Focus on Impact Investing 💸🌳
Welcome to the second session of our series about Impact! This week, we deep-dive into …
💸 Impact Investing
“It sometimes doesn’t seem concrete because of the nature of investment itself. Investors don’t make the impact but finance it.”
The session aimed to demystify impact investing, understand its principles and explore its different frameworks and concepts.
Enjoy the read!
Presentation of our guests
Baptiste Fradin is an entrepreneur and an impact investor at Famae Impact. He began his entrepreneurial journey at 18, starting a nonprofit to tackle environmental issues. His first startup, a tech company, was not in the impact field. After selling it in 2017, he focused entirely on environmental issues, which he has always been passionate about. He created an environmental fund called Climate Impact that exclusively invests in companies developing positive solutions for the planet and protecting biodiversity. He recently took on a new role as general manager in a startup studio where he can be more involved with impact entrepreneurs, providing them with advice and resources to grow their companies, whether they are early-stage startups or scaling up, but always with a positive impact.
Sybille Ranchon was part of the second French cohort of baby vc. She works at Serena, a generalist venture capital firm that has diversified its investments to cover AI, retail gaming, and impact. She often invests in climate topics with the generalist fund but is more focused on Racine2, Serena’s Impact fund. It’s a joint structure that started a year ago in collaboration with MakeSense, which has ten years of experience supporting entrepreneurs who aim to tackle societal challenges. The collaboration between Serena and MakeSense aims to demonstrate the scalability of impact by startups. They have already invested in a few companies which include Helios, a Fintech echo bank; may, a parental app; and Lokki, a marketplace that enables retailers to rent their products.
Felix Ferstl was among the first to join Ananda Impact Ventures after the partners established the fund's environmental and climate tech side. He has a strong interest in the intersection of impact and entrepreneurship, which he developed when he created his first startup that aimed to facilitate sharing of teaching materials among teachers. Ananda was built 13 years ago to demonstrate the feasibility of blending financial returns with impactful outcomes. In 2023, Ananda is managing its fourth fund with €108 million dedicated to investments from pre-seed to Series A stages across Europe. They are an agnostic impact fund, investing not only in climate tech but also in sectors such as education, healthcare, elderly care, and diversity & inclusion.
Defining Impact Investing
🔢 The role of defining the impact created by a company:
Impact relates to the fund’s activity and its mission. It is not yet regulated.
It can be distinguished from ESG (Environmental, Social, and Governance) factors, which relate to achieving your duty, deal with the different stakeholders, and are regulated.
Baptiste emphasised the need to define the impact, whether it is measurable and ensure that negative effects are well managed.
❓Example of what each of those key dimensions could be:
What: Desalination through investments with solar panels
Mission, Impact: Enable people to drink where there is no water, without the need to transport water
Negative externality: When doing this desalinisation, there is waste. If it is thrown away in the ocean, it kills all species because it is too salty
So, in theory, the more water desalinated, the more impact, but we need to ensure the externalities are well managed.
👀 Therefore, the analysis grid before an investment must be carefully adapted to impact as many regulations do not yet exist, and awareness of those topics is needed. Both Sybille and Baptise mentioned that entrepreneurs should be opinion leaders to be able to drive this awareness. → For example, Racine2 invests in education, sports and climate. So the impact is inherently in the business of the companies.
Impact requires additionality, intentionality and measurability when achieving the mission. In particular, Sybille defined 6 criteria for assessing impact:
Intensity: While for traditional investments, we would size the addressable market; here, it’s the same but for the impact process and consequences ahead
Newness: Is it new? How is it positioned in the ecosystem? Is it a leader, a follower, or an enabler?
Relevance: How relevant is the impact? Can we quantify the impact resulting from the solution?
Accessibility: In terms of price and technology (for example, for a smartphone app)
Value consistency: More about internal and ESG values, is the business a B Corp company, a mission-driven company…?
Negative externalities: Total impact the business can have (not just the positive impact, can be direct or indirect), called Principal Adverse Impact indicators (PAI) and used to measure all the business risks.
🤝 Navigating the tension between the need for reporting impact metrics externally and the unique impact goals of each investment
Felix & Sybille agreed that comparability is important for reporting KPIs (key performance indicators) for specific investments. However, they noted that there is still a lot of subjectivity and that each case is specific to the type of impact it produces.
