The early stages of research I am conducting in the Technology and Public Purpose (TAPP) project on Venture Capital and Public Purpose, with support from graduate research assistants Nathalie Gazzaneo and Campbell Howe, has consisted of conversing with and interviewing venture capital investors and accelerators.
We have spoken to investors across geographies (North America, the EU, and Israel), size ($30M-$3B+ AUM) and focus areas (AI, deep tech, and consumer). Some of these investors are from corporate VCs and some identify as impact investors. The purpose of these conversations has been to learn how these individuals and firms:
- Consider impact or public purpose beyond or in parallel to their financial returns, if at all
- Assess impact or public purpose, if at all
- What they would need in a tool or system to better measure public purpose impact in areas such as environment, labor, inequality, human rights, civil liberties, democracy, diversity, privacy, safety, security, anti-corruption and governance) in their investments.
Our overarching hypothesis is: technology investors need a better system to analyze the public purpose impact and other long-term consequences of the technologies they are investing in, and how those analyses tie back to product market fit, growth and exitability or liquidity.
Venture capital spans across what I call the “impact to traditional investing” spectrum. On one side of the spectrum, there are the investors- who primarily focus on the financial aspect of the investments they make and are largely indifferent to impact or purpose. These investors’ responsibility to and mandate from their LPs is in financial returns. On the other side of the spectrum are [social] impact investors. Socially or environmentally conscious investing has grown considerably in the past few years, with billions of LP dollars flowing into funds that use ESG criteria or focus on broader areas of impact. Oftentimes, these investors have a directive from their LPs to consider the impact on society and measure specific metrics (GHG emissions, job creation, housing provided, etc.) to assess efficacy. In the middle of this spectrum are those investors who first and foremost seek financial returns but also consider broader mission or impact.
Climate tech is a perfect example of where public purpose, policy, technology, and innovation can create positive change and how people can easily identify on the aforementioned spectrum. Cleantech investing in particular has seen one of the biggest booms of the middle to impact side of the spectrum, despite the past trauma of the +$25b loss investors experienced around 2011. Stronger than ever, climate tech investing has seen a 3750% increase since 2013 with over $16.1B in venture funding in 2019. Founders in the space have proven climate and cleantech can have scalable, lucrative companies with pathways to exits. As money continues to go to climate tech, it will be interesting to see if these investors prioritize financial returns or impact on the climate. Or will climate tech investors push beyond climate considerations and examine additional consequences of the company or technology -- on issues such as privacy, inclusion, job creation, human rights, and inequality?
From the research we have been conducting, below are a few themes and observations that show up consistently and have been informing how we are mapping out our public purpose analysis tool:
- ESG vs. Impact. Frequently, VC funds and individuals use the terms “impact” and “ESG” (Environmental, Social, Governance) interchangeably. Investors who are deeper in the trenches seem to make a distinction between the two and how the terminology shifts in other industries. Some VC investors have defined impact as an investment thesis or criteria: looking for measurable social or environmental benefits embedded in a business model (e.g. a service that reduces greenhouse case emissions). Some use ESG as more of a risk assessment around the decisions and choices made within a business in areas like product, HR, supply chain, marketing, or sales (e.g. a company’s water usage or their hiring practices). A company could be following ESG guidelines but are not exactly impact investments.
- Frameworks & Methodologies. The United Nations Sustainable Development Goals are frequently but loosely used as a reference point or moral compass when VCs define their impact criteria or investment thesis. Despite the abundance of ESG frameworks and methodologies available, impact investors are relying on an amalgamation of organizations such as MSCI, GRI and primarily SASB to create their own framework that work for their firm. There also does not seem to be a framework that helps predict unintended consequences or assess public purpose.
While many frameworks emphasize how companies should report their impact and through which parameters, the effects of impact often remain siloed and separate from financial reporting and metrics. Some investors look at financial metrics, then assess impact. Others look at these two areas in parallel with equal weight or see it entirely interconnected.
- Long-term value for the public. Regardless of whether they use the term “impact” or “ESG,” nearly all investors care about the ultimate influence the technologies they invest in will have on all stakeholders. Impact or not, most investors seem to agree that a deeper level of scrutiny or diligence could be beneficial to both the company and to society. That said, at some larger funds, there remain some GPs who believe impact considerations are less intrinsically valuable but instead more relevant for marketing strategies. Particularly in the early stage, investors may believe that standards or disclosures take away from the art and science of investing. Across all stages, investors desire a personalized interpretation of “impact” or “purpose” or the ability to adjust a threshold for those areas. A varying interpretation is the “secret sauce” of a funds’ diligence criteria.
