What a downturn in fundraising means for climate founders and their next round

2022 marked a turning point for the tech industry, as it signalled the end of a 15-year bull market and ushered in a new economic era defined by rising interest rates and inflation. As the cost of capital continued to rise, the industry saw a shift in focus from inflated tech valuations to a steadfast emphasis on profitability.

For many early-stage climate tech founders, this may have seemed like an alternative reality: 2022 saw a record number of deals in the space - over 1,000 according to CTVC data. While there was a lag, Q1 2023 deal volume, as reported by Pitchbook, now indicates that winter has arrived with a decline in deal activity and tighter capital conditions.

While it is difficult to make predictions and forecasts, it is fair to say that we have entered a different period when it comes to the cost of capital. For more about this topic, I strongly recommend reading Howard Marks "The Memo: Sea Change"

Capital will still make its way towards exceptional companies tackling fundamental climate issues

Innovation in climate technology is crucial for human survival and at ETF our ethos has always been that investing in climate technology makes a fantastic investment opportunity. But while significant capital is required to solve the climate crisis, throwing money at the problem alone is not going to cut it. It was always the case that capital needs be deployed smartly.

So, while current times are indeed tough, for those climate founders who are interested in building long lasting, category defining, game changing companies, current market conditions have ushered in a far better platform for them to build on.

Successful ventures in this era are adopting a much- needed culture of frugality, resilience, and healthy business fundamentals. The competitive landscape at the early stage would be less fierce and for the right companies there will be plenty of funding available. In the case of climate, this is a win for everyone.

How can early-stage climate companies benefit from the markets new reality?

1. Profitable growth. Much will be written about the negative impact of growth at all costs. At the current cost of money, while growth will continue to be an important KPI, investors want to see profitable growth.
   
   The best companies would be those that are able to demonstrate smart and efficient go to market and customer acquisition strategies. Frugality culture in companies would mean more focus on the customer value.
   
   In the early days of Amazon, Jeff Bezos famously instructed everyone to build “door desks” from old doors in order to save on furniture.
   

2. Finding the right partner. During the boom years, VCs often complained about not having enough time to conduct proper due diligence due to the highly competitive nature of deals. Little was said about the immense pressure on founders, who were presented with 10 term sheets and encouraged to make quick decisions with VCs raising their offers in fear of losing the deal.
   
   Taking on venture capital is like getting married - it’s a long-term relationship, and you don’t want to end up in a partnership with someone you don’t get along with.
   
   The market cooldown provides both parties with enough time to get to know each other and evaluate whether they can work together. It also allows founders to assess whether their future partner truly understands their mission and product, instead of investing in hype. Seek to build relationships early on with those with whom you can see yourself working.
   

3. Valuations and value. The legendary Doug Leone from Sequoia recently said, “I think [now] it is a better time for founders. Earlier, no matter what you did, there was some fool willing to invest in whatever valuation you asked. That was a crap feedback type of mechanism”. 
   
   Many of the companies who raised capital in recent years have now found themselves in a tough spot. They raised large sums of money at a fancy valuation which they either not know what to do with it, or worse, forced them to spend it on unprofitable growth.
   
   While a high valuation early on can seem attractive, building enough value to justify such high valuation ahead of the next funding round is no easy feat. Today, founders can build such value smartly and with less. Unhealthy competition mostly evaporated. Hiring and retaining talent becomes easier as well.

Whats the new standards for fundraising in this environment?

Founders who are raising capital this year at Series A+ should ensure that they can clearly demonstrate profitable unit economics and strong cash efficiency metrics. Key performance indicators (KPIs) may vary depending on the company’s business model, but in our view, companies at the A stage, must be able to present a sound business model with some early proof points at a minimum. In other words, it needs to be evident today that at some point in the company’s journey, it will start generating free cash flow without being dependent on a $500m funding round.

Secondly, while many founders rely on serendipity in their fundraising efforts, we strongly advise the companies we speak with to treat their fundraising process with the same level of attention as they would their sales or product development efforts. This means building an investor pipeline, qualifying leads, and following up on conversations. It also involves preparing a data room well in advance and being ready to provide specific deep dives into the separate elements of your market, competition, and business. Remember, professionalism never goes unnoticed.

At ETF we invest in Series A and B European leaders in climate - if you are a founder building in the space, we would love hearing from you.

Tomer is a Partner at ETF Partners, a London based VC investing in climate. At ETF, Tomer focuses on consumer, food, and climate tech. Tomer is passionate about working with ‘impact native’ and purpose-driven founders who are building the next generation of climate positive companies. Tomer has led ETF’s investment in Zeelo, Modern Milkman and Pieter Pot. In addition, he works with ETF’s portfolio companies Tomorrow.one and Eagle Genomics among others. Tomer is a Kauffman Fellow in class 27.