Accelerating Planetary Health.
How policy design can impact the 7 Year Cliff that scares away bigger venture participation in sustainable technologies.
Here’s the question we want to tackle today: How can we speed up the scientific development and commercialization of sustainable technologies to restore the planet’s health?
It’s a big thorny question.
We start by illustrating the pathway of science projects as they translate into commercial adoption, along with its common funding mechanisms.
The illustration is useful because it helps clarify the essential challenge.
The next great planetary health technologies are out there on the left. How do we get them to more rapidly make their way to the right?
Imagine you’re a policy analyst, or a politician, or a systems designer. You’re the guiding hand on the economy. The carrot and the stick are in that hand. You want to make sure we solve climate change, but you also don’t want to destroy the economy and cause massive social unrest. You’ve got a big fat financial incentive you can use to impact that flow. But where do you put it? Into basic research on the left? Into subsidies over on the right? Into tax breaks somewhere in the middle?
And you’ve got a little power to regulate. Very little. We’re being realistic. (Regulate too hard, and entrenched industries fight back.) So, what can you do, lightly, as a regulator, that actually would make a major difference in the left-to-right flow?
Before we share our thinking, let’s just dismiss a common misperception.
The misperception is that all those science projects on the left are already moving at warp speed towards commercialization.
At IndieBio, we’ve certainly moved along more than a few of these technologies. If you read science news, you hear of so many companies doing more amazing things than ever before. But that creates an illusion.
You might think venture firms are throwing money at all the exciting science, and sometimes that is the case. But usually they wait.
There are an amazing number of radical biotech inventions that simply don’t get invested in by traditional venture funds, because the science is considered too risky, or too early, to make a several million dollar bet on. Usually the scientist has received a couple grants at their university to get their work to a certain point, but it’s still a long journey to commercialization. Being at that stage makes investors nervous.
There’s nothing wrong with the investors; it’s not that they don’t see the vision. It’s that the terms of their funds — the promises they made when they created the fund originally — has them looking for faster returns. Long journeys, especially journeys that run any risk of taking more than 7 years to exit — are outside the scope of the funds.
Everyone’s familiar with venture capital’s “J curve” and the “Valley of Death.” After startups get their initial funding, it’s years before the cash-flow is positive, and many startups die in that span. But the J-curve describes only the process once a startup gets funded. It doesn’t describe what happens prior to that: how science projects migrate from academic research to startup form — what’s called the “translation” jump. And in that translation jump phase, there’s an equivalent to the Valley of Death.
You could call it the “Vortex of Despair.”
Many would-be startups are caught in this Vortex of Despair. They could accelerate development dramatically if they had more money to spend, but they can’t raise the money because, operating only on a couple grants, they haven’t shown quite enough progress to persuade investors they can confidently succeed in less than 7 years.
As we’ll show in this article, there’s something of a cliff at the 7-year time horizon. It’s arbitrary. It’s been encoded by historical convention. And it’s self-perpetuating, because 7 years has become the industry standard.
That’s why at IndieBio, we believe the number one factor — the number one thing we want to change — is the time horizon on investments.
Our investment markets are incredibly good at efficiently bringing opportunities into reality when that takes 7 years or less. And we’re really poor at bringing along opportunities that are 10 or more years away.
If we can make our investment capital system just as good at realizing 15-year horizons as it’s been at 7-years and under, we believe this would vastly accelerate all of biotech — and do it efficiently, with more imagination than any state-directed or internationally-coordinated effort.
That’s a bold statement to put out there.
In choosing this as the most important change, we’re rejecting a lot of other popular conversations and proposals.
For instance, we’re rejecting the quite popular idea of a Carbon Dividend.
That proposal is a carbon tax, implemented either at the moment carbon is extracted or imported into the country — where 100% of the proceeds are distributed equally to every family in the country. It’s supported by both a Republican coalition, in concert with ExxonMobil and Royal Dutch Shell — at $40 per ton of carbon dioxide — and by many socialists, at a more aggressive price per ton. This could give every family in the country an annual payout of anywhere from $2,000 to $10,000.
It’s a very tempting idea, and it’s not easy to spot at first what’s wrong with it. Our concern is that it would too closely follow the Alaska Permanent Fund, on which it’s modeled. Every citizen of Alaska gets an annual dispensation from the rights to Prudhoe Bay drilling. Under a Carbon Dividend, there’s a perverse incentive: families would get accustomed to the check, and the only way the check keeps coming is if the fossil fuel burning continues. Alaskans have never been able to turn their Permanent Fund off, or their oil wells.
