Some Thoughts on CDR Startups and the Economic Downturn in 2022
V0.3 - Dirk Paessler - Jun 3rd 2022
There are various signs of an upcoming economic downturn which might also affect investments in cdr companies. Here are a few recent links on Twitter (here and here) and from the New York Times (here and here). In this document I’d like to explore from my -- of course limited -- perspective what this could mean for climate startups, especially with regard to the urgent scale up of climate solutions for CDR (carbon dioxide reduction) which simply can’t be delayed.
Good risk management in my view means that even unlikely events don’t take an organization completely by surprise. The set of planning scenarios should cover good and bad as well as likely and unlikely events. In hindsight not even the Covid-pandemic was a “blask swan” event.
Let’s start with the now infamous document that YCombinator has sent to its founders. Their main point, I think, is that leaders of startups that are able to adapt to the new situation quicker will be better off and they should react NOW. Although we can’t tell where the market goes it is wise to have a plan in your scenario arsenal that will make you able to sustain 24 months of hardship, e.g. not being able to raise further cash. “Are you default alive?” is the correct question.
For a cdr startup this is a two or even a three tier question: It’s not only about having cash or being able to raise new investments for yourself in the near future. It is also a question if your customers (i.e. buyers of negative emissions, which are often tech/finance companies) and your partners/suppliers (i.e. carbon sink suppliers in case of a carbon market or a carbon storage company for a DAC project) will survive.
Tier 1: Own cash situation: I expect a situation where it will be much harder to collect money from investors in the second half of the year, regardless of what your business is actually doing. The situation will be better when climate companies talk to climate/ESG-targeted investors (they have different motivations), but the general market will go much slower. This would quickly deteriorate in case one of the potentially big lurking problems escalates (Covid, Ukraine, inflation, shipping, energy, food, etc.), each of them has an above zero chance to happen, any sub-combination could even create a perfect storm.
Tier 2: Customers: Even though for climate it is actually crucial to bring customers into the cdr market as fast and as many as we can -- if we will see a substantial downturn in the economy, I think no one will be able to predict if cdr purchases are the first or the last expenses that companies will drive down. The related decision process is beyond simple economical rules, as we have seen in the other direction in the previous months, when so many promising forward-looking decisions were announced (Frontiers Fund, Climeworks Financing Round, etc.) with impressive numbers. These activities are the result of long-term consideration and were based on the insight that we need to put cash into the industry now or it won’t grow enough. This insight hasn’t changed at all, but will this thought/strategy survive a downturn? I think the demand for cdr is so much bigger than supply so that even a substantial loss of demand won’t hurt the already empty cdr market too much. Most big buyers of CDR are a few large corporations that have deep pockets and won’t run away early, so some optimism is ok in this field.
I think it is important to realize that - compared to the last 12 months - there may be more leverage over the next 12 months in generating revenue from CDR buyers (more stable situation of buyers?) than getting cash from investors (will partially be dragged down by the investment market downturn?). This could be a good moment to barter long-term-offtake-agreements which will allow you long term planning and the customer gains a long term pricing.
Tier 3: Partners/suppliers: Most companies in the emerging field of climate companies can not yet stand-on-their-own because many don’t cover the complete carbon cycle, just one or few steps, and need other startups, and in some cases can’t choose between several partners for any given task, too. So your own life may depend on others and they are potentially having bigger problems than you face.
The statement of the YCombinator paper is clear: If you can get money now, get it, regardless of terms. If you plan to raise money in 6-12 months expect this to be very hard (if at all) and likely on not too attractive terms. If you haven’t achieved product-market fit don’t expect to raise at all for 24 months. Change your burn rate to ensure 24 months of runway (=time until you run out of cash).
The questions are: Does this dark outlook also apply to climate and cdr companies? Or will we see something like a safe-haven for climate companies, and if yes: why? And what will be the early indicators that this is actually happening? I don’t have these answers yet. Let me know what you think!
If we can’t make a strong argument for or an observation of such a safe-haven situation and if we don’t see any early indications of this, then the YCombinator letter also applies to climate companies, at least somewhat. Then we need to drive down burn rates of cdr startups *now*.
It seems to me that it may be a good time to shift the focus somewhat more on getting money from buyers instead of from investors. Or short: Focus more on actually selling CDR and less on adding investors’ money. Which would be a good thing: We need to move more tons of carbon (for the climate) and less hot air (for investors) anyway. In the end this upcoming phase could be good for the cdr market as we have a somewhat “slower time” to actually develop the necessary carbon moving capabilities, and don’t focus too much on scaling a market too early that doesn’t provide anywhere near enough supply of cdr as the market demands.
So: Let’s get real!
Summary from my view:
Voluntary CDR markets (where less demand will still mean there is more more demand than supply) will likely be less affected than financial/investments markets. Maybe it is better to focus work&time on this less volatile/less risky part?
Your plan A should cover a scenario with upcoming serious trouble in the economy and should already expect trouble for financing rounds and to some extent cdr sales, too, in the next 6-12 months. Get money now if you can and - if you can - try to shift focus on generating (long-term?) sales to increase your cash.
Your plan B should cover the scenario of one or more global crises escalating without much warning time and you should be able to survive without any more investment money for 24 months
I don’t think a “rosy” scenario which continues most things as they are right now is realistic, there are too many potential global problems and it is unlikely none of them actually hits us.
The crises in recent years seem to show a trend of becoming shorter but also more intense. Let’s hope that after a short period of instability we can get back to building the cdr industry soon.