Translating ESG & Impact into a Modern Fund Positioning

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In the introduction to this series, ‘Why VCs Can’t Neglect ESG & Impact’, we explained why a strong focus on responsibility and impact is mission-critical for investors. Additionally, we outlined why we’ve made it an integral part of how we run byFounders, and introduced our framework for managing ESG and impact across our fund.

In this post (#2),  we explain how we’ve designed our fund’s positioning by balancing ESG & Impact priorities with other strategic dimensions. We cover the tough choices we made, our positioning framework, and how we translated them into a clear strategy with tangible KPIs to ensure full accountability.

The article has seven main sections:

1. Translating ‘Core Beliefs’ into a clear fund positioning: VCs must balance different stakeholder priorities and decide what weight ESG & Impact take in their investment approach.
2. No clear positioning without tough choices: A distinctive brand is built by making hard choices - what to stand for, what not to stand for, and what to stand against.
3. Ways VCs can incorporate ESG & Impact into their value hypothesis: A step-wise approach to incorporate ESG & Impact related aspects into the fund positioning. 
4. Balancing ESG & Impact with other positioning dimensions: Every strategic choice determines the size of the addressable investment pool.
5. Common investor categories and their ESG & Impact priorities: VCs can take 4 different positions as investors in the context of ESG and Impact.
6. The positioning choice we made at byFounders: Impact is a clear priority for us, but due to current market dynamics and our limited geo scope, we have chosen to become an impact-aware investor instead of a pure impact investor.
7. Our strategy to deliver on our positioning: We have a clear strategy, including target ratios for a.) Negative Screening, b.) ESG responsibility and c.) Impact Investing to anchor and quantify our positioning.

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(1) Translating ‘Core Beliefs’ into a clear fund positioning

As VCs, we operate under the scrutiny of many stakeholders, ranging from Limited Partners to entrepreneurs to employees. Investors need to balance the priorities of these stakeholders and decide what weight ESG & Impact will have in their investment approach. 

This choice sets the baseline for how we communicate and market ourselves, the investment criteria we follow, the internal structures and processes we implement to evaluate deals, and the support we offer to startups.

Therefore, a clear positioning should reflect the fund’s targeted investment segment in a tangible way - closely tied to its strategic assets, which sufficiently sets it apart to have a right to win.

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(2) No clear positioning without tough choices

A clear positioning means making tough choices. We categorize these into three zones:

• Red Zone: Clear “No” Position (i.e., What are we actively choosing not to do?)
• Yellow Zone: Neutral “Acceptance” Area (i.e., What are we not advocating for or against?)
• Green Zone: Clear “Yes” Position (i.e., What are we actively supporting and using resources on?)

Nobody wants to be a “Non-edgy (yellow) generalist”. The goal is to minimize the “Yellow Zone” because trying to be everything for everybody dilutes the messaging and makes it harder to attract the right partners who share the agenda.

Step 1 Defining the red zone. Most VCs today are comfortable defining the Red Zone. There are often well-defined ethical guidelines, which make this choice much easier. For example, most funds have an exclusion list (i.e., a list of sectors and activities they won’t invest in). This may include industries such as fossil fuels, tobacco, and weapons, which have well-documented negative environmental and social impacts. 

Step 2 Defining the green zone. Having a clear Green Zone, however, means actively promoting and supporting something. Hence, it requires some level of resource commitment. For example, if we want to invest in responsible startups, we need to implement processes to find, evaluate, and support these founders. This might involve new evaluation criteria and integrating ESG assessments into due diligence.

Step 3 Maximizing the green zone. This is the toughest part. Inversely, it means saying no to Yellow Zone investments - companies that fit the investment profile but do not reinforce a “best fit” profile. For example, a fund promoting gender-diverse investments with a portfolio dominated by male-founded companies won’t be “top of mind” for gender-diverse teams. 

Of course, a clear “Yes” position means that you in some way say “No”. However, the key difference between the Red Zone and Green Zone lies in the level of proactiveness. The Red Zone is about setting boundaries and avoiding harm. The Green Zone is about actively driving an agenda.

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(3) Ways VCs can incorporate ESG & Impact into their value hypothesis

Now, let’s link this framework with potential choices in the area of ESG and Impact. As VCs, our primary purpose is to generate financial returns. Therefore, the key question is how ESG & Impact translate into a value hypothesis that closely correlates with financial returns - ultimately reflecting one’s own underlying beliefs.

