The world is witnessing an exciting and necessary surge in climate tech startups, with the tech sector having such an impact increased 64% since the end of 2020. And with this increase in supply, a new generation of investors has emerged: the environmental impact VC or impact VC.
To help drive more trackable impact investments, here are five key questions all founders should consider asking impact investors vying for space in their cap portfolio.
Is it really an impact investment fund?
First of all, it is necessary to learn the language. The recent implementation of the Sustainable Finance Disclosure Regulation (SFDR) in the EU has brought clarity to fund categorizations. It is important to discern whether the investor is an Article 6, 8 or 9 fund, understand the difference and know what this means for the company, as a founder.
Article 9 funds focus exclusively on sustainable investments, with impact as an investment objective. They are also called "dark green backgrounds." One level down, Article 8 funds, which aim to promote environmental and social features without an exclusive commitment to sustainability. That's a "light green background." Finally, there is Article 6, also known as "gray funds." They make no impact or sustainability claims, although they may dedicate some aspect of their funds to sustainable investments.
In addition to regulating funds under SFDR, the EU has provided guidance on what economic activities they consider environmentally and socially sustainable, and especially impactful. This is what is called the EU Taxonomy, a classification of business areas that warrants more capital, innovation and attention as they will truly move the needle for our planet and humanity.
Choose between articles 8 and 9
Most VCs operating today will fall into the Article 6 category, as generalists, so we will exclude them directly in this article. For climate tech founders, who opt for specialized impact investors (Article 8 or 9 funds), it is advisable to stay aligned with impact. Currently, there are about 50-50 in Europe for Article 8 or 9 compliant impact VCs.
When it comes to Article 8 funds, you will likely be asked to demonstrate that you align with several environmental or social criteria that they have defined as especially important, such as primary adverse impact indicators (PAIs), which evaluate the negative sustainability impacts of investment decisions or advice. They also show how to identify and work to mitigate sustainability-related risks.
Article 9 funds do this and more, asking that what is proposed be done. They will demand more tangible evidence of the environmental or social impact the company has and how it can be measured over time. They emphasize the need to avoid causing significant harm and to operate the business responsibly, both with internal operations and along the value chain.
It sounds like hard work, but opting for an Article 9 fund offers several advantages. In many ways, Article 9 funds are often perceived as the “real deal” in the market, providing an impact seal of approval within the investment syndicate that builds brand credibility at its inception. As your company grows, this status should give you access to more diverse pools of capital that non-impact companies cannot obtain.
What impact KPIs are prioritized?
Given the nuance of SFDR regulation, it is important for founders to challenge investors to define what they call “impact” and how they measure it. This is not a perfect science and is especially challenging when measuring the potential impact of early-stage companies that could be both pre-product and customer.
Founders should seek out impact investors with a deep understanding and enthusiasm for their business, an appreciation of the nuances of impact measurement, and a commitment to setting realistic and relevant impact KPIs. This alignment will contribute to a productive and mutually beneficial relationship between the founder and the impact investor. And, as always, if an investor avoids answering such questions, he should seriously consider whether they are right for the founder and his team.
How will you support me with ESG and impact alignment?
This question is not only key to understanding the difference between having or not having a dedicated impact VC on your cap table, but also realizing the difference between strong impact VCs and those that are not fully committed.
Less optimized VCs will give you a list of requirements and further reading. Strong impact venture capitalists will be more practical and directional. They will help you future-proof your business by offering workshops so you can frame your impact objectives and practical support to mitigate ESG (environmental, social and governance) risks and identify new opportunities.
A good impact VC can also develop the capacity to consider sustainability throughout the entire value chain, both downstream and upstream, and ensure that it meets the strict EU criteria to qualify as a “sustainable investment.” according to EU regulation and, if applicable, align with the EU Taxonomy. This is not just a nice-to-have phrase, but can provide access to pools of capital that would otherwise not be available.
When evaluating impact VCs, look toward those who understand the challenges early-stage companies face and are committed to guiding you through the impact and ESG journey. Look for investors who see this process as a value creation opportunity rather than an onerous checklist.
How do you address conflicts between financial returns and impact goals?
This is the biggest problem with impact investing. Until the early 1990s, it was almost inconceivable that sustainable impact could be equated with profits. However, the last decade or so, with successes from unicorns like Northvolt, 1KOMMA5° and Enpal, have seen clear examples of how the two can partner in harmony. It's worth digging deeper to understand a VC's philosophy and how they envision the balancing act. If they present profits as secondary, it is unlikely to be the type of investment that will help scale the business. However, if it is perceived as integral to measuring success, it is a winning VC environment.
These conversations start to become much more tangible when considering an investor's time horizon. Many climate technologies require deep societal change around emissions targets, and deep tech often requires years of R&D before scaling. If that impacts the founder, he should seek out sponsors who demonstrate a commitment to prioritizing long-term sustainability over short-term profits.
Like many of the questions presented here, this one outlines a key consideration for the founder: How integral is the “impact” to what you are building? A strong impact VC will try to mitigate their risk by only investing in companies that have an impact at the very core of the business model, so there is never an inherent risk of misalignment around returns.
While asking the questions is a good start, many impact investors (particularly Article 9 funds) openly share their investment criteria and impact return frameworks that address this topic precisely. You can see what materials an investor has available on their website as a starting point.
How do you support beyond ESG/impact regulation?
This is a broad question, but particularly relevant to this sector. Even with so much goodwill and momentum, climate technology is still in an adolescent state. Therefore, the power of networks is crucial to make your brand known. When evaluating impact investors, you should consider the value they bring beyond funding. Do they unlock mentorship, experience, partnerships or access to relevant industry networks? How interested are you in helping startup operations mature from a brilliant founder with an idea to unicorn status? This requires a considered effort with portfolio/platform support, which some dedicated longer-term impact VCs can already offer.
Additional question: Can you talk to any of the founders of the VC?
It would be unfair to say you can't trust an investor vying for your attention, but it's always helpful and sometimes enlightening to ask founders for references. Ask a potential VC to introduce companies of interest to the portfolio, not just potential ones. Feedback from these customers provides real-world insight and investor support.
There is no benefit in holding back
There can be a strange power dynamic between ambitious founders and the venture capitalist who will support them to achieve their impact goals. While asking any of the questions described above may seem like an extra burden and waste of time, they are necessary to ensure you are entering into the right type of long-term investor relationship.
Beyond the answers offered, there is something to be said for how an impact VC reacts to such questions. For us, this increased due diligence allows us to gauge the legitimacy and tenacity of an early-stage founder, how serious they are about the solution they are trying to build, and how committed they are to helping set and achieve the goals of the founder. impact.
