Green businesses, i.e., businesses that have a positive impact on environment or mitigate the risk of climate change are the need of the hour and have been growing rapidly in the last decade. However, capital supply has not kept pace with such rapid growth; reports* indicate that only 6 per cent of global Venture Capital (VC) is currently deployed in climate related businesses . With access to capital being so tight and the competition for it so intense, green entrepreneurs need to forearm for the fund raising process. This blog elaborates on two critical steps in this process: finding the right investor(s), and being prepared for required due diligence.
(I) Finding the right investors
Competition for VC capital is very stiff, with only about 8% of nearly 80,000 start-ups in India getting funded* . Investment firms have stringent criteria and typically apply the following broad filters to screen potential investments.
Alignment of investee’s mission with investor mandates: The first principle of finding the right investor is to understand if your company’s mission really fits into the investors’ agenda. For example, if an investor is scouting for companies that are creating sustainable livelihoods for farmers, a company that promotes urban organic farming may not qualify. However if the investors mandate is to promote investments that decelerate climate change , the urban farming company may qualify if its farming methods save water and do not use chemical fertilisers. Some green investors and their mandates are: Omnivore which funds entrepreneurs building agriculture and food value systems, Circulate Capital which provides funding to ventures that reduce flow of plastics into oceans, and S3IDF, which provides funding to companies that improve environment while also improving the lives of the poorest of the poor.
Information on VC investors that invest in green businesses can be found from impact investor networks such as GIN (Global Impact Network), AVPN (Asian Venture Philanthropy Network) and Indian Impact Investor Council (IIC). Other great sources of information are the websites of the VC companies comprising data on their portfolio companies, recent exits etc. Such information can help investees better understand the investors’ mandate and requirements vis-à-vis their attractiveness to the investor.
Alignment of investee’s funding requirements with investor’s ticket size: Climate finance investors include accelerators, foundations, development finance Institutions, early stage seed investors and a few VC funds. These investors have different preferences including the stage of the company (pre-revenue, post-revenue or growth stage), profitability and quantum of funding per investment.
For example, a pre-revenue company looking to raise up to $50,000 would be attractive to an accelerator that is looking to incubate several start-ups, but it may not be so attractive to a large VC fund looking to invest at least $ 2-3 mn USD in growth stage companies with revenues of at more than $ 2 mn.
Since climate finance is nascent in India, a majority of investors typically provide seed funding of up to $50,000. Large companies seeking growth capital can tap in to corporate investors or their VC arms. For instance, Punjab Renewable Energy Systems Pvt. Ltd (PRSPEL), a biomass based energy company raised capital from energy major Shell. Similarly MITRA agro equipment, that designs and manufactures proprietary sprayers for horticulture crops raised capital from Mahindra and Mahindra.
Communicate with the identified investors: Once you have identified right investor, identify the key performance indicators that they are looking for and include them in your communication. For example, it could be compliance to particular Sustainable Development Goal (SDG), such as eliminating hunger, reducing greenhouse gases, creating employment etc. Discuss both width and depth of your impact such as number of farmers impacted as well as income increase per farmer as a result of your intervention.
(II) Being due diligence ready
For those investments that qualify through the screening round, investors evaluate them further through detailed due diligence on earnings quality, product performance, legal contracts, customer feedback and environmental, social and governance aspects. This can be a time consuming process and can delay or stall the fund raising process if the investor’s findings are not consistent with the investee’s story/pitch from the screening process.
Due diligence typically has two components: financial and legal due diligence. While data requirements may vary depending on the size and growth stage of the company, the following are some key areas of focus that investees should be ready with even as they start the fund raising process.
Ensure that the company financials reflect the product performance/story: Financials are true indicators of the health and progress of the company. For example, if a company’s product is most cost efficient and popular in the market, it should be reflected in monthly or yearly customer growth and an increasing share of repeat customers. If the costs of serving customers decline with the revenue growth, the unit level operating margins should be improving. It is a good practice to keep detailed revenue and cost metrics (such as revenue & cost per customer, revenue & cost per service) and/or activity based costing for at least the past 3 years ready and answers ready for any aberrations or mismatches. Alongside, projected financials specifying the capital needed and the milestones to be achieved with it should also be kept ready.
Past Investment and stock ownership: Investors would like to understand the amount of investment that has already been made in the company and stock ownership pattern(s). As such, investees should retain data on such past investments supported with the bank records/invoices, accounting ledgers and board meeting notes, for scrutiny.
Regulatory compliances: Although not deal breakers, lack of regulatory compliances can delay due diligence. As such, investees should keep a good record of mandatory filings with MCA, filing of GST, income tax returns, up-to-date manufacturing licenses, and compliances related to employees, such as payment of bonus, insurance, provident fund etc., for due examination.
Fund raising is a long and painful process and most entrepreneurs would rather spend that time growing their businesses. By approaching right investors and being due diligence ready, investees can not only reduce the time spent on fund raising, but also improve their chances of getting funded. This may also help the investee get lucky by having more than one VC fund vying for it!
*The State of Climate Tech 2020, Pricewaterhouse Coopers
*India Venture Capital Report 2020, Bain & Company