While barriers to scale are endemic to the tech ecosystem, they’re top-of-mind in cleantech. Peter McArthur, VP, National Cleantech Lead, breaks down the funding gap in the cleantech market.
It’s no secret that cleantech has a strong foundation in Canada. The country has a sizable cleantech market with over 2,400 cleantech firms. Today, it’s home to 13 of the top global cleantech ventures. This growing sector is supported by a wealth of energy resources, dedicated government programs and a robust research and development (R&D) landscape supported by excellent academic institutions, government support programs and investment tax credits like the Scientific Research and Experimental Development (SR&ED) incentive. And with the push towards a net-zero economy, the sector is more important than ever.
Cleantech refers to any process, product, or service that reduces environmental impact using innovative technology. It’s mainly a hardware-based sector, with some software businesses. From capturing CO2 emissions to low-cost electricity storage, companies are moving the dial on the energy transition. However, change is happening at a slow pace relative to the opportunity and the need.
To enact broader change, cleantech companies need to commercialize their ventures. But commercialization comes at a price. Given the sector’s capital-intensive nature, barriers to commercialization are prevalent among cleantech companies. This is also an issue at the global level—half of the emissions reduction required in the International Energy Agency’s (IEA) net-zero emissions scenario depends on climate technology currently in its demonstration and prototype stage. Many of the technologies required to get us to net-zero don’t even exist yet.
Despite high growth potential in the Canadian market, cleantech faces a challenge endemic to the tech ecosystem—a start-up to scale-up support gap. Generally, cleantech start-ups are at the pilot and demonstration and early adoption stages of technology readiness. The reluctance to innovate and take on the potential technology risk of a cleantech product is a barrier to adoption by potential purchasers of clean technologies. Some cleantech projects are first-of-its-kind (FOAK), requiring a unique commercial plant to be built—a risk for institutional project finance investors, and high-cost for venture capital (VC) investors. As cleantech companies work to refine their solutions, they’re also struggling to obtain extra patient capital for their continued research, development, and operations. This is underscored by a wealth of research that isn’t being commercialized compared to other markets. In fact, private R&D spending in Canada is four times less than its US counterparts.
With challenge comes an opportunity. Peter McArthur, VP, National Cleantech Lead, has first-hand experience with Canada’s advances in the cleantech ecosystem. He breaks down the gap in the cleantech funding landscape, how founders can deploy strategic capital, and the importance of connectivity between stakeholders across the ecosystem to move towards increased commercialization.
What is your current lament with the cleantech ecosystem?
One of the things that makes Canada great is our general culture of investment prudence and conservatism, which is critical to the foundations of our strong and stable banking sector and civil society. There have been zero bank failures in Canada since 2001. However, healthy conservatism can sometimes bleed into a realm of complete risk-aversion, creating significant investment challenges for cleantech innovators who are often tackling problems and creative concepts within a new frontier of innovation.
Take the automotive sector, for example. For the most part, we acknowledge that electrifying cars is a viable solution as an alternative to gas-powered cars. Over time, it’s received significant investment because it’s easy to illustrate the impact of electric vehicles (EVs) on reducing emissions for investors and mass consumer appeal. Yet buildings—combined with oil and gas—contributed to 72 per cent of increased emissions in 2022. Buildings last longer than cars. But since they’re legacy infrastructures that need to be retrofitted, it’s a costlier—and therefore riskier—endeavour. If investors take the conservative approach to cost, we may not have the necessary innovation to mitigate the impact of commercial real estate.
From a purchasing perspective, businesses, utilities, and governments can be reluctant to take on technology risk—even with the promise of increased efficiency, better performance and reduced environmental impact. Likewise, when it comes to selling these technologies, Canada can be less aggressive than it needs to be. We have some of the most innovative minds working on emerging technologies in the cleantech sector. But we’re less likely to reward and recognize innovation, tolerate fast failure, and use our key learnings from our failures to pivot to a new approach. A cultural shift is required.
In short, Canada’s great at innovating. But it’s not always so great at scaling. That impacts the growth potential of these companies, and we see them being sold off to foreign buyers. To generate long-term impact and keep world-class innovation on home soil, Canada needs to be more open to weighing the potential long-term benefits and opportunities of investing in new frontier technologies to balance the risks.
Why is there an investment gap in Canadian cleantech?
Cleantech investment has seen highs and lows. Despite a drop in capital, climate tech in Canada saw a year-over-year increase in deal volume—58 in 2022, to 78 in 2023. Much of that is also being driven by early-stage deals. This is a promising trend. But cleantech is usually hardware-based, and hardware is more costly and complicated than software. The information, communications & technology (ICT) sector made up nearly half of all Canadian deals and funding in 2023. Software is typically an easier and lower capital-risk bet, since it doesn’t rely on physical infrastructure.
