Wanting to play his part in revolutionizing sustainability, former venture capitalist Scott Jacobs knew the energy game was about infrastructure rather than invention, and he planned his company, Generate Capital, accordingly.
Scott Jacobs, Generate Capital’s co-founder and CEO, has experienced two profound realizations that have changed the course of his career.
As a venture capitalist investing in the cleantech boom, he realized that energy investing was more about the arduous buildout of infrastructure and less about invention. “The players in an invention game are usually two people, a PC, a garage, and a dog,” Jacobs says. “And you can create a billion dollars for the value. That's not how it works in infrastructure.”
This epiphany led him to McKinsey, where he helped build its global cleantech practice back in 2007. But he quickly realized something was not working well in the nascent world of sustainable infrastructure: The investments in energy efficiency he had helped some of his clients achieve were proving to be successful – one of them, a USD 2bn investment, grew to USD 9bn in six years. The banks, however, did not seem keen to jump in the game.
“Banks have a single incentive: fees,” Jacobs says. “Fees happen when a deal transacts – and a deal transacts when it's easy.”
Sustainable infrastructure was a new sector which comprised different asset classes – private equity, energy, infrastructure, real estate – and different geographies, and required investors to be educated about it. “It doesn't fit neatly into the capital markets classification system,” he explains. “This is where the capital markets are broken. There are two substantive intermediaries in between the real economy and the real money: banks and asset managers. Both are fee driven.”
Alongside fellow co-founders Matan Friedman, Generate Capital’s chief investment officer, and Jigar Shah, who’s now the director of the Loan Programs Office of the US Department of Energy, he decided to bypass the intermediaries and go straight to the money: sovereign wealth funds, pension plans and insurance companies.
“And I said, would you not fund these sorts of sustainable infrastructure projects that have these really great cash flows over long periods of time and pretty low risk? They're like, we would like to do that every day of the week and twice on Sunday,” he recounts.
And that’s how Generate Capital was launched in 2014.
Balance sheet funding
Rather than raising funds like other renewable energy infrastructure managers, Generate Capital invests in assets through its balance sheet.
Every 18 to 24 months, it conducts equity raises, bringing in corporate equity from some of the largest and most sophisticated infrastructure investors globally. AustralianSuper, QIC, Harbert Management Corporation, Aware Super, CBRE Caledon, AP2 of Sweden, Railways Pension of the UK and The Wellcome Trust were among those that participated in the latest round, which raised USD 2bn in July 2021.
“Unlike a fund, where you can have some 55 LPs, we have a small number of very large investors,” Jacobs says. “We have essentially ten big institutions that have been funding us. They're all straight common equity investors in Generate. So they have the same equity security as I have or as anyone.”
Some LPs, particularly US pension funds, might have some difficulties in investing directly in a balance sheet company because such corporate investments are not allowed within their private markets allocations. According to one investor source, some have bypassed the obstacle by accessing Generate Capital through separately managed accounts and similar vehicles with managers such as Harbert Management Corporation.
“We're aligned in creating value on the balance sheet,” says the investor. “The way Generate Capital makes money for us is when the value of the business increases, and it’s the same way the company makes money for itself.”
Aside from getting rid of fees, thus aligning Generate Capital’s financial interests with the ones of its investors, Jacobs says the balance sheet structure allows flexibility and longer-term asset plays. While the long-term horizon could be compared to that of an open-ended fund, its flexibility is unique.
“An open-ended fund usually has one type of capital that it can actually fund, corporate equity being the most common,” says Jacobs. “But the companies you invest in need more than just one type of capital. Even if you have an open-ended fund that might fund your growth capital for the project developer, they're going to need to go to somebody else for project debt and somebody else for tax financing and somebody else for mezzanine financing and somebody else for corporate debt. And that's an inefficient process where you have most of your time being spent raising money and none of your time deploying the assets for which you're raising the money.”
