What makes an Impact Startup investable?

Impact_Startup_investable
The world of finance and investments has long been dominated by a single driver: Profitability. With the rise of awareness about major climate and societal problems, the changes in consumer behaviour, governmental policies and business ethics, investors are embracing the growing trend of impact investing, where financial gains and societal and environmental contribution go hand in hand.
Business as usual is no longer the answer in the current state of the world. According to Deloitte’s Human Capital Trends survey, 86% of millennials believe that business success should be measured by more than just its financial performance.
 
The younger generations want to be engaged in purposeful, mission-driven businesses, they want to make an impact through their work. This shift is leading to disruptive changes in the business world.
 
The drive for innovation comes from many different angles: productivity and efficiency, abundance and prosperity, justice and equality, sustainability and future-proofing.
One of the main catalysts for innovation comes from an ever growing group of purpose-driven founders, who see doing business as a way to bring society towards a better future, leaving a positive footprint behind.
innovation_society_impact
 
As we were exploring in a previous article about the essence of impact businesses, what makes these founders stand out from the crowd is their ability to solve challenging, meaningful problems, while creating sustainable, profitable companies around that mission.
 

Overview

 

Doing Good while doing Business

 
There is no single recipe for how to align purpose with profit
 
The way to turn an impactful endevor into a profitable business certainly varies from one industry to another and it depends on a wide range of factors such as geography, type of product, business model, intended level of disruption and certainly time horizon. While we will not be able to explore in depth all factors, it is worth making a distinction depending on when is the impact expected to be produced.
 
 
Short- to mid-term impact
 
Most of the impact startups fall into this category. We are talking about businesses that are built with the intention to start contributing to a given set of goals (such as decreasing GHG emissions, reducing plastic waste, saving tones of food, etc.) as early as possible.
 
Short_term_innovation
 
Business profile
 
It is fair to say that this is true for most of software-empowered and less sophisticated hardware startups.
These are the businesses that start building their prototype from the very beginning, while testing different market hypothesis with the goal of developing an MVP.

Examples of such businesses can be:

  • P2p marketplace for second hand items
  • E-commerce platform for sustainable products
  • Transport optimization software
  • Energy saving and distribution software
  • Reusing and repurposing of waste
  • Renewable energy production optimization software
  • Sustainable agriculture producer
  • Microfinance provider to distressed borrowers
Funding
 
There will be many nuances and differences across companies and industries when it comes to how much time is needed and the amount of investments necessary until having an MVP.
 
 
Longer-term impact
 
These are those disruptive startups that are tackling major problems by creating revolutionary technologies (as opposed to bringing an incremental evolution). We are talking about technologies that require a long scientific research in order to test their viability and real world applications.
 
Business profile
These are the type of solutions that bring real breakthroughs and that can bring us closer to solving major problems such as those related to climate change.
Research_development_long-term-impact
 
Most of the time this involves complex hardware solutions, which are also often referred to as deep-tech. Some other characteristics of these type of companies are:
  • R&D can take several years
  • There might be barriers of entry (IPs, patents)
  • They create entirely new markets (instead of ones that already exist)
  • They play with a lot of uncertainty
  • They represent a high-risk, high-reward investment opportunity
  • If successful, they have low- to no- competition
  • They are highly scalable

Examples of such businesses can be:

  • Development of new sustainable biodegradable materials
  • New efficient ways to grow food
  • Alternative energy generation and storage devices
  • Disruptive technologies to harness wind, tidal or solar power
  • Zero emissions transportation technologies
  • Revolutionary medical devices
Funding
 
Given the long time horizon, these endeavors are very capital intensive and take a lot of time until any return of investment can be produced. They often start in University labs, relying on existing grants for seed funding, before accessing Venture Capital or other institutional funding which can help them bring their research to an end, develop a prototype and start commercialization. Because of the time that it takes to bring these solutions to market, the type of funding required is often referred to as Patient Capital.
 
The type of investors that will be investing in long-term impact solutions might sometimes be different from the ones looking for more immediate outcomes. It is however also frequent seeing Institutional Impact Investors (such as VCs) looking for a balanced portfolio between both categories from risk and return perspective.
 
Before we dive into the specific topic of what Impact investors look for in a company, let’s have a clear definition of what Impact investing actually is.
 
 

Impact Investing

 
As we pointed out in a previous article about Impact businesses, Impact Investments are done with the intention to obtain financial returns, alongside generating social and environmental impact. 
The growing concern about all ramifications of climate change and major societal problems has profoundly changed the nature of businesses, employment, what we consume and – as consequence – where we invest our money.
Impact Investment in Europe is growing at a fast pace in the recent years. According to a study by State of European tech, in 2021, €8.8 billion was invested in European sustainability startups versus in 2020, when €4.7billion was invested.
 
