Impact Investing
By: Damian Felchlin
Tags: Sustainability, Venture Capital, Impact, Investing, Impact Investing

This article is the first part of an impact investment series, which dives into different topics including impact venture capital, impact reporting, impact evaluation, best practice examples and pitfalls.

From Shareholders to Stakeholders

Headlines like “Will the rich keep getting richer” or “unemployed face bleak choices” have been part of our daily lives ever since. Considering the fact that the top 1% of Americans have more or less the same wealth as the middle class, we need to question our current system.

On September 13th, 1970, Milton Friedman wrote an article for the New York Times titled “The Social Responsibility of Business is to Increase its Profits” and pushed companies to disregard stakeholders and instead focus on creating value only for their shareholders.

For the last forty years, we have seen share prices soar and investors accumulating more and more wealth. The low- and middle-income class, on the other hand, have been left out and earn less money today than in the past.

The finance industry built a system around Friedman’s doctrine by ignoring the entire ecosystem. However, to create a more inclusive and sustainable world, we need to take into consideration all stakeholders when investing in companies.

Emerson provides simple but important guidance: “Do not go where the path may lead, go instead where there is no path and leave a trail”.

Heeb took this recommendation to the next level and summarized three options investors have. He claims that investing money in established funds and companies provides only limited to no impact at all. Instead, money should be invested in underestimated founders and young companies, which struggle to get access to capital.

Venture Capital and its path towards impact

Venture capital is an institutional investor asset class and a proven vehicle to provide startups with capital. Venture capital funds deploy money in early-stage companies, which either have a business idea, a first prototype, first sales, or are established but still growing and often not yet profitable.

However, the traditional venture capital model has a limited investment horizon (usually 5–10 years) and requires the startup to grow and exit (acquisition or public offering) fast. This can lead to unsustainable behavior, and companies end up striving for profit, only leaving out an impact.

Over time, however, disruptive venture capital funds have emerged, generating financial returns and creating a positive impact. Space is still in its infancy with a wide variety of models.

Global Impact Investing Network (GIIN) released data in 2019 stating that worldwide, 1,340 organizations have US$502 billion impact investing assets under management. Of all the impact assets, more than 50% are managed by 860 asset managers in venture capital, private equity, fixed-income, real assets (like timber and real estate), and public stocks. Generally, 27% are managed by 31 development financial institutions (e.g., banks), foundations hold 2% and 24 family offices hold about US$1.8 billion (less than 1%). The majority of the assets are located in North America, whereas 21% are held in Europe.

Financial and impact returns go hand in hand

Cambridge Associates, a leading developer of financial benchmarks, and Global Impact Investing Network, which is promoting impact investing globally, collaborated and released the “Introducing the Impact Investing Benchmark” report in 2015.

The study looked at 51 impact funds, of which 19 were venture capital funds, and compared these with 401 traditional non-impact VC funds (comparative universe). Even though traditional venture capital funds usually target an IRR of around 20% and more, only 11% of the comparative universe achieved returns over 20%. Overall the study concludes that market-rates are possible in impact investing and funds, including private equity and venture capital. Funds launched between 1998 and 2004 have even outperformed funds in the comparative universe. Smaller impact funds ($100 million and less) show the strongest performance by outperforming the comparative universe by 5% (9.5% vs. 4.5%).

Graph: GIIN, Cambridge Associates; Introducing the Impact Investing Benchmark, 2015

The future in Impact Venture Capital

Impact venture capital funds need to work harder than traditional VC funds. Impact venture capital funds need to not only implement the same rigorous risk management as traditional funds but also come up with sophisticated impact frameworks and reporting tools like Vox Capital to achieve competitive financial returns and create a positive impact.

Providing impact entrepreneurs with capital is certainly important. However, a fund also needs to provide ongoing support in strategy, operations, fundraising, or HR recruiting as impact fund Omidyar does.

Impact investors need to realize that a founder with in-depth expertise in a particular area does not necessarily need to be fluent in software development or marketing as long as the founder receives the necessary training and support.

A fundamental question is if venture capital is the right source of capital for a startup. Unfortunately, too many startups are being pushed towards traditional venture capital money, which requires fast growth and quick exits, disregarding impact most of the time. Instead, investors should provide the right kind of capital based on the startup’s goal and stage. Institutions and individuals like Indie.VC or Cathy Clark, Director of CASE, addresses this issue by providing alternative sources of money and venture capital models.

Overall, venture capital impact and financial analysis reports show that Heeb’s investing in young impact companies’ thesis can create a positive impact.

Fortunately, due to the current COVID-19 crisis and the Black Lives Matter movement, we see more and more funds entering the impact investment space. Hopefully, soon, a majority of private equity and venture capital investors apply impact frameworks.

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