How can existing UK public finance support for growth-stage climate tech be optimised to bridge the ‘missing middle’ financing gap? Scaling growth- stage climate tech companies July 2024 Barclays’ Group Policy Development team creates public policy thought leadership content on behalf of Barclays. Our work draws on the bank’s expertise, data and insights, and is intended to inform the design and application of public policy solutions in response to pressing economic and societal challenges. The intended audience for this report is public policymakers and other actors engaged in shaping public policy. Any views expressed in this report are those of the author(s) and may differ from those of the wider Barclays group. The report is general in nature and provided for information/educational purposes only. It does not take into account any specific investment objectives, the financial situation or particular needs of any particular person. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful for them to access. ©Barclays 2024 About this report Contents 1. Summary 3 2. Gap analysis and research question 4 Why is financing at this stage of climate tech scale-up challenging for the private sector? 5 A fragmented policy landscape 6 Barclays is supporting firms at this critical stage on the climate tech ‘escalator’ 9 Climate tech needs to be scaled up now if it is to deliver in time to enable net zero targets 10 3. Methodology 11 4. Results 12 (i) Financing 12 (ii) Approach to public finance and government support 13 Insights 14 5. Policy recommendations 15 Recommendation 1: Address the financing gap between £10m and £25m ticket sizes in direct public support for companies 16 Recommendation 2: Bolster impact of public finance institutions through maximising deployment of existing tools and mandates, and expanding available financing mechanisms 18 Recommendation 3: Improve organisational connection and collaboration 21 Recommendation 4: Consider whether the existing infrastructure of UK public finance institutions operates within the most effective structure 22 Scaling growth-stage climate tech companies Summary SUMMARY | 3 The scale-up of climate tech will be critical for the net zero transition, but financing currently falls short of what is needed to deliver the transition, with only about 16% of global climate finance needs currently being met. This finance gap is not evenly spread across financing rounds, with a particular gap in the UK at Series B+/ growth rounds where the features of these firms, and the type of investment needed, provide a challenge for traditional forms of financing. Drawing on insights from Barclays support for climate tech companies as they scale, this report looks at how existing UK public finance can be optimised to best support growth- stage climate tech companies and bridge the ‘missing middle’ finance gap. This report therefore sits alongside adjacent policy workstreams such as how best to deploy the additional capital earmarked for the National Wealth Fund and, separately, the extent to which public policy can or should encourage pension fund assets to be deployed into UK private markets including growing companies. Our results highlight the challenges many companies face in securing finance to scale, with the key features of climate tech firms – high capex requirements with longer paths to profitability – resulting in a risk profile that creates barriers to securing traditional investment. Firms often need help to navigate and access a fragmented landscape of public finance support available, and investors look to clear commitments from government to give them confidence to invest in the growth and development of climate tech. To overcome these challenges, this paper puts forward a series of recommendations on how public finance institutions can best support climate tech companies at the growth stage. This includes addressing a gap in direct public finance support for companies, maximising deployment of existing tools and mandates, improving organisational collaboration, and considering the most effective operating structure across the landscape of UK public finance institutions. Scaling growth-stage climate tech companies $4.35 trillion THE FIGURE THAT CLIMATE FINANCE MUST INCREASE TO ANNUALLY BY 2030 TO MEET CLIMATE TARGETS 1,2,3 < BACK TO CONTENTS Climate tech, short for climate technology, refers to the physical and digital technologies that will reduce or remove greenhouse gas emissions or improve resilience or adaption to the physical impacts of climate change. GAP ANALYSIS | 4 Globally, only about 16% of climate finance needs are currently being met, meaning climate finance must increase more than six-fold – to $4.35 trillion annually by 2030 – to meet climate targets.1,2,3 As part of this, there is an urgent need to finance and scale climate tech – which we use here to mean technology or new business models that seek to address climate change, through directly mitigating or removing emissions, improving resilience or adaptation to the physical impact of climate change, or through deepening our understanding of climate and nature. According to the International Energy Agency, an estimated 35% of greenhouse gas emission reductions required by 2050 will come from technologies not yet on the market.4 But financing for climate tech currently falls short of what is needed to deliver the transition – and this gap is not spread evenly across financing rounds. Early seed and venture rounds by UK-headquartered climate tech companies have almost quadrupled in value since 2012, rising from around £100m in 2012 to almost £400m in 2021.5,6,7 On the other end of the scale, established infrastructure and debt financing is available for larger companies with a demonstrated commercially viable product. Gap analysis and research question Yet, there is a ‘missing middle’ at the Series B+/ growth rounds, where climate tech companies are seeking finance for high-potential but not yet commercially deployed technologies.8 Funding provided at this stage fell 48% year on year in the first half of 2023,9 and data from the UK Cleantech Group suggests that from 2018 to 2022, a £1.5bn climate tech financing gap has emerged at Series B.10,11,12 Scaling growth-stage climate tech companies £1.5bn The climate tech financing gap that emerged from 2018 to 2022 at Series B 10,11,12 (UK Cleantech Group) 1. Environmental Finance. Financing the ‘missing middle’ for climate tech. 2023 2. World Fund estimate that climate finance must increase by at least 590%, to $4.35tn annually, to meet climate targets. World Fund. White Paper : Investing in Climate Tech – An Opportunity for Europe. 