Derisk to accelerate: how the IRA works
Investors and the government are working together surprisingly closely
Some of you may have noticed that I have occasionally added a second post per week, oftentimes an interview. Going forward I’m going to add a Friday post to the usual Tuesday post. I’m finding that I usually have more to say on a topic than I can fit into a less than ten-minute read. Tuesday posts will continue to be the same and Friday will be some combination of a follow-up to Tuesday, an interview, or a smaller topic that I want to cover.
This week I’ll post an interview on Friday (city planning folks, get excited!). For today, I’ve been meaning to write about an event I attended From Billions to Trillions: The Inflation Reduction Act as a Catalyst for Private Investment hosted by Duke University. It was enlightening to listen to the strategy and hear directly from folks responsible for implementing the policy alongside businesses who are figuring out how they can benefit from it. Let’s dive into some major themes and quotes I managed to jot down during the sessions. I will, of course, add my perspective along the way.
Sharing a fate with investors
Just like the Star Wars Skywalker Saga, we’re going to start with the most interesting topic of all…taxes! The Inflation Reduction Act investment strategy is different from the “shovel-ready” projects of the Obama administration. I don’t recall there being a big focus on the investment strategy when the legislation was deliberated in the media. Such nuances are usually lost in red versus blue politics. However, John Podesta, Senior Advisor to the President for International Climate Policy headlined this conference and called it, “Government-led, private sector enabled.” The goal is explicitly to have the private sector put in at least one dollar for every dollar the government puts in. This has resulted in some shared fate behavior.
First, the Department of Energy’s (DOE) Loan Programs Office (LPO) is set up to operate differently. Instead of underwriting loans for ideas that they believe to be good, they require private-sector investment matching. If you have an idea and want a loan from the DOE-LPO, you need to find matching funds from private investment somewhere to be considered. Jigar Shah, the head of the DOE-LPO spoke explicitly to looking to bridge the gap for companies who have proven their technology works and need to scale. That stage usually comes after a Series C for a venture-backed company. Because the companies that can impact climate change most are not pure software companies, they often need to raise billions in capital before they can see enough scale to start paying back the investment. The DOE-LPO expects to be paid back but has the authority to loan up to $400B at this point, with the government only required to budget projected losses. This is a clever de-risking strategy I hadn’t fully understood by reading the bill.
Second, these aren’t your grandaddy’s tax credits. Tax credits can now be distributed through elective pay so that non-profit and government entities can get the money. My local town hall can take advantage of the 30% solar subsidies instead of passing that cost onto me. The federal government is still paying for it (from tax dollars), but this is an obvious win for opening up opportunities to take advantage of the available funding. Relatedly, tax credits can now be transferred for a ~5% fee, meaning companies like First Solar have been able to generate liquidity more quickly while providing some benefit to those companies who would otherwise probably not allocate funds to them. Again, it is money from the government in the end, but Fiserv wouldn’t be providing cash to First Solar without this system and this lets First Solar run a bit faster. Otherwise, they would be waiting until next year to receive the cash for the credits.
We’re going to see if the amplified investment strategy pays off. We haven’t seen the lagging indicators in construction for long enough to know with confidence but some big announcements from companies like First Solar and Form Energy give some hints that the next year or so will see an acceleration in building in the US, directly attributable to the IRA.
Scaling beyond VC
Adjacent to the mechanics of the IRA itself, was the discussion about getting away from waiting for more venture capital money and moving directly toward partnership. Sarah Cannon, General Partner at Coatue, talked about how hard it is to create these sales channels for technologies in the physical world. On top of that, it takes a long time to become a trusted seller in regulated industries. With these capital-intensive businesses, you need to get the products in customer hands quickly, even if that means taking a bit of a margin cut at first. This is a strategy Tesla went after early on to scale the company.
Beyond partnership, investors were asked what they’d like to see more of and I was surprised the answer was “more exits”. Investors like exits because that’s how they get paid, but the rationale was more about not being able to raise capital to make investments in the first place if every business is the first of its kind. There was a lot of talk about how much easier it is to fund the third or fourth business with the same model that operates in a new area. This resonated with me because so much of this work is not done at a global level or takes long enough to build out that multiple players make sense. These investors were looking to inspire entrepreneurs. Genevieve Kinney from General Catalyst even got everyone laughing uneasily when she said, “Not sure fusion is much longer to scale than fission.” In other words, shoot your shot.
Effects of regulatory uncertainty
Eric Toone from Breakthrough Ventures had a dynamite quote, “Economies decarbonize when they are wealthy enough to afford the luxury.” His sentiment for this comment was that we have to get past uncertainty in the regulatory environment to avoid less wealthy countries growing up without scaled-out clean technologies. The 2024 presidential election was a big theme because it’s topical but also because the candidates come down on completely different sides when it comes to working on the climate problem. There’s a fair amount of concern that IRA funding here in 2024 won’t be around in 2025 and investors are taking a wait-and-see approach.
We also know interest rates will come down at some point, but no one has an idea when that will happen. This means lots of capital is sitting on the sidelines collecting interest until 2025. Those that are investing are in a decidedly buyers market, so they can wait for the lowest risk, highest return deal available. Lately, that has been development of solar farms, but Mark Florian from Blackrock explicitly called out that permitting reform could make a difference in unlocking further opportunities. He wants to see a model for site permitting where any request not rejected within a certain time frame is automatically approved to avoid the scenario where permits are held in limbo for years, tying up capital that could be deployed elsewhere.
Final thoughts
There’s a lot of money available to build a cleaner economy. Much of the focus today is on moving from fossil fuels to something with zero emissions for energy and transportation. However, this event made me think more about the future ten years down the road when those problems are well on their way to being solved. There’s so much to build and the way the IRA is set up in the tax code gives the US investor ecosystem an on-ramp back toward building a manufacturing base that can compete at least domestically. Software and the Internet have been a great boon to the US economy, but it is good to see some money shift back toward making physical goods. Good luck to NC State’s basketball teams in the Final Four this coming weekend!