The US expanded its carbon sequestration 45Q tax credit last year; we now give a $50-per-ton credit for sequestering carbon dioxide, and a $35 per ton credit for capturing carbon dioxide. But it’s led to some bizarre consequences. The best example of this is the Petra Nova facility near Houston, Texas, which is part of the 3.65 gigawatt WA Parish power plant. The WA Parish plant is the second-biggest power plant in the US, and Petra Nova is the single biggest carbon capture system in the world today. With the carbon dioxide they capture from burning coal in the WA Parish boiler, Petra Nova sends it back underground to gas fields 82 miles away, earning tax credits. Which sounds great — except that, they use the underground carbon dioxide much like fracking an oil well with water. The carbon dioxide pressures oil to come out of the earth faster. How much more oil? 50 times more. Before Petra Nova was built, the West Ranch Oil Field was producing 300 barrels of oil a day. Now it produces 15,000. So our carbon credit is generating more oil extraction, not less. The very opposite behavior we want. Oh, and the US gave Petra Nova a $190 million grant to do this.
Meanwhile, under the 45Q carbon credit, if you don’t use carbon at all, or if you use less carbon in the first place, you don’t get any tax benefit.
We’re also rejecting (outright) the popular debate over whether capitalism can solve human and planetary health at all.
The argument is often made that capitalism’s goal of maximum profits can’t lead to affordable, widely distributed solutions. Meanwhile, others argue that state-run political economies like China, where power is in very few hands, have the upper hand, because they can force businesses to comply with national objectives.
We reject these discussions outright simply because climate change is a global problem, and it has to be solved by a mixed-bag of political economies around the world. It has to work across socialist democracies, oligarchies, absolute monarchies, capitalist republics, and state-run market economies. In every country, there’s a patchwork of both intelligent subsidies and crony handouts. (The U.S. subsidizes fossil fuels by $52 billion annually, even as it offers a tax credit at $50 per ton for carbon dioxide sequestration.) Those are the side effects of empowering a guiding hand — but we do need all those guiding hands.
So while it’s true that we need global agreements, and statutory legislation and legal enforcement, and subsidy programs — all of which shape private capital activity — we need to look at the capital market mechanisms themselves.
Only a microscopic slice of investment capital has a time horizon over a decade. While venture and private equity investors respect long-term vision, all of the money put to work is bound to its fund period, when it has to be liquidated/divested. Average exit times are steadily going up (and now average 7 years), so we’re going in the right direction, gradually. Very gradually.
How might we vastly increase the private capital invested for the 10 to 20 year horizon?
Let’s quantify this.
At first glance, it appears like a lot of money is fueling the jump. There’s $80 billion annually in research (just in the US), then a billion in SBIR grants, and then about $6 billion in US venture capital ($13 billion globally) invested annually in the seed and pre-seed stages, looking for the next great company.
But is that, actually, a lot of money?
Only one-eighth of the venture money goes to biotech. So it’s really only about $750 million put into seed and pre-seed biotech.
Let’s zoom out and compare it to other investment markets and how much money is at work there. Here’s what that looks like, scaled.
So, it’s enormously exciting that there’s such a great ecosystem of angel investors and seed funds, and all this sincere new interest in patient capital and deep tech and moonshots. But to put it in full perspective, the amount of money working out there on the far left isn’t even 1%. It isn’t even a tenth of 1%. It’s less than a twentieth of 1%.
So imagine you cashed in a $20 bill for rolls of pennies. You stack those pennies up, into a single 13-foot tall stack. That represents the investable capital in the world today. Only the final penny, in that entire 13-foot stack, is at work in the 10-year investment range.
Does that seem like enough?
To succeed at this, the formula for success is simple. Talent + Capital. The talent is there. But only 1/2000th of the capital is there.
Meanwhile, money is flowing rapidly into private equity, so much so that private equity can’t find adequate places with 3-to-5 year time horizons to invest it. There’s a trillion dollars of uninvested private equity money. Dry powder. It can be sunk into private companies, real estate, stock markets, late-stage venture — and maybe a little into growth-stage venture. It just can’t be invested past 5 years. So much money, with nothing attractive to spend it on.
Venture funds have another $90 billion in dry powder, too.
