Cleantech investors: You can’t fight climate change with software alone!
It’s a great time to invest in the renewable energy sector, with global renewables investment set to rise 8% to around $2.4 trillion this year. That shows goodwill from policymakers who incentivize that level of investment. The story seems to be similar across PE and VC investment, and according to S&P Global, investment in renewable energy has increased 144% in 2022 from 2021 in the same time period.
But goodwill alone isn’t going to avert the most catastrophic effects of climate change. We need to talk about where that money is going and the trend for early-stage investor preference for software over hardware. More and more often we see climate tech startups that tell us that they have had no luck raising VC funding due to the hardware nature of their product. While there are several early-stage VCs willing to back hardware startups, more is needed to help companies get off the ground.
So why the software preference?
This first question is easy: software companies are generally seen as faster and cheaper to set up, with an idea and a couple of developers, you could be in business. Compare that to a hardware startup which may need products to be prototyped, iterated, manufactured, stored and shipped.
Software businesses also scale much more easily. They exist virtually, so there’s no limit on real estate whether you’re making a simple app or a full-blown digital solution, while hardware faces the restrictions of the physical, as well as much higher capital requirements.
VCs (and we are no different), of course, want profit. With software, the potential for growth is theoretically limitless if developers can keep the ideas coming. While Apple has shown that there doesn’t need to be a limit on hardware, we are also aware that a lot more issues such as supply chain and logistics come into play.
Hardware does the hard work
However, we need to ask what this is doing to the renewables market, and to the energy transition in general? Well, the answer is probably not much right now, as investment is growing in both hardware and software, albeit in a heavily skewed proportion. But sooner or later, we’re going to start bumping our heads against a ceiling of our own creation.
More advanced software is great at driving efficiencies, but it doesn’t make the energy transition happen. It’s hardware that makes renewable energy a reality (wind turbines, solar panels etc.); physical technology that actually allows us to go green and reduces CO2 emissions.
If we don’t tackle this investment imbalance now, the coming years could see our transition stall. Insufficient capacity and energy market share will become more problematic than whatever issues we can solve with software.
If we’re truly serious about renewables, our priority needs to be getting that energy to market in the first place.
Correcting the investment balance
Fixing this disparity means helping amplify the case for investment in hardware. Aside from the reality of actually generating power, a lot of the old objections are starting to be overcome. For one thing, the rise of smart technology means that very few hardware companies now produce hardware alone. Many are software companies in disguise, opening up revenue streams from the data their products collect. Likewise, smarter supply chains and digital prototyping are driving down the cost of developing new hardware. That’s even before you start to consider government incentives.
The potential to invest in renewable energy hardware is very real and we do see other VC firms starting to invest in hardware. 40% of our own portfolio is in hardware. We led the €6.4m financing round for Roofit.solar last year, a metal roofing material which generates solar power as efficiently as PV modules. Then there’s Blixt, our very first investment from back in 2018. They produce solid-state miniature circuit breakers for smart meters and smart grids. What is interesting about these two companies is that despite being hardware, initial capital requirements were comparable with some of the software companies we have seen in our industry.
There is, admittedly, a need for more products on the market with true scaling potential. Consider the returns investors in microchips saw in the 80s and 90s, that’s what we’re waiting for in renewables. But these products will start to show up as they’re given space to innovate, and someone is going to be there to invest.
VCs have a role to play
It’s worth touching briefly on the role of VCs in the energy transition. The bottom line is that the energy transition has to happen and innovations in hardware must be developed, so it must get funding from somewhere.
Organizations like MIT in the US have been talking about alternatives to the VC model for years. Investors who focus too closely on speed to market and scalable returns are only cheating themselves. More patient sources of capital will bring riskier projects to completion, and reap the rewards for doing so.
BayWa r.e. Energy Ventures believe in the power of investors to change the world for the better. That’s why we engage early with a balance of projects with potential to scale and to make an immediate positive impact. No element of the energy transition can be neglected, the stakes are too high.