Ryan Bisch, managing director for private markets at Ontario Power Generation’s pension fund, says his fund wasn’t necessarily looking for energy transition investments when they first invested in Generate Capital in 2017. “But we were starting to see broad trends suggesting that other emerging renewable energy sectors were becoming increasingly compelling,” he says. “So, without making a specific investment into one of several interesting sectors, we liked the approach that Generate had, which was multi-vertical: different segments of the wider energy transition space.”
Investing in Generate Capital “allows us to kind of get exposure to the whole distributed infrastructure thematic in a way that we couldn't do ourselves, because the checks tend to be small,” says the first investor source. “And the intellectual property is kept within the company and we continue to get to see that as a shareholder. With a fund manager, if you want to keep exposure to the asset class, you have to invest in the next fund.”
Generate Capital started out with battery storage and commercial and industrial solar, and it now invests more broadly in sustainable power, mobility, water and waste, and cities. It is active in North America, Europe and Brazil.
Upcycle from scratch
In addition to providing financial possibilities to its partners, Generate Capital also handles operations and business development.
“Our partners need a flexible mandate with a long-term time horizon, and then they also need to serve the customers at the end of the day,” Jacobs explains. “And what the customers need is an operator, not someone with operational expertise. They need an operator who has their back for 35 years.”
Zaid Ashai, CEO of solar and energy storage developer Nexamp – which received investment from Generate in 2021 – says a permanent capital horizon is important for energy transition entrepreneurs. “Because when you build large, scalable companies like Nexamp you can't think short term,” Ashai says. “We are looking at a variety of opportunities for the long run, and having a permanent capital structure where you're not forced to think about liquidity prematurely is a great feature set."
Among its partners are companies such as renewables developers Delaware River Solar and Cypress Creek Renewables. Starbucks invests in solar projects alongside Generate and powers some of its New York stores with green power; and Walmart partnered with Generate Capital on fuel-cell-powered forklifts in their distribution centers and then connected them with its partners that were doing battery storage and high efficiency heating, ventilation, and air conditioning systems. Walmart also contracted with Generate Capital’s partner Nexamp as an anchor tenant to support 129 MW of community solar projects.
Its latest announced investment is the launch of Generate Upcycle, a waste initiative that is emblematic of how Generate Capital can build its own platforms from scratch.
In 2015, it bought its first anaerobic digester projects, building an operating team around them. Once the operating team got comfortable with the assets, it slowly started to expand within the waste sector, investing in animal waste, dairy waste, and renewable natural gas. Last January, it announced the acquisition of Atlas Organics, a composting company based in South Carolina.
Earlier this month, its expansion into organic waste culminated with the acquisition of Ontario-based circular economy and decarbonization solutions developer StormFisher Environmental Services, and the launch of the Generate Upcycle platform, which operates within organic waste, recycling, composting and wastewater treatment.
“Generate's mentality is to build a business, operate it to maximize value, but don't ever worry about having to sell the business – we say our time horizon is forever;” says Bill Caesar, Generate Upcycle’s president and operating partner.
“I'm focused on driving operational performance that leads to improved cash flow. I'm trying to make money the old-fashioned way, and I'm not trying to do it by increasing multiples. The valuation stuff will come. And because I'm not looking for an exit, I’m not worried about it.”
Before joining Generate Capital in January of 2021 to help shape the waste platform, Caesar was CEO at former Macquarie Asset Management-backed company WCA Waste. Having the intention of holding a company for an indefinite amount of time does make a difference in the asset’s growth trajectory, he says.
“We went on a j-curve: first we were rapidly growing, then we put the brakes on because we were getting close to selling the business,” he says of his time at WCA Waste.
The underlying ethos of long-term asset holding serves as a means of optimizing operations and, in theory, fuels Generate's ability to produce returns and perpetual investment.
“A ten-year fund doesn't make sense if you try and use the words ‘sustainability’ and ‘infrastructure’ at the same time,” Jacobs says. “Sustainability isn't a ten-year activity and infrastructure assets don't live for only ten years.”
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