⚖️ Impact Series: Focus on Regulations and next steps
Welcome to this final part of our deep-dive on Impact! After setting the State of the Arts, focusing on Impact Investing and sharing stories of Responsible Entrepreneurs, we close with a focus on Regulations and Next Steps.
Enjoy the read, and a Merry Christmas from the whole baby vc crew 🎄.
Presentation of the guests
Clara Wat is an Associate at Kopa Ventures where she is developing the impact methodology and reporting. Previously called Wi Venture, this is a German climate tech early stage fund (pre-seed, seed, series A). They specialize in energy, mobility, climate, carbon, and nature tech. She previously worked at Lombard Odier Investment Managers, within their Climate Transition Fund. There, she found her passion for impact, already nurtured by her studies of Sustainable Finance at ESCP. Last but not least, she is part of our valued alumni within the community and has been community lead, bootcamp lead and a mentor for baby vc in the UK.
Melina Sanchez is a Principal at AENU, a climate and social impact fund. She worked in Government, Fin-tech and B2B SaaS in New York. She moved to AENU to focus more on how she could create impact through her job. AENU focuses on circularity, climate insurance and sustainable fin-tech, and counts today 100 million in asset under management (AUM), after having launched in July 2022.
Rebecca Ravenni is also part of the baby vc community, works as an analyst, and is in charge of the accelerator program at Techstars Sustainability Paris Accelerator. Techstars was created 15 years ago, with a unique accelerator model that includes an initial investment (equity and convertible notes) and a 3 months accelerator program. This made the success of the company as they today have 3000+ graduate companies in their portfolio. Rebecca is also part of the baby vc community and was a community lead in France.
Sustainable Finance Disclosure Regulation (SFDR)
🧐 How does the SFDR help to improve the transparency and sustainability of businesses within the European Union?
Melina mentions that in 2023, regulations do not only incentivize VCs to invest in climate but rather allows to identify those that do it correctly, adopting a long term vision.
The SFDR is designed to help investors compare the many different characteristics of sustainable investment funds available. It aims to do this by standardizing sustainability disclosure. The SFDR creates a basis for VC reporting, with guidance on the key impact point of "principal adverse impacts" KPIs.
As mentioned in the previous parts of this deep-dive, there is a real global lack of standardization when it comes to sustainability reporting.
According to Clara, it forms a good protection against greenwashing. Indeed, several funds stopped claiming that their product were sustainable when it wasn’t.
However, more can be done to develop this regulation:
Under SFDR, Article 8 funds are required to consider ESG but do not have ESG-binding criteria.
Compliance to SFDR is not yet audited
📏 What is required for asset managers who must adhere to the SFDR?
From an ESG perspective, Article 9 Funds (Impact VCs) are always preferred over Article 8 Funds (Sustainable VCs).
A few elements should be further considered:
ESG Policy = Establish a clearly defined ESG policy that outlines their commitment to sustainability and responsible business practices.
To be an element of differentiation, funds should put sustainable investments as a core objective instead of just “promoting environmental or social characteristics”. A good target is to have 50% of investments ESG focused
ESG Disclosure = ESG commitments and policies should be disclosed on the website and in annual reports. Specific questionnaires should be filled by startups considered for investment to make sure of what are their current criteria, their long term vision in terms of impact and ESG.
Due Diligence = ESG risks and impacts of their portfolio but also ESG Policy and practices of the target company should be analyzed thoroughly prior the investment.
Transparency = This includes being open and honest about their ESG performance, challenges, and areas for improvement in all of communications with investors.
😬 What are the challenges of SFDR and EU Taxonomy reporting?
The EU Taxonomy is a classification system that sets out a list of environmentally sustainable economic activities.
Climate change mitigation
Climate change adaptation
Sustainable use and protection of water and marine resources
Transition to a circular economy
Pollution prevent and control
Protection and restauration of biodiversity and ecosystems
It is not necessarily relevant to startup at an early stage, yet it becomes more relevant at a Series A level. However, it is important that the VC guides the startup to consider the sustainable practices from the start.
Melina thinks this is distracting impact VCs in their action by trying to restrain and comply to these early. Because of the range of possible investments that exist in climate impact investing, not everything is defined as impact under this regulation and therefore it limits the VCs in the reporting of the impact they generate.
❓ For example, let’s consider a company in which AENU invested that allows customers to invest their assets sustainably; this would not be considered as an “Impact” investment under this regulation.
Compliance and requirements of these regulations makes it a long process for onboarding new LPs. Additionally, Clara mentions that as these regulations are new and regularly changing, reporting is resource-intensive for small funds.
EU investor protection framework was first introduced in 2018. It allows clients purchasing financial products in Europe to express their "sustainability preferences".
This means asset managers will have to declare the minimum proportion of "sustainable investments" in their products as defined by either the SFDR or the EU Taxonomy.
