The Great Funding Freeze of 2023: Climate Tech Watershed Moment

When I started my gaming company in 2021, the VC funding was at it's peak. When we went to the VCs with our idea and a solid team access to funding was not an issue. We were able to raise 2 Million dollar at that time.

But then the party was over and the private equity market went for a toss, this impacted all the sectors by end of 2022 and this continued in 2023 as well. This funding winters did not spare climate tech investment as well.

It feels the whether has become cooler with out reaching net zero solutions," an entrepreneur friend said over a coffee!

He was referring, of course, to the dramatic cooling of the climate tech funding landscape in 2023. After years of investment and sky-high valuations, the sector experienced its first major contraction since the cleantech bust of the early 2010s.

During this discussion I was thinking if this is merely a temporary setback for climate tech, or are we witnessing a fundamental shift in how these crucial technologies are funded and developed?

To answer these questions, we need to dig into the data and see how climate tech funding did in 2023 and what can be the projections for 2024.

The Numbers Don't Lie

Let's start with the headline figures, which paint a stark picture of the current funding environment:

Overall climate tech funding plummeted 30% year-over-year in 2023, dropping from $102.5 billion in 2022 to $72.9 billion.
Equity funding took the biggest hit, declining by a whopping 40% compared to 2022 levels.
The number of deals also fell sharply across all stages, with early-stage rounds (Series A and B) experiencing a particularly steep 25% drop.

To put these numbers in context, climate tech funding had been on a steady upward trajectory since 2019, more than tripling from $27.5 billion to $89.7 billion in 2021. The sector even managed to buck the broader tech downturn in 2022, growing slightly to $102.5 billion while funding for other verticals contracted.

So what changed in 2023? In short, macroeconomic headwinds finally caught up with climate tech. Rising interest rates, persistent inflation, and fears of a potential recession led investors to tighten their purse strings and adopt a more cautious approach to deploying capital.

The impact wasn't uniform across all regions and subsectors, however. Let's break it down further:

Regional Variations Across Continents

While funding declined globally, some regions proved more resilient than others:

North America saw the steepest drop, with funding falling 36.7% year-over-year to $31.3 billion.
Europe fared slightly better, experiencing a 27% decline to $25.1 billion.
Asia bucked the trend entirely, with funding actually increasing by 18.8% to reach $17.7 billion in 2023.

What explains these regional differences? A few factors are likely at play:

Policy environment: Europe's more stable and supportive climate policy framework may have helped buffer the impact of the funding downturn.
Market maturity: North America's climate tech ecosystem is more mature, meaning it was perhaps due for a correction after years of rapid growth.
Government support: Asian countries, particularly China, have been ramping up state-backed investment in clean energy and other climate solutions.

The Sector Shuffle: Winners and Losers

Not all climate tech subsectors felt the chill equally in 2023. Here's how the major categories fared:

🔼 Growing:

Energy: Funding share increased to 35.3% of total climate tech investment, up from 23.6% in 2022.
Industry: Saw a modest 3% year-over-year increase in funding.
Water: Funding grew by 6.3% compared to 2022.

🔽 Declining:

Transport: Funding fell by 21.4% year-over-year.
Food and agriculture: Experienced a 51.9% drop in investment.
Circular economy: Funding decreased by 51.8% compared to 2022.

What's driving these shifts? A few key trends emerge:

Energy dominance: The energy transition remains the top priority for climate tech investors, with a particular focus on renewable energy, energy storage, and grid optimization technologies.
Hard-to-abate sectors gaining traction: Solutions targeting emissions-intensive industries like steel, cement, and chemicals are attracting more attention and capital.
Cooling enthusiasm for mobility: After years of massive investment in electric vehicles and other clean transportation solutions, investors may be taking a more measured approach to the sector.
Challenging environment for ag and food tech: Rising input costs and shifting consumer preferences have created headwinds for startups in this space.

The Changing Face of Climate Tech Funding

Perhaps the most intriguing trend to emerge in 2023 was the shift in how climate tech companies are being funded. While equity took a nosedive, other forms of capital stepped in to partially fill the gap:

Non-dilutive funding (debt, grants, etc.) reached a record high of 34% of total climate tech investment in 2023, up from 22.7% in 2022.
Government funding played an increasingly important role, with public sector participation in deals growing by 47.3% year-over-year.
Corporate investors remained relatively steady, participating in 80.5% of climate tech acquisitions in 2023.

This diversification of funding sources reflects both the maturing of the climate tech ecosystem and the unique capital needs of many climate solutions. Hardware-intensive technologies often require patient, long-term capital that traditional VC models struggle to provide.

Government support, in particular, could help bridge the "valley of death" that many climate tech startups face when trying to scale from prototype to commercial deployment.

