Venture Capital/Opinion/

VCs, stop figuring out how to measure impact — just start having some

VC doesn't need a definite set of rules for measuring and tracking impact, just a few decent principles.

Jonathan Eade and Christian Walter

By Jonathan Eade and Christian Walter

VCs and LPs are finally opening up to the idea of non-financial returns, in particular to ESG and impact factors. But when it comes to working these factors into their operations, there’s still a lot of confusion.

What does impact mean? What role does ESG play in the impact discussion? And most importantly, how should we measure and track impact? 

Unlike in public markets, we do not need a definite set of rules in VC for measuring and tracking impact. Allowing funds to create and adopt their own rules will encourage diverse, innovative investment approaches as we shift from an industry solely aimed at financial gains to one that works towards a positive outcome for people, planet and profits. Younger investors, who are very focused on impact, will likely be important drivers in innovation here. 

We simply don’t have the time to negotiate a common VC framework.

There is no time 

First of all, we have less than 10 years to achieve the United Nations’ Sustainable Development Goals (SDGs), and we have until 2050 to achieve the Paris targets — though accountability timelines may need to be longer. And we’re already failing to reach those targets.

We simply don’t have the time to negotiate a common VC framework.

Instead, we should utilise the frameworks that the financial and impact industry has been developing for over a decade and adopt a few best-practice and baseline principles that we outline below.

Second, it would be extremely difficult to create an all-encompassing set of rules for the VC industry given its diversity. VCs have an inherent need to differentiate their approaches to find an edge to raise capital and stand out, and thus have embraced a multitude of theses and approaches. Players should be able to pick and choose impact themes and topics most applicable to their investment strategy and model. 

Make your criteria clear 

The industry needs no more than a few decent principles, as we alluded to earlier. These will make it harder for VCs or startups to have an excuse for not having impact guidelines, since the market will expect these to be disclosed in the future. These principles will also help build trust and simplify comparison. 

Any fund should have a clear investable universe and exclusionary criteria and make explicit any impact or sustainability objectives in the prospectus. The fund’s documentation should make clear to investors and entrepreneurs what may happen if a portfolio company pivots into an excluded area.

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Portfolio founders also need to be aware of the fiduciary duty of the investor to its LPs, which should in turn also help both keep their eyes on their triple-bottom-line outcomes and impact. 

And while non-impact investors might not want to add cumbersome terms to a term sheet, ideally impact investors, in particular, would bake their philosophy into the term sheet. The term sheet should include a pledge for transparency and obligate the founders to annually report:

  • Scope 1, 2 and 3 emissions — all direct and indirect emissions produced by a company
  • A comment on the theory of change and how you are affecting your environment through your actions
  • Double materiality  — companies should report on factors that influence the value of the business but also other stakeholders such as people and the environment

By now it should be clear that damaging the environment and the livelihood of people for purely financial gains is bad business.

There are no criteria as to what would happen if these went in the wrong direction, but an obligation to the board to be transparent should ensure that the original mission is not lost.

These simple principles can be applied by any VC — no matter whether they are primarily interested in creating impact or not. VCs already use exclusion criteria by focusing on certain industries and thematics. Adding exclusion criteria on bad business practice should be part of due diligence anyway — and by now it should be clear that damaging the environment and the livelihood of people for purely financial gains is bad business.  

So what are we waiting for?

Jonathan Eade works with a UK-based family office in Berlin focusing on earlier stage investing in the impact space. Christian Walter is a founding partner at SDGx, a global technology venture capital and advisory group aligned with the UN SDGs.  

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