“Impact investors” in climate and environmental sustainability need to realize that their challenge is even bigger than they think. And that part of the challenge, in fact, is that the world’s biggest investors increasingly want to support them… but can’t.
More mainstream, institutional capital than ever is committing to invest into climate solutions. A recent survey of sovereign wealth funds managing over $24 trillion in capital found that three-quarters of the institutions now have ESG policies in place, and some such as Norway’s world-biggest fund are now actively advocating for climate considerations in their portfolio investments. Beyond advocating for broader adherence to ESG principles, these players are also often allocating significant capital toward specific climate and environmental sustainability investments.
Meanwhile, private markets infrastructure firms are more interested than ever in investing into these types of solutions, as I’ve written about before, and they have plenty of dry powder with which to do so. They’re not just looking at alternative energy project investments, we can see them increasingly looking at clean water, indoor food production, and waste-to-value opportunities as well.
So with all these huge investors actively hunting opportunities to invest into the deployment of climate and sustainability solutions, project developers should have access to all the capital they could need and the deployment of these solutions should be growing like crazy, right?
While that is indeed happening in some of the now-established solutions like solar, wind and batteries… across the other 99% of the potential climate solution set it’s simply not. Which can seem counterintuitive given all the capital eager to chase after those solutions.
Earlier this week I attended a major conference of “impact investors” who are all working hard to bring positive solutions not only to commercialization, but with aspirations to have those solutions be deployed at global scale. It was really encouraging to see so many smart investment minds focused on this shared goal. The conference hosts in particular were really experienced impact investors with a sophisticated, multi-asset approach. I don’t get to spend that much time with such impact investors on a regular basis, and I learned a lot at the conference.
But even among these experienced impact investors, I found much confusion about a simple fact of life in the institutional investor community:
The early stages of market deployment of new solutions doesn’t immediately require hundreds of millions of dollars. And unfortunately, those deep pocketed institutional investors — despite their strategic goals to invest into those solutions — almost always can’t write checks smaller than hundreds of millions of dollars.
Think about it from an organizational management standpoint… If you are a manager at a multi-hundred-billion pension or sovereign wealth fund, you report to an investment committee. That investment committee is responsible for overseeing and approving almost all investments across many different asset classes, public and private. They have to review billions of dollars of investments per year. A “small” $50 million dollar deal, therefore, usually doesn’t rise to the level of importance necessary to take up the investment committee’s time. And if for whatever reason they did decide to engage on and approve deals that small, then their team needs to manage those investments for years to come. Before long, that management team would be responsible for somehow providing oversight for thousands of investments across the portfolio. They’re simply not staffed for that, it would be a logistical nightmare.
It’s no wonder, therefore, that I’ve often been told by the managers at sovereign wealth funds (or even large private infrastructure firms) statements like, “I can’t go to my investment committee for anything under $100m, and even that small of a deal would get them complaining to me about it.”
Great, so any project developer should simply ask for $100m or more, right? After all, more investment dollars are always a good thing… right?
Well, no, actually. Not only do many innovative project developers not need that amount of capital in their early going, if they do agree to take in such large amounts of capital too early it can cause big problems down the road.
Remember that many of the fastest-growing opportunities in sustainable infrastructure are relatively smaller projects. There’s been a paradigm shift in the energy, food, water, waste and transportation markets away from large, utility-scale projects and toward more smaller, decentralized solutions. We’re talking about distributed wastewater treatment, electric vehicle charging networks, anaerobic digesters, composting, solar+storage microgrids… These projects don’t individually require hundreds of millions of dollars to develop and construct, they often need $20m or even much less. In fact, when the projects are a bit bigger, then they can often get project debt… which means that the project equity check remains small anyway.
And for a relatively small developer (which, if we’re talking about less-established solutions, then by definition they’re mostly starting with smaller developers), there are only so many projects they can tackle at once. Beyond just the sheer logistical challenge of managing multiple parallel projects at once, they also need to start out by working out the kinks of project delivery — this isn’t a question of “does the solution work”, we’re talking about the nitty gritty of figuring out how to structure revenue contracts, how to select and work with contractors, how to manage permitting and siting, and a myriad of other crucial details.
Thus, as a longtime investor into climate and sustainability solutions, I’ve seen firsthand that most innovative project developers simply can’t use a hundred million dollars right away. They quite often need something more like $20-50m for their first two to three years of project deployments while they hone their approach and build a robust pipeline of future projects.
