For tech investors, climate software is one segment to watch

Against a backdrop of declining venture funding in 2022, climate tech start-ups saw a drop in investment, though they still pulled in roughly the same share of funding as in the year before. One category, however, bucked the trend: start-ups making climate software, which is used to manage data on carbon emissions, climate risk and other climate-related performance indicators. These businesses raised around US$2 billion during the first three quarters of 2022, compared to $1.4 billion in 2021 and just $390 million in 2020. 

It’s not just total venture investment in climate software start-ups that increased. The average size of investment deals into climate software leapt up, from US$5 million in 2019 to $35 million in 2022, as an increasing number of these start-ups sought later stage venture funding and larger cheques.

We wanted to explore what’s spurring the growth of investment in this segment, by speaking to a range of VC and investor firms, industry bodies, tech start-ups and enterprise customers. These conversations described the forces shaping the market for climate software—including the following three key demand drivers:

1. New disclosure regulations in major markets are heightening the need for software to manage and report data

The sustainability reporting requirements that apply to many companies are growing more and more comprehensive – which means that organisations are likely to need software for collecting, processing and reporting climate and ESG-related data. Businesses are being asked to disclose against a range of standards: the US SEC’s forthcoming climate disclosure rules, the TCFD (Task Force on Climate-related Financial Disclosure) recommendations that are beginning to be taken into law across territories, plus current or incoming standards from the ISSB (International Sustainability Standards Board), SASB (Sustainability Accounting Standards Board), CDP (Carbon Disclosure Project) and WEF IBC (the World Economic Forum’s International Business Council).

These new reporting rules tend to be broader than many of their predecessors, both in the number of organisations covered as well as the amount of information to be disclosed. The EU’s Non-Financial Reporting Directive (NFRD), for example, requires 12,000 enterprises to report on their progress towards the European Green Deal. But the incoming Corporate Sustainability Reporting Directive (CSRD), which is set to replace the NFRD, will affect some 50,000 companies with a presence in the EU, including SMEs. It will require potentially over 1,000 disclosures on anything from GHG emissions to climate risk, pollution, health and safety, and employee rights, with expectations that these disclosures will be subjected to third-party assurance. And it will force companies to move fast—some companies will have to start reporting in 2025.

As more standards and frameworks for climate and ESG-related reporting move from being voluntary to mandatory, businesses are having to enhance processes to achieve investor-grade data needs. For most, the scale of the challenge is equivalent to that of building financial accounting systems from scratch, but for sustainability. Many will look toward software to help them bridge the gap.

2. SaaS models driving operational improvements appear familiar to investors

Although pressure from regulators is compelling businesses to improve their sustainability measurement and reporting systems, many companies are also seeing the operational benefits. Companies we’re familiar with have found that the improved data quality and consistency provided by their software solutions can help them make more informed business decisions, leading to productivity gains, cost savings and reduced risk.

Climate software also resembles a familiar area for VC investors: SaaS solutions that focus on operational improvements. Faced with other areas of climate tech where the playbook for success is still being written, investors may be more comfortable redirecting capital to what feels like known territory.

3. Beyond regulators, customers and employees are demanding reporting transparency

Given that many stakeholders expect companies to demonstrate strong ESG performance, companies that go above and beyond their compliance requirements may realise competitive advantage. When surveyed, 80% of US consumers said they were more likely to buy from brands standing up for the environment. The same goes for the talent market. Some 84% of employees said they were more likely to work for an organisation that championed sustainability. Reporting transparency—that is, visibility into emissions and progress against targets, enabled by software—can help to bolster brand messaging to reach increasingly conscientious consumers and employees alike.

Reports on venture investing in early 2023 suggest that the slowdown seen in 2022 could continue. Still, the tailwinds behind climate software indicate that customer demand for these solutions could remain healthy, and investors seem to recognize the potential of companies which sit at the nexus of two trends: software and sustainability.