Where to Find the ‘Missing Middle’ of Capital for Sustainable Innovations12 July, 2018 / Articles
I had heard of “Too Big To Fail”. But “Too Big To Succeed” was a new one for me.
It was early in my investing career, and I was talking with a senior investor at a large sovereign wealth fund, the largest type of investors in the world. These and other large players have tens – if not hundreds – of billions of dollars to invest. And they are seen by many as a crucial part of the ultimate answer to the question: “Who will invest the trillions of dollars into sustainable technologies and infrastructure that are needed.”
After all, from my vantage point as a direct investor into these types of solutions, I see a wide and deep pool of breakthrough ideas waiting for the necessary capital to become a reality, and also a lot of investible solutions that are already “ready for prime time,” with great economics, just waiting for investors to help roll them out en masse.
From my perspective it seemed that for large institutional investors like this sovereign wealth fund manager, there would be endless investment opportunities. So I was surprised to hear he didn’t see things the same way, that in fact he saw his available investment options as being quite limited.
It wasn’t that he doubted the effectiveness of sustainability solutions in sectors like clean energy, water, food, and waste-recycling. And it wasn’t that he doubted the market opportunity overall.
The surprising problem? Their minimum size of investment.
When you are responsible for investing billions of dollars per year, you need opportunities to put significant amounts at work into each transaction. “If I even bring a fifty million dollar investment idea to my investment committee,” he told me, “they ask me why I’m bothering them with it.”
The current reality is that many sustainable investment opportunities available today, on an individual basis, require smaller checks than that. These are typically venture capital opportunities, either small companies or small specialist funds writing small checks. They just can’t absorb greater levels of capital without significantly changing their models and adding more risk.
The absence of sustainable investment opportunities in the private capital markets that are big enough and mature enough to attract institutional investors is what’s being called “The Missing Middle” of impact. There are small check-writers to help commercialize a technology, and small institutional investors to help fund specialist venture firms in the sector. But we know the massive check-writers we eventually want to see investing into these solutions still have challenges taking the “hand-off” from those smaller efforts.
We can see how eager these large check-writers are for answers. Large-format infrastructure, like big wind farms and solar farms are so sought-after by big sources of capital that they are throwing even “cheaper” capital at such projects right now than for traditional infrastructure investments (ie: they’ll accept lower returns), simply because they want access to some kind of investment related to long-term sustainability that fits their check size.
But if the last ten years in the impacting investing sector have shown us anything, it’s how wide a gulf there is between many recently-commercialized sustainability techs at these early stages of market acceptance, and what big infrastructure investors need to see before unlocking truly significant amounts of capital behind these solutions. It’s rare if not impossible to see a solution jump from early commercialization straight to billions of dollars of deployment.
Fortunately this is starting to change, and as I’ve written about previously, rooftop solar provides a recipe for success to follow. Solar technology took several decades to start to become cost-effective. And then even when it did, it also faced this Missing Middle problem. Eventually, a few intrepid investors stepped in and provided capital and, crucially, new scalable investment structures to back the deployment of solar on rooftops and in small-scale power projects. My team was among those who provided such capital and helped design such structures.
And what we all saw was really encouraging. Not only did such smaller-scale projects provide attractive investment returns for those willing to step in and pioneer these structures – these early-movers also found that their efforts and success did attract the attention of very large investors, who then felt comfortable borrowing those same investment structures to invest significantly more dollars into the opportunity.
Today rooftop solar is now a big category. According to Bloomberg New Energy Finance, it’s around $40-50 billion per year in new investments into distributed small-scale solar.
Distributed solar has thus seen the “Missing Middle” challenge solved. But to get to that point, we needed investors who helped established models that worked. Who stepped in and pioneered the category. Who, well, made it pleasantly boring – I don’t mean “boring” returns, I mean “boring” in the sense that large institutional investors writing big checks don’t have to worry about any exciting (ie: risky) developments surprising them along the way.
Across the entirety of the sustainability landscape right now there are dozens of “solar stories” just waiting to be unlocked, in clean water, in sustainable food production, in waste re-use. The “Missing Middle” is holding those stories back.
More such pioneering entrepreneurs and investors are needed. Because my friend at the sovereign wealth fund, and his peers, would love to be able to figure this this next wave of sustainability innovations, too.