We are in the midst of a slowdown in the VC industry. According to data from CB Insights, global funding has fallen 19% to $144 billion from last quarter, which represents the largest quarter-over-quarter decline in almost a decade. In times like this, investors are reducing activity due to market uncertainty -- which is an understandable result of the Russian invasion of Ukraine, sudden and high inflation in the world's largest economies, and the recovery following Covid-19.
In times of uncertainty, all investors, including and especially early-stage VCs, need reassurance and focus on investment opportunities that are future-proof.
This is where the impact hardware opportunity comes in. As Nathaniel Bullard points out in Bloomberg, early-stage investment activity in impact hardware is increasing, which works against the wider ‘downturn’ narrative.
There are several reasons for this. It starts with the increasing urgency to address climate change as its effects become both more apparent and less avoidable. Wildfires, water shortages and the melting of major glaciers are creating real problems for a growing number of people across the globe.
As a result, investors are taking note of the potential advantages of tackling the issue; and, from small businesses to major corporations, companies are making net-zero pledges. These are generally received positively by consumers, who want to see that the money they spend has a positive impact. Yet despite these commitments, there remains a way to go before net-zero pledges are met. This has led to a leap in demand, from consumers and corporations alike, for solutions that will enable the planet to reach net zero.
In a difficult market, impact hardware makes good business sense. Overall, impact and climate tech have advantages in terms of being able to attract talent, customers and nowadays also capital. When looking at impact hardware in particular, it becomes clear that there is huge potential to back companies with low ‘demand risk’, making the investments more ‘future proof’ than many VC-backed companies. This with low "demand risk" comes both here and in the next paragraph, is one time enough? Or are they two different points? One might also mention that the logic is the reverse when it comes to software - lower investment but great uncertainty on the demand side.
Although the VC world has traditionally favoured software - lower capital expenditure, and easy scalability - it is clear that the climate crisis cannot be solved by software alone. What is required is a wholesale transition to newer, cleaner technologies, and climate hardware presents a range of interesting investment opportunities. Hardware solutions typically incur a lower demand risk - if you get the tech right and can bring a solution to market, the “go-to-market” risk is much lower. Due to the pressing need, the hardware will be pulled from your hands! These solutions often have higher defensibility and a higher barrier to entry.
It is still important to remember that hardware investments require more capital upfront, and investors must wait longer to realise the potential of their investment. Yet the market is becoming aware of these drawbacks and adapting as a result.
To ensure that investment remains attractive, hardware companies are creating more exit opportunities for VC earlier in the journey, such as secondaries or SPACs.
Looking towards the future, I truly believe that we will see climate tech companies – and particularly hardware-focused solutions - becoming unicorns. This could be in renewables, energy storage, fusion, next-generation nuclear solutions and sustainable transportation. The need and associated potential in this space are so great, that those investors who move early could make an enormous impact, alongside fantastic financial returns.