It is important to distinguish between Impact investing and philanthropy (donations). The latter – usually done through foundations and private contributions – aim to make a correction, to alleviate existing negative externalities, while on the other hand, Impact investors empower businesses to proactively build solutions that can effectively compete with other businesses, being self-sustaining over time.
 
Impact_Investment
The financial return is fundamental part of the driving force behind impact investing.
In fact, according to numerous studies by the Global Impact Investing Network, the majority of Impact investors look for financial return at least as high as what they would obtain with alternative investment options with similar risk.
 
 

What makes an early-stage Impact startup attractive for investors?

 
When it comes to assessing a startup, Impact investors look for a wide range of factors. These will differ from one industry to the other and will be determined, among others, by the stage of development.
 
Unlike investing in public companies through the stock market,
investing in startups is not conditioned by hard metrics that can be extrapolated in time and compared across a given industry, but is mostly driven by intangibles.
Since it is hard to make general statements – given that every investor assesses differently – I will highlight below what are my particular criteria for investment. I will split them into three different groups, being these business-, human- and impact- related factors.
 
‘Hard’ Business factors
 
First and foremost, businesses are in the market to make a profit. Impact businesses make no exception and when going out there in search for funding, they must have a clear proposition of how their business will become successful and provide a return of investment (ROI) to its investors. Among others, following metrics are of relevance:
 
Market
 
market_business
 
There are many different nuances to consider when talking about the market:
  • Size: Having a deep understanding of what your market comprises is crucial to attract investors. It is then important to identify your Total Addressable Market (TAM – total market for your product), Serviceable Available Market (SAM – portion of the total market you can acquire with your business model and targets) and Serviceable Obtainable Market (SOM – % of the SAM you can realistically acquire). The definition and justification of your SOM will be the most important metric to present.
  • Growth: It is important to see how this market grows over time (in 5/10+ years horizon). This might be even more important than the market size itself.
  • Behaviour: Are customers predominantly conservative (i.e. healthcare) or are rather in the position to innovate (i.e. eco consumer products)? While conservative industries are rather harder to penetrate, they often present the best opportunities for those able to disrupt them with a creative, innovative approach.
  • Barriers to entry: This comprises the need of a large investments in order to get into a given market (such as building an infrastructure or an expensive hardware equipment), being subject to a specific regulation, the need of licensing, etc.
 
Product
 
The product is in the core of a startup proposition and although not the most important factor (the team and the market conditions are the main drivers for most of startup investors), it is a crucial component in any startup assessment. How good is the product? Has it already been tested? Does it really meet customer demands? Is it scalable? Institutional investors want to see some traction: prototype or MVP already built, first paying customers.
 
When it comes to Impact businesses, their products pricing might often imply some Green/Impact premium. How you present this price difference – so your customers can attribute this higher value to your product – will be critical to justify also in front of investors.
 
Another important element linked to the product – and specially when it comes to deep tech solutions – would be the ownership of Patents or any Intellectual Property.
 
Business Model
 
It is fundamental to have a clear business development / go-to-market strategy, while at the same time be flexible enough to change and adapt, depending on the feedback received from the market. It is a good sign to see founders having thought of the different target groups and distribution models (B2B, B2C, B2B2C), a proof of having an open mind and readiness to explore all available opportunities.
 
Scale
 
How scalable is this solution? Is it easily replicable in other markets? Is there any downside to scaling quickly? These are all important questions for any startup investor, who will assess this depending on their risk-return profile.
 
Competition
 
Having competition is usually a very good sign, proving that there is a market out there for your solution. The lack of it can be a bad sign, given that, even though there are some exceptional examples of great disruptive products creating entirely new niches, being a pioneer in a given space and creating demand from scratch is extremely hard to do. At the same time, having lots of competitors doing something similar to you is not a good sign either, unless you clearly differentiate yourself from the rest.
 
Funding
 
Funding_round_VC
 
Has the company already attracted any funding? Is it dilutive (equity-based, such as Angel Investors or VCs) or is it non-dilutive (grants, loans)?
 
Having institutional investors on board is a strong validation and it paves the way for other investors, too. On the flip side, giving up too much equity early on can compromise the future growth of the company and founders’ control over the business.
 
In regards to the non-dilutive funding coming out of grants or subsidies, it is an excellent capital injection that comes free of charge. This type of funding is fundamental for deep tech related startups, which need this fuel to support their early stage R&D, before they can become attractive for risk capital investors. Loans on the other hand can present a big constraint for a startup that does not have a secure or predictable income generation.
 
