Tech Nation, July 20, 2022 11 min read
This article was written by Tech Nation’s Net Zero experts, Sammy Fry and Julie Martin
Climate tech has grown significantly in the last few years and is expected to continue, with investment being touted to exceed well over $1.5 trillion annually from 2025. However, there is new concern climate tech will not achieve its much needed potential, with the recent economic downturn bringing back haunting memories of the cleantech bust in 2011, where natural gas prices significantly dropped as a result of an increase in fracking, and demand for climate technology failed to materialise.
With this said, there are reasons why things have changed this time around. Since 2011, the world has woken up to the climate crisis. There is consumer and business appetite for climate solutions; many technologies have successfully matured, outperforming their fossil fuel derived counterparts; impact investors have made successful returns; and pro-climate legislation, on average, has been on the increase since the 2015 Paris Agreement, despite much more needing to be done.
On top of this, we simply cannot afford to do anything other than speed up progress. With UK temperature records being broken by 1.5C and wildfires destroying forests across Europe, it represents arguably the starkest warning yet for the UK that the future of the planet hangs in the balance. A recent study led by the UK Met Office has also concluded that the probability of the world exceeding 1.5°C within the next 5 years is close to 50%.
To overcome the downturn and get the world on a net zero trajectory, limited partners (LPs), governments, family offices, asset management firms, VCs, corporates, and society will not only have to continue doubling down on their support for climate tech, but also ensure they are focused on the right solutions which will successfully curtail emissions and bring sustained returns. This is where the importance of scaling hardware comes in.
It is difficult to overstate the crucial importance of climate hardware technology in accelerating global decarbonisation. While software has its role to play and can be used as a great facilitator to emissions reduction, hardware is fundamental across each key sector to enable a sustainable and habitable world.
We held a peer-to-peer session with Pippa Gawley, founder and director of Zero Carbon Capital, and our Net Zero 2.0 hardware climate tech founders, discussing the unique challenges that come with scaling hardware. Here are some of the insights we gathered.
As mentioned, investors are still haunted by Cleantech 1.0, since it was essentially made up of hardware climate technology companies. As Forbes highlights, these companies “had to build factories, develop large-scale manufacturing and production strategies, engage in years of basic science development, iterate through generations of hardware prototypes—often before they even knew whether they had a commercially viable product.” In the end, VC firms lost over half the $25 billion they had invested into these companies between 2006 and 2011.
The VC industry also has not been set up with hardware in mind. Indeed, as the article continues: “the venture capital model works best for startups with a particular profile: massively scalable, capital efficient, rapid iteration cycles, low marginal costs, recurring revenues.” These are all characteristics of software technologies, and that’s what investors are currently primarily focused on.
In the UK specifically, climate tech hardware isn’t catching up as quickly or getting as much attention as it is in the US. As Pippa points out, the investment culture in the US is different from the UK’s, with investors willing to take higher risks at bigger valuations. The good news is that US investors are increasingly venturing into the UK market. Bill Gates’ Breakthrough Energy, for example, have recently launched their Catalyst programme – aiming to invest $1.5 billion into CAPEX intensive solutions in both the US and Europe, including the UK, such as direct air capture and green hydrogen; a reassuring sign the downturn is not halting investment increasing.
Beyond disproportionate investment going into software, climate tech is also disproportionately supporting certain sectors over others; mobility and transport, for example, has attracted 45.7% of climate tech investment despite it accounting for 16.2% of global emissions. This is in stark contrast to the built environment sector which represents an estimated 17% of global emissions, but received only 5.1% of funding. These findings represent a systemic failure within venture capital, where crucial sectors that require funding are being overshadowed.
Hardware companies also often struggle from investors’ lack of knowledge on hard science and engineering, both central to the building of hardware climate technologies. Investors tend to prioritise a certain type of tech founder – those with MBAs and a very business-oriented mindset. With climate tech, however, tech founders often have PhDs in STEM (Science, Technology, Engineering and Mathematics), which fuels the stereotype that leadership in hardware technology companies are solely focused on science and less so on business. The resulting lack of trust that investors often place in senior management of hardware companies creates great challenges in scaling their climate tech solution. Yet if these founders can work on scientific research and earn a PhD, you would expect it to be possible for them to upskill in the areas of business investors value so highly.
If the climate hardware solution and the tech is right, there is no go-to-market risk as demand will already be there. In addition, hardware typically has higher barriers to entry for competitors, since it is harder to replicate.
Finding investors that work for you and your business can be challenging, but it is by no means impossible. Network with your peers and find out which investors have and haven’t worked out for them, and why. Look at investors’ portfolios to have a better understanding of their track record. When speaking to investors, make sure they understand your vision and the impact you want to have – even if they don’t fully understand the science behind it. When pitching, make the science easily digestible to ensure investors who have more of a commercial focus can clearly see your technology’s real-world applicability.
