The rise of impact investing VCs fuelling startups solving global challenges

Impact investing is a potent force in finance that blends profit motives with social and environmental considerations. In recent years, we have seen tremendous growth in impact investing. In 2022, India's impact enterprises attracted $5.8 billion in equity investments as per an Impact Investors Council report, reflecting a growing recognition of investment vehicles to create positive social impact alongside financial gain.

As the paradigm shifts, impact investing venture capital firms become key players, pivoting to fuel startups solving global challenges that may dictate the technological and methodological landscape of the future.

This explores the rise of impact investing venture capitals, their role in driving social change, and the transformative potential they hold.

Impact investing VCs

In the face of pressing global social and environmental issues, activism has served as a platform for amplifying voices, mobilising communities, and holding institutions accountable. In response to the growing awareness brought about by activism—corporations, institutions, and businesses have started becoming active participants in the solutions to societal challenges.

Startups have the most transformative endeavours in this setting. Analysing its evolution over the years, we note that impact investing VCs play a catalytic role in supporting and empowering solutions.

We can understand it by considering that the prevalent constraints that most pioneering solutions face are related to reach and finance. Since social and environmental changes take time, requiring long-term patient capital support through various stages of development and growth, most financial avenues are inaccessible to them. Impact investing VCs take up that crucial role. The involvement of impact investing VCs also stimulates broader market adoption and systemic change—accelerating the process.

These investments are not made solely on moral grounds. Backing transformative technologies and ideas with the potential to change the future is the core principle behind investments made by VCs. In line with this principle, impact investing VCs prioritise investments that align with specific social or environmental objectives, selecting ventures that have the potential to generate positive impact alongside financial returns.

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Evolution and diligence of impact investing

Impact investing among VCs has evolved in response to several key trends and developments.

The heightened awareness of global social and environmental challenges has spurred increased demand for investment vehicles that can address these issues effectively. Technological advancements and globalisation have facilitated the emergence of innovative startups and business models that leverage entrepreneurship to tackle societal problems. Finally, a shift in investor preferences towards values-aligned investing has created a conducive environment for the growth of impact investing venture capital.

The result of this growth is that impact investing VCs are active across a wide range of sectors, including renewable energy, healthcare, education, sustainable agriculture, and financial inclusion. Equity impact investments in India have impacted the lives of over 500 million people in the past decade. Thus, impact investing VCs must conduct thorough due diligence to assess the social and environmental impact potential of prospective investments.

They employ rigorous metrics and frameworks, ensuring accountability and transparency. Examples of widely used impact measurement frameworks include the Impact Reporting and Investment Standards (IRIS), the Global Impact Investing Network (GIIN) Standards, and the Social Return on Investment (SROI) framework. Some impact investors engage third-party verification and certification agencies to independently assess and validate the social and environmental performance of their investments.

Challenges and opportunities

The Indian government has introduced several policy measures and regulatory reforms to promote impact investing and social entrepreneurship. Like Long-Term Finance (LTF) Framework, launched in 2015 to mobilise long-term capital for infrastructure and social sectors, attracting impact investors through instruments like green bonds, social impact bonds, and catalytic capital. Yet, despite its rapid growth and potential for positive impact, impact investing venture capital faces several challenges and opportunities for further development.

Scaling impact investment models while maintaining financial viability remains a significant challenge, particularly in sectors characterised by high capital requirements and long gestation periods. The need for standardised impact measurement and reporting frameworks to enhance transparency and comparability across investments persists, and it is coupled with the need for dedicated talent with expertise in both finance and impact assessment.

Looking ahead, the future of impact investing VCs holds immense promise. As investors increasingly recognise the importance of aligning their capital with their values, the demand for impact-focused investment opportunities is expected to grow. By leveraging their capital, expertise, and networks, impact investing VCs have the potential to drive meaningful social change and create a more sustainable and equitable future for generations to come.

(Venkat Vallabhaneni is Managing Partner at Inflexor Ventures, a technology fund looking at investing in early-stage companies.)