A Beginner’s Guide to Impact Investing
Venture Capital is often viewed as a “growth-at-all-cost” sector or a race to make the most money possible. But in recent years more of the sector has focused on investing in companies that can make a positive impact on society.
As environmental and social problems have taken center stage, there has also been greater demand from customers and stakeholders for corporations and businesses to do more than just turn a profit. Are you passionate about VC but also want to do some good in the world? Impact investing could be the perfect career path.
Here is a beginner’s guide to this increasingly popular sector of VC.
What is impact investing?
Generally speaking, impact investing means investing in companies not just for financial gain but also to help solve environmental, social, or governance issues in the world. This may sound common now but in the past charity and philanthropy have really been separated into different categories from VC or business.
But with issues like climate change now becoming a huge threat to humanity, we all need to battle these issues. It is also much more common to see charities and philanthropic organizations run more like a business in order to achieve the largest impact possible and sustainability. This is really the inspiration for impact investing.
What is the size of the market?
According to the International Finance Corporation (IFC), a member of the World Bank Group, there were nearly $2.3 trillion of impact investments made in 2019 (under a very broad definition of impact investing). However, this included roughly $1.34 trillion of investment managed by public development finance institutions.
Of that $2.3 trillion, there were $308 billion of private impact investments made from the likes of VC firms, private equity, real estate, private debt, and more. And in 2020, the Stanford Social Innovation Review estimated there were roughly $715 billion in assets under management devoted to impact investing.
The IFC thinks the size of the impact investing market could grow to $26 trillion if nurtured correctly, although there is a wide discrepancy in what counts as an impact investment. But the takeaway here is that there is massive potential in the space.
Biggest players in the space
Before we jump into some of the qualities and characteristics of an impact investment, let’s first take a look at who the big players are these days. Some notable impact VC firms include Better Ventures, Obvious Ventures, Reach Capital, and VIAGlobal Ventures.
A good example of an Impact fund is Better Ventures, which is a certified B-Corp, meaning that the fund’s social and environmental impact is part of how the fund measures its success. B-Corps are certified and must meet many requirements, so it’s not just a title.
Better Ventures writes checks from $500,000 to $1.5 million and invests in a range of companies. From those creating alternative meat to companies attempting to further develop business activity in Africa to those trying to improve the environment. Better Ventures also has a public diversity goal where it looks to invest in portfolios with founders that are 50% female, 10% Black, and 10% LatinX.
Impossible Foods, with its meat alternative is one of the most popular examples of an impact startup. Some might consider Tesla one as well, given what its done for the electric vehicles industry (although there is certainly debate here).
Some other lesser-known impact startups are the surplus food management startup Goodr, Persefoni, which leverages artificial intelligence to help companies measure their carbon footprint, and Aspiration, which provides environmentally-responsible retail banking and investing capabilities.
4 characteristics of impact startups
1. The first one is passion. If you’re an investor, you want the founder and their team to care about the issue they are trying to solve on a deep level. Whether it’s helping to solve the climate change crisis or social for something related to diversity, equity, and inclusion.
The team should actually know a lot and clearly understand the issue they are trying to solve. If they don’t seem passionate and are just there because they see an opportunity to make money, this may not be a good fit because the goal is to make a positive impact on society.
2. That said, you also don’t want a company too far on the other end of the spectrum where they don’t have a clear and sustainable business model. This can often be a reason why charities or nonprofits don’t have as big of an impact as they might like.
You are still investing in a business that needs to be able to make money to grow and have a greater impact. After all, you have investors that you as a VC need to generate returns for. But perhaps more importantly, what good is an impact startup if it goes out of business in two years. There needs to be a healthy balance between social impact and financial stability.
3. Look for founders and teams that set clear goals and have a clear methodology for evaluating their performance. For instance, a startup with a stated goal of improving the environment is far too vague. But if that team says they would like to reduce the amount of carbon generated from meat packing plants in Texas by X amount, that’s a much more intentional goal that can be clearly evaluated.
Also, some environmental issues are extremely large so you want the startup to set a realistic goal they can achieve and then ramp up. You don’t want a startup biting off more than they can chew and getting too overwhelmed.
4. Do your companies practice what they preach? For instance, if you are backing a startup focused on DEI efforts, is the team actually diverse? If not, that likely isn’t sending a good message to the broader market. Or if you are working on some kind of environmental impact to reduce trash, is your company recycling? It may sound simple but it’s important to practice what you preach and send a positive message to those following your company.
Think about portfolio diversity and risk
Remember, impact investing is still a business (and not an easy one at that). So, if you are managing a portfolio of impact startups, think about risk and diversity. It may not be the best practice to have all of your startups focused in the solar industry. What if the price of panels goes significantly higher or lower?
There are also segments of impact investing that could be riskier and more complex than others. For instance, investing in startups trying to make an impact in Africa could be riskier than an electric vehicle company or a startup that focuses on housing issues in the U.S. Like any other VC fund, you have to think about the portfolio as a whole but luckily there is a wide arrange of opportunities within impact investing.