Reports and studies — Financial Advisory, Growth Capital Advisory

DRAFT The Increasingly Horizontal Climate Software Opportunity

November 05, 2023

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The Increasingly Horizontal Climate Software Opportunity
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Section I: Key Takeaways

Through conversations with private market investors and sector experts, as well as organic market research, we’ve concluded that climate software will likely soon be widely viewed as a horizontal investment opportunity supporting a continually expanding set of cross-industry applications.

Software as an enabler: software plays a vital role in advancing the clean energy transition because of its ability to buttress the efficiency and resiliency of energy and infrastructure assets, and enable broad enterprise adherence to regulatory and voluntary reporting and decarbonization trends. Software also appeals to a diverse set of private market investors and generates tangible economic value from the large quantum of carbon and ESG-related data generated by – and impacting – nearly every industry. Moving forward, we see significant potential for “hardware-as-a-service” models and full-stack hybrid / software solutions to provide some of the highest-upside opportunities for investors as the interdependencies of funding both categories become magnified to the broader market

Tangible value creation: software innovation must co-exist with continued investment into renewable power, electrification, long-duration storage, and grid / distributed energy hardware assets, and can drive direct bottom-line impacts by: 1) providing emitters with a baseline to evaluate and implement emission reduction strategies capable of justifying future CapEx / development spend, and 2) offsetting the impacts of increasing grid complexity by simplifying predictive analytics and forecasting functions to ensure appropriate scoping and execution for new projects

It’s still early innings: the overall market for climate tech software is still relatively nascent; some categories are further along the development curve than others, however there is a shortage of at-scale case studies to provide “benchmarks for success” when it comes to evaluating climate software GTM models and unit economics, which are slightly different than traditional enterprise SaaS profiles given their slower sales cycles and implementation and servicing-related COGS

Time to be opportunistic: private climate software-focused funds are heavily concentrated at the early stages, where there has been robust company formation in the industry; there is a significant market opportunity for new investors to lead Series B+ rounds over the next year and beyond as these businesses compete for scale-up capital. Sector-focused funds leading rounds at this stage raised only 13% of the total funds raised across all stages from 2021 – 2022. “Pure software” investments continue to see the strongest YoY growth (~30% in 2022) in climate tech amidst a high interest rate environment and investor hesitancy to back long-duration hardware assets and pre-revenue development projects

A global, interconnected ecosystem: climate tech is one of the most globalized innovation sectors we have studied, and national / regional legislation has accelerated the pace of climate tech innovation and accessibility of fundraising in certain geographies. The US and China – which have attracted the greatest private investments historically – have begun to shift focus away from mobility-related start-ups to emissions control / energy efficiency technologies, even as EV infrastructure continues to attract significant funding (including half of Q3 ‘23’s largest deals). Europe has emerged as the fastest-growing climate tech incubation hub since the height of the COVID pandemic

By market segment, we drew the following conclusions:

Emissions management / built environment software is a key innovation area at both the venture and growth stages. This is mostly due to the rampant opportunity to improve the collection and analysis of emissions-related data that is growing in direct parallel with the capital deployed toward infrastructure development and the renewables transition

Both the carbon accounting / reporting and data services categories are software’s “bread and butter” in terms of value creation, but in different ways. Carbon accounting / reporting demand is heavily driven by disclosure regulations and internal company reporting standards, and the category is well-suited for AI-native applications backed by models trained on industry-specific emissions data points. Data services software continues to see segment growth with rising demand for interpolated models that facilitate estimation and evaluation of companies and asset performance by external sources

The horizontal influence of the ESG reporting segment is perhaps the greatest of all we covered, however the market is fragmented and crowded by an increasing number of legacy enterprise data and workflow management vendors adding ESG-related modules and features to facilitate automated reporting. Product development has been largely opportunistic, and its effectiveness has been primarily hampered by: 1) a lack of reliable data collection capabilities and 2) inconsistent metrics and reporting across sectors. Software platforms that streamline solutions to both problem sets will help new entrants challenge legacy corporates who are cross-selling ESG features to long-standing customers

The voluntary carbon offsets / marketplaces category is becoming truly horizontal in its appeal across industries. Yet, investors remain cautious as the industry determines how to verify and validate the inherent value of voluntary offsets projects (i.e. reforestation, renewables, agriculture), and await further clarity on sovereign participation in these markets through Article 6 of the Paris Agreement

In “asset-heavy” verticals – such as grid / distributed energy and battery / storage – standalone software platforms integrating with physical infrastructure assets are in early stages of innovation, yet could be among the greatest long-term economic and environmental value-creators. Some of the most proactive innovators in these categories to date have been operating companies and service providers layering software suites onto their existing service lines

