Why climate startups should turn to corporates for fundraising

What is the common thread tying the stories of electric vehicle (EV) manufacturing company Ather Energy, EV charging startup EVQPoint Solutions, and EV battery startup Log 9 Materials? All of them have raised at least one round of funding from industry incumbents: Ather Energy from Hero MotoCorp, Log 9 Materials from Amara Raja Batteries, and EVQPoint from Minda Industries.

These examples highlight an increasingly relevant trend of strategic partnership between EV startups and industry incumbents, who bring in long-term capital along with industry expertise. Although recent partnerships seem to be biased in favour of electric vehicles, opportunities are likely to open up for other climate-driven businesses such as alternate fuels, water, manufacturing, and process automation as well.

Climate startups find it tough to raise capital from mainstream VC investors, as their long gestation period and dependence on government policies do not make them an attractive investment for VCs, who have a short investment horizon of five to seven years. Industry incumbents, on the other hand, are interested in partnering with young companies to learn from new technologies and to improve their green credentials. As such, certain types of climate startups may find it easier to source capital from corporates, rather than from VC investors.

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Why Indian climate startups have little VC funding

As per the recent report by India Impact Investors Council on early-stage climate-tech startups, Indian cleantech startups received a funding of $1.2 billion between 2016 and 2020, and only 17 percent of those that raised seed funding were able to raise the second round. This is in sharp contrast to overall VC investments in Indian startups (mostly tech) of approximately $37.2 billion during the same period, with nearly 30 percent of the startups raising the second round.

The reasons for the lack of VC funding in climate-driven startups can be broadly classified into three categories: long product development cycle, dependence on government regulations, and poor exit track record.

• Long product development cycle: In contrast to pureplay tech software companies, climate-related ventures create physical products requiring higher upfront investment and time to bring their products to market. And this is true not only for high technology industries such as those working with battery storage and hydrogen fuel, but also for seemingly simple products such as plastic recycling solutions, solar pumps, etc.

For example, it took Rudra Environmental Solutions, which provides solutions for converting plastics into oil, seven years to commercialise their product. Similarly, Khethworks, which manufactures mini solar pumps for small farmers, took nearly 40 iterations and three years for getting their product ready. Such long development periods deter VC investors.

• Dependence on government policies: Sustainable products need to be competitively priced, be it solar energy, biofuel, electric vehicles etc. This makes the sector all the more dependent on government policies that must subsidise the upfront cost required for developing the products, and incentivise users to switch to these. Since government policies can be unpredictable, VC investors with a limited time horizon may not want to bet on the policy outcomes.

• Poor exit record: So far, there are very few VC investors that have been able to profitably exit from their climate investments, and those that exist have also been on account of the startup getting acquired by industry incumbents. Other popular modes of exit such as a secondary market sale or IPO will be possible only when climate companies can raise multiple rounds of capital, which, in turn, again depends on other VC investors. These factors make climate investments less suitable for venture capital investments.

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What is in it for corporates

Corporates are looking to invest in newer technologies, as their products and business models face challenges from greener alternatives. Additionally, they are also looking to enhance their green credentials to access capital at a lower cost. For example, Indian cement major UltraTech recently raised $400 million through a sustainability-linked bond at a coupon rate of 2.8 percent. 

However, the coupon rate stands to increase if the company fails to achieve its target of reducing the carbon footprints of its products by 22.2 percent by 2030. Based on their urgency to turn green, the companies can be divided into the following three buckets.

• Fossil fuel producers: These include companies such as coal miners, thermal power plants, refineries, and traditional automotive companies whose products are already being replaced by greener products.

These companies are already investing in new companies that can enable them access to new technologies. For example, Reliance Petroleum has invested in Ambri Inc, an energy storage company based in Massachusetts, US and oil marketing companies such as IOC and HPCL are partnering with various start-ups to offer electric vehicle charging services.

• Energy and capital-intensive companies: These include companies in sectors such as steel and cement, that don’t face any threat from green alternatives yet, but they need to find a path to reduce their carbon footprints to raise capital and also to meet the expectations of their international customers who are going green. 

These companies are looking for circular economy solutions such as increasing the availability of steel scrap, concrete recycling, and alternate fuels. For example, Tata Steel has recently set up a 500,000 tonnes per year steel recycling plant, as manufacturing steel from steel scrap has far lower environmental footprints as compared to those manufacturing from iron ore.

• FMCG/retail companies: They need to innovate to keep up with changing consumer preferences for plant-based products and use less packaging. Such companies have also been investing in startups.

For example, Jubilant Group, which has interests in the food sector and is a franchise partner for several brands, including Dominos, and has invested in “Mister Veg”, a plant-based protein provider. Similarly, Procter&Gamble and other consumer goods companies are the limited partners in Circulate Capital, a VC fund that invests in companies that offer plastic waste management solutions.

Conclusion

Climate startups will play a significant role in decarbonising the Indian industry and should also utilise their partnership with the industry for raising capital.

If you are a climate startup looking to raise funds, you would need to articulate your value proposition to the industry incumbents in either enabling them access to new markets, cost reduction, or in solving any other critical pain point. Since incumbents prefer solutions that are ready to be deployed quickly (or at least as a pilot), they should be approached only after initial use cases have been established.

Equally important would be to identify the right partner, a company that is seriously scouting for new opportunities. Such a company is likely to have a healthy balance sheet, a history of investing in new technologies/partnerships, and dedicated resources or its own venture capital arm for scouting such opportunities.

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