And don’t forget – one of the silver linings of the COVID-19 pandemic has been the embracing of remote working. US investors are only a Zoom call away, and our founders have emphasised the importance of taking advantage of this opportunity to connect to investors globally:
“We’re in the middle of a paradigm shift in fundraising, where geography is no longer becoming a barrier to connecting great investors and startup companies. Today, UK based startups can readily connect with Hardware focused investors around the world, and access partners who understand the journey of hardware development and its importance in achieving Net Zero goals.”
Jack Reid, co-Founder and CEO of Unicorn Biotechnologies
For very early-stage companies, corporates and their venture arms can be of great benefit to enable pilots, process engineering, or scale very specific aspects of the business. However, even though founders often see corporates as better partners than investors, it might result in more loss of control. Particularly at an earlier stage, it is important for founders to keep as much control over their company as possible. Brian Lynch, CFO of Solivus, mentioned:
“If a corporation is an acquirer or investor of your business, the last thing you want is for them to control the valuation of your future rounds. Be very careful about having them as a majority investor.”
Jack Reid agrees that corporate investors often impose too much structure, arguing that it poses a particular challenge for scaleups, since flexibility and rapid movement are critical to their development.
This being said, Jack believes having a corporate VC arm in your investment round is acceptable if the round is below $20m. But he specifies that they shouldn’t be leading the round – they should either be a minority player in the round (<10%) or be among 2-3 other corporate VC arms (to avoid implications of favouring one corporate VC arm over all other classes of investors).
Corporate funding can also be risky because of potential reputational damage. In climate tech specifically, accepting funding from a large corporation to scale your business can backfire if greenwashing on the corporate’s part is uncovered. Many big oil and gas companies, for example, are investing in climate technology en masse. And although climate technology certainly needs funding, the founder’s reputation and own business activities will ultimately influence what customers think of the scaleup. Due diligence is vital to ensure any interested investor is actively divesting from fossil fuels and committed to net zero.
While investment into climate hardware solutions is increasing, Freddie Talberg, founder and CEO of EMSOL, believes there is still a large void to be filled, and argues that crowdfunding is a “must” for hardware climate tech companies. Freddie sees crowdfunding as a great proof point for negotiating with follow-on institutional investors. With the general public increasingly concerned about the lack of action on climate change and actively looking for ways to make a difference, crowdfunding can be a win-win. For many people, supporting a crowdfunding campaign for climate tech alleviates their climate anxiety and allows them to feel they are making a difference.
Since crowdfunding is truly international, founders are able to see which countries engage and resonate with their proposition, making it a great indicator for global markets. The liquidity opportunity within the crowdfunding platforms is also a compelling option to have, offering access to capital directly from retail investors from day one. A pitfall to avoid here is inflating your valuation. While it is appealing for companies to dictate their valuation when crowdfunding, over-estimations can have severe implications on future investment rounds, since later-stage investors may decide not to invest if they do not agree with the valuation.
Founders of hardware companies will often sell more equity in the early days in contrast to software startups, in order for them to fund the R&D and people costs required to scale. This ultimately results in early stage investors becoming diluted, due to the need for the company to raise more capital over time. As a result, companies may be unable to produce meaningful returns to investors, even if the company is successful. Investors have been known to subsequently push founders to achieve unrealistic traction scenarios, which increases risk and creates a drop in quality. Founders therefore often have to choose whether to reduce their equity position to keep the business afloat or face a shortage of capital to retain their shareholding position.
Fortunately, public-private partnerships are beginning to form to support the growth of high-impact climate tech companies. One such mechanism is through the British Business Bank’s Breakthrough Future Fund. The Breakthrough fund is a £375m UK-wide scheme which will encourage private investors to co-invest with the government in high-growth, R&D intensive firms, to support VCs in de-risking their investments – particularly relevant given the current economic environment and raising more capital while giving away less equity. Initiatives such as these are critically important to enable these companies and technologies to scale and create the impact required to drastically reduce emissions, without the high risk.
While the challenges of raising funds within hardware are plentiful, Pippa Gawley highlights that scaleups have to be extremely honest with themselves. Pippa states that if a founder is struggling to secure funding, it might not be just because of the hardware element – even if this is what investors say – as it is often “an easy get-out” card. Indeed, Pippa highlights that having hardware technology doesn’t necessarily equate to solving big problems, which is what is required to create a valuable company. She advises startups to truly listen to customer feedback and to find trusted advisors who can support other aspects of the business which might be putting investors off, including team quality, product market fit, or market plans.
Some companies talk about “de-risking” their business models at every level when speaking to investors. Indeed, many hardware companies also have a software component to their technologies, and founders will then try to put an emphasis on the latter to increase their chances of success with investors – a “digital-first approach” that may be reassuring to software-loving investors.
