Grants and Green bonds are good, but need of the hour is Risk capital
Climate change and why are venture funds urgently needed in this space!
|Nov 18, 2020||1|
India consumes 1/3 of per capita energy as compared to global standards and plastic usage per capital is one among the lowest in the world. India has just 4% air conditioning penetration. As India moves up on the development ladder and aims to be 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 ppl in next 10 years, consuming the same level of plastics, oil, building material, cars 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 point of no return as far as climate change is concerned.
Hence hard reality is that we can not get energy, food or transportation using the same framework which the western world used. Hence existing and the traditional models of power generation, distribution, air conditioning, housing, building infrastructure is 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 solutions 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 a 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 nature and type of capital than the amount of capital. Impact capital by its very definition is the capital focus 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 focus 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 principle as well a small interest however low that it 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 startup world every year! So despite best intentions, grants can not 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 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 instrument and hence by very nature of it, remain risk-averse and dependant on matching equity and strength of balance sheet. This ensures that innovation and startups are devoid of this capital and only large corporates with large infrastructure projects can access it.
This risk-averse capital drives away the innovation 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 to take bold, moonshots 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 plan speaking out of 10 investments, only 3 return oversized returns. However, the critical point is not the success ratio but rather the failure rate. Ths business model of venture world with high failure rate, make 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 startups focused on moonshots as well as simpler pain points and many times some of the moonshots 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 driverless car or billion transistors on a chip equivalent in clean energy / Agri / waste management/mobility space as innovation always precede policy. So it is not the policy but innovation backed by risk capital which will eventually find solutions to climate change.
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