The world is witnessing an exciting and necessary surge in climate tech startups, with the impact tech sector up by 64% since the end of 2020. And with that increased supply, a new breed of investor has come to the fore: the impact VC.
As an impact specialist working within a VC, I’m committed to supporting founders in achieving their ambitious goals and invoking positive change. To help drive more trackable impact investments, here are five key questions that all founders should consider asking impact investors competing for a space on your cap table.
Are you actually an impact investment fund?
First things first, you need to learn the jargon. The recent implementation of the Sustainable Finance Disclosure Regulation (SFDR) in the EU has brought clarity to fund categorizations. It’s important to discern whether the investor is an Article 6, 8, or 9 fund; understand the difference and know what this means for you, as a founder.
Article 9 funds, like us, are exclusively focused on sustainable investments, with impact as an investment objective. They’re also called “dark green funds.” One level down, we have Article 8 funds, which aim to promote environmental and social characteristics without an exclusive commitment to sustainability. That’s a “light green fund.” Lastly, there’s Article 6, otherwise known as “gray funds.” They make no claims of impact or sustainability, though they might 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 to be environmentally and socially sustainable, and especially impactful. This is what’s called the EU Taxonomy, a classification of business areas that warrants more capital, innovation, and attention, as these will truly move the needle for our planet and humanity.
Choosing between Articles 8 and 9
Most VCs operating today will fall into the Article 6 category, as generalists, so we’ll exclude them outright here. For climate tech founders, opting for specialist impact investors (Article 8 or 9 funds), it’s advisable to stay impact aligned. Currently, it’s around 50-50 in Europe for impact VCs complying with either Article 8 or 9.
When dealing with Article 8 funds, they will likely ask you to show that you align with several environmental or social criteria that they’ve defined as especially important, such as the Principal Adverse Impact (PAI) indicators, which assess negative sustainability impacts of investment decisions or advice. They’ll also show you how to identify and work to mitigate sustainability-related risks.
Article 9 funds do this and more, asking you to walk the talk. They’ll demand more tangible evidence of what environmental or social impact your company is having, and how you can measure this over time. They emphasize the need to avoid causing significant harm and to run the business responsibly, both with internal operations and throughout 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 stamp of approval within the investment syndicate that builds brand credibility in your startup. As your company grows, this status should give you access to pools of more diverse capital that non-impact companies cannot obtain.
Which impact key performance indicators (KPIs) do you prioritize?
Given the nuance of SFDR regulation, it’s important for founders to challenge investors in defining 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 might be both pre-product and customer.
Founders should look for impact investors with a deep understanding and enthusiasm of their business, an appreciation for 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 ever, if an investor evades answering such questions, you should seriously consider whether they are a match fit for you and your team.
How will you support me with ESG and impact alignment?
This question is not only key for understanding the difference between having a dedicated impact VC on your cap table or not, but also realizing the difference between strong impact VCs and those not fully committed.
Less optimized VCs will give you a list of requirements and further reading. Strong impact VCs will be more hands-on and directional. They’ll help you to future-proof your business by offering workshops so you can frame your impact objectives and hands-on support to mitigate ESG (environmental, social, and governance) risks (and identify new opportunities).
A good impact VC can also build capability to consider sustainability throughout the full value chain both downstream and upstream, and ensure you meet rigid EU criteria to both qualify as a “sustainable investment” under EU regulation and, if relevant, become aligned under the EU Taxonomy. This is not just a “nice to have”; it can allow you to tap into pools of capital otherwise not available.
When evaluating impact VCs, gravitate toward those who understand the challenges faced by early-stage companies and are committed to guiding you through the ESG and impact journey. Look for investors who view this process as a value-creation opportunity rather than a burdensome checklist.
How do you address conflicts between financial returns and impact objectives?
This is the biggest rub with impact investment. Up until the early noughties, it was almost inconceivable that one could match sustainable impact with profit. However, in the last decade or so — with unicorn successes such as Northvolt, 1KOMMA5° and Enpal — we’ve seen clear examples of how the two can be married in harmony. It’s worth digging deeper to understand a VC’s philosophy and how they imagine the balancing act. If they present profit as secondary, it’s unlikely the sort of investment that will help scale your business. If it’s perceived as integral for measuring success, however, you’re onto a winner.
These conversations start to get a lot more tangible if you consider an investor’s time horizon. Many climate techs require deep societal change around emission goals, and deep tech often requires years of R&D before scaling. If that resonates with you, look for backers who demonstrate a commitment to prioritizing long-term sustainability over short-term gains.
Like many of the questions presented here, this one outlines a key consideration for you as a founder: How integral is “impact” to what you are building? A solid impact VC will try to mitigate their risk by only investing in companies that have 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 tackling this exact topic. See what materials an investor has available on their website as a starting point.
How will you support me beyond impact/ESG regulation?
This is a broad question, but particularly relevant for this sector. Even with so much good will and momentum, climate tech is still in an adolescent state. Therefore, the power of networks is crucial to get your brand name out there. When evaluating impact investors, consider the value they bring beyond funding. Do they unlock mentorship, expertise, partnerships, or access to relevant industry networks? How keen are they to help you mature your startup operations, from a bright founder with an idea to unicorn status? This requires a considered effort with portfolio/platform support, which some longer term, dedicated impact VCs already have to offer.
Bonus question: Can I talk to some of your portfolio company founders?
It would be unfair and unjust to say you cannot trust an investor vying for your attention, but it’s always useful and sometimes illuminating to ask for founder references. Ask a prospective VC for intros to companies you are interested in within the portfolio — not just their go-to winners they like to roll out to prospective companies. Their feedback will provide a real-world perspective on the investor’s support.
There’s no benefit in holding back
It’s fair to say there can be an odd power dynamic between ambitious founders and the venture capitalist who will support them in achieving their impact goals. While asking any of the questions outlined above might seem like an additional time suck and burden, they are necessary to ensure you’re getting into the right sort of long-term investor relationship.
Beyond the answers offered, there’s something to be said for how an impact VC reacts to such questions being asked. For us, this heightened 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 we are to support them both to set and achieve their impact goals.