From an investment perspective, we see roughly four steps along which ESG & Impact can be incorporated into a fund’s value hypothesis:

1. No consideration: No active consideration is given to any ESG- and impact-related choices in the context of the fund’s strategy. This does not per se have negative implications but is rather a reflection that the fund puts low to no emphasis on ESG & Impact.
2. Business Risk Mitigation: Focus on actively mitigating ESG & Impact-related risks. Prominent examples include the exclusion of environmentally or socially harming industries (e.g., oil and gas, weapons, etc.) linked to the assumption that regulation will be incrementally tightened, posing a significant downside business risk.
3. Responsible Business Operations: Putting increased emphasis on properly implemented ESG practices - linked to the underlying belief that this correlates with sustained long-term value creation. Examples include promoting equal career opportunities and pay, fostering an inclusive work environment, and adhering to the latest data and privacy regulations.
4. New sustainable solutions: Prioritizing companies that develop products/services that directly tackle major societal or environmental challenges - usually based on the belief that they have equal or greater business potential. Examples can include innovative solutions in the space of decarbonization, education, or healthcare.

These choices exist on a spectrum and are not mutually exclusive. More importantly, they’re just examples of how ESG and Impact-related aspects can be gradually incorporated into any fund's positioning. From our perspective, modern VCs can’t neglect these. However, depending on the underlying beliefs, they might be more or less prominent in the overarching fund positioning.

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(4) Balancing ESG & Impact with other positioning dimensions

“ESG & Impact” are just one of the dimensions that can define a fund’s strategic focus. They must, therefore, be considered in the broader context of the investment strategy. Every strategic decision (e.g., stage, geography, sector, business model, etc.) influences the size of the addressable startup pool and the specificity of one’s own brand, which positions a fund to win. 

Accordingly, there is a delicate balance to strike between (1) a broader, less distinct positioning resulting in a larger addressable startup pool and (2) a very specific positioning resulting in a small addressable startup pool and a relatively good position to win in that specific niche. This is especially true for up-and-coming challenger funds and less for the established top market leaders.

Any distinct and successful positioning is typically built around at least one leading dimension, which puts you “top of mind”. ESG and Impact are key additional dimensions that enable a distinct positioning in the crowded VC space. 

The below graphic illustrates a few examples:

1. The Impact Leader - centered around its distinct focus on ESG & Impact (e.g., underlined by its distinct network & team composition incl. renowned knowledge domain leaders). 
2. The Local Champion - centered around its strong geographic focus (e.g., underlined by access to local talent, founder networks & on-the-ground support) 
3. The Global Explorer -  centered around its broad geo and market scope, often with the luxury to invest at any stage (e.g., underlined by a strong track record/international brand, incl. a broad knowledge stock)

The more specific choices we make, the more constrained our investment universe becomes. However, the size of the investment pool needs to align with the fund’s size and investment structure. Therefore, we need to find the right balance between a narrow “max-value” position and securing sufficient supply.

For example, a geo-constrained investor that only targets Impact startups may not have enough deal flow to deploy their capital each year. 

Accordingly, the differentiating question is how central ESG & Impact is to the fund’s value hypothesis and what weight it carries relative to the other elements of the investment strategy. Fully neglecting it would mean ignoring key trends which modern VCs can’t afford.

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(5) Common investor categories and their ESG & Impact priorities

Because investors integrate ESG & Impact into their positioning in different ways, several distinct categories have emerged. These can be mapped out based on how central ESG and Impact are to their fund’s value hypothesis—even to the degree that financial returns are compromised to secure the targeted social Impact (although, from our experience, these typically aren’t VCs - at least not deliberately). 

The spectrum runs from traditional investing (low presence of social impact in the fund’s value hypothesis) to philanthropy (purpose-built around the targeted social impact without requiring any financial return). In between these two ends of the spectrum lies responsible investing - also called ESG investing - and various types of impact investing. All of these investors target competitive returns but differ in how much they prioritize social impact in their investment strategy.

We have adapted the original model from INSEAD professor Jasit Singh to include a new category - ‘Impact-aware investing’. This category lies between impact investors and responsible investors. It is our zone of targeted social impact and financial returns, shown by the dark green area in the image above. 

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(6) The positioning choices we made at byFounders 

At byFounders, we believe that an explicit focus on ESG and impact will translate into superior financial returns as long as it’s not forced into an impact quota of 100%. And we realized that we’re not the only ones who have this belief. Therefore, we carved out a new investor category called “Impact-aware investors” in which we also place ourselves as a fund. 

As Impact-aware investors, we actively invest in but are not limited to, impact startups. This means that impact investments are intentionally made, but the fund also has the mandate to invest in “non-impact” tech companies (as long as these do not have a negative impact and are run by responsible founders). As impact-aware investors, we, therefore, focus on maximizing financial returns while, where possible, investing in companies where revenue growth coactively solves global challenges. This means that an impact-aware investor puts impact higher on the agenda than “regular” and “responsible” investors but has fewer restrictions than an “impact investor”.

