July 27, 2022

Are impact VCs chasing vanity metrics?

There’s a new debate in town — should investors tie their carried interest to their impact performance?

Bethnal Green Ventures

It seems a week doesn’t pass without a new impact fund launching. As the space hots up, so does the debate on the "right" way to do impact.

In the VC world, a mechanism hoping to answer this question is gaining more attention: tying impact performance to carried interest (also known as “carry”). This approach means that if investors don’t ensure their portfolio companies deliver the positive social or environmental outcomes they promised, they won’t get financial rewards when their portfolio companies exit.

But is making carry conditional on impact really a silver bullet? Let’s dig into it.

How ‘impact carry’ works

"Impact carry" usually works as follows. A VC agrees with their LPs (limited partners, the investors in a VC firm) how they will measure their portfolio’s impact. To do this, the fund manager works with each portfolio company to define between one and five impact indicators. They then put an estimated value on each of these indicators before the investment. On a yearly basis, the fund manager calculates and reports the "impact multiple", defined as the comparison between pre-investment targets and realised value. A VC’s carry is subject to the impact performance of the fund.


In a nutshell: this approach enables investors to put a number on their impact, such as 2x, in the same way financial performance is reported. 

An answer to mission-drift?

Tying impact to carry is designed to keep investors (and their portfolio companies) on the straight and narrow. While the financial viability of impact is no longer a concern, sceptics argue that startups won’t stay true to their vision of positive impact as they scale. This fear is otherwise known as mission-drift. 

Take Theranos, for example — a company that became more known for selling hot air and hype than accessible healthcare. Or consider Airbnb, which started out by pitching a new vision of tourism, one that benefited local people and their economies. Yet 10 years on, the negative connotations of the "Airbnb effect" points to how the company inadvertently increases property prices and causes damage to communities. 

Perhaps if their investor’s returns were contingent on these companies doing what they set out to, they would have been held more closely to account. In Theranos's case, there would have been more pressure to prove that their product worked. With Airbnb, a VC with stronger impact incentives might have worked harder to ensure the company stayed true to its intentions. 

A way to avoid impact-washing

As well as helping investors hold their portfolio companies to account, this approach can also help signal a certain level of conviction, differentiating real impact funds from impact-washers.

Impact investing is defined by outcomes that can be measured. Tech for good startups are set to become some of the most successful companies over the next decade, but only if they can prove their positive outcomes. For example, we’re increasingly seeing a backlash against ESG funds that market themselves as doing good for the world, yet in reality are doing very little. It’s vital we avoid that happening in the impact space. 

A hindrance rather than a help to portfolio companies?

While tying impact to carry answers some questions, it also raises others. Investors operating on this basis often want to be closely involved in setting their investee companies’ "indicators" on which they are evaluated. At BGV, we’ve heard from some founders that they’ve been pushed to adopt metrics which they hadn’t previously measured, nor felt were right for them. 

Adopting new metrics can be particularly problematic. In this instance, that "pre-investment" value can only be an estimation. Therefore it’s in an investor's interest to set it fairly low, so that they can report a healthy uplift after their investment. This becomes a sole pursuit of vanity metrics, accounting figures in a way that suits the investors, and not necessarily their portfolio ventures.

What else can VCs do to align performance with impact?

Reducing the impact of a portfolio to a single number certainly risks oversimplification. Not to mention the potential pressure on portfolio companies to adopt metrics that don’t suit them. So what are some other ways VCs can align their performance with impact? Here are three suggestions to consider.

Firstly, appreciate nuance. Become accepting of the fact that solving social and environmental issues is complex. Frameworks developed by leaders in the field, such as the Impact Management Project and the Global Impact Investing Network, explicitly advocate for qualitative measures. It’s vital to understand what product or service users are experiencing in reality and sometimes these measures need to be reported as stories, not numbers.


Secondly, put founders first. Trust that founders know their business better than anyone else. Of course, as impact investors, part of our value-add is to bring deep expertise in this area. But guiding founders is more productive than enforcing measures on them. Instead, empower them to develop their own impact acumen with guides or connecting them to specialists. 

Finally, consider involving independent evaluators. Just as financial accounting is expected to be audited, so too should impact assessments. Especially when financial incentives rely directly on them. For example, this could be done by creating an independent impact committee. Providing "checks and balances" serves a similar purpose to that of independent investment committees. 

At BGV we don’t currently tie our impact to our carry; instead we remain accountable by rigorously analysing and publishing our portfolio’s impact performance. And recent data shows that, far from mission-drift, our companies actually get better at impact as they scale.

As the popularity of impact venture investing only continues to grow, so too do the different approaches investors are taking. As for tying impact to carry, the jury's out. We don't necessarily think it's a silver bullet, but it's certainly a debate that we think will only get hotter as more pile into the space.