Since 2008, nearly 700 billion US dollars have been invested by venture capital rounds in the US alone. Much of this capital went into building innovative, high-growth companies such as Airbnb, Uber, WeWork, and Salesforce.
The great thing about venture capital funding is that it enabled thousands of innovators to build their products and solve real problems, while creating thousands of jobs and some of the world’s highest valued companies.
Startups are being built in a culture that we all know: go fast, and break things. In other words, it doesn’t matter how you get there, it only matters that you’re moving.
In early 2018 we all read the headlines about the Facebook-Cambridge Analytica scandal. The company that claims to have a mission to connect millions of people worldwide has spectacularly failed at the very basic level: to protect the most intimate data of its users. This scandal, and many others that followed, are an outcome of the same culture that has created these companies in the first place: build and scale, without much respect for the real cost.
No one sets out with the goal of creating a company that fails to protect privacy or pollutes the environment.
So how did we get here? To look for answers, we need to go back to the basic question of how these companies are being built and funded.
Investment deals between entrepreneurs and investors are all constructed in a similar way. Companies generate new shares that they sell at a price that investors are willing to pay. The company’s valuation is based on track record, financial projections, and the size of the target market. In exchange for the investment, entrepreneurs undertake to deliver specific business goals, most often expressed in set financial results. This is not in any way revolutionary – companies have always been expected to generate profit for shareholders. But there’s one simple thing about such an economic model: When we only incentivize bigger financial returns, it’ll be the only thing we get. Whatever negative or positive impact is being created along the way is only a byproduct of everyday business. Facebook’s example is just one of many where, driven to create shareholder value, companies ignore any social or environmental impact they might have.
Henry Blodget, CEO and cofounder of Business Insider wrote three years ago that the only role of management in today’s capitalism is to generate bigger profit for shareholders. After all, the management team is accountable only to the latter.
So the question is, are we able to create companies that will be systematically equipped to create positive social and environmental impact and balance it with financial returns?
Impact investing enables companies and investors to establish a setup wherein expected deliverables are expressed not only in financial profit, but also a social or environmental impact. The important thing to remember: this is not philanthropy or charity. Impact investments are oriented at bringing financial profit just like any other investments.
Impact investing adds one more layer to the investment agreement, including impact goals alongside other business milestones. Depending on the terms agreed, reaching those goals can trigger different scenarios, for example activating additional financing or increasing interest rate.
This obviously adds to the complexity of investment agreements. How do you balance the importance of financial goals vs environmental/social returns? What happens when a company reaches impact goals but not expected financial results? Those are the questions that many investors are tackling, and the answer depends on individual cases.
Adding such impact goals is a paradigm shift. Companies’ decisions become motivated not only by the need to generate bigger financial profit but also reaching a set impact.
“Progressive capitalism is not an oxymoron; we can indeed channel the power of the market to serve society,” said Nobel Prize-winning economist Joseph Stiglitz.
Adding the impact layer comes with new obligations and responsibilities that go beyond typical relations with investors. While this might sound scary, it’s easier than you might imagine. Multiple venture capital and private equity firms around the world have implemented impact into their investment process.
The Global Impact Investing Network, the industry's leading think tank, sets core characteristics of impact investing. First, there is intention - where companies define their desired impact in exact numbers. Then, there is the transparent management of impact performance, where companies report on their impact to shareholders in a similar fashion to how they report financial statements nowadays.
If not treated properly, impact investing could be little more than a brand-washing exercise. That’s why we need transparency and scrutiny when it comes to how impact is measured and reported. Impact investing makes it necessary for us to redefine not only the way we invest, but also what the expectations are, and, in turn, how we define success.
Is it the 55 billion US dollars in revenue that Facebook generated in 2018, or is it the 87 million users whose profiles were exploited by Cambridge Analytica?
The last year or so has seen the creation of a number of impact-focused venture funds. Fifty Years VC, Social Impact Capital, Ananda, DBL Partners, SJF Ventures and BlueOrchard are just a few, and there are many more being built as we speak. Following the words of Matt Rogers, cofounder of Nest & an impact investor, who said:
A new wave of investors is looking beyond the common definition of success and for companies that will help us fight the world’s biggest problems. What bonds them all is not only the urge to fight climate change or gender inequality, or build financial inclusion, but the fact that they see those as an opportunity.
So what about the financial performance of impact-oriented investment assets? According to Global Impact Investing Network (GII)’s study of 71 funds, private equity impact funds are generating 5.8% internal rate of return, on average.
And while those funds aren’t using exactly the same model as venture capital, often investing only in emerging markets or in very narrow areas, they serve as an indication that impact might be a good investment, both in short as well as long term.
There is no doubt that upcoming social and environmental shifts will impact businesses around the world. Not acknowledging this can leave their investments unprepared for the seismic changes that are already occurring
Jeremi Jak is the Head of Impact at Neufund, where he leads research and development efforts around impact investing products. With a background as a marketing & communications expert working with top venture capital firms & startups across Asia and Europe, he also advises companies on their impact and ESG strategies.