Cleantech founders and investors are also missing out on homegrown opportunities to collaborate across different stages of a cleantech project’s journey. Both are flocking to foreign markets—that’s talent and dollars leaving the country. Companies are being sold off, and equity is being raised outside of Canada. Don’t get me wrong—it’s terrific to have access to international capital to fund the growth of Canadian technology. This is welcome capital. But if this means selling a majority interest or the full business, it robs Canada of the opportunity to build a full and vibrant industry domestically. Last year, we saw a company sell its innovative direct air capture technology to a US energy company. While its billion-dollar US valuation was terrific, the technology is now owned by a company that doesn’t have roots in the Canadian economy and ecosystem.
On a more positive note, I look at Heidelberg Materials—a Swiss-owned conglomerate with Canadian operations. To produce the world’s first net-zero cement, they’re developing a carbon capture facility in Edmonton. But they’re doing this with significant capital investment and high ongoing operating costs. They’ve made a conscious decision to live up to their environmental commitment, and we need more Canadian corporations doing this with the presumed understanding that they can take away key learnings to do this more efficiently over time.
With $2 trillion estimated to get us to net-zero in Canada, there is a need for massive amounts of capital to be deployed if we’re going to succeed. As of March 2024, RBC announced it would be allocating $1 billion by 2030 to support the development and scaling of innovative climate solutions. Institutions have a huge role to play, including ours.
It’s widely recognized that the planet is warming due to human activity, and that reducing our greenhouse gas emissions to zero—or even negative—is essential for a stable climate on earth. To tackle climate change, we need companies across all industries—including cleantech—to be open to new pathways and solutions. But risk is always inherent in the new, so expanding our risk tolerance across the ecosystem should be a well-accepted factor in the road to net-zero. So the question is, how can we translate confidence in cleantech into extra patient capital at every touchpoint prior to commercialization?
Where are the challenges and opportunities across the end-to-end flow of cleantech capital in Canada?
Investors need to be willing to step up to address the pain points for founders. But cleantech founders also need to create a capital strategy that aligns with their business milestones. Canadian investors and cleantech companies are at a disconnect, and they need to meet in the middle. And investors representing diverse funding sources should do the same.
It starts with R&D. Despite having a solid R&D culture, Canada’s technology and innovation ecosystem doesn’t always have the capital to support innovators that want to make the jump from prototype to product. In recent years, Canadian cleantech saw over 80 per cent of domestic cleantech capital deployed in foreign markets. Then you’ve got cleantech companies relying heavily on foreign investment, which represented 55 per cent of Canadian private cleantech investments. More capital needs to flow at the prototype stages, and there should be a push for increased R&D spending in the private sector.
Capital also tends to drop off at the FOAK project financing stages. In some cases, FOAK projects are being deployed by earlier adopters. These early adopters are highly motivated corporations that are committed to achieving decarbonization objectives to ensure they have the social license to continue producing—especially as consumers of their products increasingly scrutinize their environmental impact. For example, Amazon is an early investor in several cleantech technologies, such as CarbonCure. FOAK projects demonstrate the commercial-scale utilization of an innovative technology that has the potential to dramatically reduce our footprint, but they’re unlikely to have an impact unless the technology is widely deployed.
Much of the cleantech sector depends on government programs and public financing. Where is the opportunity for VCs?
Advocate and invest to keep capital in Canada. When Canadian cleantech ventures move to more favourable markets, we lose our competitive edge in the global innovation economy. Some of these start-ups are getting acquired by global players, including the US. While economic uncertainty can be a burden, more investments help to de-risk cleantech start-ups.
Early-stage VC firms can step up and send a signal to the market. Many established VC firms are comfortable financing software. But fewer firms are comfortable with hardware, which makes up most of the cleantech market. Again, the ICT sector attracted 47 per cent of all deals and 58 per cent of total funding in 2023. VCs such as Evok Innovations and ArcTern Ventures are a part of the effort to grow these emerging cleantech start-ups, with a clear investment thesis for their limited partners (LPs)—including RBC Capital Partners in collaboration with RBCx. Roughly a quarter of venture debt deals through RBCx have been cleantech. Venture debt helps extend a company’s cash runway from a previous equity raise to enhance the enterprise value in preparation for their next equity raise.
There are also strategic investors or Corporate Venture Capital (CVC). On the equity financing side, cleantech companies can be a bit more discerning with their investor collaborations. Not all money is equal. Strategic investors offer value-adds such as network connections and informed advice pertinent to their unique business. They can even stock the cleantech solution on their shelves and provide distribution to end users. In other words, they can connect founders with risk-averse purchasers as advocates to break that scaling barrier.
