The summer of 2023 led to record temperatures across the world, illustrating again the increasingly urgent need to fight climate change. Forest protection and restoration is recognized as one of the key strategies in this fight, which is why more companies and funds are working to bring innovative solutions to this sector and preserve these critical carbon sinks. While their early-stage development is being supported by public and philanthropic funding, they are struggling to unlock the necessary commercial funding to scale.
It is against this backdrop that Mobilising Finance for Forests was created. MFF is a blended finance program funded by the UK government to demonstrate the business case and mobilize private sector capital the sustainable forestry and land use sector. FMO acts as a program manager, both directtly financing companies and projects active in the sector, and indirectly by financing funds. The protection and restoration of forests is globally acknowledged as an important strategy to mitigate the threat of climate change and biodiversity loss. However, the sector also is perceived as high risk by commercial parties, and its funding is often limited to public or non-commercial actors, limiting the large pools of capital needed to significantly scale the companies and funds.
As such, MFF commissioned a study carried out by Terranomics which focused on understanding barriers commercial investors see when it comes to investing in this sector, and what funds and companies looking for financing can do to overcome them. To do this, they conducted a literature review, interviews and a case study to better understand the steps that funds and companies could take to attract more funding.
The overarching message from the report is that an impact narrative is not enough. To successfully create impact, businesses need to be financially sustainable. This means companies and funds need to have strong business models which specify the road to long term returns and a plausible exit strategy. In other words, the key barriers impeding commercial interest are financial. More specifically, this includes a mismatch in tenor preferences between investors and companies; the lack of strong fund and company track records; and low risk-adjusted returns and liquidity challenges. Another key set of barriers relate to management: this includes a lack of a proven track record and a competency gap, both in terms of financial expertise and relevant technical knowledge. Further barriers include structural barriers (such as the novelty of the sector and political risks in the countries relevant to the sector) and implementation barriers (related to ESG risk, inadequate impact metrics and uncertainties around carbon markets).
While fund managers and company executives can be aware of some of these barriers, the interviews revealed that they are not sufficiently acted upon. Moreover, there are other barriers which funds and companies need to be aware of. These include high due diligence costs, the mismatch in understanding between investors and project developers on benefit sharing obligations, weak credit profiles or currency risk.
All is not lost: there are ways to mitigate and overcome these barriers, as outlined in the reports’ recommendations. Companies can give commercial investors more assurance by including detailed business plans and financial models which clearly disclose risks and offer support to make the due diligence as efficient as possible. Meanwhile, funds can engage with investors early on to tailor the fund vehicle to Limited Partners and build partnerships with NGOs to support a pipeline. Both funds and companies can find ways to diversify income streams, offering investor-friendly liquidity options, while paying attention to their hiring practices to ensure there is significant experience represented in the team.
These and other recommendations can go quite some way in diminishing the skepticism that currently may deter investors. At FMO, we believe all players active in this sector can make use of the recommendations in the report. While some may be more relevant than others depending on the starting point for each company looking for funding, there are interesting insights to be found for all. It is undeniable that being part of this sector means contributing to very ambitious climate action goals; if this report can help anyone to unlock more partnerships and funding to bring us closer to our shared target, it will have been worthwhile.