Download Discussion on Theoretical Basis and Practical Condition of Venture

Discussion on Theoretical Basis and Practical Condition of Venture
Capital Involved in Energy-Efficient Industries
SUN Yanxiang, ZHANG Wei, LI Xin
School of Economics, University of Jinan, P.R.China, 250022
[email protected]
Abstract: The investment and financing activities taken by financial institutions, while in pursuit of
profit, must be guided by the sustainable development concept. Green credit reflects the financial
requirement of sustainable development for the banking sector, and venture capital investment in the
field of energy conservation is also not only to pursue the self-profit performance. From the theoretical
and practical two levels, this paper tries to make a good analysis of theoretical basis and practical
conditions for venture capital invested in energy-saving industry, and maybe provide some references
and guidance for institutional investors.
Keywords: theoretical basis, venture capital, green finance, energy efficiency
1 Introduction
、
Economic environmental and social development harmoniously is becoming a goal for every countries
as the sustainable development is gaining a common recognition as a theoretical paradigm all over the
world. Energy efficiency (EE) is an industry that needed to give more attention to and plays an
important role in address the issues of environment and resources. EE is an investment that has a focus
on reducing energy waste. Penni M.C.(2009) think that EE benefits consumers, businesses, and the
organizations that provide the services from an economic perspective, including specifically lowers
energy bills, represents cost-effective investment, achieves fast and significant energy savings, delivers
environmental benefits and fosters economic development.
Following green economy, green finance has embedded in financial institutions at all levels and evolved
the potential trend of modern financial institutions. Wang and Jiang (2006) think that, based on the
principles of sustainable development, green finance brings environmental and ecological indicators into
the sustainable financial system, recognizing the role of financial industry on achieving global
sustainable development. Compared with commercial banks, venture capital investment projects focus
more on profitability, however, as innovative financial means, venture capital’s activities must reflect the
environmental content as well as pursue high-yield under high-risk in its investment and financing
activities. Although the idea of “Green venture Capital” has strongly advocated under the guidance of
“Social Responsible Investment”, the theoretical guidance of venture capital investing energy industry is
not as clear as commercial banks. This paper discussed its theoretical basis and the practical condition,
trying to provide some references to venture capital’ investment activities in energy industries.
2 Discussion on the theoretical basis of venture investment involved in
energy-efficient industries
2.1 Eco-civilization theory
Ecological civilization is a wholly new socio-economic pattern following the agricultural civilization
and industrial civilization, and is a new evolutional stage of human civilization. Liao (2004) thought
ecological civilization means that human mainstream values can spontaneously take ecological effects
(positive and negative effects) into all socio-economic activities, to realize the dual harmony of
man-man and nature-man, further to gain free and comprehensive development of society, economy and
nature. Chen (2001) thought that a basic characteristic of ecological civilization society is emphasis on
rational allocation of resources and putting compensation funds to exploitation of resources, which is to
realize a benign ecological cycle and establish a national energy-saving economic system and the
ecological productive structure as well as sustainable economic order.
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Report of the Seventeenth Party Congress took "ecological civilization" into a programmatic document,
determining that China will go on a civilization road of economic development. In the current
eco-oriented economic development strategy, the finance should innovate its service system changing
with the economic development to better promote China’s eco-economic construction. Gong(2009)
point out that, the future development of China's ecological economy needs eco-innovation of financial
services system and establishment of financial service system based on ecological civilization, including
two premises: switching the understanding of service goal from a single economic growth to integrated
development of economy, society and environmental benefits; transforming the understanding of service
subject from the single commercial banks to a common-involved process of governments regulators and
financial institutions.
As part of the financial service innovation, venture capital should also be guided by ecological theory,
and take ecological civilization into its operation, including the formation of ecological-based
management team, sustainable requirements of project selection and investment and financing activities,
making ecological-oriented profit goals, so to pursue the unity of economic efficiency and ecological
effectiveness.
、
2.2 Stakeholder theory
Stakeholder theory has been gradually developed since the 20th century and 60 years in the countries
such as United States and Britain carrying out a long-term external-control corporate governance model.
Liu and Zhou(2005) thought that, compared to the narrowly shareholder value-based corporate
governance model, corporate governance in wide sense means that a series of institutional arrangements
making up of the company’s internal structure or internal control(including shareholding structure,
organizational structure, financial leverage, incentive mechanism, development strategies) and external
mechanism or control right market(acquisition, merger, bankruptcy). According to the wide-sense
governance structure, any company’s governance and development are related closely to the input of all
stakeholders and their participation. Based on the correlation degree with the company’s survival, we
divide the stakeholders into internal stakeholder including corporate shareholders, creditors, employees,
customers, suppliers, etc. external stakeholder such as government departments, the whole consumers,
local communities, the media, pressure groups and radiation stakeholders affected directly or indirectly
by business activities, such as natural environment and human generations.