You might think it’s really about the math: that money will go wherever it can get the best return, and thus, if there’s not a lot of money working beyond 7 year horizons, it must be the case that the returns have been poor.
But there’s no evidence of that. Seed and pre-seed returns have been fine, and just as good over the long-term as growth and late-stage investing. Our SOSV funds, as well as the IndieBio portfolio, are an example of that. Also, if you look inside the private equity numbers, there’s great data, compiled by University of Chicago Professor Steven Kaplan, which shows that private equity, over the long term time frame (10 years and 15 years), pays off.
Then why is investment capital so timid about being illiquid for ten+ years? I think it’s not about the returns.
Rather, it’s psychological. Venture and private equity were burned by the first green tech explosion. In 2008, legendary investor John Doerr of Kleiner Perkins raised a $500 million Green Growth Fund. But then the 2008 financial collapse stifled follow-on investment. China began to undercut the solar market. In 2011, Solyndra went bankrupt, and was unable to pay back its $535 million federal loan. Natural gas fracking technology took off, making energy cheaper. Investments into geothermal, synthetic biofuels, synthetic gas, and smart grids all now couldn’t compete with the new cheap economics.
This hard lesson really lingers, across the whole global market. The 2008 financial crisis was a harsh reminder to all investors of holding illiquid positions when you want nothing more than to get your money out of the market. And the way energy prices can fluctuate so dramatically — the volatility that creates — means investors don’t want to be trapped on the wrong side of a price swing.
So, considering this history and our planet’s future at the same time, how can we incentivize capital to look for opportunity out beyond ten years?
In the Tax and Jobs Act of 2017, South Carolina senator Jim Scott included a provision for new “opportunity zones.” He’d been turned on to the idea by Sean Parker of Founders Fund/Facebook/Spotify. Parker dreamed up the idea because he knew there was $6 trillion in unharvested capital gains in the market, and he wanted to incentivize wealthy investors to reinvest those gains into underserved communities that were being left behind.
In April of 2018, states designed thousands of low-income census tracts as “opportunity zones” under federal law. They created 8,762 zones, each one a tax haven — an American version of Curacao or the Cayman Islands. Investors could take recent capital gains and reinvest them in real estate and businesses located in the opportunity zones, avoiding both the tax on the capital gains from the prior investment, and, if they leave their money in the opportunity zone for 10 years, never pay any capital gains when they exit.
“If Facebook could have chosen to locate itself in an Opportunity Zone, like the Tenderloin in San Francisco, the investors would’ve paid no capital gains on their equity,” Parker told Forbes magazine.
This will certainly lure billions of investment into the census tracts in the next couple of years.
We think this is the model for encouraging investment into long-term climate-impacting technologies. It’s elegant, simple, and not very controversial. It’s not much of a leap from opportunity zones for impoverished neighborhoods to similar zones for green tech, defined not by neighborhood or zip code, but by impact. Planetary health investments which pursue the United Nations Sustainable Development Goals, held for ten years or more, should be rewarded with no capital gains tax.
We believe this tax incentive would attract a significant amount of money to get active in the ten year+ time frame. Dry powder would get to work. A lot of those technologies that are currently caught in the Vortex of Despair would suddenly find themselves in the time horizon sweet spot for funds — and almost overnight, they’d be well-networked, plugged into plenty of capital to accelerate their solution.
But it’s far more than that which would be unlocked.
Longer-term thinking allows us all to reimagine entire systems, rather than just make products that drop-in to our current systems. It unlocks our imagination.
In the same way that Amazon, Tesla, and WeWork imagined whole new futures built on new infrastructure, beyond ten years we can imagine new food production & distribution systems, new healthcare systems, and new electricity storage and transmission systems.
We can create systems that automate emissions and pollution accounting, and then make that data transparent to all. We can create financial markets for pollution offsets and other externalities, to fund the implementation of environmental solutions. Since 90% of the ocean plastic comes from just 10 rivers, we can imagine both monitoring and cleanup solutions that work before the plastic ever gets to the ocean. We can imagine pulling methane out of the atmosphere, the way we’ve started to do with carbon dioxide. We can engineer bivalves to grow thicker shells, so as they purify seawater, they store more carbon. When renewable power makes biofuels unnecessary, we’ll imagine what to do with the tens of millions of acres of land where we’re currently growing corn and soybeans for biofuels. We can imagine the US having curbside recycling and composting in 90% of our cities, rather than 34%.