Grants and Green Bonds are Good, but Need of the Hour is Risk Capital
On climate change and why are venture funds urgently needed in this space!
India consumes 1/3rd of per capita energy as compared to global standards and the plastic usage per capita is among the lowest in the world. India has just 4% air conditioning penetration. As India moves up the development ladder and aims at being a 10 trillion economy in next 10 years, there can be a tremendous demand for housing, energy, food, and transportation. Same is true for all emerging economies in the world. This creates a tremendous opportunity for capital to be deployed in these sectors and this seems to be the good news.
However, this can be really bad news if India and the emerging world consume in line with western standards of consumption.
Imagine India, a country of 1.5 billion people in next 10 years, consuming the same level of plastics, oil, building material, cars, etc., on per capita basis as that of Norway or US or any other developed economy! Even at a 50% per capita increase in consumption compared to the western standards will push things beyond the point of no return as far as climate change is concerned.
Hence, the hard reality is that we cannot get energy, food or transportation using the same framework which the western world used. So, the existing and the traditional models of power generation, distribution, air conditioning, housing, building infrastructure are not going to work and will rather create havoc.
However, this hard constraint also creates a huge opportunity for capital and innovation.
China built its massive infrastructure like the West or rather much better than the West but at a much lower cost (30% to 40% cheaper than the West). Likewise, what is needed in these sectors (energy, waste, mobility, etc.) is not a pure investment solution but technology solution that can help India and rest of the emerging world to have the same standard of living without consuming the same level of resources and that is the biggest opportunity.
However, this opportunity can only be solved by putting capital to work in these sectors.
If one analyses total number of impact investments done in the last 3 odd years, one can see that more than $500 billion has been deployed as impact capital in climate change areas and issues related to poverty alleviation. This shows that significant capital is coming to impact sectors. Interestingly, the amount of capital being committed to impact sectors is almost at par with VC funds who generally see annual commitments in the range of $100-$150 billion every year.
Evidence of VC capital at work is quite visible in our day-to-day life. It is difficult to imagine life today without Microsoft, Apple, Intel, Cisco, Amazon, Grab, Swiggy, Paytm, Uber, Lyft, Airbnb - all funded by VC capital. The impact created by these companies is very much there. Ironically, similar stories of impact do not exist in the impact investment area.
Sad truth is that one needs to appoint fancy and fee-charging impact advisory firms to figure out the impact of impact funds which is quite an irony in itself. So, what is missing?
The challenge seems to be more about the nature and type of capital than the amount of capital. Impact capital, by its very definition, is the capital focused on doing good than generating returns. It is driven by this utopian fantasy of passionate teams working on solving large and complex problems without worrying about generating returns. Unfortunately, there lies the problem. It is in odds with the basic tenet of capitalism.
Impact capital focuses on the good and not returns, so the majority of it is either in the form of grants or in the form of green bonds. Grants are grants while bonds do expect the return of principal as well as a small interest, however low that is.
Since grants are non-repatriable capital, it creates a limit on available capital so by nature they remain small - grants above $10 mn are almost unheard of, except 2/3 rare events in a year. Compare this with 100s of $10 mn rounds which happen in the start-up world every year! So, despite best intentions, grants cannot ensure supply of large capital to a problem, and hence, by design, keep large problems capital-deficient.
Further, there are no large incentives for teams to build a faster, better. and cheaper solution or, to put in VC terminology, there is no alignment of interest. Hence, the problems remain capital-deficient as well as entrepreneur-deficient, as great entrepreneurs are not drawn to these sectors due to paucity of funds as well as lack of alignment of interest.
On the other hand, climate bonds have no such challenge. A huge amount of capital is raised through green bonds and there are many examples of super-sized raises in the past and it does help in funding large projects. However, the challenge with bonds is that they are debt instruments, and hence, by the very nature of it, remain risk-averse and dependant on matching equity and strength of balance sheet. This ensures that innovation and start-ups are devoid of this capital and only large corporates with large infrastructure projects can access it.
This risk-averse capital drives away the innovations as the best outcomes are driven by risk capital and not debt. Imagine starting Google or Uber or Intel or Paytm by raising debt where interest needs to be paid quarterly!!
Hence, while we do need all grants/climate bonds to make the basic layer to build basic infrastructure as well as support core research, the real need of the hour is risk capital which can fund innovative ideas and help entrepreneurs take bold, moon-shots in solving large problems.
But the question is - why you need risk capital in the first place, and can capitalism really solve these issues?
Risk capital, or venture capital, by the very nature, is geared towards high business failures. Almost 40% to 60% of the investments by funds are written off and grand success rate of any fund is not more than 30%, or in plain speaking, out of 10 investments, only 3 return oversized returns. However, the critical point is not the success ratio but rather the failure rate. This business model of venture world with high failure rate makes the whole chain of investors (from angels to large funds) mentally attuned towards failure. This, in turn, results in funding of a large no. of start-ups focused on moon-shots as well as simpler pain-points and many a times some of the moon-shots do succeed, resulting in the paradigm shift of the whole industry. Hence, VC world has been able to create a large impact on every sector they have dabbled in, without focussing on impact, while impact funds, despite all focus on impact, have not been able to recreate similar success stories.
While we do need a lot of policy push, green bonds and grants, the real need is to have risk capital which can spur innovation and help us create a driver-less car or billion transistors on a chip equivalent in clean energy / agri / waste management / mobility space, as innovation always precedes policy. So, it is not the policy, but innovation backed by risk capital, which will eventually find solutions to climate change.