💡 Each fund should support portfolio companies in obtaining mission-driven company certification, as it’s a great starting point for defining impact KPIs when the way to measure impact is not regulated in itself. This involves clarifying the company's mission and then identifying the targets and indicators associated with this mission. This process aids in understanding and quantifying the impact.
Impact KPIs should align with operational ones so they aren't viewed as external financial ones and that reporting these doesn’t become a burden task for the company. This helps make them more tangible and actionable, as a tool for daily operations, much like financial discipline is. For example, a key aspect of Ananda’s investment strategy is ensuring that the impact of a company is intrinsic to the business model, negating potential conflicts of interest.
❓Example: Racine2 and Ananda linked their carried interest to achieving specific impact targets, showing commitment to the financial side of their portfolio companies and their impact. This is done with the help of an external entity, ensuring impartiality in defining KPIs.
🤔 The difference between outcome, impact and the role of counterfactuals in investments:
What's crucial to remember, especially in this initial stage, is that concrete data may not be readily available. Thus, relying on counterfactual data or trying to calculate potential outcomes is both time-consuming and speculative.
❓ Example: Ananda’s approach primarily focuses on the intention in the context of early-stage investment. They invest in nascent concepts or products, understanding that there are unknown variables, such as how the startup will evolve or what the alternative scenarios could have been. Essentially, it requires looking twice into the future: once for the evolution of the startup and once for the evolution of the market. Since no one has a crystal ball, certainty is impossible.
During the assessment process, it’s important to identify whether the startup we're investing in addresses the industry's key bottlenecks. This can be done through rigorous studies and expert interviews.
Measuring Impact
🖇 The concept of double materiality:
It is now widely accepted that information about climate impact on a company are important and therefore requires disclosure. The concept of double materiality takes the concept one step further and recognises that the impact of a company on climate or any other specific dimensions of sustainability should also be reported.
Companies can focus on measuring and reporting a smaller set of material social and environmental issues that are most relevant to their core business activities and stakeholders concerns, rather than attempting to cover all possible dimensions.
Each sector has unique key performance indicators (KPIs), so it's challenging to consolidate all these diverse metrics into one comprehensive measure.
🥇 Is there an priority or hierarchy between all possible forms impact can have/is measured?
For climate-related missions 🍃, Baptiste introduced one approach which consists of using an equivalent of CO2 emission as a main KPI, which can then be presented to LPs. However, this isn't a straightforward process as this metric is not always relevant to a startup activities.
❓Example: Famae's reports begin with a standardized measure, but they go into greater detail with individual metrics for each investment.
Another approach is to use the planetary boundary framework instead of a specific KPI. This framework encompasses nine planetary boundaries, including CO2, water, biodiversity, etc. The idea is that overshooting certain thresholds in any of these areas can trigger environmental tipping points. Thus, if an investment addresses one or more of these nine categories, it could be considered for investment.
Baptiste mentions using the European Taxonomy as a critical framework for their investments. This taxonomy aids in determining the sustainability of an investment, which can be challenging when working independently. He values this framework's standardisation, promoting clarity and delivering universal information.
For social impact 👩👩👧👧, the metric should be adapted to the company's mission, for example, the number of people that could benefit from the solution. It doesn’t necessarily focuses on a specific KPI but rather considers whether there is a disadvantaged target group and allows to understand how this solution is helping reducing this disadvantage.
❓ Example: Let’s use an example of online tutoring in education. An investment in the startup can be rejected because their pricing for an hour of tutoring is significantly different from traditional offline tutoring. Despite potential innovation in their teaching methods, the service would not made more accessible. Indeed, students from less advantaged backgrounds can't afford this tutoring, it doesn't meet the impact criteria.
Sybille mentions that the Donut Theory is used as a framework to understand Racine2’s primary focus and how they can address climate change. They believe that the contribution of social companies, advocating the necessity of good education and healthcare is required to respond to climate change issues effectively. Instead of solely focusing on key performance indicators (KPIs), they suggest that sometimes it's more about quantifying and assessing impact. They list several main criteria they use to evaluate impacts, such as accessibility, severity, diversity and inclusion.
Those examples are related to the concept of disadvantaged target groups, notably future generations that inherit an environmentally damaged Earth will face diminished opportunities and adverse living conditions. They can't influence today's decisions that shape their future living conditions, placing them disadvantaged. This lens of disadvantage is thus applied across social and environmental impact considerations.
⏰ Should the speed at which a company can scale its energy savings or CO2 reductions be considered an important factor in the assessment?
