The Inflation Reduction Act offers much-needed certainty for climate start-ups

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Illai Gescheit, Partner, Siemens Energy Ventures, Siemens

• 60% of start-ups fail to make positive returns — uncertainty is fuelled by a variety of factors and is part and parcel of creating a start-up.
• This “entrepreneurial uncertainty” also impacts investors and as the world faces a global economic downturn it is getting worse.
• But for climate start-ups in the US, the new Inflation Reduction Act actually eases some of this uncertainty by allocating billions in funding to carbon reduction over an appropriate time period.

One of the most challenging things about building a new start-up is the element of uncertainty. This feeling of uncertainty is what founders go to sleep with and what they get up with every morning.

Uncertainty plays a role in every aspect of company building, from hiring great talent to raising your next round of funding.

I call this “entrepreneurial uncertainty.” It is a constant uncertainty that needs to be managed by founders and supported by investors to build resilience of leaders and a healthy business culture.

Recent moves in the market and the potential for an economic downturn have only heightened entrepreneurial uncertainty — but the United States’ Inflation Reduction Act may actually go some way to assuaging it.

Uncertainty is part of start-up culture

There are many reasons why the level of uncertainty is high in the venture space. Fundamentally, it is because the chance of success is low — over 60% of start-ups never make positive returns on their business.

Founders know it is unlikely their new venture will succeed. Investors know that most of their investments will lose money — that’s why they build a portfolio of companies to de-risk their investments, in the hope that their due diligence and support will lead to a few ‘home-runs,’ where most of their return on investment will come from.

The truth is that whether a start-up succeeds is a combination of infinite parameters: the team, the advisors, investors, strategic partners, the market, legal and intellectual property, operations, supply chain — the list goes on. This composition of elements creates “entrepreneurial uncertainty.”

It is simply impossible to predict if a start-up will succeed or not. Many times, venture capitalists view founders as the sole bearer of responsibility of failure or success.

Some have suggested that it’s possible to reduce the likelihood of failure, but ultimately building and investing in start-ups will always be risky.

Managing an economic downturn

Start-ups do not exist in a bubble. They are a part of the global economy and are affected by the global markets. Every economic crisis shakes investors, start-ups and entrepreneurs. When, this year, the stock market started showing signs of a downturn, many well-known venture capitalists took the initiative to support and guide their portfolio companies in how to manage a downturn.

Sequoia Capital stressed to their portfolio companies that we are only at the beginning of the market slowdown and that companies should prepare for it to last longer than expected. They reminded their founders that hypergrowth companies are not rewarded when there is no free money — a slower but more sustainable growth is preferable.

The geopolitical environment — inflation, war in Ukraine and a global pandemic — created significant macro uncertainty, and that is reflected in the ability of investors to think long-term and take technology and business risks.

Venture capitalists halted their investments, and the cost of capital increased. The ‘magical’ valuations of companies we knew during 2020 or 2021 became irrelevant. While disappointing for some, there is now a prevailing sense that it is healthy for founders and investors that valuations are once again reasonable.

In response to the downturn, many start-up founders announced layoffs after previously pursuing rapid growth in their teams. Some even carried out layoffs while still recruiting many people to their workforce, which sent mixed messages to investors and the market. So far in 2022, more than 600 start-ups have laid off a combined total of over 81,000 employees — and more than 150,000 have been laid off since the pandemic began.

The Inflation Reduction Act: stability for climate start-ups

The US Senate’s new Inflation Reduction Act allows climate investors, entrepreneurs and other players to think long-term and take technology and business risks. The Act allocates $369B over the next 10 years to reduce annual carbon emissions in the US by about 1 billion metric tons by 2030.

It takes on average 7-10 years for a start-up to scale, and the average lifetime of a venture capital fund is 10 years. This means the timeline of the Inflation Reduction Act fits the start-up ecosystem in the climate space. Some critics argue, however, that in the energy and carbon removal spaces companies have longer lifetimes to profitability and scale, some requiring 20-30 years to reach the scale required for real impact. Time will tell whether the critique is apt.

The Inflation Reduction Act funnels inflation in a way that will create a positive impact on climate start-ups, by creating macro certainty in this part of the market.

It does not address the start-up ecosystem specifically, and it does not guarantee early-stage start-ups funding or offer financial incentive. But it does offer some respite from entrepreneurial uncertainty.

Amid macroeconomic warnings across the wider economy and in the start-up ecosystem, this legislation is an island of certainty for climate innovation in an ocean of macro-economic uncertainty.

While uncomfortable, this situation is a call for founders, venture capitalists and corporate venturing arms to build and invest in businesses that are sustainable and hold a long-term view on scaling. This realistic mindset can help us find solutions that start the energy transition from day one, while keeping ambitious targets for the future.