There is a growth equity “missing middle” in climate finance, presenting both a barrier to decarbonisation and an opportunity for investors, according to a new research report seen exclusively by New Private Markets.
With investment capital gravitating towards infrastructure and venture capital, growth equity and private equity are “asset classes that are underrepresented in the climate sector”, according to the research, which was conducted by CREO, a syndicate of family offices and foundations with an interest in combating the climate crisis.
Climate as an investment theme has proved relatively compelling to private markets investors. Amid a slowdown in dealmaking and fundraising across asset classes, climate-focused activity has remained comparatively robust.
On fundraising: “the rate of increase in climate investments since 2014 has far outpaced the broader market, which remained relatively flat through 2020”, the report states. On deal activity (looking at the dollar value of private equity and venture capital specifically): while the wider market declined 27 percent from 2021 to 2023, climate dealmaking declined only 15 percent across the same period.
Asset owners, including many public pension plans, have earmarked capital for climate investments. This week, for example, the California Public Employees’ Retirement System said it was making progress against its $100 billion target for climate investments.
While capital is starting to flow, however, it is unevenly spread across investment strategies, with venture capital funds accounting for an outsized proportion of capital formation in North America, and infrastructure funds dominating climate capital allocations in Europe. From 2012-23, more than one-quarter (27 percent) of the capital raised for climate investment in North America went to venture capital. In Europe, 51 percent of the capital went to infrastructure funds over the same timeframe. Private equity and growth capital represented relatively small slices of the pie. “This gap is critical for companies to scale and commercialise climate solutions effectively,” the report notes.
Most of the climate capital, meanwhile, has flowed to larger funds, the research shows, with large funds accounting for 58 percent of the total climate capital raised between 2010-23.
While the creation of climate mega-funds is a positive development, the median deal size across climate VC, growth equity and private equity suggests that what is needed is more mid-market climate funds, the report notes. The average (median) cheque size written by a large growth equity fund ($1 billion or larger) between 2018-22 was $65 million, the report states. The median climate growth equity deal size, meanwhile, was just $34 million. The energy and transport sectors would be exceptions to this, however, as they present opportunities to deploy larger cheque sizes.
As well as highlighting a potential size mismatch between funds and opportunities, the research also notes that capital is not readily flowing to the sectors with the greatest potential for mitigation.
“Almost 70 percent of all capital invested over the period 2018 to 2023 flowed to the energy and transport sectors,” the report notes. “Agrifood and Land”, a sector with among the highest potential for emissions mitigation, has attracted just 7 percent of the investment over the same period.
“Many of the technologies in sectors that offer greater mitigation potential have costs above their reference technologies and would benefit from investment to drive innovation and deployment, increasing market adoption and lowering costs,” the report authors note.
Elsewhere the report describes how emerging managers – those raising funds one, two or three – have accounted for an increasing amount of the annual climate capital raised each year. In 2023, 48 percent of the capital raised was from emerging managers. It is worth noting that where an established manager has launched a new climate fund family, this does not count in CREO’s emerging manager definition.
CREO had this to say as part of its conclusion: “Diverting capital, particularly from large asset owners to smaller ($250 million-$500 million) funds focused on the growth equity and PE opportunities, will help to scale emerging climate businesses, as will greater commitment of ‘climate relevant’ fund capital in the sector and increased regulation. Increased deployment of climate solutions will help drive down costs and accelerate movement towards tipping points, becoming self-reinforcing.”