The FOAK Dilemma

Speaking of scaling challenges, 2023 saw increased attention paid to the unique hurdles faced by "first-of-a-kind" (FOAK) projects in climate tech. These initial commercial-scale deployments of new technologies are critical for proving viability and unlocking further investment, but they often struggle to secure adequate funding.

The FOAK project stage is possibly the most crucial de-risking step for the long-term success of a startup, as it entails proving both the technology working at scale, as well as the business model.

The funding gap for FOAK projects stems from their awkward position between venture capital (too capital-intensive) and traditional project finance (too risky). Addressing this challenge will likely require innovative blended finance approaches that combine public and private capital.

Some notable FOAK deals in 2023 point to potential solutions:

Verkor raised $2.2 billion in a mix of equity, debt, and grant funding for its battery manufacturing factory.
H2 Green Steel secured $1.6 billion in equity and debt for its green steel plant.

These deals showcase the creative capital stacks that may become more common as climate tech matures and investors grapple with the unique funding needs of hard tech solutions.

Buzzwords and Breakthrough Technologies

No discussion of climate tech funding would be complete without a look at the hottest trends and technologies capturing investor attention. In 2023, a few key themes emerged:

Artificial intelligence: The AI boom touched every corner of the tech world, and climate tech was no exception. Investors are particularly excited about AI's potential to optimize energy systems, improve climate modeling, and accelerate materials discovery.
Batteries and energy storage With renewable energy deployment accelerating, the need for better energy storage solutions has never been more pressing. Advanced battery chemistries, long-duration storage, and vehicle-to-grid technologies all saw significant investment.
Green hydrogen: The hype around hydrogen as a clean energy carrier continued to build in 2023, with particular focus on electrolyzers and hydrogen production from renewable sources.
Carbon removal: While still a relatively small slice of overall climate tech funding, technologies for capturing and storing atmospheric CO2 gained momentum. This includes both nature-based approaches like reforestation and engineered solutions like direct air capture.
Alternative proteins: Despite the broader downturn in food tech funding, plant-based and cultivated meat companies continued to attract investor interest, albeit at a more measured pace than in previous years.

It's worth noting that many of the most heavily funded climate technologies in 2023 were focused on emissions reduction and avoidance rather than adaptation or resilience. This aligns with the overall funding data, which shows that 78.2% of climate tech investment went to mitigation-focused solutions.

While this emphasis on mitigation is understandable given the urgent need to curb greenhouse gas emissions, it does raise questions about whether we're adequately preparing for the climate impacts that are already locked in.

The Road Ahead: Cautious Optimism for 2024

So, where does all this leave us as we look ahead to 2024 and beyond? While the funding environment remains challenging, there are reasons for cautious optimism:

Policy tailwinds: Major climate legislation like the US Inflation Reduction Act and the EU Green Deal are starting to drive increased demand for clean technologies, which should translate into more investment opportunities.
Corporate commitments: A growing number of companies have set ambitious net-zero targets, creating a built-in market for climate solutions that can help them decarbonize their operations.
Technological progress: Many key clean technologies are reaching cost parity with fossil fuel alternatives, improving their economic competitiveness and investment appeal.
Investor education: As the climate tech ecosystem matures, more investors are developing the expertise needed to evaluate and support these complex technologies.
Urgency of the climate crisis: The increasingly visible impacts of climate change are likely to drive continued public and private sector focus on developing and deploying solutions.

That said, challenges remain. The ongoing macroeconomic uncertainty could continue to dampen risk appetite among investors. And many climate tech companies, particularly those working on capital-intensive hardware solutions, will need to find creative ways to extend their runways and demonstrate clear paths to profitability.

The only comforting thing is : The past year may have been challenging in terms of climate tech funding, the end game of the energy transition remains unchanged. In the long term, there is a market with fixed needs that must be addressed."

The Bottom Line

The great funding freeze of 2023 marks a watershed moment for the climate tech sector. After years of seemingly boundless growth, the industry is facing its first major test of resilience. How companies, investors, and policymakers respond to this challenge will shape the trajectory of climate innovation for years to come.

While the current funding environment is undoubtedly tough, it may ultimately prove beneficial by weeding out less viable business models and focusing resources on the most impactful and economically sustainable solutions.

For climate tech founders, the key will be demonstrating clear value propositions, capital efficiency, and realistic paths to scale. Investors, meanwhile, need to take a more nuanced approach that recognizes the unique capital needs and timelines of different climate solutions.

And policymakers? They have a crucial role to play in creating stable, long-term demand signals for clean technologies and helping to bridge funding gaps, particularly for early-stage and hard-to-commercialize innovations.

The climate crisis isn't going away, and neither is the need for technological solutions to address it. The companies and investors who can weather this funding winter and emerge stronger on the other side may well find themselves at the forefront of one of the greatest economic opportunities of the 21st century.