Can VCs mix profit and sustainability?

European venture capitalists are beginning to see sustainability as something in which they want to invest. A survey of 23 institutions shows that €1.25 billion of funds raised in 2006 were nominated Venture Capital for Sustainability, or VC4S. This is equivalent to 6 per cent of the total venture capital market.

“While these figures are modest, what is notable is that five years ago the VC4S market was almost non-existent,” says the study, ‘Venture Capital for Sustainability,’ carried out by the Paris-based European Social Investment Forum (Eurosif).

The VC4S sector is focussing mainly on renewable energy and clean tech, but also includes funds that aim to bridge economic divides, or to invest in companies that use sustainable management processes.

In many senses sustainability and venture capital are already tied to each other, since both are dependent on innovation. In this first attempt to survey the market ESIF defined three categories of VC4S:

1. Investing in companies whose products will change the nature of an industry by making its products more sustainable, as in cleantech;
   
   
2. Investments in companies in depressed areas, or which provide access to products not previously available in an area, such as medicines in the developing world;
   
   
3. Investments in companies with sustainable management practices.

In the survey 54 per cent of investors were interested in sustainable products and 42 per cent in targeted economic impact.

Matt Christensen, Eurosif’s executive director, said venture capital and sustainability are increasingly linked together as, “investors see that financial returns can also coincide with societal benefits”.

Eurosif’s research shows that the size of VC4S investments ranges from €1 Million to €5 million, and focus on the earlier stages of company development. But at the same time, VC4S funds still look for traditional-size returns of 20 to 25 per cent on sustainable investments.

Only two of the funds surveyed began investing in the sector pre 1997. There has been a steady stream of funds launched since then, with a boom in 2006. In the same time the number of investments has grown steadily, with investors in the survey saying they had found adequate deal opportunities for their capital.

Given the young age of most VC4S investments, exits are still scarce, but in a separate study of a subset of 57 clean tech companies, five had completed an IPO, and three been sold in trade sales. While 9 had raised second rounds at a higher valuation, 34 had not had any subsequent funding, and 6 were liquidated.

While there was rapid growth in 2006, the factor still restraining development of VC4S is a lack of capital from institutions. In some ways this parallels the position in mainstream venture capital, where European institutions remain more conservative than their US counterparts.

The report notes that the objectives of VC4S investments are in line with several of the European Union’s economic and environmental policy objectives. Such investments could help in meeting the goals of the Lisbon Agenda, and, says Eurosif, there should be tax breaks and other incentives to promote the development of the VC4S sector.

Eurosif was set up five years ago to promote sustainability through the financial markets. To date it has focussed on public markets. Now the rise of private equity/venture capital means private markets have an increasing role to play in promoting sustainability. Eurosif says it hopes to encourage other firms to consider investing in VC4S.