Developing Innovative Blended Finance Models to Catalyse Private-Sector Investment into Climate Tech

Client

Innovate UK (IUK)

Challenge

The UK faces a critical challenge in scaling private finance and accelerating capital flow into climate tech businesses. Despite a large pool of global capital actively seeking opportunities in competitive return-generating green investments, funding is not being deployed at scale into these businesses due to a complex interplay of uncertainty around investment returns, real and perceived risk, and information asymmetry.

IUK wanted to understand how this challenge affects the UK climate tech landscape and assess the role of blended finance solutions, where public-sector capital is utilised to efficiently mobilise private investment, in addressing the problem. Carbon Limiting Technologies was engaged to evaluate the nature of the funding gap for early-stage and scale-up climate tech businesses in the UK, with a focus on high-capex hardware companies, in order to then develop innovative blended finance models. The overall aim of the project was to design a blended finance model that could rebalance risk and significantly accelerate capital flow to climate tech ventures.

Solution

CLT implemented a comprehensive research methodology across several phases of work.

Phase 1 involved detailed analysis of the funding requirements and investment flows across the climate tech landscape. The UK climate tech market was broken down into 27 verticals which were evaluated by funding received over time from different sources of investment to identify where funding received was falling short of requirements. In addition, stakeholder engagement, including expert interviews, was used to develop a comprehensive understanding of the business characteristics contributing to the funding gaps identified. This resulted in the prioritisation of the capital-intensive First-Of-A-Kind (FOAK) stage of development for hardware-oriented, engineering-intensive businesses as the critical funding gap to be addressed,

In Phase 2, CLT conducted more detailed analysis of the scale-up funding gap for businesses at the priority development stage. In-depth research into the market failures at play was completed in parallel with an evaluation of best-in-class blended finance mechanisms relevant to the UK market. This work was refined through extensive stakeholder engagement. Exploratory interviews were conducted with a wide range of stakeholders across start-ups, specialist climate investors, institutional investors, and supporting actors such as lawyers. These interviews honed in on the risk factors which prevent FOAK-stage climate tech projects from successfully commercialising and deter investors from deploying capital into climate tech. Additionally, requirements for a potential blended finance funding mechanism to address investor needs around risk, return, scale, and liquidity were discussed in detail.

This phase culminated in an interactive workshop for 60 participants across the ecosystem, held at the Innovation Zero World Congress. During the workshop, the findings of the phase were presented to stakeholders before validating the research and reviewing the potential of different funding mechanisms through structured group discussions.

Phase 3 involved the design of a blended finance solution to address the FOAK funding gap identified. A shortlist of potential mechanisms was prepared based on the findings from investor engagement and evaluated based on their ability to address the market failures, de-risk investments to meet the needs of investors and innovators, and leverage private capital. The shortlist was then refined through further interviews with select investors and quantitative modelling of return on investment to develop the final proposed solution.

This solution provides investment both in the form of equity and project-related debt, allowing companies to access the right kind of capital. It is large-scale, backed by a cornerstone investment from the public sector, allowing institutional investors to deploy capital at scale. Investment decisions are made by specialist climate investors to reduce risk, and further de-risking is provided through a government-backed guarantee. Additionally, a key finding of the research was that there is also a clear gap in access to support and guidance on scaling operations to commercial scale, as well as a lack of data and knowledge sharing between stakeholders, which compounds the effects of the funding gap to stifle growth. To address this, an additional technical assistance facility, or ‘FOAK Builder’ scheme, was proposed to provide high-quality project support and disseminate learnings between stakeholders.

The final phase of work involved dissemination of the findings. The research was written up into a clear whitepaper detailing the existing state of the market and market failures, as well as the proposed blended finance solution to address these, for IUK to publish. The outcomes of the work and detailed modelling of the proposed fund were shared with decision-makers at the National Wealth Fund, the British Business Bank, institutional and specialist investors, and the Treasury, with CLT providing ongoing support to IUK to progress the development of the fund. Key findings from the work were also shared with senior investment leaders at the ‘Industrial Decarbonisation – Financing the Missing Middle’ event with Microsoft and the ‘Scaling Climate Solutions – Navigating the Transition from First-OAK to Nth-OAK’ with IFM Investors during London Climate Action Week.

Outcome

CLT conducted detailed research to provide IUK with a clear understanding of the nature and causes of the funding gap in UK climate tech, evidenced by rigorous data analysis. Input from a wide range of stakeholders was synthesised with this data to obtain a deep understanding of the risks which any blended finance mechanism must address in order to remove barriers to investment for private-sector capital. These learnings were taken into the design of the proposed funding structure, whilst also drawing on existing best-in-class funding mechanisms worldwide, to produce a fund design which addresses the critical barriers whilst meeting investor and start-up needs.