The opportunities of impact investment.
There is a lot of buzz around impact investment, as investors smell opportunity. The word opportunity might evoke stereotypical images of greedy wolves of wall street. Only this time there is a different kind of opportunity. One with more than financial benefits in return. But let me start by exploring the term beyond the stereotypes. The word opportunity defines “a time or set of circumstances that makes it possible to do something”. In my opinion, both, the time as well as the set of circumstances, are given.
The time is now. The world is heading into a system collapse driven by an economy built on exploiting natural resources, a throwaway society and the pursuit of short-term financial profitability. The current path threatens livelihoods, health and prosperity for many. Demographic growth exacerbates the seriousness of our problem, leaving us with limited time to shape an economy operating within the planetary boundaries.
This sounds dire. And it is. To halve GHG emissions until 2030, every sector of the global economy needs to transform and radically decarbonise in just over two business cycles. Many of the technologies and solutions critical to enable this ‘net zero’ transformation need rapid commercialisation, while many more need to be accelerated out of the lab or even conceptualised.
But things are changing — and this change is gaining speed. Newly elected President Joe Biden has unveiled a slew of climate-related actions in his first few weeks in office, including having the United States rejoin the Paris Agreement and proposing net-zero carbon emissions policies. Droves of entrepreneurs (and, often, very experienced ones) are continuing to flood into the climate and impact space. Private investors as well as institutions like Black Rock or the Bank of England, just to name two, increasingly demand investments in line with their values. On the other side, institutional investors ask their constituencies to integrate sustainability considerations. They want to gain a better understanding of how to price environmental, social and governance (ESG) as well as climate-related risks and therefore a better awareness about their financial materiality.
Already, over half of global GDP, 2.6 billion people and a quarter of carbon emissions are covered by a national net-zero target. Close to 300 major global companies (and rising weekly) have made net zero pledges. And over one hundred countries are committing to net zero emissions economies before 2050 (including China). We can expect to see continued and rapid tightening of regulations over coming years, including carbon pricing, subsidies, standards, bans and phase-outs, public finance mechanisms and green infrastructure investment. Which is leading me to the second part:
The set of circumstances.
In December 2019, the EU Commission presented its program to develop Europe into the first climate-neutral continent by 2050 with the help of the Green Deal. The expressed goal of the Green Deal is for the economy of the EU member states to become climate friendly. In practice, this means a huge transformation process that poses new challenges to numerous existing business models and confronts investors with a new set of risks in respect of their investments. In particular, climate regulation as well as new legislation will lead to significant reevaluations of companies and their business models across all sectors.
Additionally, policy-makers are looking into companies that make a profit by externalizing their costs, i.e. having a negative environmental and social impact, which are eventually paid for by society as a whole. The valuation of these externalities will serve as the basis for new environmental regulations. The social cost of carbon emissions, for example, will be taken into account when determining the size of a carbon tax.
The EU Commission presented several new acts over the last years, among them the Single Use Plastic Directive (2019), a new tax on non-recyclable Plastics (2021), the Plastic waste export ban (2021) as well as the Action Plan for Financing Sustainable Growth in 2018. Having started on January 1st 2021, the new EU Plastic Tax charges EUR 0,80 per kilogram of non-recyclable plastic while at the same time the EU act expects to increase recycling of plastic packaging to at least 55% by 2030. This increased regulation will drive up the cost of using virgin plastic by 100%+ and brands need to adapt.
Regulations are helpful to gain control over what has gotten out of control. But what is needed most are ideas and solutions that create new possibilities and goals to strive for. Ideas that create new opportunities. These ideas can both improve existing models and markets and create brand new ones. Equally, they can scale up existing technological solutions and support the development of more disruptive ones. They do not necessarily need new technology to innovate. While breakthroughs in technology are critical to generate new opportunities, both in terms of value creation and impact, not all ideas need to play out in the breakthrough tech fields. There is a huge potential in deploying and scaling up existing technologies through business model innovation and, especially, digitization. Turning these ideas into products and services will need the support of the financial sector and especially of private investors. The EU estimates a yearly investment gap of EUR 175 to 290 billion to meet the envisaged target of a 50% cut in greenhouse gas emissions by 2030 and to be climate-neutral by 2050.
