Startup pitching new type of bond to fix California’s wildfire and water woes
Deep in the Stanislaus National Forest, an hour’s drive from the foothill town of Sonora, two forests stand side by side.
One is open and airy, with light that streams through gaps between vast sugar and ponderosa pines down to an almost bare forest floor. The other is so dense with brush and smaller trees that little sun peaks through, even at noon on a clear day.
Standing between them during a visit earlier this year was a group of would-be financiers — an investment analyst, an engineer and a bond trader — who see potential profit in that stark contrast.
In the coming year, they hope to sell investors on a new type of bond that, instead of financing a corporate acquisition or a pool of mortgage loans, would address two of the biggest challenges facing California: fire and water.
The founders of fledgling San Francisco firm Blue Forest Conservation want to use the proceeds of what they call a forest-resilience bond to pay crews to cut down small trees, clear out shrubs and burn off ground cover in overgrown forests.
That thinning work would reduce the risk of destructive forest fires by removing extra fuel, and theoretically allow more water to flow downstream to reservoirs, hydroelectric dams, farms, and faucets, instead of being soaked up by plant life.
That would benefit the U.S. Forest Service, public water agencies, private power utilities and possibly other entities that rely on a healthy forest ecosystem — stakeholders that need to be persuaded to pay back those bonds, with interest, for the whole scheme to get off the ground.
“There are all these entities that benefit from the work, but there’s not really any money to pay for it,” said former investment analyst Leigh Madeira, one of Blue Forest’s founders. “If you can bring all those parties together and repay investors over time, you have a financial instrument.”
The Forest Service, which owns vast tracts of forest land in Western states, pays for thinning or restoration work, but lately has had to spend more on fighting fires than preventing them, a trend made worse by a drought that has killed millions of trees. Last year, firefighting accounted for more than half its budget, up from 16 percent in 1995.
The Forest Service estimated it did restoration work on 4.6 million acres of land in 2014 — but still has a backlog of as much as 82 million acres.
For Blue Forest’s founders, a September visit to the Stanislaus National Forest was a chance to see up close the difference between a thinned forest and an overgrown one. Crews in 2012 thinned out a section of the forest near the town of Pinecrest but didn’t touch an area along a dry creek bed.
“It’s unbelievable,” Madeira said. “In some forests, there are between four and 10 times as many trees as there used to be. Until you see it, it’s hard to picture.”
Which is why, when pitching potential investors, Madeira begins her presentation with a photo of a forest taken in the 1890s — when small fires were allowed to naturally burn off brush — and the same, much denser forest in 1993 after decades of fire suppression.
The images, she said, help audiences get past a common question: Why does a company focused on conservation want to cut down trees?
“People are unaware that we have so many trees and that that’s a problem,” she said.
What Blue Forest’s founders envision is the latest variety of a relatively new class of investments dubbed social-impact bonds, which channel private capital into programs aimed at addressing social problems.
When those programs meet their goals, governments pay investors back. But when programs fall short, investors lose their money. That’s why they are also called pay-for-success bonds.
The first program funded by a social-impact bond — one aimed at reducing recidivism at a British prison — kicked off in 2010. The first domestic project, another recidivism program, was launched in New York in 2012.
Last year, California’s first social-impact bond program, aimed at reducing homelessness, launched in Santa Clara County in the Bay Area. Blue Forest’s effort is among several new ones in the state under development.
Madeira, along with co-founders Zach Knight, Nick Wobbrock and Chad Reed, met while finishing their MBA degrees at the University of California at Berkeley last year. They developed their forest bond for a sustainable-investment competition sponsored by Morgan Stanley and Northwestern University’s business school.
They won and were invited to speak at last year’s Milken Institute Global Conference in Beverly Hills. There, they drew the attention of an investment officer of the California State Teachers’ Retirement System, a massive pension fund with hundreds of billions of dollars to invest. Though he made no promises, he said their idea was interesting.
“That’s when we realized we were on to something,” Madeira said.
Though state and local governments, as well as major philanthropic foundations, have been keen on the idea of social-impact bonds, the financing mechanism has its detractors.
One persistent argument is that they give private investors a chance to profit from what the government should be doing already. Jon Pratt, a bond skeptic and executive director of the Minnesota Council of Nonprofits, said the programs have only become popular because governments are chronically underfunded and there’s little will to raise taxes.
“Much of government has lost public confidence, and so this feels like a solution,” Pratt said. “It can feel like we’re going to get better results, and it’s going to create new money to do this work, which kind of sounds too good to be true.”