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Impact investment, which aims to achieve both financial returns and tangible social or environmental outcomes, differs significantly from traditional venture capital. The growing interest in impact investment is leading an increasing number of individuals, family offices, and financial institutions to align their investments with broader social and environmental objectives. While impact investment may entail significantly lower financial return expectations compared to traditional venture capital, both approaches are essential for supporting exceptional projects and teams that are shaping the future of the economy. And in both cases, investment liquidity challenges are ever-present.
E. Krieger
What do companies like Tesla, Beyond Meat, Zoom Video Communications, Moderna, or Impossible Foods have in common? Besides their technical and commercial achievements, these former startups are also examples of success in terms of impact, having both generated value for their investors and positively contributed to real social or environmental issues.
While these companies combine impact and financial returns, the investment logics are not always the same when comparing venture capital and impact investment. Venture capital involves investing in startups with high growth potential and return on investment, developing innovative products or services. Impact investment, on the other hand, aims to generate positive social or environmental impact alongside strict financial returns. Such investments aim to support companies or projects with clear goals in sustainable development, social responsibility, and/or environmental issues.
In recent years, we have observed a noticeable increase in interest in impact investment. A growing number of individuals, family offices, and financial institutions are now seeking to align their investments with broader social and environmental objectives. Global challenges such as climate change, poverty, access to education and health are important themes for impact investment.
A potentially lower profitability requirement for impact investment?
A venture capital fund will select projects that could multiply the initial investment by 3 or more within 5 years, to offset capital losses related to inherently risky companies. Even though the average performance of most venture capital funds falls below these 25% annual return rates (they are around 15% according to the research firm Prequin), this financial goal highlights the stakes and ambition of this profession.
Impact investment fund managers will generally lower their financial return expectations, provided that the societal or environmental impact is significant, in order to remain aligned with the investment thesis presented to their individual or institutional subscribers. The idea here is to select projects that could double the initial investment within 5 years, which still corresponds to an internal rate of return close to 15%, significantly higher than what the stock market delivers in the long term. Once again, reality falls somewhat short of this goal, with an average profitability of 10.5% for impact investments in the private segment according to the 2023 Global Impact Investing Trends report by Preqin. The average return discount compared to general venture capital is therefore 4.5%.
Limited liquidity of impact investments: a major constraint
Regarding unlisted investments, each with considerable risks of failure and substantial liquidity issues, it is understood that general venture capital and impact investments in the unlisted sector can only apply to exceptional business projects driven by high-caliber teams.
It’s worth noting that the median exit timeframe (sale or other liquidity event) for a startup funded by venture capital funds is now 9 years according to the investment bank Avolta.
This liquidity constraint is a major challenge for unlisted investment. The pursuit of liquidity for impact investments is even more difficult since an impact-oriented company cannot simply be sold to the highest bidder without ensuring a strong compatibility of values and corporate cultures between the buyer and the target.
The unstoppable growth of impact startups
Clean energy, MedTech, EdTech, Agritech, FinTech for inclusion, circular economy, social impact platforms, sustainable fashion, clean water and sanitation, mental health, and well-being: the list of fields conducive to disruptive innovations is long.
Whether it’s early-stage, venture capital, or growth capital, investors will naturally seek to support startups that integrate sustainable or socially responsible solutions into their business models more systematically. Impact investment will therefore gain importance in the venture capital domain.
However, even though impact investment is gaining popularity and is expected to play an increasing role in venture capital, it would be presumptuous to assume that it represents the exclusive future of this form of investment. The combination of both approaches could be a path towards a future where financial objectives and social and environmental impact mutually complement each other.