In this process, they must disclose which products have "principal adverse impacts", or are harmful to the environment or people.
Article 8 and Article 9 products have to provide periodic disclosures in accordance with Article 11 of the SFDR and Articles 5 and 6 of the Taxonomy Regulation.
Surprisingly, some investors are now starting to downgrade their funds in order to comply with what they believe will be stricter requirements under SFDR 2.
👉 Read more about the relationship between the SFDR and the EU Taxonomy
What’s next?
♻️ How do VCs contribute to shaping the transition to net zero?
According to Clara, investors fund high impact and high growth climate startups that would for example require more heavy technology. Through their trust & investments, they also de-risk the startups and empower them to develop. This allows to scale decarbonisation technologies faster.
VCs also have the role to build and grow the climate tech ecosystem. They create synergies within it and connect smaller and larger scale of stakeholders.
Additionally, public actors can also rely on the private sector:
EU Green Deal plans for 1Bn+ to come from investors in its decarbonization plan;
The EU has set up various initiatives to mobilize private capital, such as the European Investment Bank's (EIB) Green Bond program and the European Fund for Strategic Investments (EFSI), which provide guarantees for private investment projects that contribute to the EU's policy objectives, including climate action.
Melina introduced the concept Impact Capitalism. It’s a new system that requires measuring and pricing negative externalities but also incentivizes investment flows into the right companies while maximizing investor’s profits. Indeed, it attempts to break the ‘elitist’ barrier and encourages more diversity in terms of who receives but also who invests the capital. Lastly, it also considers how impact involves other actors, outside of investors, like policy makers, corporate and what is their roles to make sure that everyone is aligned on the goals. This last point highlights how investors can push regulations toward a certain direction.
Impact Capitalism transforms our economic system in a way that the interests of people, planet and profits are fully aligned. This is a paradigm shift in the way we perceive society and the role investors have in shaping it.
🫴 How has the discourse around impact and VCs evolve over the last years?
It is important to demystify the vision around impact: Impact driven / ESG investment can be highly profitable. To make sure that both are considered together, Melina mentioned interlocks: when they are investing into a product or a service, it has to be linked to the operational KPIs of the startup. For example, it would be a case where if a company sells more of a product, it makes more impact by definition. However, a company that sells a product but also donate that product somewhere else would not be considered.
Climate Tech Venture investment is now 40x larger than it was a decade ago, proving how the interested increased in the last few years. Indeed, despite the current crisis, VC funding for Climate in Europe has increased significantly, more than doubling in 2022. Europe is now investing more in this area than China for the first time.
Impact is today being embedded into how regular funds operate and in their investment process. Impact VCs take more into account the direct impact but also the negative externalities of potential investment than others and actually measure the impact they are making against their impact goals and frameworks. For example, for AENU, the 4 impact goals are: Green Gas emissions, water, wellbeing, biodiversity.
👀 What would be the advice to early stage founders building their company when tracking their impact? How to become attractive to impact investors ?
Focus on your related challenges specifically = every fund is different, they all have their our own impact thesis, find the one that fits the problem you are trying to solve.
Adaptation VS Mitigation
Facilitate the task of the investor = even adapt to their existing framework such as Theory of Change but always mentioning the approach taken
The Theory of Change identifies what the company is doing, and how it will drive change with its impact and beneficiaries in the wider environment (related to the externalities). It directly links the company’s activities to their outputs and outcomes.
Implement Impact KPIs such as PAIs as part of your strategy
Be transparent with the investors
Have a long term vision, implement impact from day 1
Keep long-term impact goals in the discussion: post investment, what are the objectives in terms of impact goals, sustainable practices, reporting? Clara mentioned this is something they do not only for the reporting as a fund but also for the supporting of the startup itself post-investment.
On this topic, Rebecca mentioned that at Techstart Sustainability Paris they encourage their startups of the Accelerator to consider Impact KPIs from the beginning, especially for Impact-driven businesses. They assess the startup from an ESG point of view so having these actionable KPIs is important. At early stage, it’s all about estimation, but they encourage their startups to do the estimation for a time horizon of 5 years - which is also taken into account when considering investments.
🤝 How can VC use their investment decisions to signal their commitment to impact and influence broader market trends?
Investment criteria: one way to signal a commitment to impact is by setting investment criteria that prioritize companies with a strong social or environmental mission.
Taking a hardware bet: not easy with the current economy, the hardware startups will require funding more than ever but they will also enable the long-term transition.
Be willing to invest with a long term vision: evergreen structure.
Active ownership: Impact investors can use their influence as shareholders to encourage companies to prioritize impact in their operations.
Trends
🔎 What do you foresee as the upcoming impact investing trends for the next five years?
