States of the union take the lead + Mast Reforestation's new biomass burial carbon credit strategy

It's Friday, February 27th. I'm Brian Walsh and welcome to this Week in Impact, where I talk with Impact Alpha journalists and editors about some of the most interesting Impact investing stories we featured this week. I'm back with editor David Bank. We'll discuss States of the Union. In a federal system, states take the lead on clean energy and the ownership economy, among other policy areas. Plus, small funds can lead to big returns in Africa and Arua Capital has the data to back it up. And finally, from planting trees to burying them, how mast reforestation pivoted in its efforts to generate high quality carbon removal credits. That's all coming up on this Week in Impact. Hi David, welcome back to the podcast. How are you doing this week?

0:00

I'm doing well, Brian. How are you?

0:48

I'm doing well. I got hit by the blizzard here on the east coast, so I extended my New York trip by a couple more days because there's still no power in Provincetown, where I usually live.

0:51

Well, I'm very happy that your dog is safe.

1:01

My dog is safe and sound, thank goodness. And the power should be back any day now. Speaking of power, this week was the state of the Union. But as our Amy Cortese wrote for us, we had the states of our union talking about local policy at the state level. David, what's up there?

1:04

Yeah, we listened in on the hour and 47 minute speech and I think it left many people kind of hungry for a little more policy detail, let's just say, and we have been tracking this state level innovation, there's Justice. Brandeis famously said states are the laboratories of democracy. They're also the laboratories of kind of innovative finance and innovative policy. So for example, in Utah, and this is not quite a state policy, but it is a public private fund, the Utah Dream Fund has kicked off and it helps first time home buyers make the down payment for their home. And it's a something called a shared or a fair shared appreciation note from a company called Homium that in a sense becomes the co investor in the home and puts up part of the down payment and becomes like a second mortgage. And what's different is there's no interest payment, there's no repayment at all until the home is sold or refinanced. And what's also different, and this is the fair part of fair share appreciation is that homium or the investors in this case the Utah Dream Fund get essentially their pro rata share of the home. So if they put up half of a 20% down payment and that's 10% of the home they own 10%, they don't own half the home. And that's different than some other programs that can be frankly extractive. So look for fair share, not just shared appreciation.

1:20

Yeah, so this Utah Dream Fund is all about expanding access to home ownership. But we've also looked at the ownership economy more broadly and looking at employee ownership. And that takes us to Illinois. What's happening there?

2:47

Yeah, Illinois has become interesting. It's kind of become the testing ground or the proving ground for this kind of state level innovation. I think California, sometimes seen as either an outlier or wacky or possibly toxic to some of the country. Illinois, kind of solid heartland state. And so just in this legislative session, there's something called the Wiser act, the Impact Investing alliance, as Fran Siegel wrote about that for us a few weeks ago, that's about human capital management, kind of disclosure of workplace conditions, compensation retention policies. And now we're learning about the Employee Ownership Development act that's now in the legislature there. And that would empower the state treasurer to, to invest part of the non pension funds that the state holds in employee ownership funds. And we've covered many of those in Impact, Alpha, APIs and Heritage and others that help finance these transitions to employee ownership. And this is a way to get some of the public money to flow into these kinds of funds to finance more of these kinds of transitions. There's a whole wave, people talk about the silver tsunami of baby boomer business owners retiring looking to exit. Employee ownership is a terrific option. There's not only the legacy aspects and the employee benefits and the keeping the business alive and operating and the goods and services it provides. There's also good tax breaks for both the business and for the exiting business owners. So there's a big kind of incipient or potential demand for that. These funds spinning up to try to finance those transitions and now trying to pull some public money into those funds to expand that whole opportunity.

2:59

And when you say public money, I think it's important to clarify here. We mean not necessarily government spending in the traditional sense of they raise taxes and they spend it on these kind of programs. This is the investment portfolio of the state. And the states are already investing in private equity or infrastructure and this is just now expanding the asset class to allow the state that invests in these other types of asset classes to invest in employee ownership as an asset class.

