How to measure the climate performance potential of startups
By: Danijel Višević
Tags: Climate Change, Performance, VC, Impact Investing, Investors

Suddenly, everyone in VC is talking about CO2 drawdown potential. As a more general trend, public markets and corporations talk about ESG and jump on purpose-driven communication. Probably that’s the capitalistic response to ill systemic developments that drove us into crises of mental health, resource depletion, human exploitation, climate change, and arguably even a pandemic. These crises will put our society in an even greater state of shock, changing our lives significantly, even taking too many of them. Since time is of the essence, maybe we should embrace the capitalistic response and guide it better.

When it comes to climate change, we’ve argued in this Sifted piece why it’s essential to care about climate impact metrics: it’s crucial, not just to the planet and the people, but also for investors seeking superior returns. This is the thesis in one sentence:

Climate performance is a predictor of financial performance.

Therefore any climate VC that cares about financial returns should assess a startup’s CPP (climate performance potential) before investing. But still, no one does it. Investors and startups lack a common lexicon for discussing and achieving impact.

We’ve been talking to many leading experts to make up our minds about the role of assessments for investors. So now, let’s talk about how we can leverage these assessments today and accelerate their development.

Why it’s tough to talk about climate performance potential

To introduce best practices to estimate CPP and advance climate assessments, we first need to look at current bottlenecks — why is it so hard to make them?

The complexity of climate models, societal, and economic change

If you want to assess a technology’s, say, avoidable emissions over the next 20 years, you can rephrase that as

or, equivalently, if we assume the evenly distributed impact per product on the system across time:

So, we need a crystal ball for a tech product’s sales, the target market, the tech’s influence on that market, its climate footprint, and interrelations with other solutions, in particular, some serious climate science. That’s a long list!

All of this further depends on how our society will change over 20 years. (Would you have predicted 20 years ago mass phenomena like TikTok or Clubhouse? Or even two years ago, a pandemic?)

These are complex problems with a lot of uncertainty. Ideally, we’d get the best scientific consensus for a specific tech, but that might not exist. And even if there are some papers, how will an investor go through all of these to make up their mind?

Well, you can see that most assessments enjoy a relatively low validity. Assessment tools that have tried to solve this have often failed due to the complexity or remain premature.

There are many potential ways of impact of a startup

So, how do we measure “climate performance”? Every being, society and every organization has a footprint. And it’s a multidimensional footprint with interacting dimensions connected through real-world climate and societal effects. A company can directly affect biodiversity, ocean health, carbon emissions, or even vulnerable communities. That can happen through their product, their operations, or their supply chain. Depending on where these impacts occur, we call them Scope 1, 2, or 3.

Focusing on only one dimension can be, as in every other region of life or business, at the cost of another.

We can find examples easily: on paper, it seems like having efficient cookstoves in Africa reduces emissions significantly. But giving them for free (through aid or Atmosfair offsets) can harm the local economy and prevent job creation or tax income, which is not sustainable. You can also find a manifold of examples for tree planting doing more harm than good. And we’re sure you’ve heard of the rebound effect…

Climate breakdown is colonial in nature; solutions can’t be. (Source)

You can’t compare apples and pears

Now, let’s say we have two tech startups working on two different problems in entirely different sectors. Which one do we assume to be more impactful? How can we even start to compare them? Even if we had some quantified dimension, e.g. the GHG drawdown KPIs, and reduce the problem to benchmark their emissions reduction potential purely, how would we go about it? How do we account for competition? And what is the business-as-usual scenario we compare it with?

And if you want to have it even more concrete: if, as an investor, we have the decision to invest x resources in a startup A at valuation y in stage z of an oversubscribed round, how do we compare that to investing i resources in a startup B at valuation ii in stage iii with little investor interest, given that the impact potential is similar/different?

(Hint: an investor’s contribution to its investee’s impact is called “additionality”. Only investing in startups that would not get investments otherwise is called catalytic capital and can be considered high additionality. Here’s an interesting HBS Case Study looking at Prime Coalition who pioneered catalytic capital.)

It is, and remains, not the most important thing about a startup

In all the rising impact of data fetishism, let’s calm a bit down and note that it is just a data point in the bigger picture. Not a deciding one, but rather a qualifying one.

Particularly for early-stage startups, the team’s ability to execute on their purpose-driven vision (incl. pivots) and the business model’s ability to solve a pain for customers today remain the most decisive factors of success. The team will only achieve the climate potential if the startup scales!