A Net Impact Model for Tech Startups
At Impact First Investments, our goal is twofold: to deliver market-rate financial and social returns by investing in high-tech startups in Israel, and to push the boundaries of the global impact ecosystem by building capacity locally and becoming thought-leaders of impact tech. Ultimately, we aim to position Israel as a leader of impact tech in the world.
As an evolving industry, impact investing faces many definitional challenges as well as execution obstacles. Being an early-stage investor also complicates how we think about and report returns and impact given the fragility of startups in their early years. Over the last decade, we have gathered knowledge, best practices, and feedback from our stakeholders. This framework is the culmination of many years of conversations of the needs and desires of impact tech startups and investors.
Quick recap…
In our first article, we described the basics of impact tech investing. For a startup to be considered an impact tech company, it should not only offer a technology that intentionally targets a social or environmental problem, but the impact also must be measurable and manageable.
One of our objectives as an impact tech investor is to educate and support the ecosystem in Israel and around the world. Although we don’t have all the answers, we strive to be transparent about our learnings and thought-process. In this article, we will dig deeper into Impact First Investments’ net impact model, which combines best practices from global standards*.
The 3 challenges of impact measurement
If defining impact is no small feat, measuring it in a way that makes an investment comparable across portfolios or funds is a challenge that no one has been able to master yet. These are the three main challenges of measuring impact:
Challenge #1: As opposed to traditional venture transactions where the financial unit is the dollar (or any other currency), impact valuation has no standard measurement unit. 100 patients saved is not the same as 1 million tons of CO2 emissions. A reduction of 33% of premature deaths of noncommunicable diseases (SDGs) is not the same as 250 jobs created. $100K of cost savings in children’s education is not the same as a 50% reduction in poverty.
Challenge #2: In the financial industry we don’t compare the asset turnover ratio of the airplane industry to the asset turnover ratio of technology companies. Neither should we be doing this in impact investing. Although SASB is pioneering the quest for impact accounting standards by sector, there is a long way to go until the impact community approves and adopts social/environmental accounting standards.
Challenge #3: In impact jargon, the ultimate goal is to be able to identify the effects of an intervention (outcomes), not just the results of an intervention (outputs). For example, a fintech startup that leverages alternative credit scoring to make financing more accessible might propagate the system’s unfairness. Indeed, this seemingly impactful activity can have the exact opposite effect: alternative data such as ZIP codes might deny credit to underserved populations by excluding “poverty zones.” Most impact investors are comfortable collecting output metrics; outcomes are, unfortunately, more expensive to identify and assess.
Impact First Investments’ framework tries to address all three challenges cognizant of the fact that there is no one right answer or commonly adopted standard in the industry yet.
Net impact
Our impact philosophy stems from the understanding that all businesses have a positive and negative impact in the world. A subset of these companies have the intention to create positive impact through their business models. By aligning business and impact, startups should be able to scale in both directions in lockstep. Shall there be any mission misalignment or drift, or unintended spillover effects, a growing incongruity between business and impact growth would emerge in the form of negative impact.
Impact tech is better positioned to achieve lockstep impact/financial returns. Both the scale and depth of impact, parameters which are embedded in our forward-looking impact projections, are competitive advantages of the tech industry.
The 4 dimensions of Impact
Our impact framework is based on Impact First Investments’ mission: to leverage the power of high-tech to solve the world’s greatest challenges. Our north star is to contribute to the SDGs through our portfolio of startups. To make our mission a reality, we assess four dimensions of impact:
Impact targets (what, who, how much) start with the identification of the startups’ mission, stakeholders, and impact KPIs. We then calculate (to the extent possible) the startup’s contribution to relevant SDGs or internal impact targets. For example, SDG 3.4.1’s target is to reduce by 33% the mortality rate from non-communicable diseases through prevention and treatment. One of our portfolio startups has contributed by 0.04% to this target thus far through its healthtech product.
Additionality (where) is a measure of the multiplier effect of impact investors on the startup and of the startup on the impact ecosystem. Impact First Investments works closely with its portfolio companies to craft and define the impact mission and theory of change, and to track the right impact KPIs.
ESG (how) is especially difficult to assess due to the limited resources and human capital of early-stage startups. However, we analyze the most material factors for our tech companies as well as the mitigation strategies. For example, our healthcare startups mitigate evidence risk by conducting vetted clinical trials.
Impact risks (contributions & risks) include the deadweight** of other stakeholders to the impact goal as well as the risks that could reduce impact scale and depth (e.g. evidence or execution risks) and result in negative impact.
These four dimensions are weighted by different factors to create an impact score indexed as a scale of 0 to 10. By default, all startups have a score between 0 and 2 during the first few years, which should increase over time as the business unit economics improves. Impact score projections should be calculated and tracked to ensure that mission drift or business/impact misalignment does not occur.
A word on ESGs
Many of the startups we have talked to do not consider ESG factors relevant to their business. A company that has 5 employees and is renting a low-cost working space to survive for the 6-month cash runway left will not prioritize, or even think of, conflict of interest policies or internal energy consumption. After all, the social or environmental footprint of startups is tiny compared to the billion dollar companies listed in public stock exchanges worldwide that are part of the ESG movement.
We believe this thought-process is wrong.
Instead of looking at the aggregated footprint, we consider the materiality of specific factors and how they could help or harm the businesses at the top and bottom lines (e.g. revenues vs. cost savings). This “business” lens informs us of the main operational risks and opportunities that are directly linked to the startups’ survival and success. For our impact tech startups, privacy and data security is a material risk that needs to be integrated into the business model. For instance, not abiding by the GDPR or other privacy certifications might preclude operations in certain geographies or impair the startup’s license to operate.
We also consider the stage of our startups as an advantage in the ESG alignment process. Our early-stage intervention allows startups to plant environmental, social and governance seeds that will grow as the company matures, propagating sustainable operations.
What’s next?
Our next articles will cover Israel as the “startup nation” of impact tech, the difference between impact natives and impact migrants, the SDGs of impact tech, and how millennials can revolutionize the impact tech industry.
**Deadweight is a measure of the amount of outcome that would have happened even if the activity had not taken place. About the author
Melina Sánchez Montañés is an entrepreneur in the public, non-profit, and financial sectors. She is Director of the Tuck Social Venture Fund and co-founder of European Horizons, the first student-led policy incubator in the world. At Impact First Investments, Melina leads the impact management and measurement project.
Originally published at https://medium.com on July 29, 2019.