4:41

Indeed. And that's why folks think this will pass because it requires not a dollar of taxpayer money. As you say, it's really just an allocation within an existing portfolio of state money. And again, this is not retirees pension fund money. This is other state funds that the treasurer in that state and other places has purview over. But it is a solid investment and folks can make a good return. And it's, it is kind of a private credit play as opposed to a sort of equity and VC play because you're basically lending money to the employees to be able to buy the company and then they pay back the loan from the proceeds or revenues, profits of that company. And given if you do your due diligence on the company and it's a going concern, that's not a terribly risky bet. So solid investment for the state and then it has the secondary and even tertiary benefits, as I said, of, of, of making employees owners that has good retention and morale implications for the business, keeps the business operating, keeps it out of private equity's hands, keeps it out of foreign hands. People are sometimes making that argument now and gives the departing owner, you know, a chance to go to the golf course or the beach or what have you and enjoy the fruits of their labor.

5:08

Right.

6:25

So that's all in the benefits of employee ownership as the model. And this is just saying let's treat this as a serious asset class that folks can get into. And this is just saying let's have the public investment get into it as well.

6:25

Indeed. And that's why I think it's probably not that controversial. And employee ownership itself has a lot of bipartisan support. So this should as well.

6:37

Speaking of bipartisan support, let's move on to AI where there is some interesting red, blue kind of convergence on AI policy. Tell us about what we're learning there.

6:45

Yeah, AI regulation is actually a good example of this state level innovation because the federal government, particularly in the Trump administration, has essentially washed its hands. And in fact not regulating AI was kind of one of the things that, that the President ran on. And in fact in that big beautiful bill they passed a while back, there was going to be a preemption of all state level regulation of AI. The Senate bipartisan basis actually rejected that. And so now states are actually innovating with, trying to kind of get their hands around this AI juggernaut that's underway. And what's interesting is that Florida Governor Ron DeSantis has pushed through an AI Bill of Rights kind of data privacy, parental controls, disclosure on these AI based mental health apps, which people have, you know, raised concerns about what, what they're actually telling you or, or your kids, how insurance companies can you use AI to deny benefits how data centers, you know, the electricity and the water used gets the increased prices for that get passed along to consumers. So Florida has jumped ahead on trying to put some guardrails around this. And then California, possibly more predictably, has the AI transparency law. Some of these same kinds of disclosure, really just disclosure around safety protocols, standards, and then something they're calling a public computing cluster, a framework to give the public a stake in the AI infrastructure. Not just the public, big tech giants. So you've got Florida and California, unlikely allies or strange bedfellows, some might say.

6:55

All right, thanks for that policy roundup, David, on letting a thousand flowers bloom in the states of our union. You can read all about this on the Policy Corner section of impactalpha.com, we'll also have a link in our show Notes. Later on, we'll discuss mast reforestation's new approach to generating removal credits in the voluntary carbon market by burying dead trees for 100 years. But for now, we'll take a quick break. When we come back, small is beautiful. Arua Capital has the data on the big performance of small funds.

8:34

Sign up for Impact Alpha's free weekly newsletter Impact Alpha Open a crisp, expert curated investment briefing that lifts up people, data, tools, trends and job opportunities to help you stay ahead of the curve. Find the alpha in impact. Visit impactalpha.com open to learn more.

9:06

Next up, David Bridging the financing gap in Africa, Impact Alpha's Lucy Ngigi caught up with the founder of Arua Capital, a Lagos based growth equity fund, making an argument that challenges one of the default assumptions of institutional investing, that bigger funds mean better returns. So David, the argument is that at least in African markets, smaller funds can outperform and Arura Capital has the data. So what's this all about?

9:29

Well, it's been an article of faith among big institutional investors not to invest in small funds or first time funds seen as too risky or too much trouble or not high enough return potential. And so there's been a sort of gravity up towards bigger and bigger funds. This both starves the newer and younger fund managers just starting out, but also starves the companies that those smaller fund managers could support. So this is not just about fund managers raising funds. This is about the kinds of capital that businesses need to grow and bigger funds have to write bigger checks. And oftentimes the Companies can't put 20 or 30 million dollars to work. They need one or two or three million dollars. So this is particularly germane to Adesua Akonbo Rhodes at ARUA, who raised 20 million in her first fund, is raising 40 million in her current fund. And she went out and did the research and she went to Cambridge Associates and Pitchbook and Carta and collected all the data. She found that small funds up to $25 million and then mid sized funds up to $100 million achieved returns that were double that of the $100 million plus funds. So you can kind of have your cake and eat it too. Higher impact with these smaller funds and better returns.

