Should VCs evaluate impact startups differently?

An impact founder walks into a venture capital investment committee. It’s not the beginning of a joke, but a very serious base for what we're about to discuss in this article.

For the founders, even for those in the field of sustainability, the questions sound familiar when talking with investors: how big is the market, how fast can the company grow, what are the margins, how defensible is the technology, how much capital will it take to scale. And maybe the most important one: could this become a billion-euro business? 

Eventually, for such a startup, another question may appear: what impact does it actually create?

Inherently, there’s nothing wrong with these questions. VCs back startups capable of generating exceptional returns. That’s a known fact. We read about it every day in the news. A company incapable of scaling is unlikely to become a successful venture investment, however valuable its environmental or social mission may be.

But impact startups pose some interesting re-evaluations of this traditional model to look at investible companies.

If a company exists specifically to produce an environmental or social outcome, shouldn't investors evaluate that outcome with something approaching the same rigour they apply to revenue, market size and growth? And if they do this, would they fund different companies? 

The impact startup and the startup test

A climate-tech founder is trying to decarbonise an industrial process. A circular-economy startup may reduce the amount of virgin material needed to manufacture a product.

Once they enter a VC process, however, they face familiar requirements to all startups. Investors need a sufficiently large market, evidence that the customers will pay, a strong founding team, competitive advantages and credible unit economics. They need to understand capital requirements and how the company could eventually produce an attractive exit for those investors.

But treating an impact startup as a charitable project because its mission sounds worthy ultimately helps neither investors nor founders. The problem arises when conventional venture metrics become almost the entire definition of investability.

Revenue tells us whether customers are buying. TAM tells us how large the opportunity might become. Margins tell us about the economics of scaling.

None necessarily tell us whether the company is actually solving the environmental or social problem it claims to address.

Commercial scale doesn’t equal impact scale

This is why the Global Impact Investing Network's IRIS+ framework goes beyond asking whether a business simply has impact.

IRIS+ assesses impact through five dimensions: what, who, how much, contribution and risk.

What outcome occurs? Who experiences it? How significant and long-lasting is it? What did the company contribute beyond what would have happened anyway? And what is the risk that the expected impact does not materialise?

These are some questions that expose the limitations of a simple impact startup label. 

Two companies addressing the same environmental problem can produce very different outcomes. Two businesses with similar revenues can have radically different impact profiles.

Perhaps the most interesting question for investors is contribution, closely connected to additionality. 

Suppose a startup's technology prevents one million tonnes of CO2 emissions. That is very nice, but what if its customers would have adopted another low-carbon technology anyway?

The more important question is “what changes because this particular company exists that would not otherwise have happened?”. 

How do you measure impact before it happens 

This creates an obvious problem for early-stage investing. A pre-seed company may have little revenue. A climate-tech company may still be developing a prototype. Production assumptions, market share and customer adoption are all uncertain.

If investors struggle to forecast a startup's revenue five years from now, how can they credibly forecast its environmental impact? 

Project Frame is one attempt to solve this problem. Developed with participation from climate investors, its methodology helps investors estimate the forward-looking greenhouse-gas impact of technologies from pre-seed through growth equity.

Rather than waiting until a startup has scaled, investors can ask before investing: if this technology succeeds commercially, how much impact could it realistically produce?

Frame connects two variables: the impact generated by each unit of the solution and the volume that could realistically be deployed. And this creates an important link between business and impact analysis. 

How many products will be sold? How quickly will customers adopt them? What existing technology will they replace? These are commercial assumptions, but they also become inputs into the impact calculation.

From impact reporting to impact underwriting 

This opens the possibility of evaluating impact startups differently. Conventional due diligence remains necessary. Investors still assess market, team, technology, customers, margins, defensibility, capital requirements and exit potential. But they also can add another layer by asking the right questions.

What specific environmental or social outcome does the product create? Who benefits? How significant is it? What happens compared with the status quo? Would the outcome have occurred anyway? Does impact increase as revenue increases? And what negative consequences could emerge as the company scales?

This is not just theoretical. GIIN explicitly positions IRIS+ for use across the investment process, including screening, underwriting, due diligence and performance assessment. Its impact due-diligence guidance is designed to incorporate impact into prospective investment decisions. 

The distinction is important. Impact reporting asks “what impact did our portfolio produce?”. Impact underwriting asks “what impact must this company be capable of producing for us to invest?”.

Impact and venture potential 

Maybe it’s time for impact investors to assess impact startups from at least two points of view. The first one is the classical venture potential and it deals with team, market, traction, margins, defensibility, scalability, capital efficiency and exit potential.

The second is impact potential and here they should assess the magnitude of the problem, depth of the outcome, beneficiaries, additionality, scalability of impact and impact risk.

A company that underperforms on the first may be an important organisation but not suitable for venture capital. 

A company that performs badly on the second may be an excellent startup but difficult to justify for an impact fund. 

So, should impact startups be evaluated differently?

Not necessarily differently, but with a more extensive check list. Impact can’t compensate indefinitely for weak economics, poor execution or a product customers do not want. But conventional venture metrics alone can’t establish whether an impact startup is actually creating meaningful change.

The alternative is not to replace TAM, traction and returns with emissions, SDGs and impact scores. It’s to connect them.

What happens to impact when revenue grows, what behaviour does the product replace, how much of the outcome would have happened anyway, what unintended consequences appear at scale are some of the questions that could make impact startups more investible. 

But maybe the ultimate test of an impact startup shouldn't simply be whether it can become a billion euros company. Maybe it should also be whether becoming a billion euros company would make the problem it was created to solve in the beginning, meaningfully smaller.