Here’s where it all comes together — if the innovative developer can get those two years of successful track record and build a big pipeline, then not only can they indeed use hundreds of millions of dollars of project capital, that’s also exactly when mainstream project finance investors and even larger institutional investors start to think the developer is de-risked and ready for “cheaper” project capital, and they eagerly jump in! And as we saw a decade ago in the distributed solar market in the US, that really starts a virtuous cycle of more rapid deployment leading to even lower cost of capital leading to even more rapid deployment. Et cetera.
To the impact investor universe, getting these innovative solutions and project developers into that virtuous cycle should be the “holy grail”. That’s when the global finance markets take these desperately needed solutions and deploys them at scale, truly making meaningful impact.
But how to bridge that capital-scale gap? Most impact investors are an order of magnitude smaller than pension funds and don’t have nearly the amount of capital necessary to be throwing $20-50m in project development and deployment capital at individual innovative developers. And yet as noted above, that amount of capital is too small for the big institutional investors to even try. As one smart impact investor described at this conference I attended: “Help is NOT on the way.”
And so I way too often see such innovative developers facing a major capital gap. A very few are able to raise the hundreds of millions of dollars from larger investors. But if they’re not ready for it, that way leads to unnecessary failures. Early mistakes in projects that lead to the supposed $100m+ investor backing away. Or the investor simply has a hard time approving projects in the first place, and the money never actually flows. And often that $100m+ in capital comes along at a really high capital cost that might make sense for the first year or two, but because the developer won’t use up that amount of capital for four or five years they’re now locked into an expensive capital solution for years to come even as they’ve de-risked their solution, hindering future growth. And of course… that’s only the very few who are able to raise such capital; way more innovative developers simply languish in an “early commercialization” status without access to sufficient deployment capital, and grow very slowly as a result, if at all.
What is clearly needed is a new set of climate and sustainable project investors who not only can stomach such relatively smaller check sizes, but in fact will specialize in such deals. Filling the gap between early stage investors and mainstream project finance. Not only providing the right size of investment, also providing important know-how and assistance, to maximize the chances of those innovative developers successfully getting to that magic inflection point of two-plus years of successful track record and deep project pipelines. That’s what’s needed to give the big institutional investors permission to write those big fat checks they need to write. And to give the solutions a chance to be successful, with billions of dollars of fresh capital ready and available to make it happen.
That’s when these innovative solutions will truly start to have a meaningful level of impact on global-scale problems like climate change.
The good news is that there now are a hardy few investment firms who are providing this desperately needed “bridge” to the mainstream project finance market (full disclosure: my firm is one of those). The bad news is, it’s only a few. The worse news is, most “impact investors” don’t even yet recognize the capital-scale problem, much less know about those firms and the important role they can play. And so the connections aren’t being made.
It all reminds me of a decade and a half ago, as a venture capital investor, when I would sit in rooms full of experienced, smarter VCs, and we would all be talking about investing into climate innovations that were going to change the world. To save the world, we thought. And looking back on those conversations, I’m chagrined to realize how naive we all were. So many of those very smart VCs explicitly expected that all they needed to do was to provide just enough capital for the startups they were backing to “prove” that their solution “worked”, with a completed project or two. And then mainstream infrastructure investors would just take the baton from there and run with it.
Now we know better — that’s not how it works. What a VC thinks of as a “proven solution” is not what a mainstream infrastructure or institutional investor thinks of as “proven”. And of course, there’s this capital-scale mismatch at work as well. And thus, so many of the solutions that held so much promise back then (and took in so many venture capital dollars!) never ended up making a serious impact.
Many of the impact investors I met with this week are now coming to realize the same dilemma. They’ve been investing into early stage venture capital deals and now are running right into this same capital-scale gap. And they see both the need, and the opportunity. But we need even more than just a recognition of that. Overt action is needed if the impact is truly to be achieved.
As I’ve described for a few years now, we need a more robust capital ecosystem for sustainability innovation. While that’s now coming together, unless impact investors want to repeat the mistakes “cleantech VCs” from a decade ago, they need to more purposefully engage the institutional investor and infrastructure capital communities early on. And now more than ever, we need a specialized set of smaller project investors who will help bridge the gap between these communities.
Not only is that the pathway to actual market-rate returns on these investments, it’s also the pathway to meaningful scale and thus meaningful impact.