Redesigning VC: a hypothesis

I recently published two articles about the challenge of redesigning venture capital (read Part 1 here and Part 2 here).

In The Challenge, I argue that the traditional venture capital model is severely limited in its ability to leverage the power of entrepreneurship to address the complex societal challenges of the 21st century.

In A Blueprint, I outline how to develop a selection framework for a new asset class: the transformative entrepreneurship investment program (TEIP). In this article, I present my own hypothesis for what a TEIP selection framework could look like. I am doing so as a reality check of whether we are indeed onto something or whether this is just more of the same.

What is the ultimate goal?

My starting point is the Intergovernmental Panel on Climate Change’s scientific position that to avoid the most perilous consequences of a warming planet, the world requires the “rapid, far-reaching and unprecedented” transformation of the socio-technical systems that form modern civilisation: national economies, regional transportation systems, infrastructure clusters, energy, industry supply chains and cities.

While there are multiple definitions of the word “transformation”, what they all convey is that transformational change is not incremental but deep, structural and irreversible. In other words, we must rewire almost all aspects of how societies operate: technologies, values and social norms, materials extraction and use, institutions, education and skills, economic paradigms, policy and regulation, and financial flows.

How can we make sense of system transformation?

In my research, I have come across a plethora of analytical frameworks that conceptualise the idea of system transformation in different contexts. None of these struck me as particularly helpful in articulating, on an ex-ante basis, the system-transformative potential of an entrepreneurial initiative.

Then Kate Wolfenden, a systems innovation practitioner who has supported me in developing Transformation Capital, published an article about a simple dualism – system optimisation versus system change. This typology strikes me as intriguing.

System optimisation versus system change

System optimisation is the dominant paradigm in the climate action community. It is the hope that we can keep our current version of capitalism, that all we need to do is infuse it with sustainable products and practices to achieve “green growth”. This is the domain of energy efficiency, grid management, food waste reduction, electric transportation, low-emissions construction materials, and sustainable consumer products. It is the world of traditional cleantech VC

System change looks – and feels – very differently. This is the world of new mechanisms for value generation, capture, and distribution; of markets with different agents, rules and structures; of new digital, social, and institutional infrastructure; of civic capital and a new breed of utilities; and of new consumption and production paradigms.

It is also the world in which we establish boundary conditions for a system’s behaviour, for example through sufficiency mechanisms, emissions overshoot correction, resilience and conservation and antifragility protocols, and – dare I say – ethical population control strategies. It is not the world of traditional cleantech VC.

Transformative investment strategy

Let me now posit that an investment  program looking to enable system change invests in three areas:

1. the catalysts that accelerate the system’s transition,
2. the building blocks of a transformed system, and
3. the guardrails that keep the system in check.

Such an investment program would not only care about the WHAT (to invest in) but also about the HOW (to invest). This means that the mechanisms deployed in the investment process must be designed in a way that maximally supports the entrepreneurial initiative’s impact mission and avoids, as far as possible, unintended consequences and mission drift.

The program would thus not use the cookie-cutting, one-size-fits-all approach typically deployed by venture capitalists Instead, it would make full use of the mechanism toolbox, selecting those that are most appropriate, blending different instruments where useful, and replacing some, over time, as the investee grows and evolves (hat tip to Indy Johar).

What would emerge from such an approach will almost certainly not fit any traditional category. It would look like a potpourri of initiatives and instruments, all with different business models, legal wrappers, risk profiles and return expectations. It would associate with several identities – venture capital, impact investing, concessional capital, catalytic finance – and not be easily comparable to anything else. It would require that we dissolve the boundaries between for-profit and non-profit and between the private sector and the public sector. It would make people feel very uncomfortable. It would be messy – just like the world around us.

List of (potentially) transformative entrepreneurial initiatives

So what could this look in practice? Below are some examples of entrepreneurial initiatives that I believe fall into one of the above categories.

What patterns do you see? What unifying traits emerge from this list? What other entrepreneurial initiatives might fit in?

Building Blocks

Winners

Many smallholder farmers in developing countries have no access to financial capital – one of the most important production factors in agriculture – because local banks do not assess them as being creditworthy.

