Since 1990, global greenhouse gas emissions have risen by nearly 50%, posing a threat of climate disaster unless immediate action is taken. This is why world leaders set a target in the shape of the Paris Agreement to limit global temperature increases to 1.5°C above pre-industrial levels by reducing emissions by 45% by 2030 and achieving net zero emissions by 2050. However, many countries are struggling to fulfill their commitments. To overcome this, authorities around the world are tightening regulations as the green transition requires substantial innovation as well as investments. According to the EU, €8 trillion will be required by 2030 in Europe, the majority of which will have to come from private capital. Consequently, venture capital firms are at the forefront of this green transformation by investing in innovative solutions, generating returns for limited partners, and actively transforming companies.
This study examines the momentum of climate concerns in the tech ecosystem, as well as the integration of climate-related targets by VC firms and the challenges facing the ecosystem in the future.
Their action is driven by three main factors: the shift of investment towards sustainability, regulatory pressure and talent concerns.
The tech ecosystem is shifting towards sustainability as VC funds are stepping up to face the environmental issue.
With its implementation having started in 2021, the SFDR provides a clear framework for the integration of environmental factors in the decision-making processes of investment firms.
Young entrepreneurs are leading the way in creating startups focused on addressing climate concerns, with a record-breaking $111bn invested in climate tech by startups and scaleups in 2021. As a result, VC funds are adapting to this shift towards sustainability by taking interest in new types of investments. Meanwhile, founders are recognizing the importance of demonstrating a commitment to sustainability to attract talents and stay competitive.
The increasing trend driving LPs towards an environmentally conscious investment approach is triggering more professionalized methods for measuring environmental and climate impact, leading to a new wave of reporting across the investment ecosystem. As a result, VC funds are recognizing the urgency to professionalize their approach. While some continue to view climate concerns as a marketing issue, others have integrated sustainability considerations into investment policies. In fact, more than 60% of respondents consider that the integration of climate-related issues has significantly increased in the past 5 years.
Their actions can be broken down into three segments : the evolution of investment policies, the influence of VCs on their portfolio’s ESG practices, and the measures taken by VC to reduce their own environmental impact.
In response to a growing awareness among LPs as well as a supportive framework, VC funds are increasingly integrating sustainability criteria into their investment strategies. Some funds are incorporating climate-related verticals while others allocate a dedicated pocket of investment for impact-driven companies. Despite these efforts, one of the primary challenges faced by funds is developing the dedicated tools for growing companies and incorporating ESG issues into legal documentation. It is worth noting that today, about 85% of VCs consider companies’ climate impact in their target screening process.
VC funds have the power to influence portfolio companies in adopting best practices, such as addressing environmental concerns. Additionally, they are offering training and guidance on the subject. The use of KPIs to measure the impact of a company is important but finding the right level of reporting is crucial, and VC funds can provide guidance and support to their portfolio companies in becoming greener.
Measuring carbon footprint is the first step for asset management firms to address climate issues. In fact, 80% of firms have already completed this process, and many are equipping themselves with dedicated personnel to structure their efforts. To further incentivize progress, firms must align compensation with environmental targets, linking up to 50% of their carried interest to extra-financial reporting. By doing so, asset management firms can ensure that their efforts to address climate change are integrated throughout their organization and are given the necessary resources to achieve their goals.
Low maturity of target companies is the number one factor (70,6%) limiting the integration of climate-related criteria in VC investment activity. This is why upskilling the tech ecosystem is crucial for effective action on climate change. This requires a significant investment in education as a lack of understanding of climate-related concerns remains among the tech ecosystem, including startups and VC funds.
"Today, the industry is at the stage of transparency. The next step is the auditing of this data, which is the only real way to avoid greenwashing. [...] This takes time, but like the audit of financial data, environmental audits will gain momentum."
To mitigate the impact of climate change, stakeholders must deepen their knowledge of the phenomenon itself. Additionally, VC funds must also understand innovative business models, such as biotech and DeepTech, to meaningfully contribute to this fight. Therefore, educating all stakeholders, from VC funds to startups and intermediary bodies, is essential to achieve this goal.
Reporting is a challenge for climate commitment in the tech ecosystem and VC partners are expressing concern about the disproportionate burden of start-up reporting requirements. This issue is not limited to VC-start-up relationships, as VCs themselves report to LPs, resulting in a complex web of different demands. Despite these challenges, there is a willingness to work towards common standards. In fact, the ecosystem is witnessing the beginning of extra-financial reporting standards.
The current VC model has certain constraints: it has a closed-end fund structure, a focus on financial performance, and it may be risk averse.
This makes the current VC model unsuitable for longer-term sustainable investment strategies. However, to address these defects, some VC funds are exploring new models, such as evergreen funds that offer alternative methods of financing. Some believe that future financing will involve multiple players or Corporate Venture Capital, while others suggest that large international private equity or infrastructure players could develop their venture capital activity to offer the required firepower.
Venture capital firms are at the forefront of the green transformation by investing in innovative solutions, generating returns for limited partners, and actively transforming companies. This study examines the momentum of climate concerns in the tech ecosystem, as well as the integration of climate-related targets by VC firms and the challenges facing the ecosystem in the future.