Felix agrees that timely solutions are crucial and highlights that while long-term "moonshot" innovations are necessary, immediate solutions are also needed. He mentions that their assessment of climate tech companies explicitly accounts for the time factor, categorising solutions into short-term, mid-term and long-term innovations. He also shares his scepticism towards "Gigacorn" companies (those claiming they can reduce a gigaton of CO2 emissions per year), stating that reaching such targets is highly challenging.
❓Example: A company that is reducing CO2 emissions in the construction industry today, contrasts with startups working on new materials that could take 10+ years to impact the industry.
Speakers advocated for maintaining realistic expectations while still generating excitement in investments that might create impact in a more longer term.
Ananda doesn’t have a specific number for CO2 reduction target. They prefer to evaluate the potential in specific sectors and explore what needs to be accomplished instead of focusing solely on CO2 emissions. They also highlight the complexity in measuring the impact of enabling technologies, which themselves might not reduce CO2 emissions but facilitate others to do so. Calculating who should claim the credit for these reductions throughout the value chain, from technology providers to end customers, presents a challenging dilemma as these could be overstated.
Sybille explained that this time dimension should be part of the fund strategy and business model.
❓Example: At Racine2, out of 4 startups, maybe they’ll invest in 2 that will have big growth with a scalable impact and a go-to-market that is near. They might also invest in 2 biotechs which have a longer go-to-market and therefore impact and profitability.
So it’s all about balance.
Relationship with LPs
👀 What role do impact investors play in driving industry-wide standards validation for reporting and measurement. How does that influence how more traditional funds operate?
Sybille highlighted the importance of raising awareness among other funds by, for example, organizing climate risk training sessions.
While Racine2, as an impact fund, focuses mostly on impact topics and also practices what they preach by implementing sustainability in its investments and operations, Serena also incorporates sustainability practices in its other funds, even those not specifically designated as impact funds, covering sectors like storage, gaming, etc.
Upcoming regulations might further connect sustainability, ESG and impact topics.
🤝 How have the ecosystem and best practices regarding this relationship evolved, notably on the potential trade-off between financial returns and impact? How easy was it to raise funds in the past compared to now?
In 2010, when the term "impact investing" was not widely recognized, Ananda started with a modest fund of 7 million euros, sourced mostly from high-net-worth individuals and family offices interested in combining social impact with financial return. The initial goal was to return the principal amount, but they achieved market rate returns while creating a significant impact. Over the years, as the quality and quantity of founders in the impact sector grew, the fund began aiming for high impact and high returns, demonstrating that there doesn't need to be a sacrifice between the two. This evolution has increased interest from institutional investors, foundations, and others keen on investing in impact funds. This shift has become more pronounced in the past two to three years, particularly with their fourth fund, which has seen significant interest and inflow from institutional impact funds.
Regarding Racine2, their initial engagement was to deliver impact. Regarding Investment Rate of Return (IRR), it was the same as traditional funds, and they are aligned with their LPs on the vision that they can scale up the impact, which was not the case 5 years ago.
For Famae, the ecosystem in 2010 was less developed, and it was challenging to raise funds as LPs were unsure about the difference between ESG (Environmental, Social, and Governance) and Impact. The team had to clarify this difference and align on short- and long-term visions. Now, the landscape has significantly changed.
The Impact ecosystem has matured, and there is more activity.
There is a need to standardise the frameworks used in impact investing and appropriate regulations.
Impact frameworks at early stage can be challenging due to several factors:
Limited resources,
Lack of standardised metrics,
Evolving business models,
Short-term focus,
Data availability and quality.
Speakers pointed out the risk of bias in determining what is considered impactful, admitting that they've overlooked certain topics because they didn't initially perceive their impact. Additionally, Sybille mentioned that impact KPIs are defined on a case-by-case basis, different from financial and ESG metrics. So, consolidating these at a macro or portfolio level is challenging, requiring significant time and reflection to identify suitable measures and methodologies.
A standardized framework would be beneficial, helping to provide accurate measurements, enabling comparability, and reducing the tendency to 'sugarcoat' numbers.
Compliance
SFDR (Sustainable Finance Disclosure Regulation)
The classification aims to categorise funds based on their approach to sustainability and to prevent 'greenwashing' or 'impact washing'. The SFDR regulation gets updated every six months, which can be challenging to keep up with. It comprises three classifications:
Article 6: For traditional funds which do not necessarily consider ESG (Environmental, Social, and Governance) factors.