Climate FinTech is still in early stages of development and will likely continue to emerge as a high-growth category enabling the transition to a low-carbon economy. Investable opportunities are layered across full-suite banking, lending, payments, and UW / risk solutions for energy and infrastructure providers, as well as wealth management and sustainable investment marketplaces that expand consumer access to the industry

EV / mobility software is a category with less horizontal applicability, however has one of the largest TAMs that is inherently tied to broader EV adoption rates. We think it is likely this category sees consolidation as a finite group of software players partner with the leading charging station developers and auto OEMs to amass market share. Continued private investor demand for EV infrastructure and lithium-ion battery investments will likely bolster the need for interoperability, infrastructure management, and performance optimization / analytics software solutions

The circular economy / supply chain category within climate tech continues to expand in scope (i.e. the way goods and services are sourced, produced, consumed, and disposed) with greater public awareness of the mutual dependencies between each step along the circular value chain and broader net zero goals (70% of GHG emissions are directly tied to everyday product consumption)

Sources: MIT, B Capital Group, Deloitte, PWC, BIS, Energize Capital, London & Partners, UNDP, CB Insights, Union Square Ventures

Section II: Why Climate Software?

Burgeoning cross-industry applications for software solutions deterring and mitigating the effects of climate change and facilitating the global transition to renewables should make the category a top priority for a diverse set of private market investors over the next 12+ months.

To set the stage for our analysis, we break down the climate software market’s core investable opportunity segments below in Figure 1. While there is some overlap between categories, this mapping serves to provide a “zoom-out” perspective on the growing, sector-agnostic use cases intrinsic to the sector.

Figure 1: Climate software market segmentation

Source: Lazard VGB Insights

1. Robust market tailwinds and capital stack:

Even with the proliferation of billion-dollar sustainability and impact-focused funds flooding the market ($23B+ of new climate tech capital raised YTD 2023), we believe climate tech’s fundamental drivers – including mounting global decarbonization pressures and corporate net zero commitments, government budgetary and regulatory tailwinds, cost savings from renewables and electrification, and robust early-stage company formation – will continue to increase generalist growth investors’ appetites for investing in the clean energy transition over the next several years. In 2022, climate software private investments grew ~3x the rate of other climate tech business models as new investors continued to enter the market (Figure 2), and early-stage company formation has skewed heavily towards software models in recent years to the point where there is now relative balance at the venture and growth-stages across all climate tech business models (Figures 3 and 4).

Figure 2: Climate tech new private market investor growth

Source: PWC

Figure 3: Multiple change in the number of climate tech companies incubated by business type

Source: Endeavor Insight

Figure 4: Climate tech VC-backed start-ups by type (as of Aug. 2023)

Source: Powerhouse Fund

2. Clear opportunities at the scale-up phase:

Despite total private market funding decreasing 50% YoY through Q3 ‘23, climate tech continues to proportionally increase its share of the total venture and growth investment pie (see Figure 5). In an industry where software and hardware must co-exist and innovation has historically been characterized by capital intensity, long lead times, and delayed returns, this new wave of climate software companies with fast-growing enterprise and consumer end-markets is creating on-ramps for growth-oriented investors to enter the industry, particularly at the early-growth stages (Series B and C), where there has historically been far fewer participants (see Figure 6).

Figure 5: Climate tech private market investments as a % of total start-up investments

Source: PWC

Figure 6: Estimated total private climate tech-focused funds raised by focus stage in 2021 and 2022 ($B)

Source: Union Square Ventures

3. It’s all about data:

We believe software’s role as an innovation catalyst in climate tech will continue to expand as widespread enterprise demand for automation tools that optimize the collection, analysis, and reporting of the reams of data being generated by historic investments into clean energy infrastructure (IEA projects $1.7T in 2023 following six years of increases). Currently, the highest-growth areas within the software category include industrial / manufacturing data and automation platforms (often paired with hardware and sensors), emissions control and offsetting tools, and energy management solutions covering the production, conversion, distribution, and consumption of energy for both consumers and enterprises.

Figure 7: North America and Europe climate tech investment trends by type in 2022 ($B)

Sources: Net Zero Insights, PWC

4. Attractive end-market potential:

Much like we are seeing in the current AI “hype cycle,” the realization of climate software’s broad enterprise applicability will likely hand a competitive advantage to the first-mover investors who craft a well-defined thesis and identify the categories that maximize ROI. In Figure 8, we map these key categories to the verticals where we have seen evidence of enterprise customer adoption to date. We also outline the relative maturity of each category based on our analysis of market competitiveness at the venture and growth stages.

Figure 8: North America and Europe Climate Software YoY Investments by Type (2022)