Five Red Flags to Watch for When Investing in ClimateTech

The transnational push to net-zero, sealed in the Paris Accords and boosted by the latest conference in Glasgow, is a long-term global commitment pulling the weight of the most powerful sovereign nations. VCs have more pressure on them than ever before to make impact investments. With 19 billion invested in startups in the first three quarters of 2021, ClimateTech is an attractive sector, not just in terms of ESG reports but in terms of pure profit potential. But due diligence is especially essential in this young fast growing sector. Here are some warning signs which would-be investors in this space will want to watch out for.

1) Don’t bank on subsidies, use them as catalysts

The original cleantech involved investing a lot in basic research and development rather than investing in product. While R and D will always need to be part of the mix, with ClimateTech most of that should be bMomentum is determined by policies, and subsides. Subsidies don’t need to exist for the entirety of the company’s life, just long enough to create momentum, allow the company to pop, and then yield to new customers who come for other reasons allowing organic growth at scale. There’s every reason to be on the lookout for subsidies to go green from governments, whether those handouts come directly to the company or incent consumer demand by offering rebates for buying energy efficient devices or switching to an electric vehicle. But it’s a mistake to depend on geese to keep laying golden eggs. Crack those eggs while you have them, but use them to broaden markets and create something self-sustaining without the help of subsidies.

2) Claiming “Because it helps the planet” is not enough

The next most important factor is to have an active executive who is really strong in commercializing the product, everything from sales operations to marketing and branding. It’s extremely important. What I’ve often seen is that a lot of these companies will get their product out there and then just focus on squeezing the juice out of that kind of the low-hanging fruit: that relatively small camp of environmental true believers, consumers who are already gung-ho on going green. But what about everyone else? Tree-hugIdealism won’t produce exponential growth in customer acquisition. Entrepreneurs should not bet the farm on this. Good intentions are admirable, but a good business needs to think about how cost-effectively you can scale. It’s great to remove plastics from the ocean, but if you business is going to recycle 100,000 plastic bottles to make 100 chic designer chairs, there’s a disconnect in terms of the viability of your business model. Only a tiny fraction of consumer markets is motivated primarily by altruism or idealism. A much broader slice of the consumer pie is more concerned with economic savings and, more subtly, by the appearance of altruism and idealism. It’s not superficial: it’s the expression of a lifestyle choice and a statement of values: Many are saying: I care about the planet, I’m smart, I’m stylish, and I make good money. That’s an attractive and practical combination, not just idealism That’s sex appeal.

3) Don’t Underestimate the Difficulty of Finding a Founding Team

So having that key growth-hacking executive is key, but the rest of the founding team needs to have skills which differ considerably from what would be required for a fintech company, for example. You do need someone who really understands the science and the RD, who can keep up with what’s happening in the field and the government, from the UN to NGOs to national and local governments in one’s target markets. Following what’s going on with climate policies is almost a full-time job, just to keep up. You need to have a thought leader on board in the ClimateTech space.

4) Seek Entrepreneurs who Know they Need More Than Money

If founders simply expect to take passive money from a venture capital firm, \they may be the wrong fit for a savvy VC. Many VCs will push what they call their “platform team” as a value add. But too often that only adds up to marginal assets like a little bit of legal expertise or some run of the mill accounting services. What smart entrepreneurs should be looking for from their investors is domain expertise and experience in ClimateTech or at least cleantech. That’s what they are likely to need the most to cross the death valley between rounds and to reach profitability and scalability. If they do have this recognition, and you as a VC can deliver the know-how, be prepared to temper passion with patience. ClimateTech is in its infancy, and — even though it’s a planetary imperative — founding teams need the humility to seek and accept not just funds but also expertise from VCs. Both must be prepared to adapt initial assumptions and business models to fast-changing conditions and technologies.

5) Don’t Skimp on Transparency and Measurement

True transparency at every level and accurate measurement tools to make sure companies actually deliver real-world solutions, not just big claims. “Test and measure” is a motto that every startup should take as a mantra, but especially in a new industry like ClimateTech where the terms of measurement are themselves evolving. Companies must avoid “drinking their own koolaid” — the key to that is to establish external measures of success and then live up to them rather than moving the goalposts to create the appearance that you’ve reached your goals.

That doesn’t mean you should expect investors to be indefinitely patient. They won’t be as patient as they were, for example, with cleantech in the early 2000s. We shouldn’t expect them to be. They were burned by vague promises, sketchy science, and premature tech. Sure, VCs need to look for a certain IRR and the pBut there’s also an opportunity in creating tools for measurement and reporting, It’s inevitable that each and every company is going to need to prove compliance by documenting their carbon numbers as well as other emissions and consumption data. Gold rushes — real and fake — come and go, but the outfitters of the miners and pan-swirlers — think Levi’s and flashlights — tend to last far longer.

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The editors of Impakter have made a real contribution by laying out nine principles for VCs interested in jumping on the impact investment training. Without exception, we can get behind these values as relevant to the ClimateTech sector. Most of us are inspired by the combination of investing in causes as worthy as saving our shared planet. But we are also sobered by the daunting challenge of finding and founding companies which both make a positive environment and social impact and make VC-scale multiples in IRR.

The recent creation of nine and ten-figure funds by top private equity firms is a sign, reported in Crunchbase, that impact investing has reached a whole new level. Social and environmental causes are no longer the nerdy uncool kid on the block. “Profitable cause” is no longer an oxymoron. The launch of Bain Capital’s $390 million double impact fund and TPG’s $2 billion Rise Fund are landmarks that impact investing has truly come of age. Michael Baldinger, who heads sustainable and impact investing at UBSm considers impact investing “a $250 billion market” and “growing fast.” While there is considerable overlap in the emerging fields of climate and clean technology, the two key branches of environmental impact investing, there are some distinctions which both investors and entrepreneurs need to keep in mind.

Taking these five warning flags we have discussed to heart and addressing them proactively is preventative medicine for ClimateTech startups seeking to avoid the consequences of unrealistic expectations and unmeasurable results. And they are due diligence items for angels and VCs to consider when evaluating both potential investments as well as the performance and management of the ventures in which they’ve invested.

The overarching goal should be to put in place a business model that relies on realistic results and has measurable potential to scale along a realistic timeline. ClimateTech is likely to produce a gold rush in the coming decades. But that’s no guarantee that a given company will find gold. Or that its investors won’t be fooled.

About the Author: Nolan Gray is a Silicon Valley SaaS exec turned ClimateTech entrepreneur and investor. American-born and based in London, Gray was selected in 2020 for Forbes 30 Under 30 in Europe. He is co-founder of Svea Solar, a pan-European digital energy innovator that has eliminated millions of tons of CO2. The company has generated $130 million in revenue, while raising $31 million, with more than 500 employees. Previously, Nolan served as CMO at Jobscience, a San Francisco-based SaaS company sold to Bullhorn, owned by Vista Equity Partners, for $50 million. He has helped raise over $80 million for multiple SaaS and ClimateTech startups in the U.S. and Europe, and has made a series of impact investments.

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