Sustainable Venture Capitalism: The new investment trend that has amassed $100 billion and counting

Private players are increasing investment into sustainable businesses across sectors like food and agriculture, cities, energy and materials, and health and well-being. Qiraat Attar looks into why this trend is catching on

Venture Capital

The business paradigm comprises several factions that uphold their end of the deal to create a successful enterprise. Entrepreneurs are the idea-makers, without whom business is impossible. However, the history of private businesses would be a very short and dismal one without the existence of investors.

When an idea is new and untested, with the brains behind it naive or unseasoned, formal setups like banks and co-ops often turn away from supporting an underdog. In such a scenario, a wise investor makes all the difference, placing their bets on new ideas and businesses they see potential, growth, and success in long before anyone else does. Beyond garden-variety investment, the rise of venture capitalism, where investors give money to those startups they see a surging potential in, has changed the shape of several industries, including tech.

Since its emergence in the 1970s, VC has grown in strength. About 3 of 4 startups fail, so VCs refrain from putting all their eggs in one basket and prefer to diversify among several upcoming companies so that a single successful venture covers the failing costs of the others. For this reason, tech startups have no trouble securing VC funding because they promise tremendous returns owing to their ability to scale.

Now, a new wave of VC is starting to proliferate and garner attention, much to the surprise of those who believe in traditional investment principles – sustainable venture capitalism. Simply put, sustainable VCs are on the lookout for startups that are innovating ideas, products, and services that take the environment into consideration while also showcasing enormous growth potential. VCs act as the guiding light for these ‘green tech’ firms to learn how to use the capital, set up processes, and navigate the finer points of business building and growth in the early stages.

Famed VC John Doerr is bought into the game-changing investing opportunity offered by sustainable ventures. According to him, “Green-tech could be the largest economic opportunity of the 21st Century.”

BRANCHING WITH SUSTAINABILITY

Sustainable VCs are relatively new to the investment business. Kicking off in the early 2000s, their growth has since been unstoppable. In 2002, roughly 43 clean energy startups received venture capital funding in the US, raising a total amount of around $230 million. Merely 20 years later, investors allocated about $64 billion in total funding to cleantech businesses in the first half of 2021, which is anticipated to cross $100 billion in the coming time (Source: Cleantech Group survey).

However, given its recency, it’s easy to get muddled up and put all sustainable companies under one umbrella. Rather, let’s understand the subtle ways in which sustainable VC is categorized so that you can understand the space before you foray headlong into it.

Firstly, there is a key differentiator segregating sustainable investment from the more traditional model. Here, the deciding factors are not wholly dependent on profit, ownership, scalability, or expansion, but rather on considering environmental, societal, and governance-related (ESG) factors, which will be invaluable in the long term. Thus, while the markers of traditional VC are important, they are not singular dealbreakers. A cool way to grasp this is to look at sustainable investment as an addition to investment theory rather than as an embargo from the old method.

THE MANY BRANCHES OF SUSTAINABLE VCS ARE:

ESG

Easing into it, ESG refers to an investment’s environmental, social, and governance practices that may have a material impact on its performance. What’s important to discern is that while the financial outcome is still the main objective, the integration of ESG factors is used to enhance traditional financial analysis by identifying potential risks and opportunities beyond technical valuations.

Martin Kremenstein, head of retirement and ETF solutions at Nuveen, explains ESG metrics in more detail. “It’s about analyzing companies and comparing them to their peers on ESG metrics. E, or Environment, stands for how efficient they are at managing their resources but also caring for the environment. S, or Social, stands for how well they treat clients, workers, and lower-level employees. It also includes the diversity aspect of the company staff. G, or Governance, talks about share structure, governance structure, and how well run the company is. Essentially, it is about assessing the company without looking much at the balance sheet and more about how it benefits society at large.”

It is interesting for us to note that even traditionally tech and manufacturing organizations try to amass an impressive ESG source in order to prove their accountability towards people, the environment and society, not just profitability. As per Investors Business Daily, tech giants Microsoft, Salesforce.com, Nvidia, Accenture, and non-tech companies like Linde, J.B. Hunt, and Gildan Activewear all have secured ESG scores of 70 and above.

Venture Capital

ESG refers to an investment’s environmental, social, and governance practices that may have a material impact on its performance

SRI

Socially Responsible Investing (SRI) goes one step further than ESG by actively eliminating or selecting investments according to specific ethical guidelines. It means, if you’d like to leave the world better than you inherited it or be associated with a company that tackles challenges the world faces, this is for you. But, of course, this isn’t all goodwill either; going for such companies can enhance your risk-return profile.

