5 learnings about Sustainable Finance — two deals and one year later
One very long year ago we shared the beginnings of our thesis on Impact, Climate, ESG and Sustainable Finance — an area we believed would transform financial services in the decade ahead. We were wrong. This will not take a decade. Change is happening much faster than we anticipated and we are more bullish now than we have ever been. Here are some of our learnings two deals and one year in.
1. It’s hard to see you are on an exponential curve until you look backwards. This is happening faster than we anticipated.
One of the most frustrating things about enterprise cycles is that change can take a long time. Interests need to be aligned, stakeholders must get bought in and behaviours often have to change. It is for this reason that investors talk about ‘hair on fire’ problems — there must be something so lacking with the status quo to drive change.
One of the concerns we had with Sustainable Finance when we started exploring this segment was that this was a ‘nice to’ and not a ‘need to’ have. Happily, this is not the case. We are clearly past the tipping point and this problem has become a ‘hair on fire’ and ‘must address’ for financial institutions to remain both compliant and competitive. Covid-19, Black Lives Matter and other events of 2020 have only further highlighted this need.
Expect more regulations, shareholder activism, corporate boycotts, climate events, changing client demands, and large revenue opportunities for firms who can successfully position themselves.
2. We underestimated how large the opportunity is
Climate, Carbon, ESG & Impact are rapidly morphing from niche, standalone box-ticking segments, to something that will touch multiple functions and users. When we first began researching this landscape we hypothesised (and feared) that ESG data providers would follow a similar path to the alternative data companies. The development of the market in the last year shows this clearly isn’t the case.
The use cases for impact data and measurement are varied and span the full value chain in a way that alternative data sources never would. We are not simply trying to price financial performance. A company can no longer only operate to maximise shareholder profit alone. That social contract is breaking. They must show they are operating in a net positive way or face regulations and consumer backlash.
Bloomberg, Refinitiv/Thompson Reuters, IHS Markit, FactSet, S&P, Moodys, MSCI… there is a long list of multi-billion-dollar vendors who sell financial data, analytics, risk, reporting and pricing tools to professionals trying to value and manage portfolios of assets.
But what if the absence of granular Impact & ESG data meant that analysts were buying just 50% of what they needed to make decisions?
Whether that number is 5%, 50% or 95% it points to an enormous opportunity for new vendors to become the torch bearers for Impact & ESG and help define the new standards we need to judge how a company is affecting society beyond the earnings it makes.
Carbon and Climate Fintech are part of this larger opportunity. As we learn more about the impact of companies beyond their financials, we have started to price other assets — like carbon and water to name just two. This will, in time, demand a whole host of infrastructure (which doesn’t yet exist) to trade, track, quantify, manage, and price these assets.
3. Existing solutions — mainly scores and ratings — are clearly not able to serve all these use cases leaving a huge white space
The problem with using a single score to judge something as complicated and nuanced as a business’ Impact has been the topic of debate for a while and merits a whole separate post. In brief however, in the same way that you need more information on a company’s financials to judge performance than a ‘B’ rating, the same is true of Impact. A score simply cannot cover all the use cases that are emerging and require detailed, comparable, quantifiable data to allow us to successfully measure outcomes.
While this means the opportunity size is much larger, it also implies that competition will begin to come from some ‘non-ESG’ vendors who begin to add specific ESG modules or data sets to their solutions. In each use case and segment there will be a mix of specialist newcomers, non ESG data incumbents, non-ESG analytics and visualisation providers and use case specific tools all competing for this new budget. The segment is fast moving, and we believe the winners …
4. The winners will be the ones who can successfully build a community around them to help educate the market
For all the recent momentum, this is a nascent market. There are no fixed standards (in spite of multiple attempts) and buyers are still working to define both what they are after and how this will change their existing business processes. Vendors of frontier technologies have a lot of work to do educating their users, the same is true here.
There is not just a data, analytics and infrastructure gap for the financial industry to transition — there is a talent gap. Bringing ‘non-sustainability’ professionals up to speed is something every start-up will have to do as a hygiene factor. Revenues might all be ‘SaaS’ or ‘licence fees’ but the reality is a large amount of this will be services and consulting masquerading as ARR. Financial institutions will be relying on the providers they select to help bring them up the curve. The businesses who do this best will win mindshare, influence direction, help set the standards and become the inevitable go-to.
There are only a select few teams with both the right green credentials and broader financial industry and stakeholder awareness who can do this. We are proud to have backed two already in Yves Blue and Net Purpose and are excited by the number of talented, driven, and ambitious people who are being attracted by this opportunity.
5. There is a real risk that this becomes over-hyped; start-ups should choose their investors carefully
Given the size of this opportunity we think there is a real risk that the ‘hype-cycle’ goes into overdrive in the near term. In the mid 2000s there was a similar wave, and again we saw this with renewable energy and solar ‘clean-tech’. Although as a fund we strongly believe we are both past the tipping point and that this opportunity is enormous… change will still take time.
Investors need to be patient, as do founders, as they think about funding cycles and the time it will take to build their businesses. If we had to place where ‘Climate tech 2020’ was on the Gartner cycle it would be somewhere between the initial wave innovation trigger and close to the ‘peak of inflated expectations’. Yes — this will fundamentally change the way we assess companies but that will not happen overnight.
The exit route for most of the businesses playing in the ESG, Impact and Carbon measurement space will likely be a trade sale to the S&P, Moody’s or MSCI’s of the world… all of whom have a track record of buying climate solutions. These acquisitions however are usually in the tens or hundreds of millions, not multi-billions. These are fantastic outcomes for founders and early investors, but less for later stage investors if their mandates are not aligned. For this reason, we think that start-ups need to think very carefully about who they have on their cap table.
These are only some of the high level observations on what we are seeing play out in the Sustainable Finance arena. If you’re active in this space either building a company, investing or adopting these solutions in your business then please get in touch!