2023 3. Deloitte. Could technology innovations help reverse the climate change trajectory? Not without a lot more money. 2023 4. International Energy Agency. Net Zero Roadmap: A Global Pathway to Keep the 1.5°C in Reach – 2023 Update. 5, 6. Department for Energy Security and Net Zero (DESNZ). Market assessment – UK venture capital market for early-stage clean tech companies. 2023 7. KPMG. Venture Pulse Q4 2021: Global analysis of venture funding. January 2022 8. S2G Ventures. The Missing Middle: Capital Imbalances in the Energy Transition. 9. Sifted. Is the party over for ‘recession-proof’ climate tech? 2023 10, 11. Cleantech for UK. Building the next generation of cleantech champions. 12. Barclays Corporate. From science fiction to decarbonisation: Scaling climate technology for positive global impact 16% 35% 48% Climate finance needs currently being met globally1,2,3 Greenhouse gas emission reductions in Europe likely needed to come from new technologies by 20504 Fall in Series B growth funding for European climate tech year on year in the first half of 20239 IN NUMBERS: >> < BACK TO CONTENTS GAP ANALYSIS | 5 Much of the capital to meet the climate tech financing gap will come from the private sector, especially once these technologies become commercially proven and attractive.13,14 But the financial profile of these climate tech companies creates barriers to securing the financing needed to reach this stage (Box 1). Given this mismatch between the financial profile of capex-heavy climate tech companies, and the investment profile requirements of various financial players in the market, consideration is needed of how to rebalance the risk profile of climate tech growth financing to allow for a wider pool of traditional investors to participate. Why is financing at this stage of climate tech scale-up challenging for the private sector? Scaling growth-stage climate tech companies This might involve approaches such as the development of innovative private financing structures, or targeted public finance intervention to create blended finance solutions. Public policy and finance can play a key role in helping reduce and transfer risks.15 Recognising the benefits and necessity of climate tech, governments globally have been directing public support and subsidies to support climate tech firms through their lifecycle. Yet, given the evidenced gap in financing for scaling climate tech companies, this note will consider whether existing public support is sufficient to bridge the ‘missing middle’ financing gap. Drivers of the ‘missing middle’ – what may cause the climate tech growth finance gap? INVESTOR NEEDS This combination creates a risk/return profile that is challenging for a range of investors seeking a more traditional risk profile and non-concessionary returns: Banks Whilst traditional bank debt instruments usually provide the capital to support a large increase in technology deployment, they will usually require clear track records and evidence of steady cash flow, and banks typically have a lower risk tolerance for failure in their portfolios.16 These features are often missing from climate tech companies at this stage, especially given those delivering First of a Kind (FOAK) technologies, which in many cases will not yet be profitable. Venture capital (VC) Whilst VCs are usually more comfortable with the variable cash flow and risk profile of early-stage climate tech companies, scaling these businesses will be significantly more capital- intensive than the software companies in which VCs are traditionally accustomed to investing. The profile of revenues is also further out than the usual three to five years VCs are looking for. For example, McKinsey estimates that the time from Series A to D for digital marketplaces is three years, versus around seven for climate technologies.17 Private equity These actors will traditionally invest into businesses that are already cash flow-positive, which many climate tech companies are unlikely to be at this stage.18 The climate tech growth financing gap may be explained by the key features that make companies at this stage a challenge to finance. These include: • Capital expenditure- intensive with high upfront costs • Long timeframes to profitability • Commercial uncertainty • Often requiring technical or scientific knowledge to understand revenue drivers and scale potential FINANCING PROFILE This mismatch between financing profile and investor needs drives the ‘missing middle’ financing gap. 13. Blended Finance Taskforce. Better Guarantees, Better Finance: Mobilising capital for climate through fit-for-purpose guarantees. 2023 14. Our World in Data. Why did renewables become so cheap so fast? 2020. 15. United Nations Framework Convention on Climate Change (UNFCCC). Enhancing Access to Climate Technology Financing (TEC Brief #6). 2015 16. PWC. State of Climate Tech 2023: How can the world reverse the fall in climate tech investment? 2023 17, 18. McKinsey. A different high-growth story: The unique challenges of climate tech. 2024 BOX 1: >> < BACK TO CONTENTS