- Capacity. Time is a huge variable when it comes to how much investors pay attention to impact if it’s not core to their fund. Understanding the complex layers of impact -- the unintended consequences, impact on vulnerable communities, or economies -- is something that requires expertise, primarily in policy and social sciences, to fully understand. Oftentimes, funds will partner with experts from nonprofits or academia to create mission statements or selection criteria. Some larger funds also hire experts in ESG to help with measuring and reporting. Investors are also often worried that too much time spent reporting and tracking on impact is a distraction to their founders.
- Predicting the Future. Applying a purpose lens to investing at the early stage is hard because often the startup is too early to report on metrics or to answer long-term questions about their business model and supply chain. To make up for what is not currently there to assess, investors will apply a level of rigor in their diligence for scenario building and by asking future-thinking strategic questions. So much of early-stage investing is about selling a vision, a strategy, and asking founders to answer tough questions about how they plan to act and build.
“Uncertainty, generally, is something to be avoided. If you can’t predict the outcomes of your actions you will have a hard time planning and managing. And if others see that your business proposition is uncertain they will shy away from including your product in their plans. But uncertainty can also shield against competition, allowing you to create excess value. If it does, it is productive uncertainty. Innovations, because they are new, usually come with uncertainties of one sort or another. Founders have to choose the subset of innovations where the uncertainty is productive to have the best chance of succeeding.” - Jerry Neumann’s Blog. 11/23/20
- Decision-Making. Investors have said they would use a tool that helps them analyze public purpose in pre-investment diligence or for follow on consideration. There are investors who said they would use a tool to flag areas that they would want to monitor with the startup post-investment or areas of concern they would elevate if they were to take a board seat or board observer role. Some investors have said they would not abandon investments if the company steered away from their original intended impact, while others would not double down in further rounds if the company was not consistent in their original mission or if their choices were considered harmful to the public. Some investors have gone as far as to add language in their term sheets or soft commitment clauses to hold the founders accountable to the impact they promise to deliver. Investors recognize that there are inherent biases when it comes to making choices for new investments (faster to say no) versus the choices to follow-on existing investments (want to say yes).
- Theory of Change. None of the investors we spoke with who are interested in public purpose felt that the government, regulation or policy does not play a role in sustainable solutions. What varies is which key challenges are addressable through entrepreneurship or where business models could only act as Band-Aid solutions (or regressive distraction) as opposed to systemic change. Some investors recognize that there can be an opportunity with policy (e.g. climate tech). Some have heightened sensitivity to areas that are highly regulated or dominated by policy and/or government. Widely known, there are Silicon Valley investors who believe all of society’s issues can be solved by markets or technology or that regulation limits innovation.
- Growth and Time. Another area that does not have consensus is the timeline at which these changes could realize. Some investors agree that the expectation of the elusive “hockey stick” while being intentional about the impact or having thoughtful consideration of public purpose does not always align. Investors do not seem to think there is a trade-off between overall return and purpose, but instead, it’s about adjusting expectations on time. Some investors seem to think that moving too fast and raising too much money is actually counter-intuitive to what is needed for impact or public purpose. The Long-term Stock Exchange, a new stock-exchange making waves, has investors measuring success in years and decades and prioritizing long-term decision-making and value.
In our next phase of research, in addition to continuing our conversations with VCs interested in public purpose, we will be iterating on an MVP of our analysis tool and demoing it to investors and founders. We will also continue to think through thought-provoking and tough questions that will inform our research and tool:
- Is there a system that VCs or board members could have used to foresee and flag the issues at WeWork? That would have improved decisions around labor or congestion at Uber? Facebook and democracy?
- Can a VC realistically predict how technology might go wrong?
- Can a VC realistically assess 2nd or 3rd orders of impact?
- How will LPs respond if GPs add public purpose criteria to their otherwise traditional diligence process?
- How can VCs make sure the hard questions asked to startups for diligence around unintended consequences, public purpose or potential harms carry over to the board?
- Is there a point in having an impact or public purpose thesis if a fund is not asking portfolio companies to measure and report?
- When VCs are inconsistent in the methodology or metrics they use, and there isn’t one common framework used, how much of the burden falls on the founders?
- How are product-market fit, growth, pathways to exits, and valuations affected by impact or purpose?
- How can founders and VCs work together to assess public purpose and make appropriate changes to the technology or business model?
- Is VC investing the right model for public purpose in technology?
- How are VC’s close cousins (venture capital, project finance, equipment finance, etc.) being assessed for ESG or impact?
- How much do the personal values of a VC impact how they approach public purpose?
- What does it mean to self identify as an impact investor?
- How can public purpose considerations be used for public sector innovation and investments?
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