Humanity is facing immense challenges. We have previously disclosed our intentions to play a small part in solving some of these. Hence, we raised our second fund in 2021 as an Impact-aware fund with the mission to back and support founders who want to create a better Tomorrow.
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byFounders
During the last couple of years, we’ve made a long list of changes to our ways of working and a conscious effort to step up our game in regards to taking responsibility. One small piece of this is that we started publishing an Annual Impact Awareness report to disclose not only themes we invest in and the Impact our portfolio companies have but also a range of metrics around topics that we believe matter, such as the gender equity gap.
Now we think it’s time to pop the hood to byFounders Impact-aware playbook and deep-dive into our thinking and the mechanics behind it - including open-sourcing all the tools we’ve built!
Post #4 - Cultivating a Commitment Around ESG & Impact in Portfolio Management
Post #5 - Adopting ESG & Impact Principles into Internal Operations
Post #6 - Making Binding Commitments to ESG & Impact through the Fund Setup
In this post (#1), we explain why we believe a strong focus on responsibility and Impact is mission-critical as investors and an integral part of how we run byFounders. We’ll finish by introducing our framework for managing ESG and Impact across the fund.
It will be structured into six main sections:
Clarifying the differences between Impact & ESG: ESG and Impact mean different things to different people; we’ll start by aligning our meanings with these terms.
VCs have a moral responsibility: VCs influence future developments through their investments and should, therefore, take responsibility for their investment decisions.
Why ESG, and to some extent, Impact, is crucial and should be taken into account: Three major market trends open up ESG & Impact as a new investment opportunity space.
Linking ESG & Impact to financial performance: While research on VC-backed companies is limited, public market data shows a positive link between ESG and financial success. Early signs suggest that impact startups may also see better financial outcomes.
ESG is gaining relevance in the broader investor ecosystem. A multitude of stakeholders, including other institutional investors, LPs, and resource-, knowledge-, and software- providers, are driving the accelerated adoption of ESG and impact practices.
Our ESG & Impact Management Framework: We’ve condensed our playbook into a four-part framework, which outlines how each component of our strategy connects and depends on the others.
1. Clarifying the differences between Impact & ESG
The Swedish idiom “kärt barn har många namn” (directly translated to “a dear child has many names”) is the perfect description of the world of Impact investing. The meaning of the idiom is pretty straightforward: popular things can have a variety of different names in different contexts.
Words such as Impact, sustainable, conscious, responsible, ESG, CSR, social, concessionary, and purpose-driven are used interchangeably and in different ways by everyone. To make it even more difficult, these words can be used differently in the context of companies versus investments and in the context of startups versus larger corporations. A larger company might have a CSR policy, while a startup has an ESG policy. A responsible investor might not be the same as an Impact investor, even though both might invest in sustainable companies. When you then add tons of fund-specific explanations such as ‘constructive capital’, ‘world positive’, ‘Impact unicorn’, ‘heart‑core Impact’, and now ‘Impact-awareness’ to the mix, it just becomes very messy.
We, therefore, want to start off by explaining how we define some of the words that we are using.
→ Let’s unbundle the difference between an impact startup and a responsible startup.
We want to start by stating that we use the word ‘responsibility’ instead of ‘ESG’ in most cases. We would for example say “responsible startup” instead of “ESG startup” when referring to a startup that takes environmental, social, and governance factors into consideration. However, we use the ESG framework and wording for measurement purposes.
Moreover, we use the word impact to describe the direct impact a company’s product has on the people and the planet (i.e., product footprint), while the word responsibility - or ESG - is used to describe how responsibly a company runs its daily operations (i.e., operational footprint).
Our definitions
An impact startup has the intention to generate positive, measurable social and/or environmental impact alongside financial success through their core product/solution and solves a major societal problem. If applicable, the startup should preferably also address at least one of the UN Sustainable Development Goals.
Unlike impact startups, a responsible startup does not refer to a particular type of product/solution but rather an approach to running a business where the founders explicitly integrate environmental, social, and governance factors into their everyday operations and decision-making.
In general, impact startups are focused on creating positive social/environmental outcomes, whereas responsible startups (i.e., startups with an ESG focus) usually are more focused on reducing their eventual negative effects on the world.
This means that a responsible startup doesn’t have to build a product that directly impacts the world positively, and an impact startup might not necessarily be responsible. However, the optimal position to be in is of course to be a responsible impact startup, meaning that you intentionally build a product that is generating positive social and/or environmental impact while also running your operations responsibly.
