Climate Tech’s Scale-up Challenge

DAI Magister CEO Victor Basta highlights the opportunities for investment in the technology required to accelerate the transition towards a more sustainable future.

The climate technology sector has seen steady expansion over the past 10 years and is expected to have a strong growth path in the coming decade.

Data published by provider Statista earlier this month showed that the global climate tech market was valued at US$20.34 billion in 2023, a 23% year-on-year increase. Impressively, it is predicted to register a compound annual growth rate of 24.5% between 2023 and 2033, to reach a potential US$183 billion.

A challenging macro environment marked by higher interest rates and restrained private funding saw investment levels by volume fall 12% year-on-year to US$51billion in 2023, according to BloombergNEF. However, the drop was much less dramatic than the 35% reported for all startups by Pitchbook.

This year has already seen a strong rebound in money flowing into the sector. In the first half of 2024, climate tech in Europe attracted more investment than any other tech sector, securing €7.7 billion (US$8.6 billion) in equity and €13.2 billion in debt, according to Sifted.

Climate tech – which covers a broad range of hard- and soft-asset projects and initiatives, from renewable energy solutions to carbon capture and storage techniques – is a key area for DAI Magister, a boutique investment bank focusing on mergers and acquisitions.

This can include companies producing agriculture robots, developing sensors for optimising resource efficiency, electric vehicle charging and plant maintenance.

“A lot of investment is being allocated to analytic, optimisation and monitoring software, enhancing what is already in place,” DAI Magister CEO Victor Basta told ESG Investor. “Research has shown that it is possible to make an enormous dent in the climate problem just by optimising existing practices. For example, a small improvement in the efficiency of manufacturing plants built 30 or 40 years ago could yield huge benefits.”

Mid-market gap

The buoyant funding environment must be put into context of the existential threat caused by climate change – which suggests it isn’t possible to “throw enough money and resources” at the problem, Basta stressed.

Yet, discontinuities in the market are challenging the climate tech industry. Basta pointed to the financing gap between venture capital and project finance – which he described as the ‘valley of death’.

There is a reasonable number of small ticket investments – around US$1 million – available to prime the pump for early-stage intellectual property-driven innovations in process design or renewable energy, he explained.

Similarly, there is money available for project finance, which is well understood by infrastructure funds that support large projects. This could, for example, include a company that has built a solar power plant and now needs US$200 million or more in equity and debt to deliver outputs to guaranteed off-takers.

But a financing chasm exists between these poles. Basta used the example of a company that has already manufactured several large-scale machines, and now requires around US$50 million to expand its facility.

“This is more than what traditional venture capital would sustain, yet a fraction of the ticket size that infrastructure funds are generally looking to deploy,” he explained. “It’s also a different type of risk, because while the company has proof points, it needs to accelerate rollout. There is far less capital available at the pre-scale stage.”

This is a relatively new problem for the market, as far fewer companies used to reach this stage of development five or 10 years ago.

“Many more companies are on the cusp of potentially graduating to the scale-up stage as a result of many government initiatives and a fairly active early-stage market,” Basta stressed.

Not all companies have the ability to graduate to the next stage. This can be because their initial proof points don’t scale, their processes don’t work, or their solution isn’t cost efficient to survive in the market.

Today, however, there are far more worthy projects at the post-proof, pre-scale stage, according to Basta – who says this presents a hybrid type of risk.

“There’s much less capital relative to the opportunity, because funds coming at it from either side have a hard time wrapping their mind around the risk parameters,” he explained. “As a result, a range of next-generation renewable energy projects, for example, are being throttled at this stage.”

Interestingly, this gap doesn’t exist for digitally-driven climate tech companies, such as those that produce monitoring and optimisation software, Basta noted.

“Scalability isn’t an issue for digital companies, because they can easily scale from one to 30 licences, and because software is generally well-understood by typical technology investors,” he added. “However, the physical-asset layer, where contracts and off-takes need to be organised and many companies rely on grants, is not well understood by such investors.”

The dearth of financing started a few years ago, when the market collapsed. It still hasn’t fully recovered – hence the number of funds allocating capital to this in-between stage is still relatively small. According to Basta, grants and government funding don’t fill the void as they are meant to be additive and enabling to fundraising, as opposed to replacing it.

As the world continues to strive to limit global warming to 1.5oC, the cost to society of a climate tech company’s two- or three-year drift in the ‘valley of death’ can be significant.

“If I was to encourage investment in a broad category, I would point capital allocators who really want to drive ESG outcomes to assist companies across the financing chasm,” said Basta.

Promoting change

Addressing this financing gap will take a mindset shift to modify the view of the pre-scale stratum’s ability to generate additional value, the CEO explained.

For example, an infrastructure fund could decide to invest early in a project or initiative to have the right to fund the later-stage US$300 billion rollout. In doing so, it might consciously allocate some of its money as a type of bet placement. Some more adventurous infrastructure funds have already taken this approach, according to Basta.

On the early-stage side, a company could deliberately attract a few larger venture funds to its capitalisation table early on. “While none may want to write a US$30 million cheque on their own, they could do it together,” he explained.

A third path exists through strategic investment funds, which are special-purpose investment vehicles backed by governments or public institutions. According to Basta, strategics are better-positioned to understand the risk. Additionally, they might be the off-taker for a large project, so investment at this stage allows them to secure a foothold.

In general, he believes climate tech companies need to do a better job in cultivating strategic interest earlier on, and engaging with their existing investor base.

“Of course, a company has to be in a position of some luxury to be able to pick and choose – if it is desperate for US$5 million, it will take what comes,” he said. “However, some companies have two or three early-stage investors on their capitalisation table, which together could fund their next growth stage.”

Investment opportunities

Basta’s advice to institutional investors looking at the climate tech space is to pick a limited number of focus areas.

“You can’t be an expert on everything, from electric vehicle charging to plant maintenance software,” he said. “Therefore, drill deeper into two or three areas – which will be 10 or 15 in reality.”

Investors should also look at emerging markets, as many countries are “leapfrogging” established technologies. Commercial and industrial solar companies, for instance, have achieved large valuations in Africa because residents have circumvented the unreliable grid energy supply and turned to commercially sited solar capability on factory rooftops.

“Similar to Africa’s jump to mobile [in the early 2000s], there is another leapfrog happening in renewables because most emerging market countries don’t have an existing infrastructure to unwind,” said Basta. “Yet, relatively few funds focus on this [trend] in emerging markets.”

While each emerging market may be smaller than most developed markets, an early investor can gain a strong foothold by backing a climate tech business in two or three reasonably sized markets, he explained, adding that the use cases, benefits and value that the climate tech sector creates are very clear.

“There is an enormous amount of money to be made in this space, as the world is only going in one direction – it’s just a question of how quickly we get there,” Basta continued. “For investors who have the discipline and mindset, the climate tech industry has much lower risk overall than many other sectors, and must grow to a multiple of its current size [to address the world’s sustainability challenges].”

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