Episode 185: Investing in Climate Solutions & Future of Our Planet with Generate Capital's CEO, Scott Jacobs
Today's guest is Scott Jacobs, Co-Founder & CEO of Generate Capital. We discuss how Generate Capital got started and what motivated Scott to co-found the firm. We also cover Generate’s unique investing strategy, the types of projects and sectors the firm focuses on, and why Scott is an optimist when it comes to our ability to tackle climate change.
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What is Generate Capital?
So, Generate is a permanently capitalized company that invests in and operates sustainable infrastructure projects. And I said a lot of those words quite deliberately, as you might guess. We really looked at the problem we were trying to solve, which is to build a lot more sustainable infrastructure to save the world. And we realized that the existing capital markets, the existing structures, the existing companies really weren't going to get the job done. And so, we had to start with a clean sheet of paper and think about what the market really needed. What the customers and communities really needed when it came to sustainable infrastructure. What the project developers and technology companies really needed when it came to sustainable infrastructure.
And so, we just looked around and said, "How could we do this so that all of these different stakeholders actually win?" Because when it comes to sustainable infrastructure or infrastructure, generally, it really is kind of the ultimate stakeholder alignment exercise. You've got communities who have to feel good about it. You've got customers who have to get the economic value proposition that was promised to them. You have to have investors who make money. You have to have technology companies who actually get to sell their wares. You have project developers who succeed at building a project that actually gets to COD and beyond. And you have all sorts of suppliers, and obviously, an employee base of a number of different organizations that all have to be rewarded for these kinds of things.
So, obviously, we also believe that there's a stakeholder in the planet. But really, when we think about the planet, as a stakeholder, we're really thinking about the humans who we want to be able to live on this planet for generations and generations indefinitely. And so, we think a lot about the people who aren't yet born as genuine stakeholders of the assets that we're building today. So we really thought long and hard about what the right way to do this was. And it was clear to us that we had to have the flexibility that a balance sheet gives you to provide any kind of capital that these project developers and technology companies need. They also need to have the operational capabilities, and the customer base/customer solution orientation to actually deliver for the customers and communities what was promised to them in the original pitch.
And none of that gets solved with a finite fund life like so much private capital is organized. And none of that gets solved with one tool in the toolkit like so many investors only are able to offer. And importantly, none of that gets solved without a really innovative and reliable operating capability, so that, you know, these customers and communities actually can depend on the infrastructure as the mission-critical resource provider that it is.
So, when you set out to address the intermediary gap by bringing these two sides together of the product developers and the capital without these intermediaries with the detrimental incentives, in the way, what type of vehicle did you imagine to fulfill this promise and capitalize on the opportunity?
So, we really knew that we needed to have the flexibility to provide different types of capital at the same time and at different times for these project developers. Sometimes they need corporate growth capital, sometimes they need project, development capital. Sometimes they want to sell their projects and generate their developer fees. And so, there needs to be capital for long-term ownership of these assets. Sometimes they need inventory financing. Sometimes they need supply chain financing. They need other types of working capital. They need tax equity.
So, if you look at these project developers and technology companies, the CEO is really keen to get customers and the CFO is really keen to get capital. And we said, "We need to build a business that delivers on those two problems that the people we're trying to help need to solve." So, Generate was built as a company in order to address the long-term nature of these assets, the permanently refreshing opportunities that exist serving these customers or these partners. And importantly, to have a single balance sheet from which we could actually provide any kind of capital.
And then, in addition, we realized we needed to have operational credibility so that the customers felt like they could trust that these assets would actually deliver on the promise on the box. And that meant that again, our best serve by having a company with a group of people that have the expertise and competency to operate these assets for their entire expected lives. So, we built just a typical company. And we capitalized it with the capital we raised straight onto the balance sheet. It's not a fund, it's a company. It's the same way you start any of the companies that you fund with your venture fund.
So, if I'm starting a company, and I raise, let's say, equity capital, and let's say it's from VC just because that's what I know, the investors that I'm raising from have halftime horizons, are you raising money from capital sources then that do not have time horizons?