The Action Plan for Financing Sustainable Growth aims to redirect capital flows towards sustainable investments and to promote transparency in the area of sustainable capital investment. Some of its building blocks require quick action by the financial sector. And there are indications that the EU Emission Trading System (ETS) cap might be tightened further, taking the proposal for legally binding EU nature restoration targets in 2021 as an example.
For investors and asset managers, the question is how to deal with these ambitious political plans. For a long time, most investors tended to take the topic lightly. However, this will hardly be feasible in the future, because governments have unambiguously expressed their will to change the economic model not just to embrace environmental challenges but also to encourage better social and corporate governance practices.
Consumers, corporates and capital markets are pushing the demand for environmental awareness and solutions. Global sustainable investing — not to be confused with philanthropy — has nearly tripled in the last nine years, amounting to more than US$ 30 trillion. Over the next decade and a half, that number is expected to reach US$ 160 trillion. Despite these impressive numbers and growth rates, overall funding in Europe with US$ 10 billion in Q4/2020 still amounts to only less than a third of Asia’s (US$ 31 billion) and nearly a fourth of North America’s (US$ 37 billion).
Let us narrow this down to impact investments: While global impact investments outgrew overall global VC investments over the past six years, they still only account for ~9% of the global VC market, with European impact investments representing roughly 27%. This leaves many research and capital-heavy ventures underfunded and it is obvious that there is still room for significant growth here.
Discovering the companies that will disrupt today’s structures while keeping environmental demands in mind and supporting them, offers a huge investment opportunity. So it is the right time to embrace it. Regulatory tailwinds will also grant future momentum. There are many young companies which have sustainability baked into their DNA right from the start. They will be tomorrow’s winners.
An early-stage investment in a start-up that either builds a solution for a current environmental problem and/or rethinks and restructures an existing business model in an environmentally compatible way and without externalizing its costs, promises a triple bottom line. We constantly see new start-ups emerging in various and — in terms of environmental impact — very relevant industry sectors like energy, water, waste and mobility. Companies like Sonnen, Beyond Meat or Northvolt have already made their path, developing their business ideas and generating massive annual shareholder returns. A recent study by BCG showcases the performance of investments in green companies:
Entering new markets or developing offerings that cater to high-priority economic and social needs create new revenue streams. These companies are winning new customers and strengthening their brands through a positive environmental and social contribution. Early movers are using scale and market position to create network effects and lower costs. Innovators are building more resilient business models through reinvention in the most critical parts of the value chain, reducing exposure to increasing costs and regulatory constraints. In short, they are demonstrating that innovation focusing on environmental impact is all about creating value. We currently observe a rapid increase in such highly innovative impact driven start-ups in sectors like the carbon removal market, anything connected to bio-derived materials serving as substitutes for plastics and thus sustainable packaging (enabling a truly circular economy) as well as electrification in general, for instance of the transportation sector.
But how can we leverage this opportunity? You need to offer credible mission alignment and provide tailored support. To be able to team up with these start-ups and their bold founders right from the start, we at Planet A defined our three-pillar approach: With the combination of funding, founder centric mentorship as well as impact measurement, we address all three key areas for growth in the impact space and thus improve chances of future success.
Our criteria are clear: We invest only in those start-ups that have the potential to disrupt industries and bring about massive positive change. We are looking for companies where impact is built into the product or service so that as the business grows, the impact automatically follows.
We believe that the quantifiable impact potential of a company does not only lead us towards making the right decisions for our planet, but serves as a proxy for economic success. That is why we introduced science-based impact measurement to our toolbox of company assessments. See more in our article on impact measurement “What’s the unit to measure progress”.
With investments, we decide which people, companies and technologies we want to succeed. With today’s investment decisions, we form tomorrow’s economy. So let’s take the opportunity. So that in a couple of years „sustainable investing“ or „impact investing“ will just be called “investing,” as integrating sustainability considerations will have become the new normal.
Feel free to drop us a line if you have comments, questions, ideas on impact investment.