, availability of talent, and a full capital stack. Market uncertainty remains the major hurdle, as such, we will likely continue to see sectors like E-mobility and energy continue to attract more funding in the foreseeable future.
Nonetheless, we are always on the lookout for business model innovations that work more effectively within the new models. Essentially, we would like to hear from founders who are thinking through the economic impacts of these new technologies being broadly adopted within the below segments.
· E-mobility
· Built environment
· Energy grid, energy storage, energy generation
· Carbon tech