We made the very difficult choice at the outset in 2014 to reject all time-limited money. We were fortunate enough to have far more demand for the shares that we were trying to sell. Or an oversubscribed capital raise is another way of thinking about it that we were able to choose and curate our investor base, and that has been true with each of our sequential capital raises. We thought it was super important for us to have values-aligned, vision-aligned investors because they are our partners. They're not limited partners, they're actually partners. I hold the exact same security that all of my investors do. Every employee at Generate holds the exact same security that our investors do.
And as a result, we really wanted to make sure we had alignment. And it goes back to that point I was making earlier. You have to have the alignment of interests in order to actually achieve the goals, certainly over a long period of time. So, we turned down all those funds that had 10-year lives who offered us money at the beginning. And we only took money from permanent capital sources like family offices, endowments, and foundations.
And then in our first very large capital raise, our second round of funding, we went to institutions, and we were lucky enough to attract sovereign wealth funds and pension funds in that capital raise. And every raise since has been primarily sovereign wealth funds and pension funds who have no time horizon at all, because their liabilities are indefinite just like the ones that I think you see in sustainability.
It sounds like this type of vehicle was not available before for the clean energy transition and the infrastructure. But is this a type of vehicle that these types of entities were familiar with investing in, in other areas?
Not really. At the end of the day, we look like a direct investment. And that means we are a single company, uh, that doesn't have a fund structure, obviously, or a GP the way that most investors organize private capital. So, many of these institutional investors have started doing direct investing in infrastructure projects or in companies. But for the most part, institutional capital relies on the intermediaries, the GPs, in order to invest their capital directly into companies or infrastructure projects.
So, this was pretty unfamiliar. A lot of investors said to us, "We totally get how this is better for us. This is more aligned. We don't pay you fees. We can fire you at any time. We have exactly the same interests that you have. We have exactly the same financial incentive that you have. We get that this is better than what we typically do, but we have a policy that requires us to only invest in limited partnerships that have a defined life."
And as a result, most of the institutional investors in the world are actually not candidates to be investors in Generate at this stage. But it's okay. There are tens of trillions of dollars of institutional capital out there. The key is to find the capital from the parties you want to call your partners. And we were able to find those despite the fact that, you know, the universe of potential investors is much smaller than, you know, you might find for a typical GP/LP fund structure.
So, every time you go to deploy more capital, is it a set timeframe that you go out to the capital markets?
Well, we essentially invest through partnerships we form with technology companies and project developers. So, we have a sense of what demand for capital there is among the partnerships we've formed with these companies that are rebuilding the world. So, we might have a $100 million program with a battery storage developer and a $300 million program with an electric vehicle company. And we might have a $200 million program with an anaerobic digester developer.
So, we have a sense of where they are in all their development timelines with the assets that we're hoping to finance and own. And we roll that all up and just like any company, create a forecast, and we have a certain amount of money that we need in order to fund the ability to achieve the forecast, both in terms of the operational talent and expenses that we need to fund inside Generate, i.e., a budget, and the capital expenditures we need in order to build these projects. Then, we go to our board every year, and we say, "Here's what we're going to do over the next three years, and here's an idea for how we might finance that, a combination of equity and debt. And let's go to the capital markets and raise the money."
If you take out the mission element for a moment and you just look from a financial standpoint, what are the comparables that you think most closely resemble these projects?
I would say aircraft leasing is certainly a comparable model for some of the technology and equipment financing that we do. I would say that the solar PPA project finance model is one that we've tried to apply and have successfully across a lot of other technologies and segments of the resources world. Those are probably the best examples of project financing. But, you know, as I said, we do a lot of other things and we don't know a lot of other folks who do all of these different things or have all the tools in the toolkit that we can offer. I would say investment banks like Goldman Sachs and Macquarie have a wide range of these tools in their toolkit, but it's typically that they're gonna go get the money from somewhere else.