 
’Soft’ Human factors
Who stands behind the startup is the most important decision-making criteria for the vast majority of startup investors.
There are lots of factors to assess beyond the tangible ones. For some investors, these soft components of the startup assessment are even more important than those purely related to the business. We are talking about the founders, the team, the mission, the values, how the startup presents itself to the world and how it is perceived by the public.
 
Founders
 
As the driving force behind any venture, founders are startup’s main asset – even more in its early stage – far more important than the product they are building. Among others, what will be of concern for investors to assess, are the following aspects:
  • Founders with complementary skills: Investors seek for a well rounded team of founders that complement each other (i.e. the technical & product founder on one side and the sales & marketing on the other). As a rule of thumb, a founding team of 2+ is more regarded compared to individual founders.
  • Intelligence and specific knowledge: A deep understanding of the problem in hand and the industry.
  • Energy and perseverance: The stamina to keep going no matter the challenges that might be presented on the way.
  • Ethics and integrity: This comes down to practising what you preach and sticking to what has been promised.
  • Ambition: Where do you want to bring your startup 5 years down the road? Investors love ambitious founders dreaming big, although there must be also a realistic dimension to these aspirations.
  • Flexibility: Founders must be in love with the problem, but not with the solution, remaining flexible about changing the approach and pivot whenever necessary.
  • Customer centricity: Focus on the struggle that the customer has, rather than on the product.
  • Commitment: Are you dedicated 100% to the startup or is this rather a side-gig? Are there any differences in commitment among the founders?
  • Passion: Deep interest about the problem – maybe because it is a pain that you have suffered yourself or you have genuine curiosity about the topic.

Startup_Founders

While many people talk about the importance of having Product-Market fit, it is equally important to have Founder-Problem fit, which comes out of the intrinsic motivation and concern by the founder to solve the problem.
Early hires
 
The first employees are critical for turning founders’ vision into a reality. It is important to have them engaged and properly incentivized (not only monetarily), so that they can feel being part of something bigger than themselves. While this is difficult to assess from the outside, there are some points that investors will touch, such as:
  • Positions: What are the positions that you have covered first and what talent are you looking to attract with additional funding.
  • Equity: Do you have an employee option pool? This is a fundamental incentive for staff, by which they become co-owners and participate in the future success and exit of the company.
  • Dedication: Are they hired as full-time-, part-time- employees or independent contractors? While there are advantages to hiring contractors, a startup usually benefits more from having truly committed and well incentivized people in the team.
 
Advisors
 
One of the advantages of having Angel investors in pre-Seed and Seed stage – providers of the so called smart money – is that they often act as advisors that can steer the company forward, providing guidance and making valuable connections. Accelerator programs are another common place for founders to attract mentors and advisors since very early stage.
 
Having advisors with deep industry knowledge and broad network links can be a strong point in attracting new investors.
 
 
User satisfaction
 
Customer_satisfaction_business-startup-people
 
What is the early customers’ engagement with your solution and what is their appreciation of it? High Net Promoter Score, low Customer Churn Rate, real customer testimonials or excellent consumer reviews will certainly back-up your proposition.
 
Recognition
 
Receiving an industry or innovation award, winning a startup competition or a pitch contest, being rewarded for some contribution to your field – these are all strong ingredients ratifying your credentials in front of an investor.
 
Presentation
 
How you present your company to the outside world is another key component. Do you successfully transmit what your core values are? Do people understand your mission? Do you use the power of storytelling to reach people and convey your vision? Creating buzz around your brand in the media – while not a factor in itself – increases significantly your chances of arriving to investors’ desk in first place.
 
 
Impact Factors
 
Unlike their more conventional peers, Impact-driven startup investors will have – in addition to the above – another fundamental set of criteria to assess if a given company is worth an investment or not. While every investor might use a different system for evaluating and measuring impact, there are some industry accepted standards that most of organizations refer to.
 
The UN 17 Sustainable Development Goals (SDGs) are certainly the most popular, internationally recognized set of standards to reference impact. For the most part, impact companies announce publicly which of the 17 SDGs they aim to have an impact on through their work.
 
Being impact definition and measurement a complex process, it is worth shedding some more light on the topic.
 
Impact dimensions
 
A widely used system for impact measurement and management in the impact startup and investing world is IRIS+, developed by the Global Impact Investing Network (GIIN). According to it, the impact of your company on the Planet and People can be observed across five dimensions:
  • What: What is the outcome of your actions on the planet and people and how important is this to them?
  • Who: Who experiences this outcome and is this group of people underserved relative to the overall population?
  • How much: This comes down to scale (number of people impacted), depth (the degree in which this is life-changing to each impacted individual) and duration (for how long is the impact experienced).
  • Contribution: What would happen if the company’s solution was not on the market and if the impact would still take place (i.e. by a competitor)?
  • Risk: What is the probability that the impact may not be produced as it is envisioned?
SDGs_future-environmental_impact
 
Impact investors tend to measure the impact of a company based on its performance across all five dimensions as a fundamental part of their decision-making process.
 
