Earlier this week, I posted the first part of this column, in which we’re looking at what 2021 might have in store for us. Now here’s the second of my personal predictions for the year ahead, specifically for private markets in sustainability in North America. Remember, this isn’t investment advice, but just a sharing of ideas heading into the new year. And I think 2021 could be a big one for our industry:
8) In 2021, what happens on Wall Street could impact private markets more than usual
Normally, venture capital and private equity are fairly insulated from the short-term vagaries of the stock market. The monthly ups and downs of the S&P 500 do affect the windows of opportunity for venture-backed companies to IPO or to be acquired, but otherwise in normal times private markets and public equities are generally correlated only by the fact that they both are driven by the overall state of the economy — not that one directly drives the other.
And yet for the past year, at least for some observers the stock market seems to be defying gravity, with the price-to-sales ratio near all-time highs, for example. This, in the midst of an economy that has clearly been disrupted by a global pandemic. Can it keep going up? Some investors seem to think so, arguing that negative real yields in assets like government bonds could continue to drive capital into stocks and other alternative assets.
But what happens to sustainability private markets if there’s any major “correction” to the stock market in 2021? The industry has two major points of vulnerability right now to such circumstances. First, many of the recent on-paper returns for sustainability investors are tied up in SPACs that have generally performed well, but their lock-up periods aren’t yet over. Second, when institutional investors’ public equities holdings drop significantly in value, it wrecks their portfolio allocation models. In 2020’s short-term market drop, some large institutional investors found that practically overnight, they were “overweight” on their target allocations to private markets. Which meant they needed to stop talking to potential new managers. With so many relatively new “GPs” (new VC / private equity firms) getting set up in sustainability, and currently fundraising from such institutional investors, any disruption like that in 2021 could hurt as well. Especially if it’s longer-lasting than 2020’s. I gave up predicting the stock market a long time ago, but it’s a scenario to watch out for, considering how much the stock market is out of its normal bounds right now.
9) The recent uptick in early stage sustainability investing could accelerate further
After a half a decade of being in the doldrums, early stage investments in the sustainability sector have been heating up over the past three years. Will this continue?
First of all, it’s frustrating that there are so few useful clean energy, sustainability or climate-focused VC/PE deal trackers anymore. I’m old enough to remember how a few years ago The Cleantech Group was putting out public deal trackers (they stopped in 2016, apparently), while mainstream VC trackers like PWC’s Moneytree, CB Insights, and the NVCA all had some kind of a call-out or categorization to try to capture this trend. Understandably, when the sector went somewhat into hibernation, these mainstream deal trackers dropped these special efforts. But take a look at the most recent Moneytree report — they mention 20 “emerging areas”, none of which are climatetech or clean energy or anything even close. Searching through the recent Pitchbook “2021 US Venture Capital Outlook”, I found zero mentions at all of “sustainability”, “energy” or “climate”. I know they’re tracking all the early stage deals in our market, it’s just a categorization problem. But they’re all failing to shine a light on our sector’s evident momentum. It’s past time for PWC, CB Insights and Pitchbook to start regularly paying attention to this sector again. And I do miss the Cleantech Group’s old quarterly public reports. In the meantime, we can only look to BNEF and their strange y-axis choices.
It’s a shame, because the strong trend upward in early stage investing in our sector seems bound to continue. I personally know that a lot of new venture capital GPs focused on climate and/or sustainability are being launched. Major generalist venture groups like USV are launching climate funds. The pension fund et al backers of the venture capital industry (the limited partners, or “LPs”) are all asking for more exposure to ESG. If the economic recovery continues, the capital should be flowing into these funds, and those funds will then start putting that capital to work.
This greater availability of early stage capital should encourage more entrepreneurs to jump into the sector as well, which is great. One thing to watch out for, however, is quantity versus quality. In times in the past when there were upticks in early stage clean energy investing, the newly-minted “cleantech” entrepreneurs and investors tended to gravitate into a few quickly-saturated sectors (so very many software-for-commercial-buildings plays, for instance…). We can hope that this time around, there will be broader approaches to getting into the other sectors of sustainability beyond clean energy and EVs; to tackling different business models; and to better leveraging alternative sources of capital beyond just venture capital.
10) The intersection between sustainability investing and environmental justice should get more real
As many readers will be all too familiar with, black and Hispanic communities in the United States suffer disproportionately from air pollution, lack of access to safe drinking water, and the looming impacts of climate change. Encouragingly, in speaking with members of the philanthropic community I’m hearing a renewed focus on addressing these issues as part of their environmental and social justice agendas.
