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The Circular Economy

Circular economy business models held back by lack of access to finance ... Banks are interested but funding is limited, crowdfunding welcomes the environmental benefits but has less cash and venture capitalists worry about risk

Burgess COMMENTARY

Peter Burgess

Circular economy business models held back by lack of access to finance ... Banks are interested but funding is limited, crowdfunding welcomes the environmental benefits but has less cash and venture capitalists worry about risk

Pile of dollars
Chicken and egg: circular economy businesses need to show good financial performance to attract investment. But without initial investment, how can they develop a track record? Photograph: Alamy

Companies buying into circular economy principles need to adopt new business models, in particular this means moving from selling products to selling services. In these business models, companies retain the property rights of products, which incentivises them to reduce environmental impact by designing for longevity.

Implementing and scaling these circular business models requires significant financial investment. While there is appetite from investors to meet these needs, there are also several barriers companies face when it comes to accessing finance.

Circular economy companies’ investment requirements are twofold. They must finance the ownership of products for a longer time than in a linear model, as the revenues from customers are linked to use or performance and trickle in over the lifetime of the product. Second, existing businesses moving from a linear to a circular business model need investment to change established systems, such as setting up a different revenue model.

The interest and ability of different sources of finance to meet these investment needs varies. Currently, debt is the primary source of finance to fund circular business and as banks account for the majority share of debt finance, improving their ability to finance circular businesses is crucial. But while banks’ interest in the circular economy is increasing, their actual investment in circular business models is still limited.

In the future, bonds can also be important financial instruments for circular businesses; the bond market accounts for the largest share of the capital markets. However, accessing the bond market requires that circular businesses mature and scale up to meet the market requirements.

On the equity side, there is interest and ability for crowdfunding to provide investment. A key benefit of crowdfunding is the ability to consider the environmental benefits of circular business models as well as their economic returns. Venture capital and private equity funds, which control much larger capital pools than crowdfunding, also invest in circular models, however, their requirements for high growth and relatively fast payback horizons can mean this source of finance is limited for circular businesses.

The current risks of the circular business models limit investors’ willingness and ability to translate their interest into monetary investment. The uncertainties around the residual resource value companies are able to capture from keeping product ownership has emerged as investors’ main concern.

The concern is that companies might not be able to cost-effectively repair, reuse and remanufacture products, and uncertainty about future resource prices mean that the comparative advantage circular companies would gain by buying fewer raw materials is difficult to estimate. In addition to the residual value risks, uncertainty around operational costs and customer acceptance provide additional risks.

The lack of data available on the magnitude of risks restricts investment, as performance data is required for investors to undertake robust risk analysis. It’s a challenging situation. Developing a track record on the financial performance of circular business models is essential to attract investment, however, track records cannot be developed without initial investment.

While some investors do finance circular business models already, facilitating the beginnings of a track record pool, most circular businesses are still at the pilot stage and not yet measuring financial performance. To solve the problem, non-commercial sources of finance, such as foundations and impact investment, could play a role, as they are less concerned with being able to fully compensate for the financial risks.

In addition to the investment barrier arising from the lack of track record, another problem arises from the way circular business models are currently communicated to investors. There is lack of familiarity with the phrase circular economy among mainstream investors. Also, circular business models are associated with sustainability, which for many investors translates into them being less financially attractive. This lack of familiarity with the circular economy concept can be addressed by emphasising the similarity of circular business models to other, non-circular, models.

While the concept of circular economy is relatively recent, many of the business principles the circular models incorporate are not new. For example, the shift from products to services and dematerialisation are trends that investors are familiar with, and can help them better understand circular business models.

This can help mitigate the lack of track record on circular models’ performance, as investors can proxy performance data by looking at similar models. Relating the circular models to similar, non-circular, models can also address the issue of investors negatively associating the circular economy with being primarily about sustainability.

The sustainability association can be reduced by companies focusing on presenting purely the commercial benefits of the model when pitching to mainstream investors, mentioning the environmental benefits only after the commercial strength of the model has been well understood.

Beate Sonerud is an MSc student at Imperial College London, fellow of the Schmidt-MacArthur fellowship on the circular economy, and a policy researcher at the Climate Bonds Initiative

The circular economy hub is funded by Philips. All content is editorially independent except for pieces labelled advertisement feature. Find out more here.

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