Renewable finance and investment challenges
The growth of green finance and new climate investments has been varying greatly between different countries globally. Despite the overall growth of the green finance sector globally and increasing deployment of low-carbon technologies, the equity finance and transactions for clean technology companies have recorded falls in recent years.
A good example is that the equity finance transactions for cleantech companies have been falling in the UK in recent years. The annual total values of renewable deals in the UK have halved over the last four years. This contrasted markedly with the overall venture capital market megatrend, where investments have increased by more than 50% in the UK between 2014 and 2016 (UK GET, Green Finance Report, 2017).
The key reason for these disparities was that there have been few green financiers and funders who have been willing to take the significant early-stage risks in cleantech and climate start-ups. This has led to many pioneering low-carbon technology start-ups struggling to attract the initial investment capital required for them to grow and to scale up to the commercialisation stage. There are several serious concerning factors weighing down on the sector and holding back its ability to grow. A major concern has been that there has been low appetite to invest in start-ups with long lead times to commercial development. In many instances, these long lead times have been unavoidable due to long R&D periods. Normally, cleantech start-ups will require longer timescales, and in many cases more upfront capital, to scale up to commercialisation compared to digital technology companies. An example is that the first-investment-to-exit journey time for a renewable hardware start-up could take more than ten years. These long timescales have meant that early equity investment rounds have been typically unattractive and unsuitable for many closed-end financially motivated funds. These funds would typically have a ten-ycar duration which is common in the UK and other financial hubs.
By contrast, the growths in green venture capital (VC) funds have been stronger. These new green VC funds have been primarily driven by longer-term strategic motivations of their financial backers and ethnical investors. They have also been facing some issues. One critical issue was that the knowledge spillover market failures have reduced commercial competitiveness. New low-carbon start-ups have to struggle hard to acquire the necessary new skills, knowledge and technology which could help these start-ups to deliver the returns necessary to justify venture equity investments. There has also been serious competition from fast followers who have benefited from spill-over knowledge generated by the innovators and pioneers. A good example of green VC growth is that a lot of green finance and climate investments in Europe and the EU have been generated by different corporate venture capital (CVC) setups by ethnical investors or impact investment funds (EU, Framework for State aid, 2014).
The longer time frames required for cleantech and renewable developments have caused serious concerns and challenges for investors. The vulnerability to knowledge spill-over has also been high thereby increasing the risk and reducing appetite for investment. The start-stop nature of some government grant funding for early-stage R&D could increase the risk of the technology incubation stage and lengthen the prototype development process. As these cleantech companies mature, the absence of a liquid secondary market has disincentivised VCs looking to move their capital into the next suitable opportunity. Private equity or institutional investors have also significantly different time horizons to venture capitalists. These differences have made it more difficult for VCs to exit and monetise their green investments. The situation has also been further compounded by the need for patient capital in new physical technology investments. These have then in turn lengthened and complicated the buy-out due diligence process.
There have also been some specific risks which are particularly acute for some countries. A good example is the UK with its Brexit. If and when the UK completes Brexit and leaves the EU, then it would no longer have access to the European Investment Fund (EIF). This might create a substantial gap in limited partner (LP) funding. Historically, the EIF has been a cornerstone investor in various UK VC funds. The EIF has invested over £500 million across the UK, of which £100 million has been in cleantech. It would be important for the UK to ensure that there would be sufficient new sources of green finance funding to replace those from the EIF, if and when it completes Brexit. It is of paramount importance to ensure the health of the venture capital (VC) ecosystem in the UK. Whilst there is a strong case for government funding support, it must be delivered in a way that would offer clarity and reassurance throughout the process (UK GFI Report, 2017).
These financing challenges and headwinds are likely to seriously affect the growth and development of some countries into low-carbon economies and cleantech hubs. A key reason is that the private sector response alone, with all these issues, would be very unlikely to generate sufficient investments for some countries to become world-class centres for cleantech venture capital. A lack of
Renewable finance and investment management 149 funders willing to take early-stage risks has knock-on effects for later-stage VC and growth capital investors. The lack of seed funding and Series A funding from institutional investors would lead to high failure rates for early-stage businesses and therefore a smaller pipeline of later stage deals. Hence, different governments should seriously consider these serious challenges so they can develop suitable policy supports and financial incentives to support cleantech developments at different stages of their value chains.
