European scale-ups in The New Reality Can Europe Fill a Precarious Financing Gap?

As we begin to navigate the new reality, a key priority is to continue to establish a low-carbon economy. To help facilitate this, the European Union (EU) will need at least €260 billion of additional annual investment through 2030 in order to achieve its Green Deal and Paris Agreement commitments.¹ In 2018, the EU launched the Sustainable Finance Action Plan to steer private sector investments into environmentally sustainable economic activities to support these goals. As part of the plan, a new taxonomy classifies sustainable economic activities, many of which can be found today in a host of startups and small and medium-sized enterprises (SMEs).

There are important, but often hidden opportunities in green deep-tech companies, including carbon sequestration, vertical farming, alternative meats, decarbonized transport, energy-efficient cooling systems and AI-powered electricity-grid management solutions. As these companies confront the new reality, their capital needs are becoming more complex and challenging as they attempt to scale up. To scale-up and unlock these growth opportunities, the startups and SMEs often need to build capital intensive production lines. These investments are usually done by large corporations. Finding investors with deep pockets and experience in structuring these investments in startups is a challenge.

Deep-tech startups entering their growth stage frequently stand on the cliff-edge between research and development (R&D) and commercialization. We need these deep-tech growth companies to transform industries. They need higher amounts of capital and more time for commercialization, neither of which align naturally with the traditional venture capital (VC) model.

While they are prime candidates for public investment in initial R&D, public and private funding opportunities at the scale-up stage are rare in Europe. VC fund sizes are comparatively small, and they have less experience with the sector than US investors. Closing the investment gap for environmentally sustainable economic activities will not be easy.

The World Economic Forum’s Digital Leaders of Europe community identified innovation funding as one of the key issues for European companies in the “2019 Innovate Europe” report. Its most recent report, “Bridging the Gap in European Scale-up Funding: The Green Imperative in an Unprecedented Time”, produced in collaboration with KPMG Private Enterprise, explores four opportunities to support the scale-up of European tech companies. One of the key opportunities they have identified is blended finance.

Blended finance is an emergent trend throughout Europe. It was traditionally used in emerging markets to increase the efficiency of public capital by crowding-in private investors. The German government’s €10 billion future fund (“Zukunftsfonds”) uses public capital to de-risk capital from European institutional investors that traditionally invest much less than their American peers in venture capital.

For the public sector, blended finance structures are better than subsidies or grants. Even if the venture is unsuccessful, a significant portion of the investment is recovered through employee and value-added taxes. On the upside, some blended finance funds have catalyzed more than €5 from the private sector for every €1 invested.

The demand for impact funds and sustainable investments is expected to grow along with the pipeline of investment opportunities. The sustainable economic transition will require a complete overhaul of the European asset base, from assets infrastructure to the technologies we use day to day. Asset managers are now required to disclose sustainability risks as well as any potential negative impact on sustainability factors. This has increased the pressure to create investment products that have a sustainable investment strategy. Forward-looking asset managers will see this as an opportunity to create new products and services.

While blended funds require cleantech market knowledge, they provide opportunities to participate in growth sectors and IPOs that will make up the DAX, Euronext 100, or FTSE 100 in the decarbonized new reality economy, and offer an opportunity to market them as impact products. This requires an unprecedented amount of venture capital, private equity, and skilled fund managers in cleantech sectors.

So far there are no privately managed funds-of-funds specializing in this area, investing in cleantech venture capital funds at scale. Asset managers in Europe who position themselves early and build their finance blending capacities have an opportunity to participate in a growing market and become a sought-after partner for private and public investors who are interested in financing the new reality transition.

Investors are pivoting their investment strategies in light of the pandemic as we transition into the new reality. If you are interested in learning about its impact on deals and venture-backed funding during the first quarter of 2020, read our Q1 2020 Venture Pulse Report. The Q2 2020 Venture Pulse report will be released in July.

We at KPMG Private Enterprise understand the implications of COVID-19 for private companies, including new emerging growth companies and scale-ups. I encourage you to follow our regular KPMG Private Enterprise series of blog posts as we share insights from across our global network on the impact that COVID-19 may have on your business strategy and operations, and how to embrace the new reality of a post COVID-19 world.

¹ European Parliament website