Why do we believe that this new category is needed? Why not just commit 100% to impact investments? Or why not just call ourselves a responsible investor? Our honest answer is that we don’t believe that responsible investing is ambitious enough and that impact investing, in some cases, is still questionable. 

As an example, our fund mandate and positioning are strongly built around the fact that we’re an early-stage investor with a geographic focus on the Nordics and Baltics (i.e., New Nordics). This is where we have our strongest network, built out a robust community and collective, and know the intricacies of local market dynamics. When analyzing this stage and geography, it’s clear that there’s a limited supply of pure impact companies (even though this region is one of the most impact-focused areas in Europe!). Therefore, we struggle to see how we could stay true to both being an impact investor and keeping our fund’s mandate without compromising on the quality of our investments and, hence, our financial returns.

In summary, here's why we've chosen to position ourselves as Impact-aware:

1. We’re convinced that responsible investments lead to better financial returns, and hence, considering ESG in investments is a no-brainer. You can find our full reasoning here.

2. We want to raise our ambition level relative to what is expected by a ‘responsible investor’. Focusing on reducing harm is simply not enough. We want to actively and strategically invest in companies that create a positive impact. That includes setting clear targets, transparently reporting on our progress, and being held accountable for it.

3. The correlation between impact investments and financial returns is still not proven, particularly in the current market and if you want to stay true to other constraints such as stage and geographical focus. As a 110m EUR venture fund focused on the New Nordics, our deal flow would be too constrained and competitive if we today were to limit ourselves to investing exclusively in impact companies. This can be backed up by some of the internal data we collect and from data that we publish in what we call the Shape of the New Nordics report, where we analyze all pre-seed, seed, and Series A investments in the region based on a proxy of deals announced by a respected VC (a total of 85 VCs are included and can be found on page 20 in this report). The main issues today include:
   • ‍Limited Dealflow -  Impact startups represent a minority of the total number of venture-type early-stage startups today. In 2023, 29% of the venture-backed early-stage startups in our region were so-called impact startups, as per our definition. This means that a pure impact investor in the New Nordics today cuts off more than 70% of their deal flow relative to traditional investors (and competition is tough!). 
   • Portfolio Conflicts - Impact startups are more than twice as likely to conflict with our current portfolio compared to non-impact startups (i.e., they are in direct competition with one another). This is mainly due to our high focus on impact cases, which has led to a relatively large and growing impact portfolio. ‍
   • Inflated Valuations - Almost all VC funds are targeting impact startups today which leads to bloated valuations. The rising interest in impact startups (not only from impact investors but also traditional VCs) and the large pool of earmarked capital for impact investing (which, of course, is an amazing development for society) leads to impact startups raising rounds at bloated valuations relative to other verticals. As an example: Our internal data shows that the median round size for seed-stage impact startups in the New Nordics was 45% higher than their non-impact counterparts in the first half of 2024.‍
   • It is not yet clear whether an impact positioning makes you win the best impact investments. There’s no doubt that a proper focus on Impact & ESG will help a VC to better source and support great impact startups. However, it’s still questionable if an impact investor will have a higher likelihood to win that investment over a non-impact investor. More often than not, the best founders will still choose the tier 1 generalist VC (for example, an Index or Accel) over the impact VC, even though they run an impact startup.

In conclusion, we don’t believe that there are enough strong impact startups (yet!) in the New Nordics for a pure impact fund of our size and geo scope to exist without us having to make trade-offs on financial returns. Moreover, we don’t believe that responsible investors have a high enough level of environmental and societal ambition. Hence, the category of impact-aware investing - where we also position ourselves - fills the gap between impact investors and responsible investors.

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(7) Our strategy to deliver on our positioning

To operationalize our positioning choice, we have translated it into a three-step process with clear KPIs at each stage. This is our overarching strategy.

To be eligible for an investment, a company needs to pass the 1) Negative screening and 2) ESG Responsibility screening tests. To be an impact startup, the company must also pass the 3) Impact screening test and be assessed to have at least medium impact. 

How we do these screenings and assess the level of impact is further described below:

Negative Screening 

Example: Not investing in tobacco companies
KPI: 100%

The first layer of implementing our approach to ESG is negative screening to ensure that we invest in ethical startups. We consistently ask ourselves: “Do we consider the company’s product/industry ethical, and are we confident in the company not having a direct negative effect on the people and the planet?”. This is commonly referred to as socially responsible investing or values-aligned investing, where the primary purpose is to generate financial returns that are aligned with an investor's values. You can see the full exclusion list in our website disclosures. 

ESG Responsibility 

Example: Investing in founders we can trust to genuinely care about e.g., their carbon footprint, people's wellbeing, DE&I, and product & data ethics.
KPI: 100%

Next is ESG responsibility in which we aim to invest in responsible startups who fundamentally integrate ESG impact into the operations of their company. Here, we ask ourselves, “Do the founders act responsibly with a will to build sustainable operations, and do they agree to do ESG reporting?” 