Impact Measurement and Management
In addition to having clear impact goals, Impact Investors want to see what you are actually doing to measure impact and follow-up its achievement over time.
When approached by Impact investors, you will have to prove that your impact is verifiable, scalable and measurable. How shall you do this is an open question that no one in the industry will be able to give you a universal answer to. The reason for this is that there is still not a widely accepted standardized impact measurement system across the board.
The main challenge of impact measurement is that it is virtually impossible to measure it in a way that makes different startup investments comparable across portfolios and funds.
Unlike conventional venture transactions – where the financial unit is the Euro, the Dollar (or any other currency) – impact valuation has no single measurement unit of reference.
 
Therefore, the approach of investors to Impact measurement can be very different. Some of them will accept your own measurement approach, as long as you can provide solid arguments of the validity of your method. In other cases, Impact investors develop their own measurement standards and will request you to follow their given set of criteria.
Proper Impact management and reporting is very important for the industry in order to avoid self-inflicted reputational damage, due to the rising cases of green- and impact- washing.
According to a recent PwC research, over 75% of climate-related venture capital in the past eight years has gone to solutions that address less than 20% of potential emissions reduction. If we succeed in properly quantifying the potential impact of startups in this field, we will certainly do a much better job in deploying the right capital to those solutions that provide the highest impact over time.
 
Having said the above, considering the limited human- and time- resources of startups in their early stage, they cannot get too deep when it comes to impact measurement. With the intention to simplify what can be a very complex process and make it more practical, we can divide this process into following steps:
 
1. Identify

Define the social and environmental objectives, select relevant KPIs, and refer to existing industry & sector benchmarks. What most of impact companies do is linking their own set of goals to the corresponding SDG, expressing how and how much they expect to contribute to the problem.

Examples:

A given startup might refer to the SDG 2.1 – Zero Hunger – “By 2030, end hunger and ensure access by all people, in particular the poor and people in vulnerable situations, including infants, to safe, nutritious and sufficient food all year round” and commit to saving 100,000 children from malnutrition over the next 5 years.

2. Measure

Have a process for collecting and analyzing data through different methodologies, including user and customer feedback. 

Examples:

In a Green Mobility startup for example, this could mean assess how users changed their mobility behaviours over the past year, for example: -30% car usage, +300% walking, +100% biking, +30% public transport.

impact_mobility

In the case of a Food waste prevention platform, this might translates into rescuing 18,000 tonnes of produce destined to go to waste, enough to feed 39,250 people eat in a year, saving 1,929 million litres of water and 119,868 tonnes of carbon emissions (these are actually real figures, reported by Oddbox through last year’s report) 

3. Manage

Revise metrics, reset goals and update targets to make sure they align with your vision and stay relevant as you scale and evolve.

Examples:

In a biotech firm, producing biofuels for example – after significantly exceeding its yearly target of producing two million litres of biofuel – they might want to revisit their five year goal of CO2 reduction from 100,000 to 200,000 tonnes.

In the case of an agri-tech firm, producing alternative protein initially intended for animal feed – after pivoting towards human consumption – some of their impact targets would obviously change, including possibly now goals related to SDG 1 (No Poverty) and SDG 2 (Zero Hunger), in addition to other sustainability related initially identified targets.

 
4. Report

Monitor your impact over time and develop a proper reporting system, allowing concerned  stakeholders to visualize your impact performance.

Which is the impact that your startup has achieved in the course of an year?

Examples:

Maybe you have saved 200 patients, achieved a reduction of 30% of premature deaths, reached 200K of cost savings in children’s education, facilitated 40% reduction in poverty, created 300 jobs, saved 1 million tons of CO2 emissions…

Make sure you measure it and report it to your customers, investors and all relevant stakeholders.

impact_reporting_environmental

Commonly, it is expected by investors that Sustainability and impact reporting should be made available to them at least once a year.

It is of high importance to Venture funds and their Limited Partners to make sure that their investees stick to their promises, monitoring their intended impact (on paper) against their real achievements over time, as well as making sure they remain devoted to their impact mission as they scale and onboard new investors.
 
Impact investing is still in its infancy and as new investors and institutions get on board, it is becoming ever more important to have clarity about the terms that qualify an investment as impactful. 
 
By the time being, while there is no one size fits all approach, it is important for impact startups to set their impact goals early on, so to avoid running the risk of falling victim to the greenwashing filter. 

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