Winners solves this problem by de-risking lending for local banks through a micro-insurance product underwritten by local insurance companies and backed by reinsurance companies such as Munich Re. The technology enabling this innovation is a big data solution that establishes causal relationships between climate-induced weather events and agricultural crop yields and can thus form the basis for parametric insurance products.

OpenSurface

Climate change is a complex problem. Addressing it requires interdisciplinary collaboration across large communities of thought and practice.

The mission of OpenSurface is to enable the next generation in digital measurable, reportable, verifiable-driven land management, by linking what is happening on the ground to tailored alerts or results-based payments, and creating accurate, timely, automated services for different stakeholders. Its platform embraces, integrates, and connects three disruptive technologies – internet of things, distributed ledger transaction and artificial intelligence – with stakeholder-friendly, framework-compliant and standardised processes. Catering to government and MLO partners, the initiative offers improved transparency, better incentives, and lower transaction costs.

Smart Commons by Dark Matter

The financial value produced by public goods is often captured and extracted disproportionally by wealthy individuals and organisations, for example through the appreciation of real estate benefiting from new public infrastructure. This often leads to sub-optimal social and environmental outcomes whilst constraining the financing of sustainable and inclusive infrastructure.

The Smart Commons approach developed by Dark Matter solves this problem by democratising infrastructure investment. The approach focuses on leveraging digital ledgers and smart contracts to rewrite the conventional property deed.

Catalysts

Carbon Delta

In finance, risk metrics are usually backward-looking, that is based on historical volatility. Yet climate change is primarily a risk of the future and thus not currently baked into traditional financial risk metrics.

Carbon Delta has developed a data platform to calculate and report a forward-looking climate risk metric called Climate Value at Risk (CVaR). CVaR helps investors assess future costs related to climate change and understand what those future costs could mean for the valuation of securities.

Climate Policy Exchange

Multinational corporations have enormous influence on national and subnational policymaking but are not effectively connected to local advocacy campaigns outside the country in which they are headquartered.

The Climate Policy Exchange solves this problem by connecting multinationals with local advocacy initiatives. The business model is based on charging multinationals an annual subscription fee.

Exaptive

The most tangible and pressing issues of the 21st century are complex problems. Addressing it requires interdisciplinary collaboration across large communities of thought and practice.

Exaptive develops software that enables such collaboration by allowing users to find non-obvious collaborators and new perspectives and ideas.

WaterBear Network

The root causes of climate change are society’s consumption choices, which are driven by values and norms. Documentary films are powerful means through which large audiences can be engaged on environmental issues, thereby shaping such values and norms.

WaterBear Network is an interactive multimedia platform dedicated to environment-oriented documentary films. The platform curates content for streaming and allows its audience to connect directly with active non-governmental organisations and projects related to the films.

InfluenceMap

Effective climate legislation is often undermined by lobbying from fossil fuel companies and other organisations with vested interests in retaining a carbon-intensive economy.

InfluenceMap addresses this issue by empowering investors, corporations, the media and campaigners with data-driven analysis, for example about the lobbying behaviour of corporations or the carbon intensity of investment portfolios managed by investment advisers.

Guardrails

Nori

The world is likely to overshoot the carbon budget in line with keeping global average temperature increase to well below 2˚C. Further, some economic activities will be difficult to completely decarbonise. This is why achieving a net-zero world economy by 2050 will likely require large-scale CO₂ removal.

Nori enables the development of CO₂-removal markets through a transparent and secure platform that connects CO2-removal suppliers with buyers, particularly for soil-carbon sequestration. The platform uses blockchain technology to facilitate payment, maximise transparency, and minimise the risk of double-counting.

PosAIdon

Investments in nature-based assets predominantly follow the single-asset paradigm and are typically driven only by financial risk-return considerations. One root cause is that there is no solid information about how different assets interact at the portfolio level and how much “natural capital return” an investment may create over its tenor.

PosAIdon’s deep-learning platform translates complex earth data and spatio-temporal analytics to build new value signals for investments into ocean and land-use systems. Transactions are based on tokenisation to enable fractional liquidation and trading and the term sheets are implemented digitally as smart contracts. This enables the efficient construction of strategic portfolios of cashflow-generating projects that build economic and ecological synergies at scale.