Energy efficiency: not only due to current energy crisis but because it is a long term sustainable solution;
Biodiversity: many investments are in startups that account for carbon, biodiversity can be next for example with monitoring solutions;
In May 2023, the Taskforce on Nature-related Financial Disclosures (TNFD) prepared its final framework, which includes nature-related disclosure requirements, targets, and a risk assessment approach. It will help to promote greater awareness and understanding of the importance of protecting and preserving our natural resources.
Methane: there are lots of opportunities for methane capture and offset solutions; just like the carbon industry
Water technology: un-touched opportunities like chemicals in water streams, how to recycle water, water liqueages in buildings, …
Agnostic / Generalistic investors are more are more investing in the climate tech industry. This confirms that it is a topic and will continue to grow exponentially.
📌 What do you think impact-driven founders should be working on at the moment ?
Heatpumps
These are low carbon advanced insulation solutions: heating, ventilation, and air conditioning (HVAC) systems designed to reduce energy consumption in residential and commercial buildings. These energy-efficient cooling technologies minimize greenhouse gas emissions. We’re observing today a large demand from investors.
Decentralization and greener energy
Virtual Power Plan (known as ‘VPP’): a network of connected solar batteries. The complexity of doing this was seemingly impossible years ago (e.g. producing/storing energy-on site, assessing real-time energy market prices, orchestrating information across devices, automating controls) but recent technology advancements have enabled individual buildings to operate as their own power plants and/or service providers to aggregate those buildings together under the umbrella of a VPP.
Energy communities: For example, Arcadia in the US, Exnaton in Europe. These can benefit from a legal push (carbon penalties, subsidies in the EU). Indeed, consumers want to retake power, control the energy prices.
Insetting for corporates: solutions to decrease scope 3 emissions (results from activities or assets not owned by/controlled by the reporting organisation, but that the organization indirects affects in its value chain).
Additional thoughts
🔗 How event or news-driven will the trends be over the next months and years?
Melina: it depends on your strategy. Some funds are very opportunistic, some others are more thesis-driven and will look more into the value chain and pain points with a longer and deeper analysis. Either way, the returns you’ll generate will be dependent on how you execute on the strategy.
🔦 What are your views on some of the critics of the carbon credits? Like that the additionality component is not valid, some people saying the projects they are trying to protect were not really endangered in the first place?
Clara says it’s quite a controversial topic: there is still a lot to do which is why people invest in it. Yet it needs to be better monitored and legislated. It could definitely be improved, but it is still a necessary solution…
Melina mentioned sometimes carbon credits can disappear, for example, if a forest burns down. So companies have buffers: they can pay to account for the loss like pay 100%, or the risk of it like pay 20%.
As an investor, you need to make sure that the impact you are trying or claiming to achieve is legitimate; this is why you need to make sure you are investing in the right solution.
📚 How can we get educated on Impact and not miss the wave?
For progress and sustainable change to happen, we need to connect the right stakeholders together and start a greater conversation - where every actor, direct or indirect, can be heard, engaged, and held accountable.
Yet at a more individual level, there are many ways to start getting more educated and involved:
Make it (almost) part of your education, and do not hesitate to specialize yourself - Studies will help, even more as this is a new topic. Get informed, there are lots of masters’ degrees and other university studies addressing these new topics!
Stay up to date - may that be in terms of investment trends, of new technologies and startups being developed across the different ‘Impact’ sectors (agritech, cleantech, energy…), but also in terms of regulatory changes.
Ask questions and challenge the established - wherever you may be working, get aware of what is already being done in terms of impact and reporting (start with an « as-is » assessment); then question the to-be state: what more could be implemented? How could we move forward?
Identify quick wins and start small - as you get more aware and educated on what can be done differently, identify different types of actions to be taken and lay-out your business plans: quick wins (short term, more easily implemented, usually less value-added at first) vs long-term initiatives (more resource-intensive, usually integrated in a larger strategy).
Integrate Impact measurements and criteria at all stages of your decision-making process - from market research, to a startup’s analysis, to your due diligence and then investment decision, always include Impact indicators to keep Impact at the core of your value proposition.
Thank you!
As we close this first series, we really want to take the time to thank our great speakers who took the time to share their experiences and insights that we don’t hear when we usually talk about Impact. 👏
A big thank you to our amazing team who organised the entire Impact Deep-Dive series back in April and gathered all insights into these 4 special newsletters! 💛 Quentin Renaud, Amicie Favre, Ghita Benjelloun Benkacem, Rebecca Ravenni, Clément Favre, Clara Wat, Anaïs Roussel and Justine Pelisson.
We hope that this series helped you to understand Impact better but also how you can contribute to it.
If you have any feedback or recommendation for a future series in a similar format, do not hesitate to let us know directly at hello@baby-vc.co or through our LinkedIn! 🤓