However, it must be acknowledged that right now, a lot of the clean energy solutions being offered would only indirectly benefit these disadvantaged communities. Big solar and wind farms built in rural areas do offer some indirect climate change and air pollution mitigation, for instance, but don’t create a lot of clean energy jobs or pollution reduction right in the most impacted communities. In fact, there’s evidence that many of the benefits of current clean energy incentive programs are going into the communities that need them the least.
That said, there are some inspiring for-profit and not-for-profit efforts to drive more rooftop solar and energy efficiency in these communities, as a starting point. I expect that in 2021, impact investors, philanthropic groups and policy-makers will all start to more explicitly target sustainability entrepreneurship and project development in such communities. Project development accelerators, not just startup accelerators. Development-phase capital for community project efforts. More incentives and support for capital to go into sustainable, distributed infrastructure specifically in these communities. These kinds of efforts would have direct jobs benefits, would add to economic development and local wealth creation, and of course would help address racial disparities on environmental issues. And if these funders and policymakers can make sure to target opportunities beyond just rooftop solar and energy efficiency (for instance to enable more EV adoption in these communities, and distributed clean water systems), we could start to see cleaner air and water, and more resilient essential infrastructure, for these communities. It would be a start, at least.
11) In 2021, it will become even clearer that sustainability isn’t just a venture capital and large infrastructure game anymore
If you track by ink spilled in the mainstream financial press, venture capital remains the most important asset category in the world. And if you track by dollars invested, utility-scale solar and wind project finance remains the majority of the investment universe.
But in speaking with big institutional investors, they are clearly looking for more than those two choices. I see a lot of activity in the “real assets” space, specifically around sustainability and climate resiliency. This covers a lot of area, from farmland to forestry to distributed infrastructure. But it’s a broad category that seems to be gaining a lot of LP interest right now as they look to shift more assets into sustainability.
And that’s important for entrepreneurs and their venture backers to take note of as well. Gone are the days when the only way to finance the growth of a startup or even a project development firm was venture capital. Now, for the inevitable “hard assets” side of sustainability businesses, there are a wider range of capital models available (such as my own firm’s “catalytic project capital” model), which can go in alongside venture capital and increase the odds of success for all involved. Beyond the large number of new VC efforts I’m seeing, as noted above, I’m also seeing more activity around entirely new capital models. 2021 should hopefully see a strong continuation of the emergence of a robust capital ecosystem around sustainability.
12) FERC may take center stage
There’s a lot of talk right now about how Federal legislative efforts around climate change and clean energy may fare under the new Democrat-controlled Administration and Congress.
But in the meantime, what happens at the mostly-independent Federal Energy Regulatory Commission may have even more impact. If so, it will be through pretty arcane rulings and policy changes and thus won’t get written about very broadly.
But FERC Rule 2222, for example, could dramatically impact the ability of project developers to maximize the economic benefits of distributed solar and storage. And orders around arcane frameworks like “minimum offer price rules” are also going to have significant impacts on specific regional markets.
For some time now, US states and regions have been the true innovators around clean energy policies. That’s great, but also means we have seen an already fragmented regulatory environment get even more disparate. FERC’s role in 2021 could be to encourage the laggards to catch up, or they could get in the way of further progress among the leading regions. Or, FERC could play a mix of both roles. But while we wait for more effective Federal legislation around clean energy and climate, the role of FERC in determining the pace of progress at the state and regional level shouldn’t be discounted.
13) We will likely see a lot more talk about additional transmission capacity. Will there be any actual progress?
On paper it makes a lot of sense. In both the US and Canada we have tremendous renewables resources that have a hard time getting to where the consumers actually are, because of a lack of transmission capacity. So, just build more transmission capacity, right?
As an old man given to yelling at clouds, I’m skeptical that any of this can happen in a timely fashion. It’s just really hard to get the rights of way and other permissions to do any new transmission lines across states and regions. For example, the “Clean Energy Corridor” effort here in the Northeast has taken years of negotiations and is still facing significant obstacles. We’ll probably see more efforts to build out significant new transmission capacity in the U.S., but more talk than action in 2021. I’d be happy to be proven wrong on this.
14) Wait, there’s a fourteenth?
The title of this column is “Thirteen Predictions” but after the year we just had, I don’t want to tempt fate by leaving the list at that number. The triskaidekaphobia struggle is real. So here’s a total amateur-hour observation that has nothing to do with sustainability, but that has me wondering…
In 2020, Americans bought and adopted dogs like never before. In 2021, these same families are all going to want to go on long vacations as soon as they’ve gotten vaccinated.
Are any entrepreneurs and private equity investors making big moves in the pet kennel / pet hotel industry? Just something I’m curious about.
Here’s to a great 2021, everyone. As these “predictions” (really, just musings) show, I’m personally expecting it to be a big year for sustainability and private markets. But even if it’s just a calmer year than last year’s, let’s consider that a big win.
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