FYI: Our thinking is very aligned with the explanations in this blogpost co-authored by Big Society Capital and VentureESG.
2. VCs have a moral responsibility
VCs play a critical role in shaping the future of technology and, subsequently, the leading companies of tomorrow. Thus far, VCs have focused on funding companies with the core focus of growth potential. Growth has been the North Star metric, being used as a compass to make almost every decision a startup faces. Growth has almost always been prioritized no matter the social cost - with moral, ethical, or even legal boundaries being temporarily disregarded in the service of disrupting an industry and achieving rapid time to market.
As investors, we need to appreciate the scale of implications these decisions can have. Not only in shaping future industries but also in shaping our economy and society. By our nature as VCs, we invest in companies at their earliest stages of development and hence have a unique opportunity to embed Impact and ESG considerations into the foundations of tomorrow's leading companies.
3. Why ESG, and to some extent impact, is crucial and should be taken into consideration by VCs
Historically, the ESG framework has mainly been used by VCs as a risk mitigation tool. This is achieved by integrating environmental, social, and governance risk factors into the analysis and decision-making processes of investments. Hence, if done right, it can reduce the long-term operational risk of an investment or a portfolio.
However, ESG has significant benefits beyond pure risk management.
Several studies show a systematic link between companies with a strong purpose and sound ESG practices and key business benefits, including top-line growth, cost reductions, higher employee retention, increased productivity, and greater influence over consumer preferences.
Moreover, a pragmatic yet clear focus on investing in Impact companies seems to add additional financial benefits beyond the ESG contributions.
Before digging into the believed improved financial outcomes for VC funds with an ESG & Impact focus, let’s first understand what we believe drives these market changes and why the timing to act is now. A paradigm shift is well underway, and we see three main game-changing trends in the market.
A new purpose-driven generation
A new generation of purpose-driven founders, consumers, and employees are driving the ESG and Impact agenda. This is evident from 1) The rise of Impact-focused startups, 2) Employees wanting to work for purpose-driven companies, and 3) Customers actively choosing responsible products & services.
Rise of Impact-focused startups:Extreme challenges need equally extreme solutions - something the next generation of founders is eager to build and deliver. We believe these solutions will become the highest-valued companies, thus representing great investment opportunities. What was once a niche market is becoming more and more mainstream:
Over the past ten years, we have seen continued growth of funding going to Impact companies in the Nordics - going from $61m in 2013 to $4.2bn in 2022.
Internally, we see a significant increase in Impact startups in our deal flow, with a 260% rise from 2022 to 2023.
Employees are drawn to purpose-driven companies: The new generations, Gen Y (those born between 1981 and 1994) and Gen Z (those born between 1995 and 2009), are increasingly taking over positions of influence. These generations want to work for companies that embrace ESG practices and are looking for purpose-driven work at a much higher rate than previous generations. Companies aligned with environmental and social issues hold a clear advantage in attracting top talent:
Atomico's State of European Tech report of 2023 highlights the influx of talent into sustainability, health, and digital care sectors (they take the #1-3 spots), reflecting the magnetic pull of purpose-driven companies.
Nordic Impact startups are significantly more attractive to job seekers, receiving 25% more job applications per vacancy compared to non-Impact startups.
Customers are choosing responsible companies: Consumers are increasingly mindful of company ethics, with a growing preference for brands that prioritize sustainability and social responsibility. This is evidenced by:
A study from PWC showed that consumers are more likely to buy from companies that advocate for Environmental (80%), Social (76%), and Governance (80%) issues.
In conclusion, prioritizing ESG and Impact is no longer a reaction to external pressure but a response to a powerful shift driven by the next generation. By embracing these trends, companies are better positioned to attract the best talent, win over customers, and secure future investments.
EU Regulation is tightening up
The regulatory landscape is rapidly evolving, especially in Europe. New legislation like the EU Taxonomy, SFDR, CSRD, and the EU AI Act all aim to promote standardized ESG practices and mandatory disclosures. This push for transparency makes ESG a business-critical consideration for all companies operating in the EU, including both startups and VCs.
Hence, if a company has high levels of negative externalities in its operations or value chain, it will risk, in one way or another, having to pay a high price for that. Conversely, those proactively addressing ESG concerns can future-proof their business models to stay ahead of the regulatory curve.
