Venturing the green transformation?

Under the European Green Deal, venture-capital firms are expected to play a vital investment role—one for which they are singularly ill-suited. 

With the European Green Deal the European Union is once again turning to financial markets to solve its most pressing issues. Pursuing a political strategy Daniela Gabor labels the ‘Wall Street climate consensus’, it is hoping to steer financial actors towards delivering on the ecological transition by derisking investments.

Venture capital—one of the targeted financial actors—is often neglected in the policy discourse around financial markets, presumably because of its comparatively small scale. VC’s annual market size of around €40 billion would only furnish part of the €1 trillion Green Deal investment, over a decade, promised by the European Commission president, Ursula von der Leyen, in December 2019.

VC, however, has a much larger impact on the economy than its size would indicate. Its legal-economic setup limits innovation, privatises profits and concentrates massive power in the hands of the few.

Not neutral instrument

For more than two decades now the EU has been promoting VC, to drive innovation and growth. Through the European Investment Fund, its arm for small and medium-sized enterprises, it invests in VC funds to increase the capital available to startups and reduce the share of risk carried by private investors. The EIF provides around a quarter of VC raised in Europe and is the largest institutional investor.

Now, venture capitalists’ smart money is also supposed to provide answers to the urgent climate crisis. Thirty per cent of the commission’s new investment programme, ‘InvestEU’—for which the European Investment Bank and the EIF are principally responsible—is supposed to be invested sustainably. VC is however not a neutral instrument readily deployed to achieve any goal but follows its own logic.

VC, a subclass of private equity, collects institutional investors’ money and invests in startups. Ideally, after a few years, the targeted company is sold on or floated on the stock market and everyone involved profits—but certainly the VC firms do. In addition to a 20 per cent profit share (the ‘carry’), they usually receive about 2 per cent of the fund volume annually as a management fee. With median fund sizes of €113 million, this is not an inconsiderable amount.

Highly uneven

Typically, VC funds are organised in the legal form of a limited partnership. The capital providers (insurance companies, pension funds, corporations, government agencies) act as partners whose liability is limited to their paid-in capital. The VC investors themselves function as general partners. In principle, they are fully liable as well as bearing full operational responsibility. In practice, however, liability is circumvented by appointing a limited-liability company as a general partner.

This legal-economic set-up results in a highly uneven distribution of the profits of VC. Overall, the sector in Europe generates net returns of almost 16 per cent over five years—making it one of the most lucrative investment opportunities, especially in times of low interest rates, expansive monetary policy and asset-price inflation. While in theory, all providers of capital participate in these profits, in practice a few well-connected and experienced venture capitalists take a large share, while VC does not work for the majority of funds.

Thus, a double privatisation of profits takes place. On the one hand, the venture capitalists always have the soft cushion of their annual fees to fall back on, while the investors run the risk of losing their capital. On the other hand, access to the successful funds is limited and favours insiders.

Exponential growth

Furthermore, VC’s focus is on startups with the potential for exponential growth. The Silicon Valley guru Peter Thiel argues one should ‘only invest in companies that have the potential to return the value of the entire fund’. Due to the risky nature of VC investing only few startups can realise their business idea. Therefore, these few must be able to compensate for the losses of the others and generate attractive returns, offsetting the high risk.

This logic explains why digital business models make a particularly attractive VC case. With sufficient firepower VC can use the scalability of digital goods and the network effects underlying platforms—the tendency to become more attractive with more users—to build monopolists in markets where the winner then takes all.

Consequently, the range and effectiveness of innovation that venture capital can and does generate is limited. Instead of new technologies, VC is increasingly focused on proven applications in software and services, competing for a few markets with large amounts of capital. Solid small and medium-sized companies with limited growth prospects, social and co-operative enterprises and moonshots—uncertain and radically innovative technologies—all fall through the cracks of VC investing.

Delegating decision-making

The EU’s decision to initiate a structural transformation of the economy by providing capital for VC funds delegates the concrete decision-making power away from government institutions and political decision-makers to market actors. For a just transition, financing has to be rethought fundamentally.

Financing structures are extremely powerful—their logics imprint on economic outcomes. Not capital interests but a well-founded democratic discourse should set the direction.

The climate crisis can be an opportunity to create direct, long-term, transparent and democratic forms of investment for new enterprises, at the European and local levels. Direct investments exclude the inequality machinery of venture capital and escape its economic logic.

The EU recently invested directly in startups for the first time. This should happen locally in cities and communities, transparently and with the involvement of their citizens. Investment horizons should be truly long-term, to break the path dependencies blocking the supposedly impossible.

Profits can be socialised through such long-term holdings. The monitoring and evaluation of global, societal and ecological effects should be equally long-term and transparent, to avoid one-sided, unjust and counterproductive effects.