The Current State of Climate Capital
Our playbook for companies that need to raise in 2024 / 2025
We at Coral are longtime users / consumers / addicts / victims of the hellsite formerly known as Twitter. While we strongly recommend that anyone wise enough to not have rotted their brains via dopaminergic overload never start, we do occasionally come across interesting insights. See below.
We are not talking about Taylor’s chic-yet-casual cardigan choices, although those are quite strong. No, we found it more curious that Diego Saez-Gil, founder of the wonderful Pachama, which has raised $88m from most of the biggest names in the climate capital ecosystem, seems to think there’s a slowdown in climate funding. If he’s feeling it, everyone is.
While we certainly don’t have anything resembling his network, this jives. Much of Coral’s core business is in growth consulting; We engage with series seed > B climate companies to accelerate go-to-market, structure their metrics and governance, position with investors, and raise capital. It’s gotten a lot harder in the past year.
So today, in a more tactical break from our usual programming, let’s take a dive into what’s happening in the early-stage climate capital stacks, and how we’re recommending builders and allocators adjust their processes for the new world.
The Business of Venture
We’ve written about parts of this issue before, but it’s worth exploring in depth. The root cause of the slowdown in climate funding, which PWC estimates at 41% between 2022 and 2023, is that most of the early-stage allocators in North America aren’t structurally positioned to fund these businesses. Let me explain.
Venture capital funds, as these allocation vehicles are known, base their business around power laws, dilutions, and time horizons.
For example; A Seed+A fund might raise $100m in total capital, to be deployed over 3 years. It will plan to write 30 checks of $2m, each of which buys 20% of an early-stage company at a $10m valuation. The remaining $40m, if you’re curious, is held in reserve to pay fees, and to double-down on winning portfolio businesses.
So. 30 companies, 20% of each. 10 of these go out of business or are eventually sold for minimal returns. 15 companies raise another 1-2 rounds, and eventually sell at between $20-50m valuation; The fund makes $10m return on the $30m invested here. Not bad, but this takes 5+ years, and the fund’s LPs (a fancy term for their own investors) could have done better over that timeframe by sticking their money in the S&P 500 and forgetting about it. So not bad, but also not good enough.
3 more PortCos do well, raise another few rounds, and sell at a $150m valuation to BigCos. Huge success! Except not, because our fund’s ownership has been diluted down to 7.5% of each business by those subsequent funding rounds. $150m * 7.5% * 3 = $34m net return over perhaps 7 years. We’re still below S&P 500 returns. Woof.
You may notice we’re missing 2 more companies. This is really the entire game. Our fund is betting on at least one of them, and hopefully both, going public at a $2bn or more valuation. $2bn * 5% ownership (after dilution) * 2 = $200m in returns. Now we’re cooking.
Misalignment
Our example above is simplified and a little trite, but the math is directionally accurate. It is a very, very hard business to make work, and arguably only viable in environments when interest rates are low and when valuations are continually expanding as a multiple of revenue. When your author started in tech in 2012/2013, software-as-a-service businesses were valued at 6-8x revenue. That multiple slowly crept up until spiking as far as 75-100x during peak covid insanity. It is now back to 6-8x.
An efficient SaaS business can double revenue yearly, at about an 85% margin. If that gets an 8x multiple, atoms-centric, slower-scaling climate tech companies are going to get less.
Notice the incentives here. VCs are money managers whose job is to provide a return to their own investors. In environments where interest rates are up, public equities markets are rising, and valuations are down, it’s logical for VCs to invest in the most efficient, growing, pure-play software companies they can find, and lower their allocations into riskier asset classes.
So that’s the reason for the slowdown. Now let’s talk about the playbook in this environment, starting today with builders, and dovering capital allocators in a followup on Thursday.
Builders
If you’re running or thinking about founding a climate company now, congratulations! It’s going to be tough, but you’ll make it. The companies that succeed in this environment are going to be iconic. Here’s what we’re advising our clients to do;
Ignore all data from anyone who raised capital from March 2020 to June 2022. Ignore it, forget it, throw it all out. It’s all bullshit, unfortunately.
Assume that GTM is equally important to product as core differentiation for the business. Yes, we know sales is a dirty word. Get over it, talk to more customers, plan to win based on your distribution strategy and execution.
If you’re early, consider non-dilutive capital to stand up POC-scale production and get to revenue. Many universities are looking hard at public-private partnerships in order for their engineering students to practice experiential learning. This is a great source of cheap talent. The IRA also contains billions in grant, low-cost loan, and green neo-bank allocations. We’re also fans of companies like Enduring Planet to significantly speed execution and usability of governmental capital.
Until you get to revenue, even if minimal, assume that you have no access to venture capital.
Take a look at your pitch deck. Toss out the TAM slide showing that if you just capture a certain percentage of the market within 24 months etc etc. Replace it with a rolling 4M model based on actual revenue. Here’s a good explainer on how to build the spreadsheet.
Identify your ~10 dream investors at least a year before needing capital. Study their investments; When do they invest, how much, and into which sectors. If the profiles don’t look like you, revamp the list.
Practice extreme operational excellence. Identify the key metrics of your business, institute a biweekly-cadence to track and report trends and improvements over time. Send the best, most frequent investor updates in the business. Have monthly board meetings and make sure that your management team does most of the talking. Be incredibly transparent, rigorous, and based in data. This builds confidence.
We’ll say this again; Capital is a finite resource, and you are competing for it. Internalize this as a core tenet of your thinking, operations, and company DNA. Learn to love it.
Is this easy? No, but necessary and so worth it. Founders, you are no longer competing for dollars on the basis of being better for the world, but simply by being a better investment. You are, and you simply need to tell that story.
We believe deeply that climate tech is the vehicle to unlock growth and abundance for all in a warming world. Now it’s time to steal the best of the Silicon-Valley playbook and out-execute their portfolio darlings.
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