Cheng(2004) refer to the VC stakeholder as those individuals or organizations involving in VC project
activities and their benefit maybe affected positively or negatively by the project implementation and
success or not. Specifically, it includes direct stakeholders consist of VC institutions, venture investors,
venture capitalists and entrepreneurs, indirect stakeholders consist of other shareholders, creditors,
professional advice, etc. at macro level, it should also include the communities start-ups located in,
industries in which venture capital projects existed and the impact of VC activities on the natural
environment and sustainable development of future generations. Considering resource depletion and
environmental degradation as well as embodied sustainable development ideas in financial sector, VC
not only pursues the profitable objectives of direct and indirect stakeholders, but also takes full account
of the environmental and social goals of macro-sense stakeholders.
2.3 Theory of corporate social responsibility (CSR)
According to Liu(1999), corporate social responsibility means enterprises should maximize the interests
of all other social benefits other than shareholders’, where social benefits include employee benefits,
consumer interests, the interests of creditors, the interests of small competitors, local community
interests, environmental interests, community interests and the weak public interest and so on.
According to Margolis J. and Walsh J. (2001), the ultimate success of enterprise market returns was
originated in its behavior of CSR. And Baron D.(2003) thought enterprise SCR as a win-win strategy
locating SCR between charities and enterprise development as well as an effective management strategy.
Actually, enterprise, by bearing and guiding such a healthy social behavior, can improve its public image
and expand its market share. The significant roles of CSR of venture capital are mainly reflected in
following aspects: firstly, it can improve the brand image and reputation of VC. Good brand can
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guarantee venture capital institutions focus on the higher rate of investment return, attract innovative
start-ups on funding demands and loyalty for VC; secondly, it can improve the financial performance of
business enterprises. Engagement of venture capital in the energy-saving industry can greatly decrease
foreseeable risk and make the investment in more efficient way; thirdly, it can get the support of all
stakeholders, to create a good environment for the operation.
SRI consists of three investment approaches: screening, shareholder advocacy and community
investment, of which screening method is the most important method. VC SCR is a green investment
approach, primarily through project selection and sector selection. Selecting a project having good
social and environmental benefits not only can improve the corporate image, but also have a good
access to governmental policy support.
2.4 Externality theory
In economic life, the externalities mean the non-market impact of economic activities caused by market
subjects (including vendors or individuals) on others or society. And it makes the private cost of
behavior deviate from its social cost, resulting in invalid allocation of resources. According to the degree
of gain or damage to others, there are two adversely different externalities, positive externality and
negative externality. And the environmental pollution caused by producers and consumers’ economic
activities is a typical performance of negative externality. On the contrary, environment protection and
resource conservation committed by economic entities will generate a positive externality, for example,
the energy-saving industry has becoming a new-emerging industry of external economy gaining much
concerns. The activities including energy-saving product development, energy conservation technology
research, energy efficiency improvements, using of energy-saving craft and so on, not only decrease the
production cost, in spite of a slightly increasing short-term cost, and thus improve the economic benefits,
but also produce a good social and environmental effects benefiting all stakeholders.
Financial sector, as the core of the economy, assumes the functions of credit rationing of real economy,
and can expand the behavior consequences of economic agents through money supply. Energy start-ups
in the support of money and management of venture capital team grows from an energy-saving
innovation idea or technology to a well performed, even the listed companies, its externalities generated
will expands and swells as the business grows. Furthermore, the investment behavior itself also having
positive externalities, the social benefits generated by which will be greater than personal benefit.
Therefore, to develop venture capital of energy industry can get supports from government and all walks
of life as well as meets requirements of sustainable development.
3 Practical conditions of venture capital involved in energy-efficient industries
3.1 Analysis of energy-efficient financing gap
According to the research study conducted jointly by the International Energy Agency (IEA) and the
United Nations Intergovernmental Panel on Climate Change (IPCC), the energy efficiency promotion
has made a bigger contribution to global greenhouse gas emissions reduction, accounting for 49% in
OECD countries and 67% in developing countries, than the contribution of "renewable energy", 20% in
average. This report indicates that the national policies of energy-saving technology from 2002 to 2030
mainly consist of energy efficient policies, subsidies and tax cuts. So to resolve the energy crisis,
exploration for the potential of energy efficiency should be the best proactive way, besides searching for
alternative energy and renewable energy.