Scrutiny from private & public markets
Companies are getting grilled by investors and acquirers on their ESG practices. A lack of a strong ESG track record can hurt a startup's ability to raise capital or get bought out. Here's the proof:
59% of early-stage investors surveyed in Europe have declined an investment opportunity due to sustainability concerns,
This shows that ignoring ESG is not just a reputational risk; it's a financial one. Startups that prioritize responsible development are better positioned to secure funding and exit opportunities, while those lagging face an uphill battle - from lower valuations to deal cancellations.
4. Linking ESG & Impact to financial performance
There is substantial “soft evidence” that ESG & Impact make financial sense, but there is no conclusive research on VC-backed companies yet. Still, we see some signs that ESG and impact are linked to financial performance.
ESG & Financial Performance: There is a growing body of academic evidence that suggests a positive relationship between ESG and financial performance. Although conclusive research on VC-backed companies does not exist (to our knowledge), we see anecdotal evidence from public markets, including:
Positive correlation with ESG and corporate financial performance: A 2021 meta-study found that most research on investing in sustainability shows positive results, with only a few studies showing negative correlations. Specifically, 58% of corporate studies showed a positive correlation between financial performance and ESG, while only 8% showed a negative relationship.
Quantifiable increase in financial returns: A Harvard study on Corporate Sustainability found that companies addressing sector-relevant sustainability issues significantly outperform their ’non-responsible’ peers.
Better resiliency during downturns: A study conducted by BlackRock found that ESG-titled portfolios were, on average, more resilient—particularly in downturns. For example, during the COVID-19 crisis in Q1 2020, 94% of sustainable indices outperformed their non-sustainable counterparts.
This research, though not VC-specific, paints a compelling picture. As VC firms increasingly integrate ESG considerations, future research may solidify the connection between responsible startups and financial success.
Impact & Financial Performance: Impact investing is still a growing field, and while data is limited, we see initial signs of the correlation between impact and financial performance - primarily through distinct investment dynamics. The report “Nordic Impact Startups 2023”(co-authored by Danske Bank, Dealroom, and Invest Stockholm) highlights several trends that indicate a positive correlation between Impact and financial performance, including:
Higher Conversion Rates: Impact startups have higher conversion rates at every stage. The most challenging conversion, from Seed to Series A, sees Impact startups outperform the Nordic benchmark by 35%. The gap widens even further at later stages, with a 2x more conversion to Series B and 2.3x at Series C.
Faster Conversion: Impact startups in the Nordics not only have a higher likelihood of advancing to Series A but also do so more quickly. Specifically, 25% of Seed-funded Impact startups achieved Series A funding within 3 years, whereas not even 20% of all Seed startups reached Series A within 5 years.
Larger Funding Rounds: Nordic impact startups raise larger rounds at every stage, with the gap widening significantly at later stages, particularly at Series C.
Collectively, these findings indicate investors' confidence in an impact startup’s financial viability and growth potential, as reflected in key funding metrics. However, defining causality requires more data points and a holistic study approach.
5. ESG & Impact is gaining relevance in the broader investor ecosystem
ESG and Impact investing have also gained significant traction within the broader investor ecosystem. This trend is driven by several key factors, including 1) ESG integration is becoming mainstream across all asset classes, 2) Limited Partners are pushing for accountability across both ESG and Impact, and 3) The support system for ESG and Impact is evolving.
ESG integration is becoming mainstream across all asset classes
Finance is undergoing a paradigm shift, with ESG integration becoming more and more mainstream across all asset classes. Purely profit-driven sectors like hedge funds and private equity are now actively incorporating ESG factors in their investment strategies.
This shift reflects a changing perception of investor responsibility, moving beyond just shareholder value to consider all stakeholders (people and planet). For example, signatories to the Principles for Responsible Investment - a framework for incorporating ESG factors into investment practices) – represent about US$120 trillion in assets under management globally as of 2023. Giants like BlackRock, the world's largest asset manager, announced in 2022 that sustainability will be a core consideration in all its investment decisions. Other major firms, such as Vanguard and State Street Global Advisors, have also committed to incorporating ESG criteria across their portfolios.
This broader trend pressures VCs to acknowledge their role in driving positive societal Impact. As Larry Fink, CEO of BlackRock, stated, “To prosper over time, every company must not only deliver financial performance but also show how it makes a positive contribution to society.”
Limited Partners are pushing for ESG accountability
Limited Partners (LPs) - i.e., the investors in VC funds - in Europe are increasingly prioritizing funds that demonstrate a commitment to ESG. This is particularly true for government funds, which make up a significant portion of capital in Europe (around 37%, according to Invest Europe, 2023). They play a leading role in driving ESG adoption, as they typically require their investees to regularly report on ESG metrics related to their firms and portfolios.