So, yes, you may hire an investment bank, and they might like one part of the capital structure or one investment opportunity, but most likely they're going to go farm out the capital raising, you know, to others. In our case, essentially, instead of going to an investment bank, they come to us and we say we can take care of all of the capital needs that you have. We're your one-stop-shop as we like to say. And that is a very different proposition than I think anyone offers in the market.
When you think about the types of customers or projects to take on, maybe talk a bit about the financial criteria that they need to check to know that they're a good fit, but also the impact criteria, like BEV, has their half a gigaton threshold. What's the lens that Generate looks at on that side of the equation?
We don't do anything we don't believe moves the needle on the natural resource issues or sustainability issues that we're trying to solve. We obviously think about a lot more than just climate change. We think about water scarcity, food insecurity, energy poverty. These are all intertwined issues with climate change and, and natural resources. We think of it as a resource productivity question. Can we do more with less of our precious resources? So, that's an inherently economic question.
You know, doing more with less of our finite resources has been the driver of the three industrial revolutions we've seen, agricultural revolution, industrial revolution, digital revolution, we're all about doing more with less of our resources, specifically labor, of course, in these three cases. And now, we're talking about getting more productivity out of energy, water, food, land, even air. And that's what Generate is all about, and I think that's inherently an impact screen, if you will.
It's essentially a negative screen on anything not impact-oriented or not very significant with respect to social and environmental benefits. We don't have a particular methodology that we look at when we look at individual investments with respect to their environmental or social impact. We do look at all sorts of factors that a lot of people would call ESG factors today when we look at those investments, but we don't think you should get lost in three-letter acronyms.
The question is whether the management team is hungry, capable and values aligned. And the question is whether the technology or the project has a compelling economic value proposition to its customers and the communities it serves. And if you get to the point where you can say yes to those first two questions, then, you know, you really have a diligence process underway for us. But we only know the areas of the economy that we would call sustainability. So, we don't try to operate in areas where we don't really understand the trends, the economics, the risk factors, the networks that you need to know people, etc.
How important is carbon removal, and how viable is it?
Absolutely critical. And I'm not sure about the viability yet. I think we're still all waiting for better data on that, and better proof points, and really hoping that we continue to see the encouraging progress that we've seen so far continue.
I think there's a huge role, again by 2050. We will be removing carbon from waste streams, from the air. And we will have to be in order to get the carbon balance in the atmosphere to a place where humanity can not only survive but thrive.
Who will pay for climate change?
All of us. All of us are paying for it anyway. It's just a matter of where we pay for it. Is it that we're paying for it in the hospitals through health care costs? Is it that we're paying for it in taxes to provide defense and security? Is it that we're paying for it directly as a customer? We're paying for it; we just don't always realize that we're paying for it. And we're gonna keep paying for it whether it's good or bad. And so, I'd like to be a little bit more intentional and transparent about that which we are paying for. And that takes policy, frankly, for us to have that transparency in the pricing of the externalities.
How important are assets and how realistic is it that we can get that market functioning in the way that it needs to in regard to consistency, transparency, and quality?
Well, offsets play a really important role today in people feeling like they're making progress. And unfortunately, as we all know, there's a lot of fraudulence in the carbon credit market. And that's not good for the industry, it's not good for the planet. So, it would be great to see either voluntary or involuntary interventions that drive that transparency that you're talking about. That credibility is needed for the offset market to thrive. But I do believe it will play a role, it will continue to play a role. And so, we should work to improve it rather than give up on it.
Are you an optimist?
Some days. I think I am naturally an optimist. But boy am I disheartened by the lack of progress on the policy front, the lack of progress in moving beyond misinformation, in particular, in this country. The lack of progress around long-termism in general for the agents and decision-makers around the world.
But, you know, again, what does give me optimism is the people that I get to work with every day at Generate, the people that I get to call fellow travelers in our industry. There's so much talent coming into our markets. There's so much talent taking leadership roles at companies and in governments. I do have hope that humans will deliver the leadership that we need to address these huge problems.
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