Along with all of us in the sector, theDOCK has witnessed a sharp surge of interest in Sustainability and Climate Tech initiatives. We shared our thoughts regarding trends in ESG adoption in our last report (check out part 3 in Q2 LP report), and would like to further discuss the emerging challenges experienced by VCs in supporting the trend.
Since the beginning of 2022, we have been exposed to dozens of initiatives addressing the space. There are many ways to analyze and categorize the startups we have seen.
I would like to focus here on a specific angle that is top mind for theDOCK as a VC fund:
Point Solutions reflecting Incremental Improvements
Frankly, most of the ESG-related investment opportunities belong to this category. Any automated process which replaces paper, any optimization algorithm that optimizes truck and rail usage, all these examples and many others contribute to reducing emissions or reducing the usage of hardware which will become scrap and therefore have a positive effect on the environment.
There are other incremental improvements that support the environment, such as the development of scrubbers, filters, monitoring devices (IoT), etc. These all have been used as “stop-gap” solutions bringing temporary relief. As such, they share the common attributes of (relatively) low risk in developing and deploying such technologies, coupled with the (relatively) low reward to be earned by stakeholders (including investors). Hence the ubiquitous risk/reward ratio is kept. But there are other developments that bear the much higher risk and, therefore, the potential of delivering significantly higher rewards. These initiatives are discussed in the next category - the one which I call “Earth Moving” Initiatives.
“Earth Moving” Initiatives
These initiatives are Bold and Hairy. Hence much riskier from an investment point of view. If successful, though, they are likely to have long-lasting and disruptive consequences on the market and therefore reward stakeholders with significant monetary returns.
But here lies the main challenge. Are such initiatives more of a basic research nature? Or application development nature? Before discussing the differences, let's look at two examples (both were encountered by theDOCK in 2022):
Commercial scale generation of Hydrogen Fuel using scrap aluminum as a catalyst.
Capturing CO2 on scale by enhancing and expediting the natural process of ocean absorption of the gasses.
While the above two examples are presented at the title level, a few facts are clear: (i) the undertakings are significant, and (ii) if successful, they could disrupt the market - for a very long time.
And here comes the challenge - could a closed-end VC fund (with a typical investment horizon of 7 years to liquidation) afford to invest in such initiatives? Very often, these initiatives aspire to be recognized at least as owning a Proof of Concept - POC (TRL 3 or 4) while in reality, they are still in the concept formulation stage (TRL 2). The chances of evolving into a market-ready product, ready for liquidation during the 7-year term are slim. Not quite serving the comfort zone of VC investors.
The solution? - no easy answer here. The stakes are high, and VCs are paid to make the calls.