Impact Investing

Example: Investing in companies with responsible founders whose products have a positive impact on people or the environment (e.g., saving lives, reducing energy consumption)
Ambition Level: 50%

‍There are many different interpretations of impact investing. However, at byFounders, we aim to invest in impact startups whose positive impact is inherent to their business model and the products/services that they sell. We understand that it is very easy for any company to align with an SDG and thus be considered as having ‘impact’. To avoid greenwashing impact, we look at four determining factors:

1. Intentionality: The founders have a clear intention to generate positive social and/or environmental impact alongside financial success. 
2. Quantified Impact Problem: There is a clear, measurable environmental or social issue that demonstrates the scale and significance of the challenge (e.g., X% of global energy-related emissions stem from Y).  It also aligns with at least one of the UN Sustainable Development Goals (SDGs).
3. Measurable Impact of the Solution: The startup's product or service addresses the impact problem either by offering a concrete solution (e.g., creating a renewable energy source) or benefitting stakeholders (e.g., reducing negative effects) in a measurable way. ‍
4. Correlation of Impact & Revenue: There is a correlation between revenue and impact growth. However, the correlation can be either:‍‍
   • ‍Direct: Positive social and/or environmental outcomes result directly from using a product or service. For example, a renewable energy company's revenue growth translates to increased clean energy production and reduced reliance on fossil fuels.‍
   • Indirect: The product or service enables users to create positive social and/or environmental outcomes. For example, carbon accounting software helps users measure their emissions, but the actual impact—such as reducing or offsetting carbon—depends on the user's consequent actions. Revenue growth often correlates with an increase in user actions, which consequently leads to impact (which requires additional feedback loops). 

To further account for the different levels of impact a startup can have, we divided it into three groups:

• High Impact: The company is uniquely solving a key issue or drastically reducing negative effects on people or the planet.
  • Example: Corti - "We give healthcare professionals a co-pilot to improve patient outcomes" (SDG 3 - Good Health and Well-being).

• Medium Impact: The company solves an important issue or reduces negative effects on people or the planet.
  • Example: Aumio "We are helping kids tackle some of the most prevalent mental health issues." (SDG 3 - Good health & Wellbeing)

• Some Impact: The company’s core product does not solve a key environmental or social issue but contributes to creating a better Tomorrow. Impact considerations are secondary (though an important part of the value proposition), and the products North Star metric is most likely non-impact related.
  • Example: Bob W. - “We are offering a climate-neutral alternative to hotel stays”. (SDG 11 - Sustainable cities and communities)

Only those classified under High and Medium Impact are considered “Impact Startups” by us. The separation between medium and high is mostly an internal thought exercise that allows us to keep pushing ourselves to prioritize meaningful change. We included the “Some Impact” category to recognize founders who are working hard towards creating a better Tomorrow - even if their startup doesn’t fit the typical impact definition. We understand these distinctions can be subjective, and we are still refining our criteria to improve clarity.

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(8) Recap

Positioning requires making tough choices. This includes deciding what weight ESG & Impact will take in the investment approach relative to other strategic options (e.g., geo, stage, sector, etc.). Depending on this choice, VCs fall into one of 4 investor categories that have varying levels of targeted social return. 

Some of the main takeaways include:

• Red, Yellow, Green: Positioning means making choices- this includes a.) the creation of a No-Go-Zone (aka: red zone) and b.) a best-fit zone (aka: green zone). The lower the share of “yellow zone” investments, the more distinct your positioning is going to be.
• Positioning requires trade-offs: Incorporating ESG & Impact considerations has to be viewed in the broader context of the investment strategy, including choices like geography, stage, sector focus, etc. Each decision narrows down the addressable pool of startups but also makes the position more distinct. All of this needs to be in sync with the fund size to ensure that returns can be realized within the fund cycle.
• Impact-aware as our home turf: Our value hypothesis is centered around both ESG & Impact. However, we don’t believe that there are enough strong impact startups (yet!) in the New Nordics for a pure impact fund of our size and geo scope to exist without having to make trade-offs on financial returns. That's why we've introduced a new category called "Impact-aware investors". Meaning: we actively invest in impact startups, but we also have the mandate to invest in “non-impact” tech companies (as long as these do not have a negative impact and are run by responsible founders).
• Anchor it in the numbers: We rooted our positioning in easily quantifiable goals - incl. Investment ratios for a.) 100% negative screening, b.) 100% responsibility compliance, and c.) +50% of impact investments (as long as financial returns are not compromised).

In the next chapter, we will dive deeper into how we translated our positioning into the first of three core operational processes: the investment process.

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