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Despite high interest rates and elevated levels of economic uncertainty in recent years, climate tech startups are expanding at an unprecedented pace, drawing significant attention from the climate-focused venture capital sector. As of August 12, 2024, climate-focused venture capital firms have already secured roughly $7 billion from investors, drastically outraising the $5.3 billion from 2023 and $3.2 billion in 2022. Despite this influx of venture capital, climate tech—which broadly refers to technologies that reduce greenhouse gas emissions—is rife with a web of legal issues. These issues can touch every corner of the law, and can have significant impacts on the trajectory of startups, venture capital firms, and ultimately, investors. Despite the well-intentioned missions of climate-focused companies to save the environment from permanent damage, legal issues continue to dominate the field, and in many instances, often stifling or even undermining the much-needed innovation.
Patents and Innovation
Protecting innovation through patents enables companies to secure exclusive rights to their developments, ensuring a competitive advantage and incentivizing further research and investment. While patents provide critical intellectual property protection for climate-tech startups, it can sometimes conflict with the broader goals of environmental impact and rapid solution deployment. Climate-focused companies are often driven by the urgency of addressing climate change and seek to create technologies that can be rapidly adopted across sectors. Patent protection, however, grants exclusive rights to the technology's owner, limiting others from utilizing, developing, or distributing these innovations. In a sector where time is a crucial factor and rapid deployment is essential, patents can slow the spread of critical solutions by preventing other innovators from enhancing or implementing the technology at scale. In some instances, this exclusivity can result in the “patent bottleneck” effect, where promising technologies are either slow to market or restricted to select regions, impeding the broader reach that climate impact often demands.
Additionally, pursuing and enforcing patents can divert a startup’s limited resources—both financial and operational—away from its core mission objectives and toward lengthy legal processes. For many climate-tech companies that prioritize collaborative and open-source models, patents create complexities in partnerships and collaborations, which are often essential for scaling environmental technologies. Legal enforcement and licensing negotiations can strain relationships with potential allies, preventing the ecosystem-wide collaboration that is key to achieving scalable climate solutions. In this way, patents, while protecting individual intellectual property, may inadvertently stifle the collective innovation and rapid adoption needed to confront the climate crisis effectively.
Regulatory Compliance
Regulations vary from jurisdiction to jurisdiction, making it challenging to reward investors with a clear business model. The strongest jurisdictions making progress on ESG Regulations, namely the EU and California, have proposed mandatory disclosures that release key information, including material impacts on climate risks to business forecasts or financial estimates, such as capitalized costs from extreme weather events. However, lower-level jurisdictions like California have yet to detail specifics in their state bills, and many proposed initiatives are set to take effect from benchmark dates like 2026 and 2030. This delay further reduces business confidence in continuing operations or investments within the state. Major industrial companies and venture capital firms focused on reducing climate emissions may need to spend millions to meet these requirements until federal regulators also issue mandates affecting businesses in all fifty states.
Reassuringly, federal regulators, such as the SEC, have taken steps to enforce disclosure requirements. In April 2022, the SEC charged Vale C.A with making false and misleading claims about dam safety following the Brumadinho dam collapse, resulting in a $56 million settlement.
In this uncertain regulatory environment, venture capital firms have changed how they scout for new climate startups in this hazy regulatory space. When selecting for new portfolio companies, venture capital firms are 100% responsible for funding; and according to a Roland Berger survey, around 85% of venture capital firms consider a startup’s potential climate impact when deciding on investments. However, the remaining 15% of venture capital firms refrain from investing in climate startups for a variety of reasons, including a lack of pressure from limited partners or a fear of poor returns. More importantly, businesses themselves must eventually train staff to comply with agreed-upon emissions standards, a process made difficult when those standards remain undefined or inconsistent. This lack of clarity continues to stifle the ability of startups and industrial companies to scale their solutions effectively. The U.S. 2024 Presidential Elections have brought tumultuous news for the industry; as solar and wind stocks plummeted the day following Trump’s election-day win, the Biden Administration is set to spend the remaining $15 billion within the Inflation Reduction Act earmarked for climate investment, adding to the $90 billion already spent since 2022.
