What makes an Impact Startup investable?

by Plamen Ivanov
Contributor

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The world of finance and investments has long been dominated by a single driver: Profitability. With the rise of awareness about major climate and societal problems, the changes in consumer behaviour, governmental policies and business ethics, investors are embracing the growing trend of impact investing, where financial gains and societal and environmental contribution go hand in hand.

Business as usual is no longer the answer in the current state of the world. According to Deloitte’s Human Capital Trends survey, 86% of millennials believe that business success should be measured by more than just its financial performance.

The younger generations want to be engaged in purposeful, mission-driven businesses, they want to make an impact through their work. This shift is leading to disruptive changes in the business world.

The drive for innovation comes from many different angles: productivity and efficiency, abundance and prosperity, justice and equality, sustainability and future-proofing.

One of the main catalysts for innovation comes from an ever growing group of purpose-driven founders, who see doing business as a way to bring society towards a better future, leaving a positive footprint behind.

What makes these founders stand out from the crowd is their ability to solve challenging, meaningful problems, while creating sustainable, profitable companies around that mission.

Doing Good while doing Business

There is no single recipe for how to align purpose with profit

The way to turn an impactful endevor into a profitable business certainly varies from one industry to another and it depends on a wide range of factors such as geography, type of product, business model, intended level of disruption and certainly time horizon. While we will not be able to explore in depth all factors, it is worth making a distinction depending on when is the impact expected to be produced.

Short- to mid-term impact

Most of the impact startups fall into this category. We are talking about businesses that are built with the intention to start contributing to a given set of goals (such as decreasing GHG emissions, reducing plastic waste, saving tones of food, etc.) as early as possible.

Business profile

It is fair to say that this is true for most of software-empowered and less sophisticated hardware startups.

These are the businesses that start building their prototype from the very beginning, while testing different market hypothesis with the goal of developing an MVP.

Examples of such businesses can be:

P2p marketplace for second hand items
E-commerce platform for sustainable products
Transport optimization software
Energy saving and distribution software
Reusing and repurposing of waste
Renewable energy production optimization software
Sustainable agriculture producer
Microfinance provider to distressed borrowers

Funding

There will be many nuances and differences across companies and industries when it comes to how much time is needed and the amount of investments necessary until having an MVP.

Longer-term impact

These are those disruptive startups that are tackling major problems by creating revolutionary technologies (as opposed to bringing an incremental evolution). We are talking about technologies that require a long scientific research in order to test their viability and real world applications.

Business profile

These are the type of solutions that bring real breakthroughs and that can bring us closer to solving major problems such as those related to climate change.

Most of the time this involves complex hardware solutions, which are also often referred to as deep-tech. Some other characteristics of these type of companies are:

R&D can take several years
There might be barriers of entry (IPs, patents)
They create entirely new markets (instead of ones that already exist)
They play with a lot of uncertainty
They represent a high-risk, high-reward investment opportunity
If successful, they have low- to no- competition
They are highly scalable

Examples of such businesses can be:

Development of new sustainable biodegradable materials
New efficient ways to grow food
Alternative energy generation and storage devices
Disruptive technologies to harness wind, tidal or solar power
Zero emissions transportation technologies
Revolutionary medical devices

Funding

Given the long time horizon, these endeavors are very capital intensive and take a lot of time until any return of investment can be produced. They often start in University labs, relying on existing grants for seed funding, before accessing Venture Capital or other institutional funding which can help them bring their research to an end, develop a prototype and start commercialization. Because of the time that it takes to bring these solutions to market, the type of funding required is often referred to as Patient Capital.

The type of investors that will be investing in long-term impact solutions might sometimes be different from the ones looking for more immediate outcomes. It is however also frequent seeing Institutional Impact Investors (such as VCs) looking for a balanced portfolio between both categories from risk and return perspective.

Before we dive into the specific topic of what Impact investors look for in a company, let’s have a clear definition of what Impact investing actually is.

Impact Investing

As we pointed out in a previous article about Impact businesses, Impact Investments are done with the intention to obtain financial returns, alongside generating social and environmental impact.

The growing concern about all ramifications of climate change and major societal problems has profoundly changed the nature of businesses, employment, what we consume and - as consequence - where we invest our money.

Impact Investment in Europe is growing at a fast pace in the recent years. According to a study by State of European tech, in 2021, €8.8 billion was invested in European sustainability startups versus in 2020, when €4.7billion was invested. More about Impact Startup Funding in 2022: Key Regions, Sectors, and Fastest Growing Roles.

It is important to distinguish between Impact investing and philanthropy (donations). The latter - usually done through foundations and private contributions - aim to make a correction, to alleviate existing negative externalities, while on the other hand, Impact investors empower businesses to proactively build solutions that can effectively compete with other businesses, being self-sustaining over time.

The financial return is fundamental part of the driving force behind impact investing.

In fact, according to numerous studies by the Global Impact Investing Network, the majority of Impact investors look for financial return at least as high as what they would obtain with alternative investment options with similar risk.