As the urgency to address climate change intensifies, the role of venture capital (VC) in driving climate technology innovation has come under scrutiny. A recent working paper, “Catalysts for Climate Solutions: Corporate Responses to Venture Capital Financing of Climate-tech Startups,” explores this dynamic. The authors, Shirley Lu, George Serafeim, and Simon Xu, of Harvard Business School and the Digital Data Design (D^3) Institute’s Climate and Sustainability Impact Lab, found that VC investments in climate-tech startups are not only fostering innovation but are also influencing established companies to pivot toward climate solutions.
Key Insight: The Signaling Effect of VC Investment
“Our study shows that VC investments in climate-tech startups can serve as a signal to validate the commercial potential of climate solutions, leading incumbent firms to increase their focus on climate solutions.”[1]
Lu, Serafeim, and Xu’s research demonstrates that when venture capitalists invest in climate-tech startups, it sends a powerful message to the market. Established companies, particularly those operating in similar product markets, take notice and respond by increasing their own focus on climate solutions. This “VC signal” effect suggests that VC funding serves as a form of market validation, encouraging incumbents to reassess and potentially pivot their strategies toward more sustainable practices.
Key Insight: Product Market Similarity Drives Response
“We define the set of ‘similar’ incumbent firms for a specific startup as the listed incumbent firms ranking within the top one percentile of similarity scores with respect to the given startup.”[2]
The researchers developed a sophisticated method to identify which incumbent firms were most likely to respond to VC investments in climate-tech startups. Using large language models (LLMs) and the Business Description from Item 1 of SEC 10-K filings for U.S. public firms, they analyzed the textual similarity between startup descriptions and incumbent firms’ business descriptions and pinpointed a set of “similar” firms most likely to be influenced by the startup’s funding. For example, the study mentions that if a startup secures VC financing for sustainable aviation fuel (SAF), both the energy producer developing the technology and the airline deploying it would be considered relevant players in the climate solution space.
Key Insight: The Impact of Deal Visibility
“We measure the visibility of startup deals in two ways. New investors is the number of new investors that participated in the VC financing round for the startup as a proportion of the total number of investors in the round. […] Media is the natural logarithm of one plus the total number of news articles featuring the startup from four years prior to the event date to 30 days before the event date.”[3]
Lu, Serafeim, and Xu found that the visibility of VC deals plays a crucial role in influencing incumbent firms. Deals that attract new investors or generate significant media coverage are more likely to prompt a response from established companies.
Key Insight: The Evolution of Climate-Tech VC Funding
“Specifically, the period from 2005 to 2011 witnessed an initial boom in climate-tech investments with a surge in both the number of deals and average deal size. […] [T]here was a contraction in deal activity from 2012 to 2014. […] [T]he second boom period occurred from 2015 to 2021, characterized by substantial investment inflows. […] The average number of investors per deal also exhibits an upward trend beginning from the second boom period.”[4]
The team’s paper reveals a significant growth trajectory in climate-tech VC funding over time. This trend indicates an increasing recognition of the commercial potential in climate solutions and a growing appetite among investors to support innovative startups in this space. For example, in 2021, there were 578 climate-tech startup deals with an average deal size of $40.74 million and an average of 5.8 investors per deal.
Why This Matters
For business leaders and C-suite executives, this research underscores the strategic importance of monitoring and responding to VC investments in climate technology. The findings suggest that these investments are not just isolated bets on startups but powerful market signals that can reshape entire industries. The study highlights the potential for established firms to leverage VC activity as a form of external R&D, informing their own innovation strategies and product development. As climate change continues to drive market shifts, understanding and acting on these VC-driven trends could be crucial for maintaining competitiveness and capturing new opportunities in the evolving business landscape. Ultimately, this research provides a compelling case for executives to view climate-tech VC activity as a strategic barometer, guiding decisions on resource allocation, partnerships, and long-term sustainability initiatives.
References
[1] Shirley Lu, George Serafeim, and Simon Xu, “Catalysts for Climate Solutions: Corporate Responses to Venture Capital Financing of Climate-tech Startups”, Harvard Business School Working Paper, No. 25-025 (November 27, 2024): 32.
[2] Lu, Serafeim, and Xu, “Catalysts for Climate Solutions: Corporate Responses to Venture Capital Financing of Climate-tech Startups”, 10.
[3] Lu, Serafeim, and Xu, “Catalysts for Climate Solutions: Corporate Responses to Venture Capital Financing of Climate-tech Startups”, 20.
[4] Lu, Serafeim, and Xu, “Catalysts for Climate Solutions: Corporate Responses to Venture Capital Financing of Climate-tech Startups”, 8.
Meet the Authors
Shirley Lu is a Harvard Business School Assistant Professor of Business Administration in the Accounting and Management Unit and a member of D^3’s Climate and Sustainability Impact Lab. She teaches the Financial Reporting and Control course in the MBA required curriculum.
George Serafeim is the Charles M. Williams Professor of Business Administration at Harvard Business School, where he co-leads the Climate and Sustainability Impact Lab within the D^3. He teaches the MBA course “Risks, Opportunities, and Investments in an Era of Climate Change” (ROICC), which he developed to guide students in mastering the skills needed for entrepreneurial, managerial, or investment roles in a rapidly evolving climate landscape.
Simon Xu is a Post-Doctoral Fellow in the HBS D^3 Climate and Sustainability Impact Lab. He received his PhD in Finance at the Haas School of Business, University of California, Berkeley and is interested in financial intermediation, corporate finance, and banking, with links to climate finance, using LLMs to develop new metrics for assessing firms’ climate solution products and services, and their implications for business strategy and market valuation.