The ESG Mandate and Venture Capital’s Role
ESG legal frameworks are constantly evolving and subject to great change after the 2024 presidential election. One significant legal challenge in ESG-focused investing is ensuring that startups are not engaging in “greenwashing”—the practice of exaggerating or misrepresenting the environmental benefits of their products or operations.
On March 6, 2024, the SEC approved the nation’s first national climate disclosure rules. These rules offer investors greater transparency into how companies evaluate sustainability and manage their climate risk profiles for potential investments. The rules cover the disclosure of greenhouse gas emissions, predicted climate risks, and sustainability transition plans, with the aim of curbing greenwashing and misleading campaigns. While the SEC’s requirements are for publicly listed companies, there are areas of potential overlap with private markets. Venture capital markets are directly involved in the companies and startups they invest in, frequently holding board seats in these businesses. A venture capital firm’s investments in sustainable startups can play a significant role in funding innovative solutions to mitigate some of the catastrophic effects of climate change.
SEC’s implementation of the climate disclosure rules makes it easier for venture capital firms to distinguish between companies that are truly environmentally friendly and those that are not. For venture capitalists, while long-term rewards may not always be the primary objective, the goal is still to achieve sufficient growth and gain credibility. Now, with SEC’s implementation of the climate disclosure rules, investments in companies accused of greenwashing have become significantly riskier, especially given the sharp rise in related litigation.
It is now critical for companies to avoid misleading and inaccurate statements about sustainability without verifiable proof. Given the risks of SEC sanctions and costly litigation, venture capitalists must exercise greater precaution in their investments, ensuring that the companies they support comply with climate disclosure regulations and avoid misleading consumers. Fortunately, these increased risks may encourage venture capitalists to invest responsibly in sustainable technologies, resulting in greater compliance and the development of effective innovative solutions to climate change.
Exit Strategies and Long-Term Viability
Traditionally, venture capital investors aim for exits through acquisitions or initial public offerings (IPOs). However, the unique nature of climate tech—where solutions often require years to develop and scale—poses challenges to traditional exit timelines. Regulatory hurdles, lengthy product development cycles, and the need for large-scale infrastructure investments can delay exits, meaning that venture capitalists need to take a long-term view when investing in climate tech. Additionally, the unpredictable nature of government policies on climate change, such as the potential for changes in subsidies or regulatory frameworks, adds another layer of uncertainty to exit strategies.
The novelty and nonlinear progression of climate tech introduce additional risks. To mitigate these, investors should develop an understanding of how innovation unfolds at various stages and identify the key trends that highlight the evolving landscape of climate tech investment. The long term horizon that is often associated with climate tech requires sustained effort from both founders and investors. Analysis has shown that climate tech startups, when supported by both public and private funding, can accelerate the development of new technologies, making them more viable in the long run. Private investments are significantly associated with exits such as IPOs and acquisitions, while public grants fill important funding gaps in high-risk sectors such as climate tech. Public funding from the Inflection Reduction Act (IRA) serves as a crucial source of initial financing for climate tech startups, enabling these companies to develop and grow. This allows for venture capital investors to subsequently expand investments and foster growth within these startups. It is essential to leverage the diverse funding sources for climate tech startups to sustain the long-term horizon that is required for this technology. Understanding the distinct impact each type of investor can have on the success of these startups can help scale climate tech initiatives effectively.
At the same time, investors should not stall or falter if public investment fails to garner concrete guidance on their private investments. Investors, whether as board members or by setting conditions for future funding, should actively ensure their companies meet climate pledge goals by taking a front seat. 92% of the U.S. GDP has pledged to Net Zero emissions within the last decade. Investors play a crucial role in ensuring that these pledges are met.
Conclusion
Climate change represents an existential crisis for billions worldwide. Indeed, as the United Nations projects that global temperatures will continue to escalate in the years to come, we can expect the demand for innovative, climate-focused solutions to grow. Startups, venture capitalists, and investors face not only operational challenges but also complex legal hurdles. While federal and state policies may address some issues, long-term national implementation remains uncertain. With new leadership emerging from the 2024 election, the next business cycle is expected to drive increased investment in the climate-tech sector. Those who strategize around the difficult legal landscape will find success.
*The views expressed in this article do not represent the views of Santa Clara University.
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