Impact Tech Investing 101

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 local capacity and becoming thought-leaders of impact tech. Our ultimate goal is to position Israel at the epicenter of impact tech in the world.

As an evolving industry, impact investing faces many definitional challenges as well as executional obstacles. Being an early-stage investor also complicates how we think about and report returns and impact given the fragile nature 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 about the needs and desires of impact tech startups and investors.

What is impact tech VC?

Impact tech is the intentional use of science and technology to benefit people and the planet. When applied to the VC world, impact tech seeks both competitive financial and social/environmental returns. No returns, no success!

Source: Good Tech Lab

Impact tech is different from other thematic impact approaches in that it is cross-sectoral and global in nature. In Israel, impact tech VCs can benefit from:

• Public-private technology partnerships to create the best-in-class ventures
• Quick-to-market power of tech startups to deliver scalable impact returns
• Networks of tech partners embedded in the most successful global tech companies

At Impact First Investments, we keep ourselves accountable to the highest standards of impact investing. To ensure the lock-step nature (financial and impact) of our philosophy, our impact tech strategy is based on three non-negotiable criteria:

1. Intentionality: An early-stage impact VC should define its social/environmental impact thesis and that of its investments.
2. Impact measurement: Quantitative measurement does not stop once an investment is made, but must be continuously tracked throughout the investment lifecycle.
3. Impact management: Along with quantifying, impact VCs should be transparent about their impact through reporting and risk mitigation.

Given the increasing supply of impact capital, the impact investing industry is at a high risk of “impact washing.” We have seen many players raise impact funds with no real intentionality, with less than rigorous impact measurement, or at best, zero stakeholder reporting. We challenge LPs and individual investors to demand more transparency and accountability from their impact managers.

What are the 3 main misconceptions of impact investing?

Although many claim that they want to do good and do well, there are many misconceptions that limit the rate of growth of the impact investing industry in Israel and around the world.

The first misconception is the alleged inability of impact investing firms to deliver market returns. Many impact VCs have debunked this misconception. For example, California’s Kapor Capital published its latest performance metrics (2019): 29.02% IRR (net of fees) and 3x TPVI, which elevates them to the top quartile of VC firms. More broadly, a 2015 Cambridge Associates’ study found that impact investing returns are comparable to traditional funds. Yet, in order to build trust in impact investing’s potential to generate market returns, the industry requires a sizable cohort of successes. Although it is still too early to report on Israel’s impact VC success, we remain optimistic about our startup portfolio (keep an eye out!).

The second misconception is that the opportunity set for impact VCs is narrow; there are not enough companies out there that qualify as “social or environmental” companies. The truth is that all companies have some type of positive and negative impact, but only a portion of them are focused on measurable, long-term outcomes through their products or services. This is a unique opportunity for investors — by migrating startups to the impact camp, the opportunity set and quality of social/environmental startups could increase exponentially. In Israel, 35% of startups surveyed by Social Finance reported having a social/environmental mission. This is no small gig.

The third misconception of early-stage VCs is that small startups do not actually have any meaningful impact. We think this statement misses the point of VC investing: investors look for great companies and teams that have immense potential for scalability and profitability. At the time of investment, especially at the pre-seed or seed stage, startups will not, by definition, have millions of dollars worth of revenues or impact. Yet, the north star should be the potential for generating impact down the line. It is crucial to be honest about realized impact as opposed to potential impact, and track your targets along the way.

How easy (or difficult) is it to measure impact?

In the next series of articles, we will be drilling down into our impact measurement and management methodology applied to impact tech startups. At a broader level, our impact process is broken down into two main stages: pre-investment (screening for potential impact) and post-investment (measuring and managing impact). Each stage comes with a series of quantitative methodologies where impact is directly linked to the startups’ business models, and where uncertainty (business and impact) is accounted for on a risk-adjusted basis.

Spoiler alert: don’t forget to walk the talk! The impact process applies both to the startups and the venture firm. VCs should aggregate their portfolio impact and go through the same process of identifying their own theory of change, KPIs and impact management.

What if the startup doesn’t have business KPIs/revenues?

One of the biggest challenges for early-stage VCs trying to apply any impact framework to their investment process is the pre-revenue nature of many of the portfolio companies. This as much of a challenge as it is an opportunity.

On the one hand, the VC can deliver more additionality by helping the company define its mission and target outcomes, and by identifying stakeholders that could expand its business horizons and open new market opportunities. For example, we advised one of our portfolio companies in the healthcare space about stakeholders in the retiree and caregiving segment that are, or could be, affected by their product. By doing so, we helped them find new partnerships and potential revenue streams. Our background as both entrepreneurs and investors allow us to see the world through the founder’s eyes.

On the other hand, projecting impact and business KPIs can be a random “guesstimation” for companies with no fixed business model. To resolve this challenge, our approach extrapolates from VC valuation methodologies to impact projections by identifying the right impact unit economics (e.g. number of patients/clients served) and by taking into account the uncertainty of mission drift in our probabilistic model.

Impact First Investments’ footprint in impact tech

Cecile Blilious, our founder and the “mother” of impact investing in Israel, has promoted the ecosystem of impact tech startups, investors, accelerators and consultants over the last decade. Given the limited market size of the “startup nation”, all startups look at the global market to scale financially and impactfully. Although our work is local, the ecosystem multiplier of our startups does not have limits.

From day one, our strategy has been forward-looking. We were the Genesis of impact investing in Israel — we built the impact tech market from bottom up and created supply for a need we believed would come. And now that the market is here to stay, we remain grounded in our visionary approach: we believe there is a wave of “impact migrants,” of next generation investors and consultants, and of knowledge and fact-based impact measurement methods that is yet to flourish.

The reach and depth of Impact First Investments’ strategy materializes through different channels:

• Ecosystem activities: We participate in the major conferences, pitch competitions, and educational events in the Israeli impact ecosystem. Last month, for example, we spoke at the Israel Impact Summit 2019 in Tel Aviv.
• Impact capital: We help bring more impact capital to Israel through the expansion of the investable opportunity set and by validating the market/impact lockstep model.
• Standardization: We aim to bring investors to the same standard of impact measurement and management rigor by being transparent about our framework and model, and by educating other startups and capital providers.

What’s next?

Now that you have read about our high-level impact lens, keep an eye out for our next articles about why impact is the next big thing in Israel, the net impact model for impact tech startups, and the difference between impact natives and impact migrants.

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.