As Jack Reid points out, hardware startups must answer this question: “How can I generate quick, reliable, and scalable revenue streams with my hardware?” Although the digital-first approach can create additional revenue streams, Jack highlights three recommendations:
Founders often emphasise the importance of networking, preferably in-person. From their perspective, being able to connect not only with other early-stage founders but also with later-stage, established founders from who they can gain valuable advice and mentoring is key to scale and grow, along with with establishing relationships with corporates and venture firms to support their growth – all things Tech Nation’s programmes are geared towards supporting.
Finding quality talent is one of the most common and important challenges founders encounter when building their businesses, and, for some, Brexit has made it even more complicated for UK startups. For others, like Jack Reid at Unicorn Biotechnologies, Brexit has actually made hiring easier. The streamlined visa application process for foreign nationals and the increased focus on domestic policies (i.e. levelling up the north) have opened up new talent markets that had previously been overlooked by many UK employers.
One way to make the hiring process easier is to build strong relationships with universities, which offer high-quality talent pools. MBA programmes, for example, often partner with companies to provide their students with work experience. To hire more senior positions, our founders unanimously pointed to networking with organisations within a similar field as a great way to find talent.
For startups with limited resources, it might also be worth offering attractive incentives beyond the salary – stock options, for instance. However, even with limited financial capabilities, the climate tech sector does benefit from a significant advantage: its impact. With the shift in people pursuing purpose-driven careers, the post-COVID-19 shift in hiring trends, COP26 and the global realisation that global decarbonisation must become a top priority, employees are increasingly interested in pursuing a career fighting climate change. Now more than ever, people want to be personally aligned with the mission of the company they are working for. As Jack Reid states:
“I think the word which encapsulates why people want to work in climate tech is “mission aligned” – people want to be personally aligned with the mission of a company; to engage in meaningful work that they have clear autonomy and ownership over. There is nothing more meaningful now than trying to save our planet.”
With hardware technology, the minimal viable product (MVP) can be much slower to iterate than software. The desired product has to be broken down into smaller chunks and each chunk must be systematically dealt with individually to ultimately get to the full product. Any mistake in hardware is much more time-consuming and expensive to fix than a mistake in software, and it involves tracking suppliers down at every stage.
Testing or piloting the product could therefore potentially be framed as a customer trial – it should be free, and shouldn’t exceed four months. To get the maximum benefits from this phase, it is recommended the team should meet frequently to take feedback onboard, iterate, and get the product where it needs to be.
But with hardware, this is a tricky process at scale. When you’re manufacturing hundreds or thousands of devices or pieces of equipment, you need to balance the changing needs of your clients with the challenges of changing suppliers, manufacturing processes and regulatory frameworks. To reduce the risks as much as possible, you have to plan, model and have discussions with your clients, suppliers and relevant regulatory agencies from day one. This being said, Jack Reid states:
“While one always has to deal with suppliers, modular, cheap prototyping tech, like 3D printers or online-ordered dyes for injection moulding, are making it easier and cheaper to iterate through designs. New technologies are beginning to ease the challenges of iteration.”
In conclusion, hardware is indeed hard – no surprises here. Scaling climate hardware is paved with numerous challenges: the carbon funding gap between software and hardware, the overall investment landscape, the difficult balance in founder equity, the slower iteration cycle for hardware, the lonely journey of a founder, or finding quality talent. On top of all that, climate hardware has had a bad reputation since Cleantech 1.0, which doesn’t make it easier.
The good news is that climate hardware does have an increasing number of advantages too. Support systems are emerging from public-private partnerships, such as the Breakthrough Future Fund and programmes and Tech Nation’s programmes; investor appetite has so far shown no signs of slowing down with an increasing amount of institutional investors willing to fund climate tech; remote working has opened new opportunities and the opportunity to contact with investors anywhere in the world; there’s generational movement towards purpose-driven careers. In many ways, scaling hardware has never been easier than right now.
And climate tech hardware companies have already seen success. As Pippa Gawley points out, the majority of the companies on the Cleantech Group’s Global Cleantech 100 ranking are hardware companies. In addition, the vast majority of climate tech companies who have exited, IPO’d, or SPAC’d are hardware companies. On our own Net Zero 2.0 programme, 21 companies out of 32 had a hardware component.
We at Tech Nation are aiming to play our part in supporting the growth of the most impactful climate hardware companies. Our Net Zero programme, targeted at early-stage climate tech scaleups, and our Net Zero X programme, designed for later-stage climate tech companies, both offer tailored support from climate specialists and experienced founders to help these companies achieve scale. We also convene key stakeholders across the policy, investment, academic and corporate sector to directly support companies and to ensure we are creating the best possible conditions for key climate solutions to achieve their full potential.
We need technology that will produce renewable energy, and we need technology that will store it. We need technology that will cool us off without heating the planet. We need technology that will provide us the building blocks for low-carbon infrastructure. We need technology that will increase crop yields, limit water consumption, and sequester carbon. We need technology that will remove carbon from our atmosphere. We need technology that will do much more than all of that – and we know that hardware will be the key to achieving it.
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