Climate Tech Investment Sees Global Slowdown

Unfortunately, given the urgency of climate action, we've seen a significant decline in climate technology investment resulting from deteriorating global macroeconomic conditions. Our research at DAI Magister shows that climate technology investment fell by 56% in the first quarter of 2023. The number of funding rounds also fell from 384 to 132 in Europe in the same period last year. This decline is not unique to Europe; it is a global trend. The downturn in valuations and investment activity has caused investors to pull back, even from promising climate tech companies. Rounds are still getting done but require more time and effort to close, even for the most promising growth companies.

Despite this downturn, there are still promising tailwinds for the climate technology sector. Government initiatives are already in place and not yet fully reflected in overall activity, but they are set to bring down climate tech companies' effective cost of capital and create significant new sources of revenue.

Some examples of these policies include the US Inflation Reduction Act (IRA), the EU's Zero Emission Vehicle mandate by 2035, and Germany's push to implement hydrogen broadly across its economy. The IRA incentivizes investments in climate tech by providing tax breaks and subsidies to companies working on sustainable solutions. The EU's Zero Emission Vehicle mandate sets a clear target for the adoption of electric vehicles, creating a growing market for related technologies and infrastructure. Finally, Germany's focus on hydrogen is expected to drive sector-wide innovation and investment, as hydrogen is seen as a critical element to achieve a carbon-neutral future.

M&A Signals

Meanwhile, M&A activity has increased in two key European segments: energy generation and natural capital. In general, these deals are driven by strategic buyers who account for 60% of deal activity across both segments, with the remainder split between private equity and private buyers.

Strategic expansion in these two segments signals a broad-based desire to acquire key assets for long-term production of renewable energy, as financing has become more expensive for such projects in the wake of repeated interest rate hikes everywhere. In addition, strategic buyers recognize the value of integrating climate projects into their portfolios to secure their sustainability credentials and footprint.

As the sector swung into quarter two, financing activity has remained challenging, with smaller rounds still declining in number and value. This trend reflects the cautious approach of investors who are now seeking larger, more established companies to minimize risks in an uncertain investment landscape.

Overall, a persistently challenging environment will likely trigger more mergers between climate tech start-ups in the same segment, who now need to demonstrate greater scale to qualify for a successful larger fundraise in the coming 18 months. These mergers facilitate the pooling of resources, expertise, and technologies, and crucially also reduce future risk, allowing the combined entities to achieve the necessary scale and attract future substantial capital.

Promising Signs

Whilst climate tech is experiencing a global slowdown in investment, there are still promising signs. Governments still have net-zero targets to meet, and subsidies are in place to help ambitious growth companies scale. For instance, governments worldwide are providing grants, tax incentives, and low-interest loans to support the development and deployment of climate solutions.

Regardless, climate tech start-ups will need to focus on demonstrating greater scale and attracting strategic buyers to navigate the current, challenging investment environment. Scaling up operations and showcasing the potential for significant impact are crucial factors for gaining investors' attention and support. In many cases, early collaboration with strategic partners can provide the necessary resources, networks, and market access to accelerate growth.

In conclusion, while the climate tech sector is experiencing a global slowdown, there are still promising indications for its future — but founders and CEOs must focus more than ever on alternatives to “just raising the next larger round.” M&A in energy generation and natural capital highlights the importance of strategic partnerships. We expect the significance of this for partners and investors will only increase across all climate tech areas and move toward an earlier and earlier stage, as we are already seeing in the hydrogen space. Once major government programs begin to be fully felt in the market, we expect a broad-based rebound in both valuations and capital coming into key climate sectors, over the coming 12-18 months.

Victor Basta is the CEO of DAI Magister, a "boutique" investment bank specializing in climate and technology. The views expressed in this article are those of the author.