China's rapid economic growth will inevitably bring about a substantial increase in productivity,
suggesting there is a huge energy-saving potential and investment income. Based on the joint forecast of
the U.S. Energy Foundation and the National Development and Reform Commission, the market scale
of China’s energy-efficient and environment-friendly investment comes up to seven trillion Yuan during
2005-2020, an annual average of more than 400 billion Yuan. Zhang (2009) calculated and concluded
that there would be at least 2 trillion funding gap to be filled in 2020. If filling this gap only by the
government’s financial contribution, there will be a severe tax burden, let alone the mismatch of
governmental funding with public finance, which allows private capital and private equity entering into
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the energy industry.
3.2 Maturating energy-efficient technology
To reduce the risk in VC circle, VC capitalists are more willing to invest in industries having relatively
mature technologies or enterprises locating later in the development phase. Many years’ accumulated
development allows the suitability and profitability of energy-efficient technologies to gradually reach
the integration degree of market. On the one hand, the national environmental regulations and policies
promote the implementation of mandatory energy-saving technology, to create the market demands for
energy efficiency, on the other hand, cost reduction and profit promotion through the use of energy
efficient facilities by productive enterprises and market-oriented energy saving mechanisms by service
companies have driven the application of energy-saving technologies gradually from passive compliance
with corporate environmental policies into active energy conscious action. Considering demand pull and
the support of government policy, an increasingly high research enthusiasm for green technology has
been among enterprises and research institutions, ultimately promoting the maturation of energy-saving
technology. Currently, energy-saving technologies have been used widely in all walks of lines, of which
building energy efficiency and industrial energy efficiency are two major areas having mature
technologies of good applicability and profitability, in addition, transportation, and other civilian areas
also has a bright future for venture investment in energy conservation.
3.3 Comparison of different energy-efficient financing model
Currently, the energy saving project investment are generally divided into two models: One is the
traditional model, that is, enterprises use their internal money to invest in improvements of energy
techniques and facilities, to promote the energy efficiency; another is a new market-based model called
energy management contract (EMC), where energy service companies provide energy audits, energy
project design for energy companies, and then enter into energy service contracts, energy project
financing, raw materials and equipment procurement, construction, installation and commissioning,
operation, maintenance and repair, energy efficiency guarantee, after all of above procedures, share
energy saving benefits. In addition to that, bank loan and issuing stock or bond are two traditional
financing models. The former is the better way if possible but it is difficult for most energy SMEs lack
of credit basis and mortgage terms to get a banking loan; the later is also almost impossible due to
difficulty to meet the listing requirements and policy resistance to issue bond. Besides EMC, the finance
lease is another market-based financing model for enterprises, under which the company can obtain use
right of required equipment by paying a small amount of money, however, its long lease period, almost
covering two-thirds of the entire device lifetime, makes it not conductive to flexible technology update
and process improvement, ultimately leading to higher leasing risk for tenant.
Over above several financing models, venture capital has its advantages in energy-efficient industries.
Firstly, the adequate funding resource can help cope with the financing dilemma, secondly, it can
promote enterprise growth by incubation roles. In addition, it can establish a joint governance
mechanism with entrepreneurs or managers of start-ups, and combines advanced management
experience and innovative business profit model of venture capitalists with the original energy-saving
envision of entrepreneurs, to better serve the company’s development strategy.
4 Conclusion
Engagement in energy-efficient investment is the reflection of venture capital in pursuit of sustainable
development in financial sectors following the banking implementing green credit and performing
environmental responsibility. This article discusses both theoretical and practical basis of venture capital
involving in energy-efficient investment. In theory, this article summarizes four theories for VC entering
into energy-saving industry: theory of ecological civilization, stakeholder theory, theory of corporate
social responsibility and externality theory, providing VC investment with theoretical origins and
behavior criterion. In reality, the big contribution of energy efficiency promotion to gas emission
reduction and the maturated energy-efficient technology create an external condition where venture
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capital is accessible and willing to invest their money to energy saving terms based on good profitability.
What’s important, the great advantages of VC financing model over others bring about a congenital
conditions because of its provision of energy capital and management strengths as well as unique
financial services.
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Author in brief or Acknowledgment
Sun Yanxiang, male, born in 1985, graduate student in School of Economics, University of Jinan, is
majoring in green finance and sustainable development.
Contact: Telephone: 15865285503; Email: [email protected]
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