✒️ The Inflation Reduction Act: A Game-Changer for Impact VCs?
Impact Supporters Issue #11. Thanks for being here. If you have comments or feedback drop me a message.
Disclaimer from August Solliv: Everything that I write here is my own opinion and my own research, and is not affiliated with any current or former employments i.e. it’s my evening and weekend work 😉
Greetings, Impact Supporters! 🌍 It’s August Solliv 👋 This week, we’re unpacking the Inflation Reduction Act (IRA) and how it's set to reshape the landscape for Impact VCs both in the USA and Europe 🌐
Table of Contents:
Definition(s)
What industries are favored by the IRA?
What does the IRA change for impact VCs?
What differences does the IRA create between Europe and the USA?
On August 16, 2022, President Biden signed the Inflation Reduction Act into law, marking the most significant action Congress has taken on clean energy and climate change in the nation’s history - The White House, 2022
Definitions and beyond 📖
The Inflation Reduction Act (IRA) is a piece of legislation with $500 billion in new spending and tax breaks that exists partly as a response to recent inflation after the Covid-19 crisis but especially to boost the sustainable transition in the USA. The IRA has a major effect on impact VCs in the USA and around the world, so we delve into it today. The IRA has three primary aims (McKinsey, 2022):
Boost leading-edge technologies like carbon capture and storage
Reignite the American manufacturing and industrial sectors
Ensure equity in environmental policies
What industries are favored by the IRA? 🏭
Energy is the major part of the IRA. The bill reinstates and significantly expands current clean-energy tax incentives by providing an estimated $300-370 billion of new energy-related tax credits over the next 10 years, depending on how you classify different schemes (PwC, 2022; The Council of State Governments, 2022). The secondary parts of the IRA are new investments in healthcare and in climate solutions. Below is a graph of how the spending and tax cuts are built up:
Source: The Council of State Governments, 2022
The act aims to catalyze investments in domestic manufacturing capacity, encourage procurement of critical supplies domestically or from free-trade partners, and jump-start R&D and commercialization of leading-edge technologies such as carbon capture and storage and clean hydrogen - McKinsey, 2022
But this also comes at a cost. President Biden had to enact new minimum taxes on corporates and cut in other healthcare reforms in order to build the IRA. In total, the IRA actually has a positive effect on the USA’s finances. See below the split of how the IRA was financed and the total balance of the legislation.
Source: McKinsey & Co, 2022
What does the IRA change for impact VCs? 💡
The IRA creates a lot of change for American impact VCs, European impact VCs investing in the USA, and even just European impact VCs.
Start-up surge 🌊: “The IRA will result in the launch of hundreds of new climate tech start-ups that otherwise would not have existed, with some estimates predicting an increase of 5-10x“ (Blair, 2022). The new subsidies and access to debt capital will support these new start-ups to develop and this opens large investment opportunities for impact VCs (Blair, 2022). Moreover, there are new investors going into renewables when they wouldn’t before because it becomes more financially interesting according to Leslie Samuelrich (Nelson, 2023).
Valuations increasing 💸: The IRA subsidies risk increasing valuation on impact start-ups in the USA and potentially also in Europe as a consequence as American investors look elsewhere as they are outpriced in the USA. The subsidies create new revenue streams for these impact start-ups. However, this also creates some of the same risks as during the Cleantech 1.0 deroute where investors wrongly evaluated the technology risks linked to start-ups, and invested on the basis of subsidies and no real business model (Kearney, 2020). Back then investors burned their fingers by believing that subsidies would continue for years to come (Blair, 2022; MCJ, 2023). On MCJ, Irena Spazzapan explains that she hasn’t done a single deal in the US after the IRA because valuations got inflated and she only invests in deals that could also survive without subsidies (MCJ, 2023.
Lower policy risk ⏳: The IRA diminishes long-term policy risks for impact VCs. As Jake Schwartz puts it, giving a 10-year perspective changed the economics of climatetech investments and gives more certainty for start-ups and investors (Nelson, 2023; BlackRock, 2022).
What differences does the IRA create between Europe and the USA? 🗺️
IRA is gonna leave Europe behind potentially for generations to come - Irenna Spazzapan on MCJ, 2023
The IRA significantly influences the impact VC landscape in the USA and its role compared to Europe. Today, Europe represents 29% of the impact VC market, but is still smaller than the USA’s impact VC industry (Miller, 2021). By boosting the focus on climate in the USA, the IRA helps attract more impact investments into the USA as tax subsidies make the technology more interesting from an investment perspective.
As an impact VC, you have to take regulation into account and make investments based on regulation expectations and therefore the IRA is part of pushing for more investments in the USA (MCJ, 2023). A specific example is direct air capture. The IRA bill increases tax credits for carbon capture up to $180 per ton, which is a lot higher than in Europe and thereby is part of kickstarting direct air capture in the USA (Thorne, 2022) 🚀
Moreover, with the IRA, the USA is doubling down on the domestication of their industries. This is a high risk for the EU as it means that some European companies might choose to move some production to the USA to avoid import taxes (Amsili, 2022). The EU responded promptly with adding some protectionist measures in the European Green New Deal and the UK is considering how to best respond, but the question is whether it is enough (Cattan, 2023; TheCityUK, 2023)
To conclude, the IRA has been part of changing the power dynamics in impact VC between the USA and Europe where Europe in recent years had the upper hand because of high investments in climate and social impact. This changes investors’ approaches to impact VC and need to be taken into account by all impact VCs.
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