Article 8: For funds that include sustainable practices in their investment process, promoting environmental or social characteristics. This is broad and can relate to things like excluding certain sectors (like tobacco) from investment.
Article 9: For Impact funds focusing on sustainable investments, like those contributing positively to the Sustainable Development Goals (SDGs) or following a zero carbon path.
To be classified under Article 8 or 9, funds must include an annex in their shareholder agreement describing their definition of sustainable investment for the entire management company and explain their methodology for assessing sustainability in investments. They must also set and assess targets for the funds.
This process is complex and continuously evolving, requiring constant updates to fund documentation and websites. However, it's seen as a positive step as it helps prevent 'greenwashing' for new funds.
Nowadays, funds even those not specialised impact want to invest in at least article 8 or 9 funds.
9️⃣ What does reporting as an Article 9 fund involve?
Ananda is classified as an Article 9 fund under SFDR regulations, but this is a recent development. Previously, they didn't feel the need to label themselves as such because they were already intentionally investing with impact in mind. Currently, the fund is set up to meet the reporting requirements of an Article 9 fund. This process is not necessarily burdensome, but it can be complex due to uncertainties and changes in the regulations.
👀 Before, the Article 9 classification was sometimes used for marketing reasons by funds, but now it has become more of a regulatory issue, which they view as a positive change.
Baptise, from Famae, highlights the importance of having substantial assets under management in impact investing, emphasising that it allows funds to hire essential roles like a Chief Impact Officer. Although this creates a barrier for those who don't see sustainability as crucial in investing, Baptise views this development as beneficial to prevent "greenwashing" or “Impact-washing”, which is ultimately advantageous for investment funds, their LPs, society, and the planet at large.
Financial Impact
🌳 What are evergreen funds, and are these becoming the norm?
Felix appreciates the Evergreen fund structure (longer development, go to market and ramp-up periods) puts less pressure on the founders to sell, especially within climate tech and hardware sectors. Those funds believe a traditional 10-year fund lifecycle leaves ample room for growth and success, highlighting that even significant investments, like Facebook, did not force early investors to exit at the 10-year mark.
Sybille explains that Serena, follows a traditional fund structure in terms of duration and targeted return. Her and Baptiste find the Evergreen structure interesting, especially when investing in projects with longer go-to-market timelines, but admit the challenge of convincing traditional institutional investors to adapt to Evergreen structures.
There is a need for various investment methods in the market, possibly with longer durations. The speakers emphasized the need to establish a robust track record in the impact sector to prove it's possible to achieve financial returns while delivering a positive impact
Closing words
🚀 Will sustainable business models or inherent impact that a business is trying to drive become the norm?
→ Impact investing will soon become the standard, potentially not even being referred to as 'impact investing'. Many investors currently focus on climate issues, as social topics are often perceived as more challenging to derive returns from.
→ The tech ecosystem will need to address societal and social challenges increasingly, and investors have a pivotal role in this transformation. Successful investments in education and health tech or blockchain companies prove that it’s possible and it should continue in that direction.
→ Institutional investors increasingly demand sustainable practices or impact tactics for fund-raising. They are gravitating towards funds compliant with Article 9 or Article 8, suggesting that such compliance will become necessary.
Additional thoughts
⚠️ Risks and Mitigations
There are largely three buckets of impact risk that need to be considered:
The likelihood of the targeted positive impact materialising
The degree to which expected/known negative impacts could be mitigated
The nature of and likelihood that unknown/unintended negative impacts could materialise and the startup ability to avoid/mitigate these.
Will the targeted positive impact materialise? To approach this questions, the following can be analysed:
Execution risk: Can the startup overcome any scientific/technical/business risks in getting to their vision? In an early stage venture context this is by far the biggest risk!
Alignment risk: Are the founders likely to stay on their impact course? Can they turn that into a workable business model without having to pivot too many times?
External risk: Will the stakeholders including customers, users, and regulators, represent challenges in the journey to achieve impact in some way?
💲 Financing hardware for Impact
Hardware startups face unique challenges when it comes to securing financing such as:
High capital costs associated with manufacturing and distribution
Longer development cycles
Higher risks associated with physical product development
However, hardware startups also have the potential to drive significant social and environmental impact, particularly in areas such as clear energy, food systems, and healthcare.
That’s it for now!
Next week
Join us next week for the third session of our series of written content dedicated to Impact. Our topic will be “Responsible Entrepreneurs 🍃” and we’ll tell you more about some of the amazing stories that create an impact that last! Hope to see you there.