This article features as part of IFA Magazine’s celebration of World Earth Day.
The hard truth about net zero and global warming is that we will not be able to achieve our environmental goals without the emergence of new technologies that are currently not available at scale, says SFC Capital’s CIO, Joseph Zipfel.
A high level of innovation will be needed to increase the use of low carbon energy, see the emergence of cleaner industries, and develop sustainable forms of agriculture and transportation.
This is even more true if you include other environmental objectives such as tackling air pollution and biodiversity loss as well as developing less harmful modes of consumption.
Set up almost 30 years ago, the Enterprise Investment Scheme (EIS) was designed with the goal to encourage investment into small innovative companies and has been a key driver to the UK’s leading position as a tech hub in Europe. EIS has been behind the success of major British ecommerce, fintech and software companies. Now the time has come to focus on today’s and tomorrow’s challenges, and to enable the technology-sustainability revolution as it scales to all sectors of the global economy.
In the next decade, EIS will therefore be an essential tool to support the emergence of these green innovations. Having made 50 “green” investments from our SEIS and EIS funds, at SFC Capital we believe that there are 5 main reasons why EIS is well suited to bring about the Green technological revolution:
1. EIS investors have a high-risk tolerance
By definition, a lot of these new technologies are in their infancy and still require Research and Development to be fully commercially ready. These ground-breaking innovations require risk capital that can be invested at an early stage of development.
This risk capital is exactly the purpose of the EIS scheme. EIS funds and EIS angel investors have a specific risk profile, are less afraid of failure, and can invest at an earlier stage than most other investors. It is very common to see EIS investors co-invest alongside innovation grants at an R&D stage and lead the funding rounds of university spin outs or other types of ground-breaking ventures.
Outside of the biotech industry, the venture capital industry in the UK and Europe has generally been too risk averse and failed to provide the funding needed to develop these new ventures. EIS investors have the flexibility to take more risk and to invest at a stage where the commercialisation of the technology has not been achieved yet but the quality of the research, science and intellectual property behind a company is clear.
2. EIS is patient capital
A corollary to this high risk tolerance is the patient nature of EIS investors. Although EIS investors expect to achieve a successful exit on their investments, there is no formal pressure to generate returns within a fixed time frame, unlike venture capital funds who typically have specific time commitments to return capital to their Limited Partners.
This translates into a different style of investing where investee companies are not pushed to deliver short term results, rush to bring a product to market or overly focus on their exit, which can all be detrimental to the long-term success of a young innovative company. This is particularly helpful in the case of Deep Tech and Green Tech which typically have much longer product development and commercial cycles.
3. Green Tech is mostly Hard Tech
Green Tech tends to be Deep Tech and Hardware Tech, as opposed to digital. These new technologies involve complex engineering, science and physical production processes. They are often hardware companies instead of software. Bringing to market a new battery technology or a new type of industrial material typically takes more time, research and capital than a typical digital tech product.
Traditional venture capital funds tend to be therefore focused on a narrower range of sectors and to favour purely digital software companies with the ability to quickly generate recurring and predictable revenues.
This does not match the profile of companies developing these breakthroughs innovations.
EIS funds and EIS private investors are not bound by these constraints and have the flexibility to diversify their portfolio beyond digital technology and to support companies that are not eligible for other types of venture capital due to the nature of their business model.
4. EIS are disintermediated private investments
The beauty of EIS is its relative disintermediation. It allows private investors to invest their capital, directly or through funds, into young innovative companies that address major challenges. EIS is a great vehicle for investors to put money where their mouth is and invest into companies or funds that address issues that they care about, such as climate change, all the while offering significant return potential.
Using EIS, private investors can put their capital to work quickly, which is essential to address the urgency of the environmental crisis ahead of us. This contrasts with government initiatives or corporate projects that can take years to be designed and even longer to be deployed on the ground, and which are often disrupted by political and conflicting interests.
5. Green EIS investments offer unprecedented return potential
Finally, the returns generated by successful green EIS investments might outsize anything that we have seen so far. Larry Fink, CEO of Blackrock, one of the largest asset managers in the world, famously said that “the next 1,000 billion-dollar start-ups will be in climate tech”.
The return potential of an investment in a company is a function of the size of the market and opportunity that it is addressing. Some of the challenges addressed by Green Tech companies related to decarbonisation, clean energy, water, etc. are almost unquantifiable in value as they are so critical and global in nature. It is easy to imagine that the companies that will solve the world’s most pressing problems will achieve valuations in line with this achievement.
The convergence of great research and science and entrepreneurial talent is starting to accelerate and there is little doubt in our view that some major players are going to emerge in the UK. Not every green business will make it of course, but those that do will provide great returns to EIS investors who made portfolio investments across various innovations directly or through specialised funds.
With nearly £2bn per year invested in young innovative companies, EIS has a key role to play in the technology-sustainability revolution. We need a greater share of this money to be directed to Green Tech businesses addressing these existential challenges, not only because it is morally right but also because of the benefits and financial returns that it can provide.
But of course, EIS itself is a drop in the ocean and won’t be enough to bring these new technologies to market. EIS needs to be complemented by well-funded public initiatives such as the Innovate UK grant programmes, specialised VC funds and corporate players willing to put money where their mouth is and engage actively with these new innovations.
Joseph Zipfel, Chief Investment Officer, SFC Capital