9:55

And the reason here is that smaller funds expand that optionality that there's like more viable exit routes and faster capital deployment. Is that the theory you're hearing?

11:11

Yeah, Brian, it's all of that. I mean, often the early first time fund manager has staked out an innovative thesis, has worked up a pipeline, you know, it's in some sense they're putting their best foot forward. So this is their dream to be able to invest in companies like this. And also they're not, you know, competing with those big funds. So they have less competition, they can get better valuations in many cases and then frankly they can work with those founders in a much more sort of engaged way and make sure those companies are successful. So all that makes sense that these smaller fund managers would be able to outperform. The bottlenecks to that have really been structural. Like big institutional investors don't want to take up too much of a fund, so therefore they're kind of capped at how big their check is. And then if the check is small, you know, that is not really moving the needle on their big endowments or their big assets that they have to put to work. And so then they'd have to do many more such deals. That's more overhead and transaction costs. And so they just say we're going to stay out of that end of the market. And that has starved these smaller funds of capital. Here's Adesua on a recent agents of impact call.

11:20

You know, over the last 20 years there was a lot of excitement with, you know, the Africa Rising narrative, which meant a lot of capital got poured into a small handful of funds. And over time those funds have only gotten bigger, right? They haven't gotten smaller. So we have a number of large funds on the continent that are looking for large transaction sizes, but they're not a lot of companies on the continent that can absorb 20 million or 30 million or 40 million at once. And that's the typical ticket size of a majority of the private equity funds on the continent. But you do have a lot of companies that can absorb $1, 2 million or 1 to $3 million. But unfortunately there's not enough funds that are being invested in at that stage.

12:24

So what's the bigger lesson here about these smaller funds having that outperformance?

13:15

Well, I think there's a couple things that the market is kind of responding. One is kind of what people sometimes call wholesale capital. That's funds of funds, essentially, and other vehicles that can take the bigger checks, parcel them out to these smaller fund managers. That's happening. And then the other signal is that some of the bigger fund managers are actually starting smaller funds for the very reasons that we've discussed to get that kind of outperformance, to be able to go into the growth areas and the growth markets and work with founders. So Arua's analysis aligns with some of the trends and could be a pointer to the future.

13:20

All right, you can read Lucy's story about Arua Capital and how small funds might be beautiful on impactalpha.com there's also a link in our show notes. But for now, we'll take one more quick break. Coming up, how mass reforestation is burying dead trees in Montana to generate high quality carbon credits. Finally this week, our very own podcast producer extraordinaire, Isaac Silk joins us to discuss a story he wrote this week about the latest pivot in the venture backed carbon removal company Mast Reforestation.

13:53

Yeah, Brian, we dragged Isaac out from the producer's booth to actually write a story for Impact Alpha. So we're happy to see his byline this week.

14:27

Indeed. So welcome back to this side of the microphone, Isaac.

14:35

It's great to be back, Brian. Yeah, I was. This story caught my eye because I had never heard about burying biomass or trees as a form of carbon removal. So I got interested in this press release from last month where this company had buried a bunch of dead trees that were still standing and were selling credits on the carbon market on the back of that. But then as I look deeper into the story, which I thought was just a deal, it turned out it was sort of kind of represented something more about the carbon markets.

14:39

Yeah, Mast actually started as a drone powered reforestation play and the idea was to take these drones and drop seedling, these pucks as they call them, and reforest burned out areas or degraded areas and get the carbon credits. But that didn't work out that well, right, Isaac?

15:15

Yeah, David, it turns out that dropping, you know, these tree seeds from the sky was not a simple thing. It took sometimes Other times it didn't. And then, you know, the trees didn't always grow, the carbon wasn't always sequestered. So they had to pivot to a more reliable method to make sure the carbon was actually being sequestered.