On that note—too much strategic investment can turn off financial investors who look at the investment through a different lens, so a balance of investor types is ideal.
How can the broader business landscape support Canadian cleantech?
It’s important to to acknowledge that it’s challenging for legacy corporations to take on emerging technologies. There is an old adage—no one ever got fired for buying from IBM. Buying from an established corporate provider compared to a more innovative start-up is a lot less risky.
But climate goals permeate every sector. Enterprise organizations have the capital and the clout start-ups are looking for. This can create a mutually beneficial relationship because businesses can be testing grounds for these climate solutions. By working with a more agile start-up, there can be greater potential for meaningful innovation. This improves corporate and competitive positioning for the enterprise. Retail companies are looking for more environmentally sustainable supply chains, property managers and builders are looking for more energy and material-efficient solutions, logistics companies are looking for lower carbon footprints from their operations – the list is endless. With Canada’s ambitious net-zero goals, climate considerations should become a fixture in every business strategy. Even for emerging tech start-ups outside of the cleantech space, there are conversations around building ESG frameworks.
Much like VCs, large corporate players can be strategic partners. Big tech has already taken a huge step forward—companies like Shopify pre-purchase durable carbon dioxide removal (CDR) credits, which finances actual CDR projects such as direct air capture and biomass removal. The environmental benefit of carbon removal can bring valuable scarce capital to early-stage cleantech companies.
Often, cleantech is selling into regulated environments with fundamental utilities where failure is not acceptable, such as water and energy. Both private and public sectors should adapt to these realities by having a more connected ecosystem—regulated bodies such as municipalities and industry associations can share information about the adoption progress of cleantech solutions. The advocacy piece is key, especially for technologies in their pilot stages. Cooperation and collaboration mitigate stakeholder risk, striking that balance in a competitive market. A good example of this is the Canadian Grid Modernization Centre at University of Toronto, which involves multiple collaborators across the electricity ecosystem. This is a collaborative effort to de-risk the adoption of innovative technology for our energy systems, without jeopardizing the grid.
A successful investment isn’t based solely on the financial returns within a given period. Intellectual patents can open new doors for economic growth with extra patient capital. Today, Canada only produces 15-20 patents for every 1,000 peer-reviewed publications—significantly lower than the world average of 70. Given our country’s reputation, it’s clear that Canada’s cleantech market is a successful one at generating new technologies. Legacy corporations can optimize our successes by funding at-scale demonstration projects. Otherwise, we don’t get the benefit of these innovations.
On the other side of acquiring capital—what does strategic capital deployment mean for cleantech companies?
Cleantech is capital-intensive—it requires specialized equipment, labs, inventory, and skilled workers. However, there are ways for companies to build their business with strategic access to equipment and people.
For example, there are shared facilities where founders and operators can utilize assets for their needs without the burden of ownership. These include Kingston Process Metallurgy, the Verschuren Centre, and RXN Hub. Each company offers shared facilities and in-house technical expertise to support scale-up and validation for emerging cleantech across different specializations—mining, metallurgy, chemistry, biology and more. VC’s like SOSV offer up shared lab facilities to their investee companies. Until the cleantech companies scale up, the equipment can be shared. Owning a factory to build a product is costly—instead, using a contact manufacturer to develop these solutions mitigates the complexity of manufacturing.
What does the future look like for cleantech solutions?
With the right support, cleantech can be a sector that positions the country to be more competitive on a global stage. Canadian businesses can play a huge role in commercializing these solutions for the domestic market. This becomes a jump-off point for the international market. Canada can solidify its position as a cleantech leader with an abundance of resources and a bench of talent that leverages them best.
Canada has incredible competency in six areas amongst others—hydrogen, green chemistry (i.e. circular economy, waste-to-value solutions), carbon capture utilization and storage , water, nuclear (we boast the safest nuclear processes and five Canadian universities with post-secondary nuclear programs and expertise), and energy storage. This is backed by our people, our knowledge, and our competencies as we work towards a net-zero society.
In talking about climate change, people can feel challenged by the enormity of the task at hand. Humankind has demonstrated time and again its ability to take drastic action to achieve great things. Many would have bet against the UK—an island facing a very nearby and strong adversary—withstanding the onslaught of an opponent in World War II. But with the help of many other allies pulling together, including Canada, they prevailed. Katherine Wilkinson, a climate writer and speaker, once said: “It is a magnificent thing to be alive in a moment that matters so much”. I say: Let’s not waste the opportunity. Cleantech is full of opportunity for us to solve one of the greatest challenges we have ever faced.
This blog is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.
This interview has been edited for length and clarity.
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