Understanding Venture Capital, ESG, & Impact Investments

Introduction

The Environmental, Social, and Governance (ESG) principles are distinct from Impact Investing. The venture capital (VC) community is becoming increasingly aware of impact investing. However, it is not always clear what each one signifies. This article will provide a brief summary of VC and explain the distinction and similarities between ESG and impact investing.

Venture Capital: What it is & Why

Venture capital (VC) is a type of private equity and a type of finance that investors provide. It is often associated with startups as investors expect these companies to grow at a high rate - high risk, high reward. Venture capital is used to finance startups with substantial growth potential.

Large investors, such as financial institutions, provide venture capital. Venture capital can be money or a skill set that assists in a company’s development.

Investing in a startup is risky. Across all industries, 90% of startups fail, and 10% fail within the first year. An investor could lose their entire investment capital with additional risks associated with the company that prevents them from selling shares. However, as more capital and individuals enter the startup industry, investors earn above-average returns as billion-dollar companies' valuations rise. Investors, governmental funds, and private equity firms seeking large profits have participated in major transactions, altering the venture capital ecosystem.

VC and startups should appeal to ESG to ensure their company’s long-term survival and maintain their relationship with shareholders.

ESG Investing

Investors consider ESG in the context of public stocks to evaluate sustainability. The framework considers risk factors that don't fit well in financial statements but are vital to a company's long-term survival. An insightful decision can lead to avoidable consequences. For example, poor governance (G) could lead to worker strikes (S), which could halt safety measures and cause an environmental disaster (E).

The ESG is an investment strategy that considers not just the earnings of a corporation, but also its impact on society and the environment. It seeks to benefit both investors and businesses. ESG consists of environmental, social, and governance topics:

• Environmental: Nature-related topics. Examples: carbon footprint, pollution, sustainability, and deforestation.
• Social: Topics relating to human rights. Examples: Human resource management, community relations, and privacy.
• Governance: Business operations and stakeholder interests. Examples: Bribery, board diversity, salary.

Understanding Impact Investing

Impact investing is an approach that aims to generate positive social or environmental impact to help solve societal challenges. Impact investing is about leaving a positive social or environmental impact through its products or services.

Impacts are a source of value and emotion, driving startup success, leading to performance boosts, and reducing risks. Here are several companies that have profited through their valued-base goals:

• Impossible Foods ($687.5 million)
• Carbon Engineering ($107.4 million raised)
• NuScale ($42.6m)
• CommonWealth Fusion ($115m)

ESG Investing Versus Impact Investing

Similarities

ESG and Impact investing both seek to reduce negative environmental and social impacts while also leaving a positive environmental and social impact.

Companies accomplish this by complying with global standards that help investors in understanding ESG criteria, such as sector and industry-specific challenges that their company should address.

Impact investing focuses on aligning investments with their values in order to have a positive impact on society.

Differences

ESG uses public stocks, while impact investments use private funds; making impact investing harder to engage in. Investors typically expect a large return. ESG investors want these disclosures in addition to traditional financial metrics. This principle is different in impact investing when its primary motivation is its mission statement and objectives. Impact is the type of investment a manager wants to make. They aim to achieve measurable positive environmental or social outcomes. Value-based goals of impact may conflict with the goal of public companies to increase stock prices by evaluating ESG components for investment decisions.

Here are several methods impact investors could monitor the performance of impact funds:

Impact investors are looking beyond just making money. For example, One Acre Fund (OAF) invested in 78,000 Rwandan and Kenyan smallholder farmers by 2011. After growing 145% in a year, OAF studied their impacts on the Ghanaian market. This resulted in an increased annual income of $120 per farmer. For these regions, OAF’s impacts were noticed. When they started a trial program to expand their operations, they realized they had not conducted sufficient scouting, market research, or stakeholder feedback. As a result, their impact dwindled, causing them to lose their investment and shut down their business

Strong ESG initiatives create due diligence in order to achieve long-term, multi-stakeholder value. Sustainability isn't only about ecology or corporate responsibility; it's smart business. 63 investment organizations with $6.5 trillion in AUM signed the UN-backed Principles for Responsible Investment (PRI) in 2006, promising to consider ESG issues when making investment decisions. By April 2018, 1,715 signatories had $81.7 trillion AUM. More than half of global asset owners use or are considering utilizing ESG elements in their investing strategy. Companies recognize that ESG principles are critical to their future prosperity.

Conclusion

Impact and ESG investments are different. Both have been increasingly gaining investor interest, but their venture capital value remains significant. VC and startups who aspire to establish breakthrough technologies should embrace ESG practices to provide long-term value for stakeholders. As more startups develop solutions focused on tackling social issues, it becomes important for VCs to focus their attention on impact.

15Rock is an impact startup. We provide an innovative approach to net-zero by reporting carbon data to companies and investors. Our data helps you identify where your company's scope 1, 2, or 3 emissions and track progress towards their sustainability goals. On this basis, we can supply ESG data to investors, enabling them to invest with confidence.

To learn more about how 15Rock can help, contact us here for a quick demo.

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