15:37

Yeah, Brian, that's what caught my attention is sort of the tale of the carbon market. And the early credits were dependent on these trees growing out and thus sucking down the carbon. And those kinds of credits have become less appealing on this voluntary carbon market for the corporate buyers. They don't know whether they're really going to get that carbon savings. There's been a lot of headline risk, as people say, as some of these projects have turned out to be less reliable. And so this carbon removal market, of which this biomass burial approach is considered to be part of that, is considered a more robust and thus high quality and thus high priced carbon credit. So you can get kind of up to three figures for a ton of carbon on the carbon removal market, whereas on the carbon avoidance market, you know, it's languishing in the low single digits.

15:59

That's quite a, quite a difference in price there, because you get what you pay for, I suppose. So how does burying dead trees remove carbon from the atmosphere?

16:58

Yeah, it's definitely counterintuitive. But if you think about the carbon cycle, um, living plant matter sucks carbon out of the air and then it holds the carbon inside of its structure as it's living, and as it decomposes, it releases that carbon back into the atmosphere. So if you can keep the plant matter from releasing that carbon back into the atmosphere through the process of decomposition, then essentially you've sequestered carbon. So the technological sort of solution that people are working on, like Climeworks, is to use machines to suck carbon out of the atmosphere and then store it deep under the ground. This is a very similar idea. It's just using natural processes to suck the carbon out and then essentially bury them in earthen vaults or there's, there's several different methods that are in use by small companies around the country at the moment.

17:09

They, they promise that they're going to monitor these burial sites for 100 years. And, you know, I don't know who in a hundred years will hold them to that promise. But that is part of it, that they're going to have this monitoring. The other thing that was interesting to me about this story is how much money DroneSeed, now called Mast, has raised. Something over $60 million, I think. Isaac. And it's because it had that kind of techno sheen of drone Powered and kind of automated reforestation. Chamath Palapatia of Social Capital, known much more as a tech investor than really as a natural climate solutions investor, has backed both the Series A and Series B rounds and, and has really stuck with this company, you know, through all these pivots.

18:07

And so what is the technology here? I understood when they were dropping seed pods from drones, but is this just bulldozers burying trees? That's the innovation here?

18:55

Yeah, it's actually super low tech, which is kind of interesting for a Silicon Valley backed company. Right. But they're out in Montana working on these projects in these regions that have experienced a lot of wildfires and also have been experiencing a decrease in the number of forestry jobs. So they're hiring local crews, they're driving these bulldozers around, they're digging a big hole with. There's specific technical, you know, aspects to the types of soil, materials and placement of the sites and whatnot. But essentially it's just a big construction project. And what's kind of cool about it as well is that you literally just weigh the trees and then there's a calculation that you make about how much of a given tree would be carbon. And they put it on a big scale and they buried underground and they put on the top of these burial sites a monitoring system that's essentially like what you would put on the top of a landfill. And there's 247 continuous monitoring. So the scientists that I talked to about this said it was super legit. There have even recently been reports that through natural processes they found, you know, 3,000 year old trees perfectly preserved in the soil in certain places.

19:07

Yeah. One of my favorite quotes in the story was from the Nature Conservancy expert who said that when he first heard of this biomass burial, he thought it was the stupidest thing he'd ever heard of. And then he looked into it more and said it actually works.

20:28

Wow, that sounds tremendous. Groan. Okay. All right, well, you can read Isaac's story on mass reforestation on impactalpha.com there's also a link in our show notes, but for now, that's going to do it for this week in Impact. Thank you, David.

20:40

Thank you, Brian, and thank you Isaac for both writing and producing.

20:56

Thank you guys and thank you all for listening. This week in Impact is a production of Impact Alpha and part of the Impact Alpha podcast network, Smart conversations by and for impact investing professionals. For exclusive stories and insights about the world of impact investing and sustainable finance, join thousands of other agent of Impact by subscribing just go to impactalpha.com subscribe for full access. Thanks as always to our producer extraordinaire, Isaac Silk. For David Bank, I'm Brian Walsh, managing director of the impact advisory firm Human Nature. We'll see you next week for more impact.

21:00