Here, an investor’s or VC’s personal value system and ideology are hugely in play. If they champion the cause of gender equality, elimination of race bias, providing rehabilitation for refugees, or protecting the marine ecosystem in particular, these play a role when going for SRI.

Socially Responsible Investing (SRI) goes one step further than ESG by actively eliminating or selecting investments according to specific ethical guidelines

Want to know what investment companies have sustainability standards? Vanguard ESG U.S. Stock ETF, or ESGV, excludes stocks of those companies that don’t meet UN global compact principles standards or don’t meet certain diversity criteria. 1919 Socially Responsible Balanced Fund (SSIAX) criteria exclude companies that dabble in fossil fuel tangible assets, instead choosing companies with fair employment practices and seeking assets that take human rights into consideration.

IMPACT INVESTING

In impact or thematic investing, investments need to churn out positive impact through the companies they choose. Being a facet of the SRI spectrum, they’re looking for intentional outcome orientation, providing benefits to marginalized groups, and pushing for innovation that could potentially change the world for the better.

While SRIs may leave out weapons or unethical drug companies, where ESG factors also come into play, impact investment demands that they go a step ahead than just excluding negative companies. Capital is invested in a certain opportunity that yields return through endeavors that care for the planet.

Wunder Capital is an impact investment platform where the money is used to finance solar panel installation companies. CNote is a company that invests in minority-owned businesses. On a more involved level, a venture-building program and startup studio based in The Netherlands called Fresh ventures allows people to co-found companies with skillful professionals and entrepreneurs to address systemic challenges in the food system.

Venture Capital

SUSTAIN TO MAINTAIN THE PLANET

Clean tech was an emerging market at one other previous point in history – prior to 2008 when investment in the domain went from hundreds of millions of dollars to $1.75 billion and further tripled by 2008. However, the shock of the 2008 recession toppled even sure-shot businesses, and sustainable companies were not immune. Additionally, the fierce competition from the solar energy industry in China and reduction in prices of fossil fuels sent companies back into the safe shelter of petrol, diesel, and natural gas for all their energy needs.

The point we stand at in the present is once again history in the making. Our reliance on fossil fuel and other energy-intensive industries is under close scrutiny right now. Our over-reliance on these industries and even their tactics to undermine renewable resources has caused a huge fallout as far as the future of the planet is concerned. As a consequence, most countries have pledged to reduce their dependence on fossil fuels, petrol-guzzling industries and make an honest attempt towards sustainable initiatives, which was evident by the pledges made leading up to and at the Glasgow Climate Summit last year. What does this mean? Either gradually or even unceremoniously, countries will scramble towards sustainable ventures in an instant if new legislatures are enforced.

Sustainable VC, while a fairly new form of investment, looks not only for profit but also for impact on the environment and society, taking into account myriad factors

Investors are savvy; they’re starting to change their tune in the intro itself rather than at the crescendo. Sustainable VC, while a fairly new form of investment, looks not only for profit but also for impact on the environment and society, taking into account myriad factors such as ethics, governance, gender dynamics, philanthropy, and a commitment to the restoration and improvement of the planet.

What do you observe if you look at the rise in movements these days? First, a few trends that are capturing the attention of people and going from fads to habits are thrifted goods, such as pre-loved clothing (which was earlier derided as ‘second-hand clothes’), DIY furniture and decor, a rejection of fast fashion, minimalism, veganism, supporting small businesses, curbing your carbon footprint among other trends. The second, these ideas are the bastions of millennials and Gen Zs, which are the generation that comprise the customers, users, moneymakers of the present, and the inheritors of the planet in the future.

The bottom line is, sustainable VCs are a way of moving forward. This space may not be bursting on its own in the technical sense, but rather like more conscious movements, there is deliberate crafting and push to make them happen. Thus, unlike need-based movements like the industrial revolution, where ethics or balance were sidestepped for technology and progress to gain footing, these movements will see a conscious evolution where at every step, the question to be answered will be, “But how does this decision impact the environment and society?”

We can be excited and heartened for a world where instead of lip-service to good causes or philanthropy for positive press and tax breaks, the business model will ask itself the hard questions before taking the next step. If money is what makes the world go round, then this handshake agreement between profit and sustainability could just be the paradigm shift the world desperately needs.

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