The New Climate Capital Stack: Regional Funds
"It's just a banana, Michael. How much can it be, $10?"
Many months ago we wrote a piece called The Green ETF; It remains one of our most-read posts, and in some ways one of the best. We continue to think that the primary rate-limiter on the growth and efficacy for climate tech is the capital stack. We’re stuck using the Silicon Valley software growth playbook for bits + atoms businesses with disparate growth characteristics. This was never going to work, and needs to be fixed. We were just initially wrong on the methodology. Let’s discuss.
Where we went wrong
Our first piece outlines the thesis of vertical-specific, operator / investor micro PE funds. For example, get a lot of expert operators from various solar businesses together, have each of them put in $500k, then invest in the future leaders of their industry.
Useful? Yes. Effective? Not really.
It’s trite, but still true, to say that incentives create behavior.
Current operators have a complex or contradictory set of incentives when investing in their future competitors, and not enough of an incentive to ignore the money and do it anyways. Generally, major investment decisions require either (1) proven and massive upside, which is not yet true in climate tech, or (2) a visceral and personal reason to do it anyways.
Our first capital stack structure didn’t nail either of these needs. So.
There’s always money in the banana stand
We rarely say this, but turn on the news. Maui, Canada, and much of the PNW is burning. LA got hit with a hurricane. Heat domes crumple pavement in Europe, rising oceans pull buildings into the water in Miami, coral reefs are bleaching all over the tropics. No, you are not reading The Uninhabitable Earth Part 2, Electric Boogaloo. Our point is this; Climate is geographically specific, deeply personal, and has a unique way of targeting the natural phenomena and industries that made regions famous in the first place.
Our last several pieces have focused on building up a climate tech ecosystem in Montreal, and making that city the center of our industry worldwide. We stand by that thesis, and are exploring raising a fund to do it ourselves, but that’s a story for another day.
In researching the climate tech city series, we kept coming back to a version of the points above. “There’s a lot of timber fortunes in Quebec, why don’t the forestry barons bribe Mast, and then set up the world’s best center for GMO / fire resistant trees, drone firefighting, and satellite-based computer vision to find fire risks? Why don’t the tourism and property tycoons in Miami start funding coral re-seed companies to protect their cash registers snorkeling reefs? Why isn’t there a cluster of next-gen tech companies focused on water scarcity in the Colorado river basin?”
Incentives create behavior, and a lot of the world’s great fortunes are about to experience the profound incentive of having their driver of wealth beat to shit by climate change. Climate tech, which on the investor level involves taking a series of calculated bets in exchange for asymmetric upside potential, seems like a natural place for such wealth to concentrate their time, thinking, and resources. So why aren’t they doing it?
Finding the bananas
Imagine, for a moment, that you oversee the family office & investments of a Quebecois forestry billionaire. Your employer lost thousands of acres due to the 2023 fires, which puts a significant dent in your short-term capital deployment strategy, and will take many years to reforest. You’re legally separate from the actual timber company, but beholden to it because, well, that’s where the money comes from.
You want to deploy $, make it back plus 5% annualized, and shore up the forestry company.
Investing in a drone fire fighting company makes a lot of sense. So why aren’t you doing that?
Picking companies is hard. The folks who run family offices, generalist funds, foundations and the like are generally not trained scientists, and therefore need a translation layer in order to help them perform their fiduciary duty to the client.
Return expectations. Unlike traditional VC, the folks we’re discussing here play for lower-risk, lower-upside return profiles. Early stage climate investing has not yet been proven to be that as an asset class.
Signaling. This is a bit nuanced, but founders are careful of the external signals put out by where they choose to accept capital. Those planning to build unicorns are hesitant to work with investors who historically haven’t been concerned with doing the same.
Lack of unique WIFM. If our investors can’t be guaranteed the S&P-beating, low-risk returns they typically target, they need an added unique value proposition to get their $ into a deal.
Fund of Funds
Here’s what we think needs to exist; A climate fund-of-funds, with the component funds being regional vehicles designed to solve-then-scale problems for that locale. For example, The Montreal Climate Infrastructure Fund.
$25m fund, on a traditional 2&20 structure, and targeting venture-scale 4X7Y return profiles.
Invest / incubate / accelerate companies to solve; Modular hydropower for emergency workers, cheaper HEPA filters for relief from smoke, drone firefighting, and every other company we’ve written about over the past month 🙂
Only accepting LPs who are either from, or operate companies based in Quebec.
LPs have perpetual rights to buy products from any portfolio company at fixed, discounted rates. In exchange, they also commit to making a portion of their land / manufacturing capacity / riverfront / whatever available for the same purpose. They commit to buying, to being available to buy, and to helping in exchange for their diversified portfolio of small bets.
Companies are steered and coached to reach $10m revenue / commercial scale within Quebec only, then to broaden markets and seek further VC investment if needed.
Now, substitute in “The Miami Ocean-Tech Fund,” or the “Iowa Agtech Fund,” and you start to get the idea.
Conclusion
The current climate capital stack serves many masters, mostly poorly.
Companies need impactful capital, engaged investors, and ready-made initial customer bases so that they can demonstrate technical viability and initial scale. Climate businesses have a broad chasm to cross between POC and deployment, and are not getting the opportunity to do so today.
Potential LPs see the future of their core businesses as revolving around climate, and want to positively impact their hometowns. Why pay for another park bench, when they can help bring clean air back to their city? They simply don’t know where to find the best deals, or how to get in if they do.
We at Coral think there’s a better way. So, if you happen to be one of our international readers, sitting within a few miles of Mont Royal, and want to see the climate boomtown in your home…
We should talk.