Venture Capital in the Rise of Sustainable Investment

The amount of capital in sustainable investing funds has risen in recent years, as investors’ awareness towards Environmental Social and Corporate Governance (‘ESG’) heightened related issues. This phenomenon has happened both in specific markets, such as the US and Europe, as well as on a global scale.

While contemporaneous literature on debt financing in green finance is abundant, there is a dearth of coverage concerning equity financing. My recent article ‘Venture Capital in the Rise of Sustainable Investment’ fills this lacuna and analyses the roles that VC funds play in sustainable investing, how it works, what the loopholes are, and the ways forward from a legal perspective.

Compared to other forms of financing, VC fits sustainable investment particularly well. First, VC is uniquely compatible with the needs of sustainable projects. VC funds typically have a long lock-in period that aligns well with the need of sustainable start-ups to secure investment for an extended formation stage. VC funds are also able to add value to sustainable start-ups by providing technical knowledge, industry relationships, or management skills, therefore bringing the edge in addition to monetary contribution. Thereby, the portfolio company can commercialize cutting edge science to achieve the innovation needed for sustainable development and the accelerated availability of sustainable solutions, which heralds various environmental and social benefits.

Secondly, and more importantly, VC offers strong and unique investor protection mechanisms. These are urgently needed in the context of sustainable investment given its many uncertainties. VC investment normally comes with strong continuous monitoring and contractual mechanisms to guard against the issues of uncertainty and information asymmetry. Relevant features include staged financing, an implicit reputation mechanism among the VC community, and engagement with corporate governance.

Accordingly, my article proposes a contractarian strategy in facilitating the development of sustainable VC funds and seeks to craft a role for government that facilitates the simultaneous availability of several factors in a sustainable VC fund cycle (fund-raising, investment and exit). The contractarian approach includes effective contracting covering the entire VC cycle in sustainable investment. It aims to provide strong incentives for all participants, ranging from investors, entrepreneurs, fund managers, to credit-rating agencies and evaluation firms. In the same vein, government support may also facilitate the simultaneous availability of several factors in a sustainable VC fund cycle. The two-pronged approach suggested here may address the need to mobilise entrepreneurship, innovation, as well as private sector funding capacity to support the growth of the sustainable VC market.

1. At the fund-raising stage, sustainable VC funds could adopt a different approach when negotiating with investors as compared to what previously was rigid standard practice. Furthermore, governments can play an active role by expanding the source of financing for sustainable VC funds through relaxed regulations on institutional investors, provision of a clear and authoritative definition and the consolidation of sustainable standards. Concurrently, stakeholders may consolidate sustainable standards. Ultimately, these would craft a role for the government that facilitates the VC market premised on private contracting rather than heavy government intervention in the capital allocation decision.
2. During the VC investment stage, greater comparability in sustainability information disclosure by green projects is required. This would need to be supervised and enforced.
3. In the exit stage, educating investors to increase their interests in green portfolio companies and broadening exit options are crucial for a successful exit of sustainable VC funds. Junior markets or flexible listing rules may be introduced for sustainable start-ups, and this could be supported with enhanced disclosure measures.

In sum, the suggestions made in my article could be valuable for countries or regions that also attempt to promote the formation and growth of sustainable investments through equity financing.

Lin Lin is an associate professor of law at the Faculty of Law, National University of Singapore.