Investors Should Consider Leaning in to Impact-Focused Venture Capital
As we grapple with a global pandemic and significant economic uncertainty, brave venture capital investors have a crucial opportunity: through impact-focused venture capital investments, they can achieve significant financial returns and help ensure that companies dedicated to important social innovations not only survive the crisis but are positioned to flourish and change the world for the better.
During the last economic cycle, venture capital (VC) established itself as the most attractive sector in finance. Several key factors contributed to this emergence: Investors who were scared away from historically high public-equity valuations wanted access to early private deals, the best bankers and investors wanted to join VC firms, media companies loved the industry’s stories and characters, and pop culture romanticized venture capital’s tech-focused, playful nature. Some venture-backed companies wound up changing millions of peoples’ lives: Uber, Instagram, Airbnb, and others raised billions of dollars and established themselves as important fixtures of modern society.
But amid the challenges brought on by COVID-19, investors are becoming more cautious with their VC allocations, and many VC firms are struggling to raise capital. In particular, we have seen that funds focusing on social and environmental challenges face significant challenges in the current moment. Yet VCs have the opportunity now to be more impactful than ever before. Among the important reasons the VC model is so effective is the fact that these funds can be patient and wait out unfavorable economic conditions. They are thus able to encourage portfolio companies to pursue an exit when markets are most favorable. This is especially essential in today’s more volatile market. Additionally, VC general partners (GPs) are much more than investors – they are also strategic partners for young companies, and right now, they are turning their attention toward their portfolio companies to support them with strategic guidance as they navigate the challenging times ahead.
The COVID-19 pandemic has exposed significant cracks in many of our systems, including education, health care, food systems, and more. And while its immediate impacts will hurt many people, it also provides a chance for capital owners to support solutions focused on crucial long-term fixes. New venture-backed companies will be significant drivers of creating the more resilient and equitable future that we all want to see, and some will emerge from the current crisis in strengthened market positions. Venture-backed companies have lofty growth ambitions and, if successful, will become highly influential in our society. For ventures that have a social or environmental mission, this financial success progresses in lockstep with positive impact on communities and the planet.
Motivated capital owners with a long investment horizon and a desire to drive both change and portfolio returns have the opportunity in this moment to function as the source of capital required to address many of our most daunting challenges. I see three significant opportunities for such investors:
- The recession and financial turbulence will likely depress the valuations of private companies. This means that investors have the opportunity to achieve better long-term returns. This is a win for companies and investors alike.
- This is a critical opportunity to support diverse fund managers and entrepreneurs. Investors tend to revert to what they consider safer investment strategies in turbulent times, which will likely result in capital flows focused on white male investors/GPs and entrepreneurs. Capital owners should act upon on the research that demonstrates the value and efficacy of diverse money managers and entrepreneurs (including Arabella’s An Economy for All report). This will help ensure that the next vintage of VC GPs is appropriately represented across demographics.
- Finally, many companies that are working on solving the most pressing social and environmental issues of our time are at risk of failing simply due to lack of funding (and not a poor-quality product or service). These companies are creating the educational tools for the next generation, the logistics software to reduce carbon emissions for transportation, ways to provide easy access to social services, and more. Like all companies, they require outside capital to scale. If VC firms can continue to raise capital from investors, those firms can be the source of capital and strategic support that these companies need to survive the pandemic and thrive beyond it.
Given the prospect of strong financial returns, a level-setting of the industry for future equity, and important social enterprises needing support – now is the time to commit and deploy venture capital into socially and environmentally focused companies. Capital owners should initiate conversations with their money managers or consultants to ensure that their money comes off the sideline and plays an active role in building a better future.
About the Author: Cyrus Kharas is a director on Arabella’s Advisory team. He works across a broad range of Arabella’s individual, institutional, and corporate clients, and contributes to the firm’s analysis of trends and opportunities in the impact investing field.