One potential policy support option is for governments to consider setting up a Green Investment Accelerator (GIA) for early-stage green climate technology grant funding. There have been similar accelerators which have worked well for the health, life sciences and infrastructure system sectors. Governments should consider new incubators with comparable mechanisms to focus on supporting early-stage cleantech and climate technology developments. These GIA should have multi-year, multi-call schemes to provide fast-track grants for early-stage cleantech start-ups. These companies could receive new VC funding from suitable pre-qualified institutions with a good green VC track record. These would provide financial support to small businesses at all stages of their development. These should then help to develop a thriving ecosystem, with coordinated government and investor support. These schemes would also need multi-year commitments, with regular calls for applications announced well in advance. These could be complemented by public funding bodies such as Research Councils or Research Institutes, which have clean growths and clean renewable energy development objectives in their core programmes.
A good example is that the UK has already set up a successful Innovate UK Investment Accelerator pilot in health, life sciences and infrastructure systems. The UK has been considering setting up a comparable mechanism to support early-stage cleantech and climate technology start-ups. This could be complemented by funding from the Research Councils UK which has clean growth objectives in the core programmes.
Another interesting support option is that governments should consider establishing a dedicated public-private green venture capital fund. Governments should set up a new green VC fund to leverage their public seed grants and to raise further capital from the private sector. The new green VC fund should focus on backing early-stage cleantech companies and SMEs in their initial growths and expansions. These would also encourage more green capital to flow into the early-stage green investment market. These should then help to support more and larger green finance and investment deals.
Governments should also consider alternative delivery options which could include Co-Investment Fund (CIF). These will be new equity funds matching up to 50% of deal-by-deal investments in start-ups by the private sector on a co-investment basis. The CIF could select a number of experienced private sector institutions to be its accredited partners. These should help to bring various co-investment opportunities to the CIF to assess. Management and governance of the new CIF should be performed by government innovation agencies, together with key investment partners and funders.
X good example is that the UK government is considering setting up a special new VC fund to leverage the public seed grant of £20 million announced in the UK’s Clean Growth Strategy. This should help to further raise capital from the private sector and eventually deploy up to £100 million of new capital to support the growth of cleantech companies in the UK. The new UK green VC fund would focus on backing early-stage UK SMEs less than five years old with revenues of less than £1 million. These should encourage more green capital injections into the early-stage market which should then support more and larger deals. The UK is also considering establishing a new Co-Investment Fund (CIF). Management of the CIF would either be performed within the UK BEIS Ministry Energy Innovation team or be outsourced to the British Business Bank (BBB) (UKGFI Report, 2017).
Another potentially interesting policy support option is to consider increasing commercial opportunities for businesses through the use of public procurement processes. In addition to supporting early-stage technology investments, governments should consider how other sources of public finance from public entities and government procurement agencies could help to support delivery of their clean growth strategies through investments in selected products or services. The investment prospects of early-stage companies would be enhanced if they have credible customers or even better have a sound order book.
Annually, government agencies globally have been spending tens of billions of dollars on the public procurement of private sector goods and services. These could present significant opportunities for innovative private sector cleantech companies to scale up through supplying specialist cleantech services to the public sector. The public sector should also take a strategic approach to its energy purchasing, such as considering the new opportunities presented by new cleantech companies. This would help to demonstrate lower-cost, clean energy services which could be scaled up to provide services to the wider economy.
A good example is that the UK has been considering increasing commercial opportunities for renewable and cleantech businesses through the use of public procurement processes. The UK public sector is unique in having some large energy-using sites close to one another. The UK Cabinet Office could provide central purchasing support. The UK public sector offices could then consider using some of their sites as a pathfinder to demonstrate the benefits of innovative cleantech products and services. The UK Green Finance Taskforce has recommended encouraging public sector procurement to lead the UK market in clean alternatives through mechanisms such as the Small Business Research Initiative (SBRI) and using climate impact as one of the key factors in public procurement decisions (UK GFI Report, 2017).
