For the last two years, climate tech was on a tear. To be fair, so were a lot of other sectors. But when a slowdown hit tech investing in the middle of last year, climate tech startups bucked the trend and kept racking up the deals.
Now the party might be over, if preliminary data from a new report holds up.
Climate tech deal-making in the first quarter registered $5.7 billion across 279 deals, according to a new PitchBook report. The amount raised was down 36% year over year with 35% fewer deals. That’s certainly suggestive of a correction.
Investors have been keeping a closer eye on their pocketbooks as fears of a recession continue to rumble through the markets. And yet key economic indicators show a striking resilience in the U.S. economy, with strong hiring keeping unemployment low while consumer sentiment remains high. That hasn’t stopped economists and big names on Wall Street from continuing to predict a recession in the coming months. (Certainly not the first time they’ve done that.)
Still, all that noise tends to give investors the jitters. Since no one wants to be left holding the bag, investor sentiment has a way of becoming a self-fulfilling prophecy. If you’re a startup squeezed for cash, you’ve undoubtedly heard from your investors, and it may feel like a recession is already here.
Yet climate tech’s resilience has led some to call it the ultimate “recession proof” investment. Is that still true?
Maybe.
Some theories
Let’s break it down. For one, these are preliminary figures looking at data through March 31. It’s hard to say how many deals closed in the last few days of the quarter that weren’t picked up by this report. It might be billions!
Still, probably not $3 billion, so it’s likely this quarter will fall short — short enough to be the lowest quarter for climate tech investment activity since 2020. That could suggest that 2021 and 2022 were outliers for climate tech, too, with investors letting themselves get carried away by the exuberant market. It could be that 2023 is what a “normal” year looks like for climate tech.
More likely, though, is that the Inflation Reduction Act led to a surge in deal-making that starved this year’s pipeline. The bill’s passage last summer was a complete surprise; pretty much everyone thought Sen. Joe Manchin had killed major climate legislation midway through July only to see him revive it at the end of the month. President Joe Biden quickly signed the bill and almost overnight the U.S. had committed $369 billion toward addressing climate change.
In less than a month, investors had to completely recalibrate their understanding of the climate tech market.
More than a few founders told me that the Inflation Reduction Act was a game changer for their startup. Investors who had previously been playing hard to get were suddenly returning their calls. Markets that founders expected to materialize in a few years were suddenly viable starting in 2023, when the bulk of the law’s incentives kicked in. Everyone was off to the races.
Given the flurry of deal-making, it’s possible that investors have simply exhausted the pipeline. If that’s the case, then Q1’s slowdown will prove temporary. People are flooding into climate tech, but it takes time to transition into new careers and to start new companies. Plus, those new companies need to explore the sector and find their product-market fit. Once they do, that’ll send signals to other would-be founders to come off the bench and fill the gaps.
In other words, it might be another quarter or more before enough new companies lure investors back into the game.
Of course, the opposite might be true. Climate tech may not be recession proof (if the recession ever arrives), and the sector might be in for a few years of pain. It’s possible that climate tech deal-making is a lagging indicator, in part because startups and investments in the space are more mission driven than others. Investors might believe in a startup’s team and strategy, but they also believe in the mission of fixing the climate. When you believe in a mission, you’re much less likely to reverse course. No doubt many investors would object to that description, but I’d wager there’s at least a kernel of truth to it.
It’s not over
In the long term, climate tech is still a sound investment. Climate change will force economies to adapt, and that will create opportunities for founders and investors alike. In the short term, a lot will depend on investor sentiment. Have climate tech investors indeed pulled back or are they simply regrouping for another round?
The near term will also depend on whether countries follow through on their promises to rein in emissions by changing regulations and delivering more incentives. Don’t discount government intervention. Investors are fond of saying that they don’t invest based on government signals, but if hundreds of billions of new incentives were offered for, say, carbon capture and fusion, a bunch would probably dive in headfirst.
Ultimately, this is just one quarter’s figures, and preliminary ones at that. One data point does not make a trend. Real-world data tends to be messy, and when you look at the overall picture, the arrow is pointing up, not down. Is it going up as quickly as it needs to be? Hell no. But it’s still going up. I’ll need another few quarters of data before I revise my opinion.