By Matt Harrison, Director at GRAPH Strategy

On Sunday, the world’s leaders outlined a $300 billion a year global finance target to help poorer nations cope with impacts of climate change. The latest development in the challenge to reach Net Zero targets comes after the Climate Change Committee’s latest figures suggested that we will need to invest around £50bn every year to deliver Net Zero by 2050 in the UK.

An evergreen investment theme coupled with large potential pools of funding will be music to the ears of PE dealmakers.

The explosion of ‘ESG’ and ‘Impact’ investments – whether from a fund with a specific mandate or not – should, therefore, come as no surprise. Pressure is mounting on General Partners (GPs) to deploy capital in a market that achieves dual aims of investing in dry powder while achieving sustainability targets.

For GPs, however, allocating funds to companies that participate in the Net Zero transition is no mean feat. Net Zero markets present unique structural challenges – herein lies both the risk and the opportunity. Recently, GRAPH has seen a number of so-called ‘ESG’ deals fail to reach completion – below we list some of the common challenges with investing in ‘Net Zero’ assets.

  • Paucity of attractive, scaled assets – high-quality platforms are rare, and often play in fragmented markets where a roll up is not straightforward.
  • Rapid evolution of business models – the people-led, advisory services that are essential today may be largely technology-driven in the future. Investors must identify whether an asset has the agility to shift its model as a market matures.
  • Over-reliance on single funding streams or regulations – if government funding, subsidies or regulations are delayed, redirected, or revoked entirely by the next government, considerable risk is exposed.
  • Prevalence of ‘greenwashing’ – businesses are dressed up as ‘Environmental’ or ‘Impact’ investments, only to fail to demonstrate tangible environmental benefits during diligence.

Backing the right horse in this shifting landscape is difficult. Nevertheless, by asking smart commercial questions, winners can be uncovered.

A critical first step is to decipher the jargon that plagues this space by answering some fundamental questions about the business: What does it do? Who are its key customers? What are its routes to market? And finally, how, if in fact at all, is this business supporting the Net Zero transition?

Once an asset has been properly contextualised, there can be lots to be excited about – many Net Zero markets are ripe for disruption with considerable whitespace given the emergence and increasing maturity of products and services that address environmental concerns.

To identify the opportunities, and to weigh up the risks, we’ve set out some key questions which will test these out:

  • Is market spending underpinned by regulation, compliance requirements or government funding and therefore non-discretionary? Is the business entirely reliant on a single funding mechanism or regulation?
  • In a market where an environmentally friendly product or service is not yet widely adopted, is there a compelling reason to believe that said product or service will see a strong uptick in adoption in the next ~5 years? Has a recent catalyst altered the attractiveness of the market? Is this rationale equally compelling in a more benign macro-environment (e.g. stable energy markets, lower interest rates and inflation)?
  • Does the product or service deliver a tangible environmental benefit? Does it also deliver cost savings vs. the traditional approach?
  • Does the target company have a clear point of differentiation which creates a defensible moat that makes its product or service difficult for (traditional) incumbents to replicate?
  • Is there a risk of disintermediation as the market matures? Alternatively, what is the likelihood that a product or service is brought in-house as it becomes more established?
  • In a market where multiple technology solutions are vying for dominance, is there compelling evidence that the target company’s solutions will win out? If not, is the target company sufficiently ‘agile and nimble’ that it can pivot as necessary?

These are the questions which need to be asked if the true value of a company’s Net Zero ambitions, and this is the approach GRAPH has taken across multiple projects across sell-side and buy-side commercial due diligence for businesses that participate in the Net Zero transition.

With COP having recently agreed a $300 billion a year global finance target to help poorer nations cope with impacts of climate change, now is the time for organisations in the private equity sector to take a deep look at the value of companies who are looking to drive the Net Zero agenda forward.

For more information visit:  https://GRAPHstrategy.com