A recent survey by Pitchbook further emphasizes this trend. A quarter of both LPs and General Partners (GPs) anticipate sustainable investing becoming mainstream within a few years. Additionally, 73% of LPs surveyed by European Women in VC (2024) consider alignment with Sustainable Development Goals (SDGs) to be important.
With the force coming from the top, VCs are under more pressure to consider ESG. This will likely translate into a more critical eye toward potential investees, with a focus on companies that demonstrate not only strong financial performance but also a commitment to environmental sustainability, social responsibility, and good governance practices.
The support ecosystem for ESG in Venture Capital is evolving
There is a growing support ecosystem for ESG and impact in VCs, which is driving faster adoption. Just five years ago, there were few resources for VC firms. Today, a robust network has emerged, offering:
Educational Resources: Organizations like VentureESG, ESG_VC, and ImpactVC are offering practical resources for VCs to integrate ESG/Impact best practices.
Company Tools: There is a surge in ESG reporting startups like Atlas Metrics, Impact Nexus, and Kara that provide specialized platforms that allows VC firms to collect and manage their ESG data.
Independent Certifications: Initiatives like Diversity VC are building a community and offering diversity certifications for VCs.
These resources are pushing ESG and impact forward, influencing regulators, and promoting best practices across venture capital.
6. Our ESG & Impact Management Framework
Change doesn’t just happen. To drive an active agenda, ESG and Impact need to be integrated into key strategies, processes, and decision-making - ideally from the beginning so that it scales with the fund. The framework we use to structure our thinking around ESG and Impact is divided into four interconnected layers, each building upon the previous one.
Core Beliefs (Center Circle): At the center of the framework are the “Core Beliefs”, which are the fund's overarching rationale for prioritizing (or not) ESG and Impact. They define a fund’s underlying “Why” and should be the basis for any strategic decision.
Positioning (Second Circle): The second circle, “Positioning,” builds on top of the "Core Beliefs" by translating them into concrete, measurable strategic goals and key positioning elements—this is our "How”. In the context of ESG/Impact, it especially centers around the importance of these “newer” dimensions relative to other strategic dimensions (e.g., Geo, Sector, etc.).
Investment Process, Portfolio Management, Internal Operations (Third Circle): The third layer represents the practical integration of ESG and Impact considerations into our day-to-day core processes (our “What(s)”). It outlines the practical application of our guiding principles across selecting and working with startups as well as being a responsible employer ourselves:
Investment Process: How ESG/Impact factors into key decision-making processes and influences the type of startups we fund and work with.
Portfolio Management: The ongoing management and monitoring of the fund’s portfolio to ensure it aligns with the fund’s objectives.
Internal Operations: The internal structures, processes, and resources necessary to efficiently run the fund, including compliance, reporting, and administration.
Fund Setup (Outer Circle): The outermost layer ties all previously outlined strategic and tactical considerations together in a legally binding framework - our fund setup. It is the highest form of commitment a fund can make on top of the narrative, which started out in the center.
Of course, in practice, this framework is never a straight line, but all the building blocks should gradually build on each other and co-evolve.
7. Recap
Finance is undergoing a paradigm shift in the role it plays in society. Investors and companies that previously focused solely on profits and shareholder value are today taking a more holistic approach, considering both people and the planet.
Some of the main takeaways include:
ESG vs. Impact. ESG refers to how a company manages its operations with consideration for environmental, social, and governance factors, while Impact refers to the positive effects a company's solution has on people and the planet. Therefore, they define distinct areas but are often used in the same context, as both emphasize the importance of creating long-term value for society and the planet.
More than a risk-mitigation narrative: The increased emphasis on ESG & Impact is rooted in changing consumer & employee demands and not just in “doing good for humanity”. It ultimately opens up new business avenues while regulation accelerates the relevance even further.
Positive correlation between ESG & Impact and company performance: we start to see first anecdotal and early evidence underlining our beliefs that a focus on ESG and Impact translates into superior performance. Reliable large-scale studies are still lacking though.
A changing investment ecosystem: The whole investment ecosystem is adapting quickly to these changing demands and new opportunities - including other asset classes, LP strategies, and the surrounding support ecosystem.
In our next article, we will dive into how ‘Core Beliefs’ that are centered around ESG & Impact can be translated into a differentiated and modern fund positioning. Special shout out to Sara Rywe, Line Ettrich and Casper Bjarnason, who's work has been pivotal in supporting this playbook.
